Williams-Sonoma, Inc. (WSM) Q4 2018 Earnings Report, Transcript and Summary

Welcome to the Williams-Sonoma Inc. Fourth Quarter 2018 Earnings Conference Call. [Operator Instructions] This call is being recorded. I would now like to turn the conference over to Elise Wang, Vice President of Investor Relations, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.

Thank you. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. Our discussion today will relate to results and guidance based on certain non-GAAP measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why the non-GAAP financial measures may be useful are discussed in Exhibit 1 of our press release. This call also contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which address the financial conditions, results of operations, business initiatives, trends, guidance, growth plans and prospects of the company in 2019 and beyond, and are subject to risks and uncertainties that could cause certain actual results to differ materially from such forward-looking statements. Please refer to the company's current press release and SEC filings, including the most recent 10-K, for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. I will now turn the conference call over to Laura Alber, our President and Chief Executive Officer.

Thank you. Good afternoon, everyone. On the call with me are Julie Whalen, our Chief Financial Officer; Felix Carbullido, our Chief Marketing Officer; and Yasir Anwar, our Chief Technology Officer. 2018 was a strong year for our business. We outperformed revenue and EPS expectations while making important investments in our business that sets us up for accelerated long-term growth. For 2019 and beyond, our goal is to maximize growth and maintain high profitability. And we have several substantial growth engines that we'll be aggressively prioritizing, including West Elm, our newly launched Business to Business offering; our emerging brands Williams-Sonoma Home, Rejuvenation and Mark and Graham; as well as growth in our largest brand, Pottery Barn and our namesake brand, Williams-Sonoma. We'll also continue to improve the customer experience through technology innovation and supply chain optimization. We believe superior customer service is oxygen for growth. We built over time a vertically-integrated supply chain and a unique platform to launch and scale new brands and businesses. These are unparalleled advantages, which will enable us to deliver mid- to high single-digit revenue growth and margin stability for the long term. Before I discuss our growth opportunities for the years ahead, I would like to highlight some of our accomplishments in 2018 and the powerful foundation that we will continue to build upon for future growth. In 2018, we delivered revenue growth of 7.1% and comp brand revenue growth of 3.7%, the highest in 4 years and driven by positive comp growth in all brands. Growth in Pottery Barn accelerated from last year driven by outperformance in the e-commerce business and break-out growth in new businesses, Marketplace and Pottery Barn Apartment as well as strong upholstery growth. Q4 comp was below our expectation due to a softer gift business in December. And while we filled the backorders that were delayed from last quarter, net comp continued to lag demand due to a 50% increase in dropship sales and the rapid expansion of our Marketplace business, both of which take longer to fulfill. The Pottery Barn Kids and Teen business substantially improved from last year, delivering a combined comp of 2.8%. And our Baby business continues to gain momentum at up 15% attracting new customers at the entry point to our brand and through registry creations. West Elm had another outstanding year of double-digit growth driven by strong e-commerce performance and continued strength in the core furniture business. The Williams-Sonoma brand delivered comp growth of 1.7%, with the fourth quarter comp dipping to 0.1%, largely due to a reduction in promotional activity as we reduced inventories and continued to refine the balance between top line growth and profitability for the brand. Our emerging brands, Rejuvenation and Mark and Graham, continued to scale with double-digit growth and increasing profitability. Company-wide full year EPS grew 24% to $4.46, which is significantly above the high end of our guidance. For the fourth quarter, our top line and EPS also outperformed expectations, growing 9.3% and 25%, respectively. Even more encouraging is our double-digit new customer growth, which reached a 3-year high in 2018. This reflects the success of our strategy to increase customer acquisition and fuel our future growth. Across the business, you can see examples of how we are delivering more compelling experiences for our customers. As part of our strategic priority of digital leadership, we've significantly enhanced the e-commerce experience through 2 differentiators: content and convenience. In the last year, we updated our shop path with more accurate and engaging concept that is inspirational and drives conversion. We also materially enhanced our product information pages with a focus on product quality and reasons to buy. To provide our customers with omnichannel convenience, we launched buy online, pick up in store in our brands and are in the process of scaling other fulfillment capabilities such as buy online, ship to store and buy online, ship from store. As a result, our e-commerce revenue growth almost doubled in 2018 to 10.8%. And with over 54% of our business conducted online, we are among the top 25 Internet retailers in North America. We are also unlocking the power of our unique platform through cross-brand initiatives that strengthen our position as the high-design, high-quality, sustainable resource for all home furnishings, cooking and entertaining needs. In 2018, we continued to scale our loyalty program, The Key, and our complementary design service, Design Crew. The Key membership has grown nearly 6x over the past year, significantly exceeding our goals. In addition to increasing customer engagement and brand loyalty, we've also seen a significant lift in sales as loyalty members typically spend over 5x the value of their rewards. We also launched 2 new initiatives during the year, Design Crew Room Planner and The One Registry Collective, both of which are enabling a more personalized and convenient shopping experience for our customers. Since the launch, we've seen over 42,000 rooms created by the Room Planner and an increase of 290 basis points in total registry value. In the supply chain, we continue to drive operational improvements, which led to a particularly successful peak season in 2018. In our nonfurniture business, our order consolidation efforts and continued improvement in DC productivity enabled us to significantly lower our cartons for order and order to delivery time so that our customers receive their orders faster this holiday season and with less waste. Our home delivery service rating also improved from 4.77 to 4.85 out of 5 in the year. As I said in the beginning, the supply chain is critical to customer experience, and we're headed into 2019 with clear momentum. We are seeing less customer issues than we've had in the past, more on-time deliveries and fewer returns. And lastly, we are proud to be recognized once again by Barron's for all of our sustainable -- sustainability efforts across the business. At a ranking of #24, we are the only company in our industry to be among the financial publication's annual list of 100 Most Sustainable U.S. Companies. With all the progress that we made across our business in 2018, we are now in a position to accelerate our growth. Over the next few years, we'll focus on brands and businesses that target white space in the market, we will drive cross-brand initiatives that leverage our unique platform and we'll bring technology, innovation and continued improvements and customer experience. We believe West Elm is our biggest growth opportunity, and we're getting even more aggressive. We believe we can grow this brand to almost $3 billion in global revenue within the next 5 years. Customers continue to respond to the brand's aesthetics, scale and price points domestically and abroad, reinforcing West Elm's potential to capture significantly more share. We are positioning West Elm to appeal to a broader customer base through data that helps to identify new market opportunities and drive product and marketing initiatives. We will drive more brand awareness through content-led marketing that focuses on brand differentiation as well as the addition of more stores where economics are favorable. Our product introductions we targeted at growing incremental new businesses while expanding existing categories that have shown strong growth potential. Globally, we'll be aggressively expanding our presence in new markets like China, India and Western Europe and in existing markets such as the U.K. and Canada. Second, we are launching a new business division called Williams-Sonoma Inc. Business to Business. We believe we have the potential to drive $2 billion in annual revenues with this nascent growth opportunity. The business-to-business market is $80 billion, and we are uniquely positioned to gain share given our unique platform and product differentiation. We have new leadership to spearhead this division and an aggressive road map for expansion in both contract and trade businesses and across 8 target industry verticals. To support the division's rapid growth, we will refine cross-functional processes to target the unique needs of business-to-business clients, transition our customer service towards project management and reduce friction in the business to improve our win rate across brands. We are currently in discussion with a number of Fortune 500 companies, and we are securing strong interest for our offering. This new initiative is yet another example of how we are unlocking the power of our multichannel, multi-brand platform, a core competitive advantage that allows us to add and scale new businesses quickly and successfully. Over the past year, we have seen our cross-brand initiatives such as The Key, Design Crew and the One Registry become incremental growth drivers for all of our brands. We will continue to build on their momentum and explore new platform plays that augment our existing business. Our third growth engine is emerging brands led by Williams-Sonoma Home. Sustainable luxury home furnishings is another market where we believe we can take substantially more share. With new leadership, we have revitalized our brand strategy to achieve accelerated growth in the years ahead. We will pivot our product and marketing strategies to appeal to a more relaxed, modern, chic way of living. We will broaden our product aesthetic as well as add more size and scale. Growth will primarily be driven by the higher-margin DTC business, and we will showcase small impactful footprints in our best performing stores. We'll improve the digital experience with engaging content that communicates the brand's unique design, quality and sustainability. We'll also offer more room planning tools that inspire and improve product discoverability. We also see sizable growth from other emerging brands. Rejuvenation remains on track to be our next $0.5 billion multichannel brand. We'll continue to scale the brand with double-digit growth over the next few years. We are focused on solidifying the brand's leadership in the high-quality lighting and hardware market while curating offerings in utility and furniture to complete the home. Mark and Graham is also gaining momentum and on the path to be the premier online gifting destination for personalized products. We will lead with timeless quality product in core categories of women's and men's accessories, travel and tech solutions and incremental growth categories of wedding, baby and pets, driven by innovation, collaboration and leveraging our enhanced personalization capabilities. Let's not forget that our established brands remain powerful businesses that will continue to drive substantial revenues and earnings for our company. Pottery Barn is our largest brand and a highly profitable business. Pottery Barn is a proven platform for launching and scaling new businesses such as Marketplace and Pottery Barn Apartment, which are key components of the brand's growth strategy in the future. To support the growth of our Marketplace business, our global sourcing team will focus on improving the dropship experience with improved on-time delivery through vendor rationalization, dedicated order tracking and more rigor around vendor accountability. We will also expand our Pottery Barn Apartment collection with a broader assortment of products, and our core categories will partner with our vendors to innovate and create well-designed functional products at affordable price points and develop assortments in adjacent underserved rooms that complete the home. And to drive e-commerce growth, we'll amplify our content-led digital storytelling at every touch point in the customer journey and introduce more product visualization tools to increase the customers' confidence to buy. Our Pottery Barn Kids and Teen division is also positioned for improved performance. As the leader in well-designed, high-quality children's home furnishing, we will continue to diversify our product assortment and aesthetic, especially in our Baby business, to acquire new customers in the increasingly millennial-driven target demographic. We'll be more aggressive in marketing our commitments to GreenGuard-certified healthy furniture, fair trade and responsibly-sourced cotton. We believe this is a differentiator for our brand and one of increasing importance to today's consumer. As the brand is predominantly digitally-driven, we are focused on improving conversion on our site, prioritizing enhancements in content search and checkout, all with a mobile-first mindset. We also see opportunity to improve shareholder value with our strategy in the Williams-Sonoma brand. Williams-Sonoma will undergo a significant transformation over the next few years. In addition to Williams-Sonoma Home, growth in our Kitchen business will be driven by significant expansion of our exclusive private label businesses, Williams-Sonoma branded products and the Open Kitchen line. For Williams-Sonoma branded products, we will focus on key categories such as cookware, electrics and tools. While in Open Kitchen, we will place a much greater emphasis on marketing and product assortment, and we believe we can triple the size of this business annually. We will continue to drive a higher penetration of the digital business, our most profitable channel, including the expansion of our e-commerce-only offering with more product breadth across tabletop and food. We'll also be more aggressive in monetizing Williams-Sonoma's extensive repository of food, cooking and decorating content through subscription-based services. In the next year, we'll be [ operating ] curated bundles of recipes, including those exclusively developed by our Test Kitchen, as a paid service on our website as well as on our soon-to-be relaunched Williams-Sonoma Recipes app. Underpinning the success of these growth initiatives is, of course, customer experience. Over the next few years, our technology strategy will be centered upon improving the customer experience across the supply chain, e-commerce and stores. We will leverage emerging technology to transform the supply chain, including machine learning, optimization of the logistics network and robotics and automation to reduce our reliance on labor. We will continue to strive for e-commerce excellence and market share gains through more relevant and friction-free experiences. We will implement machine learning-driven merchandising, search and site recommendations and introduce personalized connected customer journeys across digital touch points. To better leverage our multichannel platform, we are focused on delivering the ultimate omnichannel convenience through improved order predictability and transparency and the continued expansion of our omnichannel fulfillment capability. In addition to technology innovation, our supply chain is critical to the customer experience. In our industry today, no one is delivering furniture as successfully as they should be. And while we know that we've made substantial progress, we have a lot more opportunities to improve customer experience. Over the next few years, we will reduce our order-to-ship lead times in our domestic manufacturing facilities by 30%, and we're targeting lower total returns by 15% through improved customer communication and order visibility. In our furniture operations in Q2 of this year, we are investing in a separate West Elm West Coast DC to support the accelerated growth strategy we have planned for West Elm and to improve the delivery times in our other brands, which have been negatively impacted by the capacity constraints in our West Coast DC. We will also leverage technology improvements, such as self-service and POS delivery scheduling, real-time order tracking and concierge program automation, to increase order visibility and on-time delivery to the customer. In our nonfurniture business, we'll be investing in automated packing and batch processing to reduce order processing time and increase processing capacity. This will also reduce labor and other operating costs in our DCs. Our multiyear transition to one inventory is on plan, and it will help support the rapid convergence of our retail and e-commerce businesses in today's channel-agnostic environment. It will enable us to optimize inventory levels by DC and be more accurate with our promises to our customers. These supply chain initiatives will also enable us to reduce costs through lower replacements, returns and damages, reduced escalations to the call center, lower out-of-market shipping costs, reduced backorders and backorder crate rates. We intend to reinvest these savings into growth initiatives that will drive our long-term success. As we look to 2019 and beyond, we are at an exciting juncture. We've made the important investments in our business, and now we have the foundation and the road map to drive long-term accelerated growth. We are passionate about the business we are in, serving our customers with shared values of quality, safety and sustainability, and we are relentless in maximizing growth and maintaining high profitability. Now before I turn the call over to Julie, we want to thank all of our associates for making 2018 the strong year that it was. Their motivation and commitment to serve our customers every day is truly our secret sauce. I'll now turn the call over to Julie to review our 2018 financial results and guidance for 2019.

Thank you, Laura, and good afternoon, everyone. We delivered another quarter of solid results on both the top and bottom line, once again demonstrating our ability to execute against our growth and operational initiatives while maintaining strong financial discipline. Before I discuss in more detail our fourth quarter financial results, I would like to first highlight our financial accomplishments for the full year. As a reminder, our results include the financial impact from a 53rd week that added approximately $85 million in net revenues and approximately $0.10 in earnings per share to the fourth quarter and the year. Our results also include the financial impact from a new revenue recognition standard that we adopted at the beginning of the year, which primarily reclasses other income from SG&A into net revenues and impacts the timing of our revenue recognition for certain merchandise shipped to our customers. For fiscal year 2018, we delivered net revenues of $5.7 billion, growing 7.1% over last year. Comparable brand revenues grew 3.7%, which was an acceleration of 50 basis points from fiscal year 2017, and was our highest comp in several years. Growth was driven by both channels. Retail revenues grew 3% despite a decline in nationwide retail traffic. And e-commerce revenues almost doubled their growth to 10.8%, reaching a record high of 54.3% of total revenues. By brand, we saw positive comps across all brands this year, with the Pottery Barn brand accelerating 150 basis points from the prior year. Pottery Barn maintained its momentum with a comp of 1.2%, increasing 20 basis points over last year. Our Pottery Barn Kids and Teen business return to a positive comp this year of 2.8% versus a negative 1.7% last year. The Williams-Sonoma brand drove a 1.7% comp on top of a 3.2% comp in fiscal year 2017. West Elm continued its accelerated growth trajectory with their ninth consecutive year of double-digit growth and another year of strong revenue comps of 9.5%. Our emerging businesses, Rejuvenation and Mark and Graham, delivered another year of double-digit comp growth of 17.4% on top of 24.5% last year. And in our global operations, we delivered almost $350 million in total revenues, including double-digit growth in our company-owned operations. From an earnings perspective, we generated operating income of $483 million at an operating margin of 8.5%, which includes the reinvestment of a portion of this year's tax savings primarily into higher hourly wages and digital advertising. This resulted in earnings per share of $4.46, growing almost 24% over last year and significantly outperforming the high end of our fiscal year 2018 guidance. And these earnings allowed us to further increase our return on invested capital this year to almost 19%, which was significantly above the industry average. We also delivered another year of robust operating cash flow of almost $600 million, which allowed us to provide incremental returns to shareholders, including a 50% increase in our share repurchases and a 10% increase in our quarterly dividend. As a result, combined, we returned approximately $436 million to our shareholders this year for an increase of 32% over last year. Now I would like to review our fourth quarter results. In the fourth quarter, we generated net revenues of $1,836,000,000 for a year-over-year growth of 9.3% and comparable brand revenue growth of 2.4% on top of the 5.4% comp last year. By channel, revenue growth accelerated in the e-commerce channel to 14.2%, and the retail channel delivered revenue growth of 3.9%. Moving down the income statement. Gross margin for the fourth quarter was 38.7% versus 38.5% last year. Occupancy cost of $181 million versus $177 million last year leveraged 70 basis points during the fourth quarter. The 20 basis points of gross margin leverage was primarily driven by occupancy leverage that was partially offset by lower selling margins, which included higher year-over-year merchandise margins being offset by increased shipping cost from higher UPS shipping rates and a larger mix of furniture sales versus last year, which is more expensive to ship. SG&A for the fourth quarter was 26.9% this year versus 26.1% last year. This 80 basis point deleverage was primarily associated with the negative impact from the new revenue recognition standard. Employment deleverage from higher year-over-year performance-based incentive compensation as well as the impact from the reinvestment of our tax savings into higher hourly wages was offset by advertising leverage during the quarter. This resulted in an operating margin for the fourth quarter of 11.9%. By channel, the operating margin in the e-commerce channel was 21.7% this year versus 22% last year. Gross margin leverage from higher year-over-year merchandise margins partially offset by higher shipping cost was more than offset by SG&A deleverage. SG&A was negatively impacted from the new revenue recognition standard, which was partially offset by advertising and employment leverage. The operating margin in the retail channel was 14.6% this year versus 15.6% last year. The 100 basis point decline was driven by SG&A deleverage from the negative impact associated with the new revenue recognition standard, employment deleverage resulting from the year-over-year impact from the partial reinvestment of our tax savings into higher hourly wages as well as gross margin deleverage from lower selling margins, partially offset by occupancy leverage. Corporate unallocated expenses in the fourth quarter as a percentage of net revenues were flat to last year at 6.6%. Higher year-over-year performance-based incentive compensation was offset by occupancy leverage. The effective income tax rate during the fourth quarter was 21.6% this year compared to 31.6% last year. This lower tax rate mainly reflects the impact of the 2017 Tax Cuts and Jobs Act, which primarily resulted in a substantially reduced federal tax rate. This resulted in diluted earnings per share of $2.10, which was $0.42 or 25% over last year and significantly above the high end of our guidance at $1.99. On the balance sheet, we ended the quarter with a cash balance of $339 million versus $390 million last year. We generated $406 million in operating cash flow during the fourth quarter, which we utilized to invest $62 million in the business and returned capital to shareholders in the amount of $110 million through share repurchases of approximately $75 million and dividend payments of approximately $35 million. Moving down the balance sheet. Merchandise inventories were $1,125,000,000 for an increase of 6% over last year. This growth was substantially below revenue growth and was primarily driven by inventory in transit and not yet received at our distribution centers. Inventory on hand and available for sale decreased 0.8%. We are pleased that the ongoing success of our inventory initiatives across our brands allowed us to optimize our inventory levels even further. Before I discuss our 2019 guidance, I would like to draw your attention to 3 changes that will take effect in fiscal year 2019. First is the implementation of a new lease accounting standard, which requires all leases with terms greater than 12 months to be capitalized on the balance sheet. We expect that this will result in a net increase of approximately $1.2 billion to our assets and liabilities upon adoption of the standard in the first quarter of fiscal year 2019. We do not expect there will be any material impact to the income statement. Second, due to the rapid convergence of our retail and e-commerce businesses and the synergies that exist between the 2, we will no longer be reporting our financial results into separate segments. As we continue to evolve and adapt to this multichannel environment, our retail and e-commerce businesses have become more similar to, and dependent on, each other on both qualitative and qualitative (sic) [quantitative] ways. This decision reflects the culmination of business initiatives and corresponding operational changes that have been, and will continue to be, implemented in our business to meet our customers' increasing need for channel-agnostic convenience. As a result, beginning in fiscal 2019, we will be consolidating our financial results into one reportable segment and will continue to provide quarterly comps and annual revenues by brand as well as any additional disclosures necessary to understand the evolving dynamics of our business. Third, as noted in our press release, we are implementing a change in our guidance practice, beginning in fiscal 2019. Going forward, we will no longer be providing quarterly guidance and instead, we'll provide annual guidance along with the long-term financial outlook. We believe this approach is better aligned with the long-term view we take in managing the business and our focus on long-term shareholder value creation. Now I would like to discuss our fiscal year 2019 guidance as well as our longer-term outlook, which reflects our strategic vision for accelerated growth with sustained high profitability for the long term. For our annual fiscal year 2019 guidance, a 52-week year compared to fiscal 2018, a 53-week year, we expect net revenues to be in the range of $5,670,000,000 to $5,840,000,000, with comparable brand revenue growth in the range of 2% to 5%. We expect our full year comp to be back half-weighted given both the tougher compares for the first half of fiscal year '18 as well as our decision not to comp several promotions in the first half of last year as we continue to balanced margins with sales. Additionally, revenues in the first quarter may also be impacted by an Easter shift, with Easter now closer to the end of the quarter, as well as a 1-week calendar shift all year due to the 53rd week, which may cause revenue growth to fluctuate by quarter. Our comps have been adjusted for this shifted week. Our operating income is expected to grow relatively in line with our revenue growth, resulting in an operating margin in line with fiscal year 2018. Our effective tax rate on the year is projected to be in the range of 23% to 24%, and our diluted earnings per share is expected to be in the range of $4.50 to $4.70. This reflects guidance that at the high end of the ranges results in top line, mid-single-digit revenue growth, operating margin stabilization and bottom line earnings per share growing faster than revenue growth. In terms of our fiscal year 2019 capital allocation strategy, we remain committed to a long-term balanced approach, utilizing our strong operating cash flow to first invest in the business to support our growth initiatives with capital expenditures expected to be within a range of $200 million to $220 million, and we plan to return excess cash to our shareholders. As far as our capital investments for fiscal year 2019, we remain focused on prioritizing those investments that support the strategic growth initiatives that Laura spoke to earlier and where we see sustainable long-term returns for our shareholders. As a result, our fiscal year 2019 capital investments are primarily focused on technology investments across our company to drive innovation, growth and an improved customer experience; investments in the further optimization of our supply chain to improve our competitive advantages and to maximize operational efficiencies; and investments in our retail fleet, particularly with new stores in the West Elm brand. We also expect to return excess cash to our shareholders in the form of share repurchases and dividend payments. Based on our balanced capital allocation strategy, we announce today a double-digit dividend increase of 11.6% for a quarterly dividend payment of $0.48 per share and a share repurchase authorization increase of $500 million. This expanded authorization will not only allow us to continue to repurchase shares annually at a level to at least offset equity dilution but will also allow us to opportunistically increase our rate of share buybacks, if appropriate, just as we did in fiscal 2018. These decisions reflect our confidence and our ability to continue to generate long-term, sustainable revenue and earnings growth and strong operating cash flows as well as our commitment to maximizing returns to our shareholders. As far as our longer-term financial outlook, we expect to deliver mid- to high single-digit revenue growth, with operating income growth in line with revenue growth and driving operating margin stability. We expect EPS growth to exceed that of revenue growth. We also expect to continue to maintain an above-industry average return on invested capital to sustain strong operating cash flow and to provide a balanced capital allocation approach, optimizing returns to shareholders through strategic investments in the business, incremental share buybacks and increased dividend payouts. We believe this financial outlook reflects our commitment to deliver long-term shareholder value. In summary, 2018 was a year of solid financial and operational accomplishments, which included some important investments in our business that has set us up for accelerated long-term growth and profitability. As we look ahead to 2019, we are confident that with our competitive advantages, including our portfolio of strong brands that serve a range of demographics and aesthetics with proprietary high-quality and sustainably sourced products; our multicountry, vertically-integrated supply chain that gives us flexibility on sourcing and control over quality and cost; our multichannel shopping platform with an industry-leading e-commerce penetration; our strong operating cash flow and resilient balance sheet; and our proven track record of strong financial discipline, we have a unique foundation to support the successful execution of all of our growth and operational initiatives in 2019 and beyond and to deliver upon our financial commitments to drive long-term shareholder value. I would now like to open up the call for questions. Thank you.

[Operator Instructions] And we'll now take our first question from Oliver Wintermantel from Evercore ISI.

Laura, you mentioned your long-term guidance, right, so the mid- to high single-digit revenue growth, but margin is stable. Can you maybe explain what needs to happen to -- that we see margin expansion? I mean we've seen over the years, your top line is growing nicely, but then we have shipping costs, we have ad costs and all of that, so that margins are not growing. So with this longer-term guidance, what would have to happen that we see a margin expansions?

Sure. Thank you for the question, and thank you for the coverage. We -- I want to remind you, you might not be aware that last year -- or I'm sorry, in 2017, we made a big move to reduce our shipping income to be competitive. And we changed from a per item charge to flat rate, and it was a substantial hit to shipping. And we don't see the need to overhaul and make another change like that. In fact, we are looking at ways to take cost out of our network so that it's less expensive to ship. So that explains one of the reasons you saw that big hit in 2017. As far as the mix of the brands and also the channels, as I think you know, the DTC channel is more profitable. And as we continue to push the growth there, from a margin perspective, you see the benefit. We're also working to close underperforming stores. Over the next 3 years, we have over 1/3 of our stores up for renewal, and so we'll either get great favorable leases, or we'll leave. And that's going to be a substantial opportunity for us to reposition at a time where our -- the mall owners and landlords really want to have great brands like ours that drive traffic. And then, of course, with our business, growth leverages everything. And we have substantial growth initiatives that we have a clear view to. And I went through some of them before but West Elm, a very profitable business that we can really maximize and leverage our great designs across multiple geographies and also pushing to grow the customer base as we have done across DTC. We continue to see the brand really resonate both in urban and suburban markets and have options to really differentiate the aesthetic and the categories that we are in. We're also, you saw last week, we have growth opportunities in West Elm, with places like Rent the Runway. And there's all sorts of new ways to think about how we sell our products and participate in this new retail environment. So West Elm, although we've been talking about it for a while and telling you about the growth story, we're really refocusing our dollars towards pushing the growth faster in West Elm, which will inevitably drive margins. And then I mentioned earlier the new Business to Business division that we're efficiently naming and supporting so that we can drive growth across all of our brands, and we've been working to convert more of our product to contract-grade. And we are marketing these services and supporting the delivery in the way that businesses want them delivered, and that it's going to push a lot of leveraged growth because it's just leveraging what we're already doing. So we're quite excited about Business to Business. And then, of course, we talked about our emerging brands and the clear road map for growth in each of those. So it's a combination of cost reduction, otherwise known as customer enhancements, because a lot of cost is wasted when you don't deliver perfectly. And we're seeing great improvement there. We talked about one inventory being a big driver of better inventory optimization but then also the growth driving leverage on the base.

We will now take our next question from Jonathan Matuszewski of Jefferies.

I guess, just first off, on port congestion. I know that impacted results last quarter, contributed to the spread between reported and demand comps. What did you see on the port congestion front during fourth quarter? And do you see any issues still ingrained at this point?

This is Julie. Yes, we did receive all the delayed goods from China. They did come in, in the fourth quarter, and all the customer orders were filled. As a result, we saw that our backorder rates, of course, significantly improved compared to last quarter, and we're seeing less customer issues than we've had in the past with more on-time deliveries and less damages, returns and replacements. So that issue regarding the China port slowdown is behind us.

Great. And then just a quick follow-up for West Elm, I know you mentioned expanding some categories where you've seen historical strength and momentum and then maybe some new product introductions. Could you just elaborate there and keep us updated on what we can expect in stores in 2019 that's different from the past?

Sure, it's very exciting. They continue to really push and lead in design. And while the specifics are quite competitive, I'm really impressed with how this team is really innovating and building new products for the modern customer. So you're going to see a lot of innovation in core categories. And then also, as you just saw, we just relaunched bath to great success, and we're still just in the early stages of building out that business, as an example.

We will now take our next question from Michael Lasser of UBS. Apologies, we will now take our next question from Curt Nagle of Bank of America Merrill Lynch.

So just one. In terms of just the guide for next year, just curious if you could comment on what you guys have factored in for onetime items because I know you guys don't guide to GAAP. And then just as a follow-up, just kind of curious what your expectations are or, I guess, why the foray into Rent the Runway, it seems like at least an interesting opportunity.

Yes, this is Julie. As far as the non-GAAP items go forward, I think we've said to you in the past that the outward costs that we're backing out, particularly associated with the transaction costs that are going to be amortized over multiple years, are going to be backed out for 2019. Those are the only things that we've identified at this point.

In terms of Rent the Runway, it's another example of a very interesting way to get into the consumer's house. We've seen success in clothing. And people, different life stages, sometimes don't want to buy things. They're going to rent them anyway. They're going to go to secondhand stores. And we see this as a really high-quality way to participate in that circular economy and give the customer what they want. And we know that when we get them early on or in a certain part of their life, we usually are able to keep them better than other retailers. So that's one -- just yet another example of how we're thinking about our business differently. No different than Business to Business where we look at the world and say, "Where else aren't we?" And we launched the Workspace in West Elm, it's been very successful, and we continue to push on contract. And everywhere that you see furniture, we want to be a part of it. And we believe that we can build a really sizable business in these different kinds of channels than we have before.

We will now take our next question from Michael Lasser of UBS.

You mentioned that you're being less promotional on the Williams-Sonoma brand. Is that in response to something you're seeing in the environment? And do you expect Williams-Sonoma to comp negative in the first half of the year? And then I have a follow-up.

We don't like negative comps any time of the year. Yes, so less promotional, we're reducing the amount of SKUs, unproductive SKUs in stores and being smarter about the inventory investments. And so you may not comp those sales that were less profitable. And as we've reduced inventory -- we're going to continue to reduce it, by the way, because we know it's the right thing to do -- you're going to have less in that bucket. On the other hand, you could make the argument that when you offer too much on sale, you trade them down. And so do you actually lose the sale? Or do you trade them up to something that's at regular price? And at the regular price, in all brands, including Williams-Sonoma, we're pushing value. So Open Kitchen is a great example where you can go to Williams-Sonoma and buy great -- the best products at the best price, all exclusive in Williams-Sonoma. And that should, I hope, offset the reduction in the clearance activity in that brand. But as I said earlier, we're undertaking a pretty transformational change and improving the profitability in the Williams-Sonoma brand, improving the ROIC in the Williams-Sonoma brand, and we really are excited about that initiative. And you could see some more muted comps. But on the other hand, we have some great opportunities in that brand and an exciting product lineup for the year.

And then my second question is as we calibrate our model, you've guided to a flat margin at the midpoint of your 2% to 5% comp outlook for the year, so call it 3.5%. Does that mean if you comp at the low end, you would see some margin compression? Or because you might be giving up some unprofitable sales, we shouldn't expect to see a margin degradation at a lower end of the comp range.

Yes. I mean, what we've guided to, obviously, is to be in line with last year's op margin. So that is fully where we believe we'll come in regardless of where we land on the revenue. So yes, there'll be things that play like that, like where we might be giving up on comps to be able to have a more promotional sale -- I mean, more profitable sale, sorry, like Laura just spoke to with Williams-Sonoma. And quite honestly, across our brands, we've been doing more of that. So that's possible, but I wouldn't read anything more into the low end of the revenue range relative to op margins.

We will now take our next question from Marni Shapiro of Retail Tracker.

Hey, guys, congratulations. The stores have looked really fantastic. Can you just talk a little bit about West Elm? Specifically, you talked about accelerating the growth. I'm curious because, Laura, you have a lot of things going on with West Elm, so I'm curious if you're looking to accelerate the growth by opening more stores? Or is it things like Rent the Runway or all of the other aspects of West Elm that you're targeting right now?

I mean, it is all of the above, which is quite exciting. So it's the cross-brand initiatives that we've talked about that feed right into West Elm's strengths. They're still really early in the registry business, so that is wide open space for them to take that business away from others. And particularly now that you can finish your registry at West Elm's furniture with Williams-Sonoma Open Kitchen, we really have the product to serve the whole house. And so that's an opportunity as well as the new channels we talked about. And then as I said within just the core brand, there's product category opportunities. There's aesthetic opportunities, price point scale. In fact, we believe that sometimes the furniture is too small. West Elm was born for an urban environment, yet suburban people in larger homes love it. And so we also are doing the opposite of what we're doing in Pottery Barn, which is expanding the size of some of our products, so that they fit in larger homes. And then lastly, I don't think we've really explained well enough the operational excellence that the team at West Elm are pushing. They've really changed the course of the profitability. The inventory is in so much better condition. It's very clean. Backorder crate rate is way down, and our on-time delivery is up. And while it's hard to put an exact finger on how much that's worth, we know that's a sizable number that will continue as an opportunity through this year.

And can you just give us an update quickly? You had launched West Elm, the Baby side, And I think it was last year, or it might have been the year before, I had seen in a bunch of stores you rolled out, what I would call like a higher-end, a more exclusive West Elm. If you could just touch on those. Are those still in the works, both of them? And where are they going?

Yes. Great question. So on the Baby side, we did a collaboration. We do lots of collaborations with different outside designers. And we realized, let's do a collaboration with PB Kids and West Elm because PB Kids understands safety in building children's furniture, and West Elm has a unique aesthetic that Kids hadn't been offering. So we actually -- they designed it together in-house, and we put the product, both in the stores for West Elm and the Kids stores, and online on both, and all brands are benefiting. And the [ volume ] is kind of similar. It's actually quite distinct. Now in terms of collection, we had tried a higher-end West Elm, and it wasn't successful, and we very quickly exited that. And the great news was it was a small test. So we feed the ones that work, and we got rid of that one. And actually, we had a store in New York where we had the separate entrance, and we had collections in there. We converted that to our bedding and bath expansion. So it was a pretty easy move.

We will now take our next question from Christopher Horvers of JPMorgan.

I wanted to follow up on the demand comp commentary. So the rough math around the third quarter is 110 basis points, call it, was shifted in based on the 150 basis point headwind from the third quarter. So that was about 110 basis points in the fourth quarter. So do you look at like a low 1 is really the underlying demand comp there? But you also mentioned that you also had some late shipments, so I was trying to understand sort of the underlying trend, how much you expect could shift into the first quarter? And then bigger picture, sort of how you think about the first quarter relative to the guide for the year, do you think that 1Q could be at the low end of the range or slightly below or midpoint? How are you thinking about it?

Chris, it's Julie. I'll take that. So I think there's a couple of things you have to think about. I mean, yes, demand comps were higher than net in Q4. And yes, I said earlier that we did get the China goods in to the fourth quarter. What you have to recall is a couple of things. First of all, we had a 2.4 comp, which, of course, is the midpoint of our range relative to 5.4 last year. But we also incurred a 70 basis point negative impact on -- from an accounting perspective as a result of the new revenue recognition standard. And so that, right out of the gate, hurt the comps and brought them lower. We also, as Laura had mentioned in her prepared remarks, also had a couple other drivers that impacted the demand-to-net's conversion, primarily associated with the Pottery Barn brand and the fact that a lot of their growth is coming out of dropship sales, which -- in marketplace and upholstery, which those take longer to fulfill. And then we also were impacted, as we just spoke to with Michael about Williams-Sonoma, with the lower comps primarily associated with being less promotional in the fourth quarter. But all that to say, at the end of the day, we had really good strong comps relative to our performance to last year. As far as giving guidance to the first quarter, obviously, is one thing that you do need to remember in the first quarter. We have an Easter shift that's pretty sizable, and I alluded to this in my prepared remarks. That's going to put the Easter revenue comps towards the end of the quarter. And obviously, as Easter drives both traffic and revenue across our brands, this timing shift makes it hard to currently read the business. But this Easter shift actually further speaks to exactly why we want to get out of the business of the shorter-term business reads and to move away from quarterly guidance as it's not reflective of our more strategic long-term vision.

Understood. And then as a follow-up, on the flat EBIT margins for 2019, any color in terms of how you're thinking about the gross versus the SG&A? Closing 30 stores, rough math, seems like about a 50 basis point tailwind to occupancy. So are you expecting gross and SG&A to be relatively flat to arrive at that EBIT guide?

Well, there's obviously a lot of moving parts in there. I mean, certainly, with higher revenues, you have occupancy leverage with lower cost like we had in the fourth quarter, it was actually one of our lowest growth rates we've had at 2.2, you're starting to see some of these costs come down, both from rent and otherwise, depreciation, et cetera. So with that continuing, that should be some tailwinds for us. Also, we saw merch margins that were up in Q4 that we continue to talk about, so I think that's another opportunity to provide leverage on the gross margin. And a lot of our supply chain initiatives to help lower some of our cost that hit gross margin should also be helpful. The tailwind -- or the headwind, if you will, is the higher shipping costs that we continue to have, obviously, from both the UPS shipping rate increases but, more importantly, from the higher mix of furniture and the China tariffs, which is everybody's question mark, as to where that's going to land. We have, in fact, included that in all of our guidance for the full year. It's factored into our op margin because we're covering that 100%. But it could, short term, put pressure on our gross margin, which, of course, then as we have higher sales leverage across the P&L like we've done in the fourth quarter, we'll continue to leverage the other areas of the SG&A lines to be able to offset that and to be able to land at an operating margin that is flat to last year.

And by the way, since we have covered the China tariffs and it's in our guidance. If it's removed, it's upside.

Understood. You mean the 10% tariff.

No.

No. We actually have -- we are anticipating -- we plan to the 25%.

And that's sort of some sort of comp benefit but some sort of gross margin headwind [ down ] ultimately.

Yes, so we put the worst case scenario in, and we've prepared ourselves. We've been working on this for a while. The sourcing team has done a phenomenal job, and it speaks to, really, our vertical integration and our sourcing structure across the world. We've moved a ton out of China. We've gotten better prices. We've moved a lot of our upholstery business domestically, which also has the net impact of, unfortunately, hurting net, Chris, because it used to come in from China and sit in our DCs and be shipped. And now we've moved and opened, as you know, Tupelo, where we're moving a lot of our upholstered furniture business. But that also was because we got ready for what we thought was going to be 25% tariffs. And so in addition to all the movement of the sourcing, we have been going after indirect vendor cost around the company. We have a team that's working on consolidating every contract. So between all these moves and also some mix shifts and some selective price increases, we're prepared for the worst.

Any comments on the degree of upside? You said -- you opened up the box, so I figured I'd ask.

I know go ahead. Yes, it's a good question. I mean, I don't think you can do the straight math because a lot is yet to be seen about this. But certainly, it's a good number.

We will now take our next question from Steve Forbes of Guggenheim Securities.

I wanted to start with the footprint expectations, right? So the 30-store closings on a net basis, maybe just help us bridge the gap there, gross to net and, if you can, any color by brand. And then given your commentaries about the 1/3 of the stores up for renewal, can you talk about how these conversations for this store class the landlords went as you went to negotiate?

So as far as the numbers from a gross-to-net perspective, it's predominantly store closures that you're seeing in that number. So -- and basically, as we've gone through and we told you in the past, there was about 250 stores that were coming up for renewal, and we said we'd close 1/3 of them if the economics didn't make sense. And so having 30-store closures in this one particular year -- it's, if you look back, one of the largest store closures that we have announced. So it's clearly a sign that we are pushing back with the landlords and being very aggressive with our stance.

I do want to add, though, that we see retail as a very important part of our multichannel model because it allows our customers to touch and see our products in person, and it does drive new customer acquisition. So while we have the opportunity, and we have over 250 stores that are coming up for lease renewal in the next 3 years, we also have the opportunity to selectively open stores and invest in new stores for West Elm and drive very profitable growth. And in terms of the negotiation, these are leases that are up. It's the end of the lease. And so there's cases where we are deciding to stay due to favorable economics and other places where we are leaving. And so the 30 is our best guess, and it just depends on what kind of agreement we can get with our landlords. And we'd love to work together to really keep a very healthy fleet in the best centers in the United States.

[Audio Gap] We spent a lot of time on the call today on the growth potential for West Elm. But maybe if you can expand on Williams Sonoma Home, right, especially as it relates -- pertains to like the presentation of the brand within the store. I think you mentioned sort of small and tactical presentations. But really, how do you plan on driving brand awareness, right, of that offering over the next, say, 3 to 5 years?

Thank you. We're very excited about the opportunity for Williams-Sonoma Home, and we have not seen -- we've seen an interesting mix in our Kids and Teen businesses, which are predominantly online. In fact, in Williams-Sonoma Home, we are choosing to consolidate out of some of the stores, actually, and remove the footprints so we can make a better impact in others. And we tried a lot of things last year, we tried it in a lot of markets. And we see ourselves -- we've already taken it out of some, and we're going to take it out of some more and then really expand it in others based on where the market is. And at the same time, online, we can drive a lot of customer acquisition through our digital efforts and also because we're introducing -- we have the Room Planner that's cross-brand. So as our designers and the other retail stores help furnish their customers' full homes and maybe they go into the Pottery Barn door, the Room Planner allows them to drag and drop products from all of our brands and put together a multi-brand house, which we think is a really big competitive differentiator for us and one that we're going to continue to build upon.

Ladies and gentlemen, there are no further questions at this time. Thank you for your participation. You may now disconnect.

Thank you all. Appreciate your support and looking forward to talking to you next time.