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Edited Transcript of WSM earnings conference call or presentation 21-Nov-19 10:00pm GMT

Q3 2019 Williams-Sonoma Inc Earnings Call

SAN FRANCISCO Dec 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Williams-Sonoma Inc earnings conference call or presentation Thursday, November 21, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Yee;Senior Vice President of Corporate Finance and Treasurer

* Felix Carbullido

Williams-Sonoma, Inc. - Executive VP & CMO

* Julie P. Whalen

Williams-Sonoma, Inc. - Executive VP & CFO

* Laura J. Alber

Williams-Sonoma, Inc. - CEO, President & Director

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Conference Call Participants

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* Adrienne Eugenia Yih-Tennant

Barclays Bank PLC, Research Division - Research Analyst

* Charles P. Grom

Gordon Haskett Research Advisors - MD & Senior Analyst of Retail

* Christopher Michael Horvers

JP Morgan Chase & Co, Research Division - Senior Analyst

* Cristina Fernández

Telsey Advisory Group LLC - Director & Senior Research Analyst

* Katharine Amanda McShane

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Michael Lasser

UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines

* Oliver Wintermantel

Evercore ISI Institutional Equities, Research Division - MD & Fundamental Research Analyst

* Simeon Ari Gutman

Morgan Stanley, Research Division - Executive Director

* Steven Paul Forbes

Guggenheim Securities, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and thank you for standing by. Welcome to today's Williams-Sonoma, Inc. Third Quarter 2019 Earnings Call. (Operator Instructions) I'd like to remind everyone this call is being recorded. And I'd now like to turn the floor over to Brian Yee, Senior Vice President of Corporate Finance and Treasurer. Please go ahead, sir.

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Brian Yee;Senior Vice President of Corporate Finance and Treasurer, [2]

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Thank you. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. Unless indicated otherwise, 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 addresses the financial condition, 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 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.

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [3]

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Thank you, Brian, and good afternoon, everyone. Also on the call with me today are Julie Whalen, our Chief Financial Officer; Felix Carbullido, our Chief Marketing Officer; and Yasir Anwar, our Chief Technology Officer. Q3 marks another quarter of strong performance. Comparable revenues accelerated to 5.5%, operating margins held flat to last year despite increased tariff headwinds and EPS grew 7.4%. Our results and continued success relative to the industry reflects that our strong value proposition of high-quality, design-led, sustainable products is resonating with our customers.

In a fragmented home furnishings industry, it is hard to overstate how important it has been for us to continually evolve to stay ahead of the pack, remained at the forefront of driving profitable growth.

Importantly, our digital-first model is a key component of our success. While we continue to innovate the experience in our stores, our revenue growth was led by e-commerce at 9%, reaching almost 57% of revenues. Highlights from the brands include West Elm, which led our performance with a 14.1% comp on top of an 8.3% comp last year. We've also had -- continued the resurgence of growth across our Pottery Barn brands. We also had double-digit increases in our emerging brands, Rejuvenation and Mark and Graham. And despite a negative comp, we improved profitability in the Williams-Sonoma brand. Key to driving results across all our businesses is our increased focus on leveraging the strength of our portfolio through cross-brand initiatives, like our growing Business-to-Business division, our loyalty program and our in-home design services.

We are optimistic about the future and excited to serve and inspire our customers with outstanding service and products that will build a deeper connection to our brands.

Before I discuss our third quarter performance by brand, I'd like to talk about the effectiveness of our efforts to mitigate the tariff impact. Despite the impact nearly doubling quarter-to-quarter, we saw sequential improvement in gross margin deleverage from Q2. This is a result of the hard work of all of our teams. We've been moving production out of China, renegotiating product costs with our Chinese vendors and we have successfully taken selective price increases. In addition, we've been reducing the level of promotions. And as a result, we feel confident in our strategies implemented to offset cost pressures and to deliver profitable growth. I'm now going to talk about our brands. West Elm standout results again this quarter were powered by our strong growth strategies and effective execution. With comp growth accelerating to 14.1% this quarter, we saw broad strength across all product categories and channels. This growth was led by furniture, with particular success in new product introductions, including made-to-order upholstery, complemented by categories key to customer acquisition which include decorative accessories and textiles. E-commerce growth accelerated for another quarter, as our ongoing digital innovation drove customer acquisition and improved traffic and conversion. Retail also accelerated due to our differentiated design services, and our new West Elm stores continue to perform above expectations.

At West Elm, our ongoing commitment to sustainability is embedded in our products and business, fulfilling our mission to design with impact. We have continued our commitment to artisans as 20% of our assortment is handcrafted. We are excited to lead our brands and Fair Trade Factory Certification, exceeding our company goal to deliver $3 million in Fair Trade premiums to workers by 2020, a year ahead of schedule.

We're on track to surpass our commitment to responsibly source wood through a wide assortment of FSC-certified furniture, and we are meeting customer demand for organic goods by fully converting our bedding and bath assortment to be GOTS or OCS certified. Looking to Q4, our holiday assortments in West Elm are off to a strong start, and increased seasonal assortment is driving incremental growth.

Looking further ahead, we are hyper-focused on executing our key growth strategies, including highlighting our design and valued leadership, expanding in the product white space, driving brand awareness and new customer acquisition, and growing across all channels to reach our goal of $3 billion in revenues for this brand.

The Pottery Barn brands also maintained their strong momentum from last quarter, delivering comp growth of 3.4% in Pottery Barn and 4% in Pottery Barn Kids and Teens. There is much to celebrate in the Pottery Barn brand as we gain traction in our digital transformation and brand refresh with accelerating demand growth and improved service metrics. We drove strong digital growth and KPIs, including double-digit increases in traffic and product engagement. We're seeing the benefits of improved product discovery with higher engagement and revenues per visit. And we are effectively marketing our differentiated quality and original designs.

Demand in our stores is being driven by our trusted service culture and the talented team of designers who facilitate putting a whole room together for our guests. Stores are our multichannel advantage, and customers are embracing omni-channel services like free DTC returns and the convenience of buy online, pickup in store. Design crew also continues to drive increased sales in stores and is offsetting the traffic declines that are happening in some malls. Growth in Pottery Barn is being driven by our successful initiatives. Our curated Pottery Barn marketplace assortment is providing our guests with more choice while driving growth. Our apartment assortment of smaller space solutions is adding volume and converting new and younger customers. And we are laying the foundation with increased assortment of Contract grade furniture to contribute towards the Williams-Sonoma, Inc. Business-to-Business growth initiatives.

Another key success has been our mindfully made campaign, which better communicates our commitment to sustainability and responsibly sourced materials. We're on track to meet our 2021 goals, with 85% of our cotton GOTS-certified organic and 33% of our wood FSC-certified. And we've extended our leadership in mindful offerings with 50% of our upholstered furniture GREENGUARD Gold-certified. These achievements have earned our company recognition by the nonprofit Textile Exchange as a top 10 company using organic cotton and preferred fibers, and Sustainable Furnishings Council as a top scoring wood furniture retailer. We believe we are set up extremely well for the holiday season in Pottery Barn. We've launched highly curated gift shops online that are inspiring and easy to shop. And early reads show our customers are responding well to our assortments of cozy bedding, velvets and plaids. We're also seeing momentum in our Pottery Barn Kids and Teen brands. We continue to see growth in our Baby business, as we expand aesthetics and price points. We're using the lens of offering the safest, healthiest products, thanks to our rigorous safety standards and market-leading approach to offering GREENGUARD Gold-certified furniture on over 90% of our assortment. Our range stands from baby to toddler, kids and teens and off-to-college where we saw double-digit growth in the quarter from our offering of high-quality dorm room bedding, furniture and no nails decorating solutions.

We're also focused on growing our customer reach through new aesthetics. Based on the success of our modern baby offering, we recently announced the launch of Pottery Barn Modern Kids and Teen, a new range of furniture crafted with eco-friendly materials, clean lines and kid-oriented functionality. Additionally, we are encouraged by the strong early reads on our children's holiday collections, which include expanded holiday decor, gifting and seasonal bedding. In the Williams-Sonoma brand, our priority remains balancing the brand's long-term growth with improved profitability. And while we did run a negative 2.1% comp, we are encouraged that execution against our transformation plan has already generated improved profitability. Much of the sales shortfall in the quarter came from electrics, bakeware, housewares and our Halloween assortments. WS branded product continued to gain momentum and will remain a key growth initiative in the future.

Consistent with our transformation strategies, we've improved our inventory levels, and we've reduced a significant amount of low-volume SKUs across the brand. We also continue to drive additional opportunities to improve overall profitability, including reduced promotional activity, margin improvements and overall expense structure. We made progress against our retail initiatives to eliminate waste and leverage our high-impact remodels, close underperforming stores and improve the in-store experience.

In regard to WS Home, we've made a strategic decision to reduce levels of promotion, focus on clearer product stories and continue to improve our retail strategy. Another point of differentiation in Williams-Sonoma is our dedication to making a positive impact. In February, we launched the Williams-Sonoma Cares campaign to increase the transparency of our ongoing commitment to the well-being of our communities and our planet. As of this year, 100% of our cookware is PFOA free. 100% of our food products are free of out ingredients such as trans fat, high fructose corn syrup, artificial colors and flavors, and nontraceable palm oil. And we are making significant progress towards our goal for 2020 and beyond.

By 2020, we pledge to have 100% of our Williams-Sonoma-branded coffee Fair Trade Certified and 100% of our bed and bath products GOTS certified organic and STANDARD 100 by OEKO-TEX.

In addition, we are transitioning all wood kitchen tools to be FSC certified. Looking forward to the fourth quarter, we are confident we will deliver improved results from Q3 in the Williams-Sonoma brand. We've increased our digital spend, optimized catalog circulation and have a higher level of new innovative products that you will only find at Williams-Sonoma.

As we deliver more relevant products and ideas to our customers, we will emphasize the Williams-Sonoma difference. We are introducing new content-rich experiences online and in our stores that reinforce Williams-Sonoma as a destination for the holidays. Initial reads on our Thanksgiving and holiday products have been positive. Our emerging brands, Rejuvenation and Mark and Graham, drove another quarter of double-digit profitable growth as they continue to scale and attract new customers. And in our global business, we saw continued profitable growth across both our company-owned and franchise operations.

During the quarter, we expanded our wholesale network to New Zealand and Ireland, which are off to a strong start. And we are really looking forward to expanding our franchise operations with our entry into India early next year.

In addition to all of our brand initiatives, our cross-brand programs have been increasingly impactful drivers of revenues and customer acquisition all year. And during the third quarter, we added another 800,000 members to our cross-brand loyalty program, The Key, bringing total membership to 7.2 million. This ongoing accelerated growth of members is an important contributor to our future growth as key members currently spend, on average, 3x more than non-key members, with 2x higher purchase frequency, and they are 3x more likely to shop across multiple brands. They also drive a significant lift in sales as key members typically spend over 5x the value of their rewards. To drive greater redemption, we optimized our redemption e-mail campaigns and enhanced rewards visibility across our brand sites. We've also been expanding our member events and experiences to engage our best customers. We'll be leveraging this valuable platform with the launch of more marketing initiatives and membership events throughout the holidays to keep our brands top-of-mind and drive more cross-brand shopping.

Our Williams-Sonoma, Inc. Business-to-Business division also delivered another quarter of accelerating double-digit growth and drove nearly 100 basis points of comp growth for the total company. Q3 also marked the successful relaunch of our Business-to-Business membership program, which now encompasses 7 membership types, providing a much broader platform to attract and acquire new customers. This expanded program also allows us to unlock the full industry range and market share potential for this new division through the delivery of more targeted and relevant content for specific businesses or project types. This will be key for driving brand awareness as well as for accelerating our speed to market.

In addition, we've introduced regionally-focused service teams and launched a complete rebranding of the program, which is included on all of our brand websites. We're also recently honored at Boutique Design New York as the best of Boutique Design winner of the best exhibit competition out of over 800 booths. Fundamental to all initiatives is our focus on the delivery of a best-in-class experience for our customers during the holiday season. Customer experience is oxygen for growth, and there's no time in the year more critical for us to ensure that we meet the high standards that our customers have come to expect from us. We've improved our website speed, enhanced the search experience of a new iteration of our machine learning algorithms and added new capabilities to display lifestyle room imagery and product information as well as add to cart functionality in our shoppable room.

And as a part of our evolution to build an agile technology-rich retail operation, we continue to test new technologies to enhance the shopping experience, including additional design chat capabilities, product recommendations, payment, financing solutions and improvements to our Outward room planner.

In our distribution centers, technology is facilitating faster and more streamlined order processing through a number of enhancements, including paperless order processing and automated packing for high-volume products. To further improve order visibility, we are continually building on our machine learning optimization framework to provide more accurate data-driven delivery estimates to customers. Within our in-home furniture delivery network, we've expanded the rollout of Glympse, a same-day delivery order tracking program, which enables live tracking of home delivery trucks on the day of delivery and real-time customer updates on order delivery progress. Our transportation team has also completed extensive planning sessions with our ocean carriers, freight vendors and UPS to ensure that we deliver a great customer experience over the holidays.

Additionally, our West Elm, West Coast DC and Fontana, California is now fully operational, facilitating growth for our West Elm brand on the West Coast. After a highly successful peak last year and with 3 quarters of operational improvements behind us, we are in a strong position heading into this holiday season. Our teams are focused on flawlessly executing the fundamentals and delivering outstanding service at every customer touchpoint. Before I conclude, I want to provide you with an update on our sustainability efforts. Across our company, we strive to make a positive impact in the world, and corporate responsibility is central to who we are and the way we run our business. The conscious changes we continue to make in our global supply chain leads to shift towards greater responsibility in the way our industry operates and in our customers' choices.

In October, we released our annual corporate responsibility report, which outlined the meaningful company-wide progress we've achieved towards environmental, social and governance leadership. We are committed to improving transparency and strengthening our long-term commitment to ESG values, including efforts for responsible sourcing, landfill diversion and improvements in worker well-being. We also recently celebrated 5 years of partnership with Fair Trade USA. As the first global home retailer to make a broad commitment to this organization, we are pleased to take part in improving the well-being of our workers through community development, such as health clinics, water filtration and other community projects. We believe all these efforts are becoming increasingly important to our customers, our associates, the communities that we operate in and our shareholders.

In conclusion, while we are pleased with our year-to-date performance, we are even more excited about seeing the continued evolution and innovation come to life in our business. Our strong value proposition of high-quality, design-led sustainable products, combined with our multi-brand digital-first operating model is a winning combination. We are confident that we will deliver great service to our customers this holiday season and lead as an example of sustainability in our industry. We believe we are well equipped for an exceptional 2019 and we are ready for what's to come in 2020. And now, I'd like to turn the call over to Julie to review our financial results.

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [4]

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Thank you, Laura, and good afternoon, everyone. We are pleased to report another quarter of strong results with profitable revenue growth exceeding expectations, including e-commerce revenues growing to an all-time high. We delivered sequentially improving gross margins, another quarter of operating income growth and operating margin stabilization as well as inventory growth below sales growth, all despite incremental China tariffs during the quarter. These results reflect the ongoing success of our growth and operational initiatives that we have seen all year and further demonstrate our ability to deliver upon our long-term commitments. During the third quarter, we generated net revenues of $1,442 million for a year-over-year increase of 6.3%. Comparable brand revenues grew 5.5% on top of 3.1% last year. Growth was led by e-commerce, growing 9.3% to a record high of almost 57% of total revenues. By brand, we saw another quarter of outperformance in the West Elm brand with a 14.1% comp, continued strength across the Pottery Barn brands, including Pottery Barn at a 3.4% comp and the Kids and Teen businesses accelerating to a 4.0% comp, another quarter of double-digit growth for Rejuvenation and Mark and Graham combined, as well as another solid quarter of growth in our international operations of 9.2%.

Gross margin for the third quarter was 36% compared to 36.5% last year. The gross margin deleverage of 50 basis points was driven by the incremental impact from the China tariffs as well as higher shipping costs, primarily from a higher mix of furniture sales, which is more expensive to ship, partially offset by occupancy leverage. Despite the tariff impact almost doubling from the second quarter, our margins sequentially improved because of the continued success we are seeing from all of our mitigation efforts and the overall strength of our business, allowing us to further reduce the amount and depth of our promotional discounting this quarter, resulting in offsetting merchandise margin gains within gross margin. We also generated incremental occupancy leverage during the quarter, which helped to further offset the tariff impact within the gross margin. Occupancy costs were $179 million or 12.4% of revenues compared to $177 million or 13.1% of revenues last year. Our ongoing retail optimization efforts and the corresponding benefits we see from reduced rents and other occupancy costs, allowed us to minimize occupancy cost growth to only 1.1%, driving 70 basis points of leverage.

Additionally, we delivered on our commitment for cost reductions throughout company to further mitigate the tariff impact on the bottom line. As a result, we saw SG&A leverage 50 basis points to 28.4% of net revenues this year compared to 28.9% of revenues last year, primarily driven by leverage across employment and advertising from higher sales and our continued cost-containment initiatives. We have reduced employment costs, primarily resulting from the reduction in force earlier this year as well as from other employment-related costs. We have further optimized our advertising spend by shifting more of our spend away from catalogs to more efficient digital advertising. We have also been aggressively reducing non-merchandise-related costs as a result of our comprehensive company-wide initiative to consolidate vendors and leverage economies of scale that we started at the beginning of the year.

As a result, operating income grew in line with sales growth to $109.9 million, and we held operating margins flat to last year at 7.6%. The effective income tax rate was 24.7% compared to 23% last year. And diluted earnings per share of $1.02, grew 7.4% compared to $0.95 last year. Year-to-date, this has us delivering revenue growth of 5.7%, operating income growth of 9.8%, operating margin expansion of 30 basis points and double-digit diluted earnings per share growth of 13%. We are pleased to see that all of the mitigation strategies we implemented have allowed us despite the ongoing cost pressure from the China tariffs to deliver strong profitable growth. Of course, without these tariffs, our performance would have been even stronger.

Moving to the balance sheet. We ended the quarter with a cash balance of $155 million versus $164 million last year. Year-to-date, we have invested $121 million in the business and have returned $226 million to stockholders, split evenly between share repurchases and dividends at approximately $113 million each. Merchandise inventories ended the third quarter at $1,259 million, increasing 5.1% over last year, or 120 basis points below our sales growth of 6.3%. This speaks to the success of our inventory initiatives, including the continued expansion of our omni-channel inventory fulfillment capabilities, more in time frequent flow of inventory from our overseas vendors as well as the continued shift of our business to more drop-ship and made-to-order inventory. These initiatives not only enabled us to drive inventory growth below sales growth despite the incremental inventory cost impact from the China tariffs but also enabled us to reduce backorders and backorder crate rates.

Now I'd like to discuss our fiscal year 2019 guidance. But before I do, I want to remind you that fiscal year 2019 is a 52-week year versus a 53-week year in fiscal year 2018. We had estimated last year that the extra week in fiscal year 2018 was worth approximately $85 million in revenues and $0.10 in EPS. And this has been reflected within our fiscal year 2019 guidance all year. Given the strength we are seeing in our year-to-date results, with strong top line growth and operating margin stability, we are raising the low end of our fiscal year guidance. This guidance includes the financial impact from all China tariffs through the end of the year, and we have not assumed that any China tariffs will be repealed.

As a result, our fiscal year 2019 guidance includes net revenues in the range of $5,770 million to $5,900 million, comp growth in the range of 3.5% to 6% and diluted earnings per share growing 7% to 10%, excluding the impact from the 53rd week last year to a range of $4.65 to $4.80. All other guidance within our press release remains unchanged. Additionally, we are reiterating our commitment to maintain a balanced capital allocation strategy. We will continue to utilize our strong operating cash flow to first invest in the business in those areas that will fuel our growth and provide the highest returns. And we remain committed to returning excess cash to our stockholders in the form of share repurchases and dividend payments.

In closing, our strong third quarter and year-to-date results reflect the continued momentum we are seeing from our growth and operational initiatives, along with the unique positioning we have in the marketplace. As customers increasingly want to shop with brands they know and trust, that sell proprietary products that exhibit quality, value and sustainability, and that can provide exceptional customer service online and in-store, we believe we are one of the best positioned in the industry to support this customer demand. And this, combined with a culture of strong financial discipline, will allow us to generate long-term profitable growth and returns for our shareholders.

And with that, I would like to wish you all a happy holiday, and I would now like to open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) First, from Barclays, we have Adrienne Yih.

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Adrienne Eugenia Yih-Tennant, Barclays Bank PLC, Research Division - Research Analyst [2]

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Laura, my first question is about, one of your pure-play competitors, Wayfair, they spoke on their call about when the tariffs came in, and since they don't carry inventory, they had a pricing disruption that delayed the consumer behavior, the purchasing behavior. I'm wondering if you've seen any of that. Seems like not. But if you could talk about that.

And then secondarily, kind of on a longer-term basis, now that Mark and Graham and Rejuvenation are double-digit kind of growth, what are the long-term plans for that?

And then, Julie, really quickly, in terms of kind of helping us with some tariff impact as we roll into 2020, can you help us kind of think about what percentage will be sourced from China. And any impact? How long your current stock of inventory, the pre-tariff inventory can carry you into 2020?

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [3]

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Sure. Thanks, Adrienne. We have not seen any delayed purchasing from our customers. We have very strong demand, and it was very consistent through the quarter, and it's continuing. So I haven't noticed that.

In terms of Mark and Graham and Rejuvenation, all of our brands work together in a symbiotic way to serve customers in life stages and lifestyles. And Rejuvenation has a very specific focus on house parts and hardwired lighting. And we know that remodeling homes and that people's love for their homes is not waning, and we're seeing great growth because we sit in a very unique place with this high-quality custom-configured lighting. And it's very difficult. I know many of you have probably done remodels of rooms and to match all the finishes in a room, even from a single retailer, can be tricky and we make it all -- we finish it all, I should say, in Portland. So all the finishes match perfectly. And we'll -- so we continue to see the growth.

We're seeing it both in the stores, which are comping nicely and online. We're debating a couple more stores in key locations, but we don't think that we also -- we don't have to open stores to continue this growth. There's a lot of natural growth and natural category growth in Rejuvenation. Mark and Graham really leverages our strong personalization techniques that we have in the company. And it's, again, a differentiated way for a customer to shop for a gift. I mean nothing like giving someone something for the holidays that has their name on it. It really shows that you thought of them. And so we see both of them continuing to grow and be sizeable. And they're both producing very profitable bottom lines. So they're helping us with our EPS, and they will continue to expand and leverage the base that we've built on the foundation of the company.

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [4]

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And Adrienne, this is Julie. Regarding the tariff impact. I mean obviously, our next call, we'll go through a lot more details of the puts and takes with 2020 in our guidance. But certainly, at a high level, we remain committed regardless of tariffs to our long-term commitment to hold op margins and operating income relatively in line with revenue growth. So therefore, operating margin stability regardless of the tariffs. But from a -- as we roll into 2020, to give you directionally some information, I mean, obviously, the first half will have more pressure than the back half because a lot of the tariffs came in towards the back half of the year.

However, on the flip side, we're also going to be resourcing more next year. So we've said externally that we plan to get out of about half of our exposure in China by the end of next year. So we're halfway there to that commitment. And so there'll be more that's resourced next year. But what I would say is that I think, you could see that we've done an incredible job of offsetting this tariff exposure. And this quarter, in particular, is a great example of that when you look at sequentially improving gross margins with almost double the tariff impact. And we've done that with strong health of our business and our ability to pull back on promotions and all of this resourcing, cost negotiations, cost reductions through our P&L. We've been working on this for a long time. And so I would say that's going to be helpful for us for next year.

As far as the inventory side of things, and maybe I didn't understand your question, but ultimately, just about all of the tariffs that come into play at this point for us, except for the List 4b tariffs, which are currently scheduled, we'll see, but for December 15. And so that's really the incremental inventory impact if you will. Everything else has already gotten the tariff in it. So there's nothing that we can really pull ahead from that perspective.

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Operator [5]

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(Operator Instructions) Moving on, we will hear from Kate McShane with Goldman Sachs.

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Katharine Amanda McShane, Goldman Sachs Group Inc., Research Division - Equity Analyst [6]

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My question is centered around gross margin. Just wondering if you could help us quantify, Julie, some of the headwinds you saw during the quarter. I noticed, too, that you didn't call out B2B as one of the headwinds to gross margin. So I wondered if you could address that, and just how we should be thinking about gross margins for Q4.

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [7]

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Sure. So from a gross margin perspective to kind of walk you through it, they basically came down 50 basis points, which is a 60 basis point improvement from the second quarter despite having double the impact from the China tariffs. And so we were pleased to see that with the fact that we had accelerating operating margin leverage to 70 basis points that, that helped offset it in addition to the fact that we were able to, given the strength of our business, as I said earlier, pull off of promotions that basically offset entirely the tariffs. So if you back out, to your point, there is some B2B exposure. It wasn't as significant relative to the total, but there was some B2B exposure in our gross margin. Of course, that's accretive to our op margin. But if you back sort of those things out and some onetime things, you get to a pure merch margin that is basically flat despite the incremental tariffs.

As far as Q4 going forward, obviously, we don't provide details necessarily at the gross margin and quarterly gross margin line, but directionally, it's another quarter that we have incremental tariffs, to be honest. So with the List 4a tariffs came in towards the end of this quarter and then we have potentially the list 4b tariffs that are coming in December 15. So it's another quarter of absorbing incremental tariffs. But on the flip side, given the success we've had in this quarter, we feel really good about our ability to cover that. And so we're, again, committed to the bottom line with op margins stabilizing, operating income growth in line with revenue growth. And so if there's pressure on the gross margin like we've done all year, we will offset it with other cost reduction opportunities within SG&A.

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Operator [8]

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And next question comes from Steve Forbes with Guggenheim Securities.

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Steven Paul Forbes, Guggenheim Securities, LLC, Research Division - Analyst [9]

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I wanted to focus on -- sorry, expense leverage, given the sequential moderation, right? You talked about the improvement there in gross, which is certainly a positive. But if we look at expenses, the leverage, right, it looked like it moderated. So I don't know if there were certain costs that hit during the quarter? Or if you could just remind us, right, as we model the -- model forward how much the corporate realignment helped you on the leverage line item and/or whether you're still leveraging store-level payroll given the strong comp performance?

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [10]

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So we definitely saw a considerable leverage again within the employment line. So certainly, the -- unfortunately or fortunately, the reduction in force in the beginning of the year is certainly helping us as we move through. We're definitely seeing leverage from a store perspective as well. The difference sequentially is simply -- of course, by quarter-by-quarter, the leverage -- the amount of leverage is going to fluctuate for many reasons. But relative to last quarter, the reason why it's a little bit less leverage is because of 2 things. One, we made some more investments on the advertising side, even though advertising leverage, it didn't leverage as much as the second quarter, and I'll let Felix talk about it in a second. And then secondly, we had a state sales tax settlement that happened during the quarter that wasn't there last year or in the second quarter. So both of those sort of put pressure, if you will, on a lower leverage within SG&A. But we're really proud that we've been able to, with our cost containment initiatives, maintain this leverage as we move throughout the year, even though it's going to vary by quarter. Felix, you want to talk about our advertising?

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Felix Carbullido, Williams-Sonoma, Inc. - Executive VP & CMO [11]

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Yes, absolutely. As Julie said, for the third quarter in a row, we leveraged our marketing spend. And our customer count, which from a longer-term perspective, we recognize that's what fuels our growth in the long term. So introducing new customers, retaining happy customers is still our #1 priority. And where we see efficient ROI, we will spend. That said, as Julie said, given the ongoing challenge of the tariffs, we will find efficiencies. We've taken all of our online media buying in-house. It allows us to better leverage costs across the digital ecosystem. We have a cross-brand learning agenda, a learning agenda with our 7 brands, which allows us to test and learn quickly on 1 brand and then roll it to the others when we see the return on investment. And finally, we -- for 25-plus years, we've been focused on performance marketing because of our catalog days. We've had a continuous improvement in investment in customer and marketing analytics that gives us the confidence to spend when we see the right return on investment.

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Operator [12]

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Then next from Telsey Advisory Group, we have Cristina Fernández.

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Cristina Fernández, Telsey Advisory Group LLC - Director & Senior Research Analyst [13]

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On the Williams-Sonoma brand, can you talk about some of the new units that's coming in, in the fourth quarter that gives you confidence that you can get a positive comp? And also, a couple of department stores have talked about incremental promotions on house worth. Did you feel like that have an -- that had an impact on that brand during the quarter?

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [14]

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Sure. Thank you for the question. In terms of things that we're bringing in, we have -- we've seen some strength in some categories that flex up during the holidays, and cookware continues to be quite strong, especially with our exclusive launches, our Le Creuset Star Wars collection, which is great. That sells in the fourth quarter. We also see continued momentum in our WS branded, and that is going to be something that we continue to tick up as a percent of total.

We've also been working on a better marketing strategy so that we can drive double-digit traffic growth online, which is really key to the holiday time period, and we have tested it and are on track to execute that, and we funded it through catalog cuts. We also really realized in a market where there is a lot of competition, it is important for us to better describe and communicate why we are different and what products are different. And so you're going to see us continue to pull back on promos and the promo marketing so we can tell better lifestyle stories. And you're going to notice that in the e-mail and also on our sites. And furthermore, in terms of the whole model, we believe that as we continue to focus on bigger stories and tell them better, we're going to be able to improve our margins and improve sales because we're not so over assorted.

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Cristina Fernández, Telsey Advisory Group LLC - Director & Senior Research Analyst [15]

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And then as a follow-up, on the tariffs, so List 3 tariffs didn't go to 30 from 25 as had been indicated in the last quarter. And then if List 4b tariffs are delayed, how should you think about that benefit of reinvesting it or falling to the bottom line?

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [16]

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Julie, would you like to...

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [17]

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Sure. So List 4b, as you mentioned, if it doesn't go through, it was supposed to go through December 15. And so by the time we receive goods into our distribution centers and ultimately sell it, it's a relatively small impact to the fourth quarter. For us, if it were to get lifted and it depends on the fact and circumstances, does it get repealed, 4a and all these other ones that are already in place, who knows? But based on 4b alone, if that one didn't go into play, it wouldn't be significant for us for the fourth quarter, but certainly, it takes pressure off of next year.

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Operator [18]

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And then moving on, we'll take our next question from Chuck Grom with Gordon Haskett.

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Charles P. Grom, Gordon Haskett Research Advisors - MD & Senior Analyst of Retail [19]

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Can you just maybe take a step back and -- how should we think about the health of your business? Only because most of your banners saw a little bit of a slowdown on the stacks. Just wondering if you're still feeling confident? And then the full year comp range, 3.5% to 6%, is pretty -- implies a pretty big or wide range here for the fourth quarter. Just wondering if you could help us narrow that range a little bit? And then on B2B, I just wanted to make sure I heard you correctly that, that was about 100 basis points of comp benefit to the third quarter. And in my understanding, that can be lumpy at times. But how should we think about that going forward?

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [20]

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So from a B2B perspective, yes, it came in about the same this quarter, about almost 100 basis points of our comp growth, but that could be lumpy. I mean again, it depends on the size of the deals and the timing of the deals, and so we're just thrilled to see again that it was a significant contributor to our results from a comp perspective. As far as how we're feeling? So what I would say is, we feel great about the strength that we're seeing in our business. We are not seeing any signs of a slowdown as we've entered the fourth quarter. We remain confident in our long-term ability to outperform and take market share. Our fiscal year guidance at the high end is in line with our outperformance we have seen year-to-date with strong top line growth of the 5.7% as I mentioned and double-digit EPS growth.

As far as your questions on the implied fourth quarter guidance in a wider range, I really wouldn't read anything into that. We have simply provided fiscal year guidance where, given the strength of our business, we raised the low end of our guidance ranges for the third time this year, despite absorbing another quarter of incremental China tariffs, which again remind everybody we're going to have a full quarter now of the List 4a tariffs and the addition of the planned implementation of List 4b tariffs. So it's another quarter of incremental tariffs. But we believe this guidance reflects the range of outcomes that are possible and, obviously, with the mixed retail results that we're seeing out there, we think these guidance ranges are appropriate at the time. But at the end of the day, we remain confident in the growth and operational initiatives that we have been executing against this year that has driven our outperformance all year and will allow us to deliver long-term market share gains.

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [21]

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And KPIs are very strong, Chuck, including customer counts, customer retention. The digital traffic to our websites, as I said earlier, is double digit, which is very good. Retail is strong. We're well set up. We're set in the stores, we've been out, we've seen them. They look great. And we're operationally ready for the compressed calendar. So we know that there's some opportunity with the last year compares in Q4. Pottery Barn was flattish last year, and it's a big -- it's a big upside for us this year because we continue to see increasing momentum in Pottery Barn.

And remember that as we grow furniture, our net comp, which is the one that we publish, often lags demand comp. So that makes us even more confident as we have seen demand comps continue to grow in Pottery Barn and some of our other furniture-based brands. So there's a lot of good news here. We also -- because last Q4 wasn't as robust as other quarters, we have the opportunity not just to drive incremental sales, but also to drive increased margins because we had a lot of plans and promotional levels last year that we are hoping not to be -- not to comp, and that could give us upside as well. So I'd say it's exactly what Julie said, we're set up extremely well. KPIs prove it. Macro backdrop is healthy, and we have opportunity on the 2 year.

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Charles P. Grom, Gordon Haskett Research Advisors - MD & Senior Analyst of Retail [22]

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Okay, great. And just one quick one. Julie, you did a great job unpacking the gross margin for us. Just wondering if you could help us quantify the tariff headwinds, specifically in the third quarter, I guess, relative to what it was in the second quarter.

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [23]

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I'm going to take that one since she didn't let me take other. I'll just say that we've assumed the worst, okay? So we continue to assume the worst. All the tariffs go into play. What we haven't assumed is that they make them worse yet. But the ones that have been mentioned, every time they mention them, we double down our plans to offset them. So that's what's in as we think about the end of this year and next year. So obviously, there would be some upside if that didn't happen, if any of them go back, of course. But you be -- who can judge what's going to happen here. It's impossible. And to overthink it, I think, is a waste of time. We're just prepared for it. We're not running all these models all the time because they change daily, hourly, as we all know. But I think we're better prepared for it than most that we're evidencing right now that we're covering it despite them increasing.

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Operator [24]

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Next question will come from Chris Horvers with JPMorgan.

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Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [25]

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So 2 questions. You mentioned December last year, obviously, the stock market dropped pretty sharply, and it seems like some of your peers at the high end saw a pretty big impact on that. So did you see that in your business, the impact of the market in terms of trends?

And then the second question is, you did mention demand comp. Last year, you talked about demand comp -- actual comp lagging demand comp by 150 basis points. That seems like an easy compare there? Is that something that helped comps overall? And how would you look at that?

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [26]

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So on the demand comp. So our furniture business is our fastest-growing business. And as you know, part of our tariff mitigation was to bring some of the upholstery back from China to America. And as a result, that upholstery is made to order, it is not stocked. So that is actually at work right now different from last year as part of our tariff mitigation, which means that when both of those things happen, you're going to continue to see this lag. And it's just the reality of a growing furniture business that's made to order. Julie, do you want to talk about the high end last year?

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [27]

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Yes, I don't think we saw as much as others have reported, the correlation between the stock market impact. We certainly had an impact in our results, but it wasn't as significant as others have said.

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [28]

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We could have done better last year. I mean last year, you remember the comps, and they were -- they were pretty flattish, except for West Elm.

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Operator [29]

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And next from Evercore ISI, we have Oliver Wintermantel.

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Oliver Wintermantel, Evercore ISI Institutional Equities, Research Division - MD & Fundamental Research Analyst [30]

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Julie, you mentioned e-comm grew about 9% in the quarter. Could you remind us or could you tell us what it grew in the first half? And if it accelerated, where the acceleration came from?

And then just to follow up to the B2B question quickly. Which -- when you said it helped comp by 100 basis points, what line item would that hit? Is that West Elm? Is that Pottery Barn? Maybe a little bit more detail where that actually is helping?

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [31]

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Sure. From an e-commerce perspective, it's been holding relatively around that spot all year long. So we're pleased to see that, that strong growth is continuing as we move throughout the year.

And from a B2B perspective, it's definitely across-brand. I would say it's predominantly in West Elm and in Pottery Barn, but it's across the brands.

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Operator [32]

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And moving on from UBS, we have Michael Lasser.

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Michael Lasser, UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines [33]

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A couple of part questions, but I hope you don't mind. First, as you look at the comp and you factor in like-for-like price increases and more full price selling because of less discounting, how much did those 2 factors contribute to the comp in the period?

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [34]

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That wasn't significant. Certainly, we saw higher AURs, but it wasn't the main driver of that. A lot of the big driver of that is the fact that we're selling just more furniture period. And more of the B2B operations is obviously more finished furniture driven as well.

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [35]

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And just remember, all of the strategy we've put into place to have the #1 furniture supply chain and then to also help people furnish their homes and make good decisions about what works together. And then our in-store design crew and Outward planner, all those things are coming together to drive that furniture, which is a much higher ticket than bedding or deck.

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Michael Lasser, UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines [36]

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And as we think about the Pottery Barn comp, should we assume that between PB Apartment, the expansion of the marketplace and the B2B, those were the 3 contributors to the comp growth during the period? Then I have one last part.

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [37]

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No. Those were big contributors, but I'll say, in this quarter, in particular, we launched a lot of new furniture that is off to a very strong start. And I've said this before, and I think you've all seen it, that when we get something that's new and it works, we have a long time to optimize that, add pieces to it. So for example, if you start with a coffee table, you can add a dining table and a bedroom collection, and so it's great to see those collections be so strong because that gives us a really strong foundation to build on. And that's not just in these new businesses. That's in the foundation and is what we're really excited about.

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Michael Lasser, UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines [38]

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And my last question is as we calibrate our models for 2020, how should we think about the outward expenses that you'll be excluding from the P&L? Will they -- will you include any of that? Or -- and will they get larger than they were this year?

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [39]

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No. So what we have said is that after this year, the Outward -- the operations from Outward will now be included within our P&L for 2020. The pieces that are associated with the acquisition of will continue until that's done, which is about another 2 years. And so you can square root the math. I think if you look at our Ks or Qs, there is some information in there for you to be able to determine how much is associated with the acquisition, and then you can come up with your estimates as to how much of that will be absorbed next year.

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [40]

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What's also going to be great is that, by the time we reach next year, all the key building bricks are going to be in place because this quarter we've just put in Pottery Barn Teen, and we continue to improve our cross-brand room planner, and there's a lot more to come next year with how that's going to work. We're also starting to really measure the impact and the lift from some of these tools, which is exciting. It's early days there. But as much as we're going to be incurring the cost of Outward next year, we're also going to be next year, really, for the first time, seeing the true benefits in the P&L from using the cross-brand room planner successfully.

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Operator [41]

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Next question will come from Simeon Gutman with Morgan Stanley.

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Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [42]

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My question, I'll put it into 2 parts. So the business seems to be growing well in both the consumer and the B2B channels. Can you talk about how your top line visibility is changing as a result? I think the B2B may have longer lead times, and so do you have a better sense of the business 6 months, 12 months out?

And then the part 2 of it is, what are the implications from the B2B growth for the margin profile of the company?

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [43]

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Sure. So B2B, we're pleased to have a second consecutive quarter of double-digit growth, and we continue to believe that's a tremendous opportunity for long term, as we told you, and we saw you, it's a very fragmented market. It's right for disruption. It's really hard for people to furnish their commercial spaces right now. And we are in advanced discussions with a number of Fortune 500 companies. We can't talk about them yet, but the progress we're making really reinforces the competitive advantages that truly set us apart in this very fragmented market. So we've said $2 billion. That's the number we believe in annual revenues. They're getting there faster than I would have thought, and I don't want to underestimate how quickly they can do it. But it's one of these things where if you get one deal done, it can really -- if you're doing something for a big chain and they take some of your products in a certain region, it can then expand rapidly as they then get used to working with you. So it's got a very fast multiplier.

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [44]

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And from a margin perspective, similar to what we talk about with franchise and things like that, there are certainly some pressure that happens on the gross margin line. But from an op margin perspective, it's accretive and it's definitely what you want us to keep moving forward on.

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Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [45]

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If I can just sneak 1 follow-up. If you think about the long-term target for margin stability, anything change in how you think about it, the mix between expense leverage or gross margin over time?

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Julie P. Whalen, Williams-Sonoma, Inc. - Executive VP & CFO [46]

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No.

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Operator [47]

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Okay. And ladies and gentlemen, that does conclude the question-and-answer portion of our call for today. I'd like to turn the floor back over to management for any additional or closing remarks.

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Laura J. Alber, Williams-Sonoma, Inc. - CEO, President & Director [48]

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Yes. Thank you all for being with us today. I hope you have a wonderful Thanksgiving and a great holiday season. Please shop with us, and we'll be looking forward to talking to you after the holidays is over.

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Operator [49]

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And ladies and gentlemen, that does conclude our call. Once again, we thank you for joining us today. You may now disconnect.