Earnings Call Transcript - WSM Q3 2022

Operator, Operator

Welcome to the Williams-Sonoma Third Quarter 2022 Earnings Conference Call. I would now like to turn the call over to Jeremy Brooks, Chief Accounting Officer and Head of Investor Relations. Please go ahead.

Jeremy Brooks, Chief Accounting Officer and Head of Investor Relations

Good afternoon, and thank you for joining our third quarter earnings call. I'd like to remind you that during the call, we will make forward-looking statements with respect to future events and financial performance, including guidance for fiscal '22. We believe these statements reflect our best estimates. However, we cannot make any assurances that these statements will materialize, and actual results may differ significantly from our expectations. The company undertakes no obligation to publicly update or revise any of these statements to reflect events or circumstances that may arise after today's call. Additionally, we will refer to certain non-GAAP financial measures. These measures should not be considered replacements for and should be read together with our GAAP results. A reconciliation of non-GAAP measures to the most directly comparable GAAP measure appears on exhibit one to the press release we issued earlier today. The call should also be considered in conjunction with our filings with the SEC. Finally, a replay will be available on our Investor Relations website. Now I'd like to turn the call over to Laura Alber, our President and Chief Executive Officer.

Laura Alber, President and Chief Executive Officer

Thank you, Jeremy, and good afternoon, everyone. We are proud of another strong quarter, generating an 8.1% comp or 25% on a 2-year basis and 50% comp growth on a 3-year basis, with record EPS growth of 12% over last year to $3.72 per share. These results reflect the continuation of backlog order fulfillment, strong product margins and disciplined cost control. Demand comps for the quarter were slightly negative. This continued outperformance reflects the unique strength of our multi-brand portfolio, our growth initiatives and ongoing execution of our talented team. Since we last spoke, the macro backdrop has become more uncertain. However, what has not changed is the large and fragmented space in which we operate, where no one player owns significant market share. We believe we have an ability to capture more of this market in any environment. We have and will continue to deliver results, leveraging our key differentiators, our in-house design, our digital-first but not digital-only capabilities and our value. These competitive advantages in combination with our growth strategies give us many opportunities for the future. As we talked about before, one of our largest is B2B, which had another excellent quarter, driving over $30 million in demand, a 17% increase compared to last year. We continue to believe our B2B business presents a sizable growth driver for us as it disrupts an underserved estimated $80 billion total addressable market. B2B is building velocity with large and repeat projects from commercial and hospitality partners like Marriott and Hilton. We are also focused on diversifying into new industry verticals, including the healthcare space through multiproperty partnerships with national accounts. In September, we successfully launched our improved corporate gifting and custom merchandise services, and we are encouraged by the early success leading into the holiday season. A key B2B customer of ours for over 3 years now is Starbucks. We are thrilled to publicly announce that our team was able to assist Starbucks with the build-out of the gorgeous 3-story flagship reserve store in the Empire State Building. In addition to incorporating furniture from Brooklyn-based West Elm, our B2B team had the opportunity to work with Starbucks to create custom furniture solutions to meet their unique needs. We look forward to growing our existing relationship with Starbucks. And now I'd like to talk about our global business where we continue to expand in key markets and grow our multichannel presence. In Q3, we saw strength in both franchise and company-owned. In the franchise business, we believe that one of our biggest opportunities is in India. After launching our website earlier this year, we opened our first Pottery Barn store in New Delhi, joining our West Elm stores in New Delhi and Mumbai. We plan to continue to focus on India and in early 2023, will be adding stores across our brands and continuing to improve our online experience with our great partner, the Reliance Group. In our company-owned business, I want to highlight Canada, where we successfully relaunched our website this year across all the brands, driving order fulfillment and improved omni experience. Another important initiative is sustainability for which we continue to be recognized for our impact initiatives and ESG leadership across the home furnishing industry. In Q3, we were named a top score on the Sustainable Furnishings Council wood furniture scorecard for the fifth consecutive year, and West Elm received the Ford Stewardship Council Leadership Award for its use of FSC certified wood. We recognize there is much more work to do in this space, and we are committed to continuing to be a leader in planet, people and purpose. One of our sustainability initiatives is our goal to plant 6 million trees across our family of brands in partnership with the Arbor Day Foundation. We are excited to report that we have planted over 2 million trees to date. Now let's turn to the performance of our brands. Pottery Barn delivered yet another very strong quarter with a 19.6% comp or 35.5% on a 2-year stack and almost 60% on a 3-year stack. Pottery Barn continues to perform, offering exclusive high-quality inspirational products and strategic growth areas like apartment, marketplace and bath renovation are driving results. We're particularly proud of our accessible home collection, which launched in late July and has quickly scaled. West Elm delivered a 4.2% comp in the third quarter or 26.6% on a 2-year stack and 48.4% on a 3-year basis. During the quarter, we improved our in-stock inventory position, and we expect to continue to make improvements in our service levels into Q4 and next year. We are also very focused on improving our e-commerce experience and customer-facing conversion-driving initiatives. I've had the opportunity to spend a lot of time with West Elm this quarter, and I am very impressed with the talented and passionate team running the brand. Our greatest opportunity at West Elm is doubling down on what has made this brand great: our commitment to design innovation and value price points. Now I'd like to update you on the Pottery Barn children's home furnishings business, which ran a negative 4.8% comp in Q3 but a positive 12.1% on a 2-year basis and a positive 35.9% on a 3-year basis. We continue to see ongoing recovery in our in-stocks. Looking to the future, we have a strong pipeline of products at compelling values. The Williams-Sonoma brand ran a negative 1.5% comp in Q3, but a positive 6.1% on a 2-year and a positive 36.5% on a 3-year basis. We continue to see that people are hosting and entertaining at home. And as such, we saw strength in entertaining areas. In Q3, we successfully kicked off the holiday season with our exclusive collaboration with celebrity chefs and author, Ina Garten. As part of this collaboration, Ina shared Thanksgiving tips for cooking and hosting the ultimate Thanksgiving dinner party. We also announced the exciting launch of a collaboration with renowned British heritage textile brand, William Morrison Company. Williams-Sonoma Home delivered another double-digit comp in Q3. We continue to see this business as an opportunity to deliver outsized growth by picking up market share from the limited luxury high-end home market. We're excited to launch an expanded furnishing line for the kitchen in Q4. As we look to the holiday season, we are prepared to meet the needs of our gift-giving customers with compelling product offerings. Our stores are a competitive advantage, and they are stocked, and our associates are ready to serve our customers. And finally, our emerging brands, including Rejuvenation and Mark and Graham, together, ran a 7.8% comp this quarter. At Rejuvenation, we saw success in remodel categories related to kitchen and bathroom, including vanities, cabinet hardware and wall widening. At Mark and Graham, wins were from the travel category, including luggage and travel accessories. We are proud of our third quarter results, but we are also aware that economic uncertainty is on the minds of consumers and investors alike. During the third quarter, we experienced deceleration and choppiness in our demand, and it is hard to know where the economy is going or how long the uncertainty will last. Nonetheless, we are controlling what we can control and looking at opportunities to reduce costs without an impact on the customer experience. In fact, we believe that protecting service and innovation is key to outperforming our peers. As it relates to pricing, we continue to be committed to not running site-wide promotions as we did before the pandemic, but we will continue to mark down and clear overstocks. We are working with our vendors to reduce costs and pass on that value strategically to our customers. As for additional expenses, out-of-market and redundant shipping expenses and transportation costs have negatively impacted our gross margin. We continue to focus on these pressures, and mitigation of these costs will be a significant benefit for us in the future, particularly in the second half of next year. In summary, we are conscious that the home furnishings market may contract due to macro factors. If this happens, we believe we are uniquely positioned to take market share even if there is a downturn, and here's why. We built a company of loved brands with a shared platform of competitive differentiators that leads the industry, in-house design, digital-first but not digital-only platform and our value. We have identified opportunities for growth through strategic initiatives like B2B, global and marketplace where we have the opportunity to disrupt. Finally, we have a culture of innovation and an experienced team who knows how to increase operational efficiencies and control costs while protecting service and driving new growth opportunities. Now I will turn it over to Jeff to walk you through the results in more detail in his first earnings call as CFO.

Jeff Howie, Chief Financial Officer

Thank you, Laura, and hello, everyone. I am so pleased to join you today for my first earnings call in my new role as Chief Financial Officer. While I'm relatively new to this particular role, I am a 20-year member of the Williams-Sonoma leadership team. I come into this role with deep knowledge and experience across our brands, operations, and financials. I look forward to applying my breadth and depth of experience to drive continued strong results. Diving into our third quarter results, we delivered another quarter of record revenues and earnings in a challenging environment. Our top line results illustrate our ability to gain market share. Our bottom line results demonstrate the power of our operating model to sustain merchandise margins and control SG&A expenses. Net revenues grew to $2.2 billion, with comparable brand revenue growth at 8.1% for a 2-year comp of 25% and a 3-year comp of almost 50%. Our revenue growth was driven by strong order fulfillment, ongoing momentum in our growth initiatives and our continued ability to take market share, even as we experienced inconsistent demand within our portfolio of brands and across the quarter. Both channels continued to experience strong growth, with retail at a 16.9% comp and e-commerce at a 4.4% comp. Moving down the income statement, gross margin was 41.5%, 220 basis points below last year and in line with our expectations. We sustained strong merchandise margins that were flat year-over-year. We remain committed to our decision to no longer offer site-wide promotions and preserve the pricing integrity our proprietary, differentiated product commands. The strength of these merchandise margins is particularly impressive given we absorbed significant cost increases from our vendors and ocean carriers, including higher demurrage and detention charges. As expected, the gross margin decline was driven by higher outbound shipping costs. This is due to our increased furniture mix, higher back order fulfillment and incremental freight costs. We also incurred higher costs to best serve our customers by shipping from out-of-market distribution centers and in some cases, shipping multiple times for multiunit orders, which typically would have been fulfilled in a single shipment. Occupancy costs at 9.2% of net revenues were 30 basis points above last year, with occupancy dollars increasing 10.5% to approximately $202 million. Our ongoing retail store optimization initiative partially offset incremental costs from our new distribution centers on both the East and West Coast. These new distribution centers will support our long-term growth, improve service time for our customers and drive cost efficiencies over time. Our SG&A rate continues to be at historic lows at 26%, leveraging 150 basis points over last year, driven by advertising and employment leverage. Our advertising leverage reflects the agile, performance-driven proficiency of our marketing team; our in-house capabilities, first-party data, and multi-brand platform allow us to test, learn and scale, which is a unique competitive advantage. Our SG&A leverage also reflects our culture of financial discipline, where we consistently challenge all expenses for return on investment and drive operational efficiency throughout the company. On the bottom line, we delivered another record quarter of earnings. Q3 operating income grew 2% to $340 million, and we delivered a strong operating margin at 15.5%, only 80 basis points below last year despite significant headwinds and cost pressures. Our diluted earnings per share of $3.72, was up 12% from last year's record third-quarter earnings per share of $3.32. On the balance sheet, we ended the quarter with a cash balance of $113 million, with no debt outstanding and year-to-date operating cash flow of $588 million. That enabled us to fund the operations of the business and expand our capital investments to support our long-term growth. In addition, year-to-date, we have returned excess cash of over $1 billion to shareholders through $165 million in dividends and $840 million in share repurchases. These decisions reflect our commitment to maximizing returns for our shareholders. With our strong and disciplined balance sheet, combined with our expected free cash flow, we have flexibility to continue to invest in the growth of the business and opportunistically invest in our own stock and drive long-term shareholder returns. Moving down the balance sheet, merchandise inventories, which include in transit, were $1.688 billion, increasing 33% over our reduced level of last year. Inventory on hand increased 34% over last year, but was up only 11% to 2019 versus sales up 52% over the same timeframe. In the quarter, back order levels decreased but remained well above historical levels. We are working hard to get these goods in to fulfill our customer orders but continue to anticipate our backorder levels will remain elevated in the first half of '23. Summarizing our Q3 results, we are proud to have delivered another quarter of record revenues and earnings. I would like to thank all our associates for their hard work and dedication in driving these great results. Now turning to our expectations for the remainder of the year and beyond. We acknowledge that the near-term macroeconomic picture remains uncertain, with conflicting economic signals surrounding consumer spending trends, decade-high inflation and Federal Reserve monetary policy, intentionally moderating economic demand. Additionally, our trends have been increasingly inconsistent and less predictable. This combination of conflicting economic signals and inconsistent trends makes our guidance unusually difficult to predict. However, we remain confident in our ability to operate in any environment, and are, therefore, reiterating our fiscal year '22 guidance of mid- to high single-digit revenue growth with operating margins relatively in line with fiscal year '21. Our outlook is grounded in three factors. First, we are currently in the early stages of our upcoming holiday seasonal ramp with the biggest weeks yet to come. Second, our Q3 quarter demand trends support a wide range of outcomes. And third, the ongoing improvement we see in fulfillment of our customer order backlog. From a profitability perspective, as we said in our last call, we continue to expect cost pressures to persist for the balance of fiscal year '22 and into the first half of '23, primarily across our supply chain. These headwinds include our incremental distribution centers, higher product and freight costs, and our efforts to best serve our customers by delivering products as timely as possible. Our capital allocation strategy remains unchanged. In fiscal year '22, we expect capital expenditures will be approximately $350 million. We plan to continue to return excess cash to our shareholders through quarterly dividends and opportunistic share repurchases. While the near term may be uncertain, the current management team has successfully navigated challenging environments before, including the 2008 great financial crisis and the 2020 global pandemic. We know the levers to pull, and we have already taken steps to reduce costs and inventory to mitigate downside risk. Given the increased macro uncertainty, we will not be reiterating or updating our fiscal year '24 guidance at this time. We will be providing guidance for fiscal year '23 and beyond at our next call. We remain confident in the long-term fundamentals of our business. Our confidence remains rooted in our ability to take market share in the fractured home furnishings industry. The strength of our in-house proprietary design, the competitive advantage of our digital-first but not digital-only channel strategy, the ongoing strength of our growth initiatives and the resiliency of our fortress balance sheet. Having been here before, we see opportunity to take an offensive stance in a challenging macro environment. In summary, we are very proud of our results. We continue to deliver for our customers, our associates and our shareholders. Now I'd like to open the call for questions. Thank you.

Operator, Operator

Your first question comes from Peter Benedict with Baird.

Peter Benedict, Analyst

My first question is about inventory. Could you provide more insight into your comfort level with the current balance of furniture versus non-furniture? It appears you have modified some receipts in light of the softer macro environment. What level of inventory are you comfortable operating with? Currently, it seems to be around 120 days, whereas you previously operated at approximately 100 days before COVID. Are there any benchmarks that could help us understand how inventory might change based on various sales scenarios as we move into next year?

Laura Alber, President and Chief Executive Officer

Thanks, Peter. I'm going to let Jeff take that one.

Jeff Howie, Chief Financial Officer

Peter, when you think about inventory, I really think it's tough to look at it on a one-year basis. I know we're up 33%. But if you think about this time last year, we were at our most aggressive inventory levels because if you think back to last year, that's when Southeast Asia was really closed, and we were still seeing the residual impacts of the COVID closures from India and China. So we're at our lowest inventory level at that point. We really like to look at it on a three-year basis, where our three-year on-hand inventory is up 12% versus our sales up 52% over the same time period. How we're thinking about it is we're making progress, but there's still a lot more work to do. Our backlog remains at historically high levels, and we're working hard to get our composition right as well as our location of our inventory to serve our customers best. We anticipate our inventory levels and our back orders to gradually improve through Q4 and in the first half of '23.

Peter Benedict, Analyst

That's helpful. For my second question, I understand the environment is unpredictable, but it seems you have some insights regarding out-of-market shipments and other items that could lead to savings. Can you provide some perspective on the potential size of these opportunities as we consider the second half of 2023 and how they might impact the profit and loss statement?

Jeff Howie, Chief Financial Officer

Thanks, Peter. I think that's a great question, and it's really how we're looking at it. So we have tremendous headwinds right now, particularly on our gross margin from higher product costs, higher inbound ocean costs. As you mentioned, higher out-of-market costs as well as shipping multiple shipments to the same customer for the same order when we should really be shipping it once. That right now for Q4 and into the first half of '23 is a headwind, and it will be impacting our margin. But we're pretty optimistic as we look to the back half of '23 and into '24. This is going to be a substantial tailwind and give us a lot of room to sustain our margins.

Operator, Operator

Your next question comes from the line of Steve Shemesh with RBC Capital Markets.

Steven Shemesh, Analyst

First one is on the slightly negative demand comp in the quarter. Can you share any additional perspective on how demand trended throughout the quarter and, I guess, where we stand in the first few weeks of November? And then as a follow-up on the backlog. I mean, it seems like the supply chain lead times improved pretty meaningfully throughout the quarter. Just curious if that materially changes your view on when you'll clear the backlog. I know you still said first half '23, but to the extent that's true, just curious why that wouldn't clear sooner.

Jeff Howie, Chief Financial Officer

Steve, let's address your question about demand first. The demand during Q3 was very inconsistent across our brands. We started strong with mid-single-digit comps, as we mentioned in the Q2 call, but it declined significantly after Labor Day when the Fed announced its fourth rate hike. Looking at the trends, whether for one year, two years, or three years, the data showed inconsistency. One-year figures decreased over the quarter, two-year figures fluctuated, while three-year figures actually improved. Therefore, it has been hard to assess the situation, and we characterize it as inconsistent and choppy. Nevertheless, we are confident that even in this challenging environment, we are gaining market share. As for your second question about the backlog, we still have a lot to accomplish, as I noted earlier. The backlog is substantial. Some of the challenges we face include delivering in the right locations and with the right composition to complete multiline orders for customers. We anticipate that resolving these issues will extend into Q4 and the first half of next year before we fully normalize our operational activity.

Operator, Operator

Your next question comes from the line of Cristina Fernandez with Telsey Advisory Group.

Cristina Fernandez, Analyst

I wanted to ask also on demand, but a different way. It seems like performance by brand is diverging. I assume that's the same on the demand level. Any insights you have into customer age or income that you see changes in how the different cohorts are responding to your products?

Laura Alber, President and Chief Executive Officer

Thank you, Cristina, for the question. You can clearly see the strength of Pottery Barn by looking at the net comps. They've been outperforming, while the other brands are in a similar range. However, it's important to consider more than just a one-year view. When looking at West Elm over a three-year period, the performance is quite strong and not as distant as it may seem. Regarding the demos, I am cautious about making significant conclusions as the data is sensitive. The only trend we observe is that lower income groups are more affected, while there doesn't appear to be a major age-related issue. This aligns with expectations. Fortunately, our core customer base remains fairly affluent. Much of this situation stems from uncertainty, as there haven't been significant changes. Home values have appreciated, and savings levels are higher than pre-pandemic. Depending on macroeconomic developments, this situation could be temporary. However, if the macro environment deteriorates, leading to wage losses and continued actions from the Fed to curb growth, it could further impact those customers. This is why we've been cautious about providing guidance for 2024. It's not a lack of confidence in our business, but rather the unpredictability of the macro environment. If conditions remained constant, we could make predictions, but things are changing rapidly. We aren't economists, but we do have many levers we can pull and effective growth strategies in place. We've discussed B2B, the marketplace, and global initiatives. When you examine our brands, you'll find exciting initiatives that are yielding great results, especially the accessible home concept for Pottery Barn, which we believe can be applied across all brands. Despite the uncertain environment, we feel we're in a strong position, similar to how we navigated past challenges like the 2008 crisis or the pandemic. People tend to worry about potential downturns, but we usually come out ahead of the competition.

Cristina Fernandez, Analyst

And then as a follow-up. If demand were to slow further, can you give some examples of the levers you can pull on the cost side to preserve as much of the operating margin, if you can?

Laura Alber, President and Chief Executive Officer

Go ahead, Jeff.

Jeff Howie, Chief Financial Officer

Sure, Cristina, we have quite a few levers, particularly on our SG&A line, where advertising, we can definitely adjust as we go. The nice thing here is we have our own hands on the keyboards with our in-house marketing team who's really agile and performance-driven. We also have opportunities on employment, which, of course, leverage with sales with most of our employment in our distribution centers and stores and call centers. And then there's a number of other cost efficiencies we can drive throughout our operations to continue to leverage our SG&A to help our operating margin.

Operator, Operator

Your next question comes from the line of Adrienne Yih with Barclays.

Adrienne Yih-Tennant, Analyst

I'm sorry if I missed this, but could you, Jeff, provide the current digital penetration or growth for the quarter? And Laura, I'd like to congratulate you on the Starbucks achievement. Could you discuss what you believe the future looks like following the renovation of their store fleet? Additionally, Laura, regarding international expansion, you're opening company-owned stores in Canada. Are there any other markets you are considering for company ownership rather than franchising?

Laura Alber, President and Chief Executive Officer

Okay. Let me discuss India. Jeff and I had the opportunity to visit and see our stores there. At that time, only West Elm was open, and I can tell you, it measures up to any store in the United States. Our partners at the Reliance Group excel in digital efforts and marketing campaigns, and the collaborations we're involved in are impressive. We realized we need to invest even more time in this market because it has a rapidly growing middle class that has a strong interest in high-quality design and products. There's little competition, so we are the first to offer a complete lifestyle suite of products. It reminds me of the early days of Pottery Barn when we introduced furniture to our stores in the '90s. This represents a significant opportunity, and we are excited to have such a strong partner. Having a strong partner in remote and challenging markets is essential. Canada is significantly easier to navigate than India or the Middle East, where collaboration with a local partner is necessary. Currently, we have no plans to open company-owned stores elsewhere. However, there may be a future opportunity for direct-to-consumer sales in Europe when the timing is appropriate. At present, I believe this is not the right time, but we can pursue direct-to-consumer through our existing platform in the U.K. Okay. Starbucks. We're thrilled we finally can talk about this. We've been working closely with them for 3 years. We've been doing a lot with them. What I can say that I think they're going to be okay with me saying is that they're great partners, and they've been very creative with us to allow us to do some designs for them to their specs, for their stores. We've really built this partnership up. I don’t know if you’ve been to that flagship; I just got the pictures and it is spectacular. That's one of many that we've done. You'll start to notice and see us popping up, but I can't give you any sort of roadmap of scale on the Starbucks other than to say it's one of the many great opportunities that we have. We continue to really believe that B2B is going to be bigger than anyone expects.

Jeff Howie, Chief Financial Officer

Sure. Adrienne, we're proud of both of our channels, and they both really did a great job this past quarter and delivered strong results. Retail was up 15.9%. To get to your question, B2C delivered a 4.4% comp and was sequentially in line with our Q2 results, coming about 65% of the total. Long term, we continue to see e-comm growing to 70% of revenues, but both channels remain part of our digital-first but not digital-only channel strategy, and we're happy to serve the customer in every channel they want to shop in.

Laura Alber, President and Chief Executive Officer

I'll just also add, Adrienne, that when you really think about last year, Thanksgiving to Christmas, this is the time when, unfortunately, for a lot of people, Thanksgiving or Christmas or both or Hanukkah got canceled. Gatherings got canceled because of COVID. So it wasn't a full open that it is now. I actually believe that retail is going to be the big winner of this holiday season. I think you can see people are out and about. We're really stocked and ready to go. We are staffed. We have the goods in the stores already, and we put them there earlier so we can capture the sales. We also have something we never had before pre-pandemic, which is our omni services. So of course, BOPIS is a thing everybody does. Shipping from store is not something that everybody does, but we have learned to get quite good at it. Shipping to the store is something we do. We've enabled shipping to any store in the company. This past summer, we saw great results in our dorm strategy. I think this will continue to build, not just because we don't have stores in every market, but because it's also a convenience play as people are back in the office more and some people don't want to have to wait at home for their packages to be delivered. This is a way to get around having to be there and wait for it to arrive at your porch. So this is yet another example of how we're taking omni, and it optimizes the retail inventory. If I'm wrong and retail isn't as good as I think it's going to be, this inventory can be shipped against DTC orders, which I think is a really exciting advantage that we have that brands without retail don’t have the opportunity to achieve.

Operator, Operator

Your next question comes from the line of Anthony Chukumba with Loop Capital.

Anthony Chukumba, Analyst

I have two quick questions. First, I'm really excited about Starbucks. In the past, you mentioned that you expected B2B sales to reach about $1 billion this year. I just wanted to confirm if that's still the expectation. My second question is regarding the competitive environment. I see you're continuing to eliminate site-wide promotions, which I completely agree with. However, are you noticing any increased promotional activity from your competitors?

Jeff Howie, Chief Financial Officer

Sure. We see our track on B2B just continuing to propel forward, and we are on track to hit the $1 billion this year. The demand pipeline through our projects and our major partners continues to be strong, and we're very confident in our ability to get there. From a long-term standpoint, it is such a fractured market, total addressable market, $80 billion. We think we have a really compelling proposition with our portfolio of brands, our in-house design, our global sourcing capabilities to really capture this. We're seeing a lot of promising signs out there in terms of pent-up demand for renovations in hotels and restaurants. We think it’s quite a great opportunity for us.

Laura Alber, President and Chief Executive Officer

Jeff, do you want to go ahead with the second part of the question?

Jeff Howie, Chief Financial Officer

Certainly. We’re definitely seeing more promotions in the environment as the economy softens. A lot of retailers have been talking about that this week. Our approach has been very consistent in terms of the level of promotions that we've been doing. I want to reiterate that we remain committed to not offering site-wide promotions in our brands, and we will do whatever it takes to continue to not do that. We think that our in-house design proprietary product really resonates with the customer because of its differentiation and commands its own pricing power, and we're seeing that in our results.

Operator, Operator

Your next question comes from the line of Max Rakhlenko with Cowen.

Max Rakhlenko, Analyst

So first, on the gross margin pressure, how would you quantify the various headwinds, just putting them into different buckets? And then how should we think about that pressure in Q4? And just any color on puts and takes into the quarter there.

Laura Alber, President and Chief Executive Officer

Thanks, Max. I'm giving that to Jeff, too.

Jeff Howie, Chief Financial Officer

All right, thanks, Max. I think all of them are heavy pressures on our gross margin, as we've been communicating. There's the product costs, which have been with us all year as part of inflation. There are ocean costs, which, although we see ocean costs overall coming down, we still have those costs in our balance sheet and need to sell through that higher-cost inventory. Our shipping costs domestically have been high, as we talked about because of the out-of-market and shipping multiple times to a customer. As I said in the answer to the first question, we still have quite a bit of work to do to get our inventory in the right composition as well as the right location to properly service our customer and work on this backlog we have. We think it will continue to be a headwind for Q4 and into the first half of '23. The thing I'm really optimistic about is when we turn the corner, when we start to look at the back half of '23 and into '24, it's going to be a tremendous tailwind. I'm optimistic that we can really sustain our margins when I think about all the cost pressures we've been under and still delivered the results we're delivering today.

Laura Alber, President and Chief Executive Officer

The other piece of this is we are starting to see our vendors reduce their pricing to us. In some cases, it's going to be important to pass along part of that to the consumer because everybody had to take a price increase. When it comes down, we want to make sure that we have the best value out there. So we’re always scrubbing to see how our design compares to the competition. How's our quality, how's our sustainability and how is our price? As we get better prices from our vendors, there will be some that are passed along to the consumers so that we can continue to grab market share by offering an even better value.

Operator, Operator

Your next question comes from the line of Oliver Wintermantel with Evercore.

Oliver Wintermantel, Analyst

Jeff, congratulations on the new role. I had a question regarding retail. I think you said up 16%, 16.9%. Can you give us a little bit more detail what drove that? Is that AUR? Or is that mix or traffic versus ticket? That would be great.

Laura Alber, President and Chief Executive Officer

Okay, Oliver. It’s Laura. Remember, the 16.9% is the net comp, not a demand comp. It's driven by AUR and the resulting traffic fill from the previous sales. As we look at demand comps now, at retail, our traffic is better than our competition, better than the industry, which is really exciting. Christmas and the holidays is the time that people love to come into our stores. I've said before, you salivate just thinking about walking into a Williams-Sonoma store. We're really focused on conversion, and we have the traffic. That's why I tend to be quite optimistic that retail is going to continue to over-deliver in the short term.

Oliver Wintermantel, Analyst

Got it. And my second question was regarding B2B. If you just think about the macro environment and let's say there's a slowdown, how do you think B2B is holding up versus the consumer business? Do you think there are more headwinds? Or could that hold up better than the consumer business?

Jeff Howie, Chief Financial Officer

That's a great question, Oliver. I think that the B2B business will hold up stronger potentially in a soft macro environment than the consumer. If you think about the dynamics of the past couple of years, the consumer market took off during the pandemic as people were home and started shopping. Now that's possibly trailing off a little bit with the Fed's monetary actions and the macroeconomic environment. B2B, on the other hand, a lot of those verticals were shut down for several quarters and even over a year. There was a big backlog of work and renovation work and projects that weren't done. All that pipeline of those deferred projects is coming online now. We're seeing it in the RFPs we have out, and there's just a general energy about the amount of projects that are out there. Funded projects, a lot of renovations. I think there's just a pent-up demand. It could be counter-cyclical if there’s a macroeconomic downturn.

Operator, Operator

Your next question comes from the line of Steven Zaccone with Citi.

Steven Zaccone, Analyst

I'll extend my congrats to you, Jeff, as well on the new role. First question I had was just how much do you think the competitive environment is factoring into the slowing demand trends that you're seeing in your business? The macro is difficult, we understand, but the home furnishing industry has also gotten a little bit more promotional. And I guess, Laura, as you look across the industry, are you concerned inventory levels are getting high in the channel?

Laura Alber, President and Chief Executive Officer

Yes, it's interesting how the competitive environment has always been promotional. If you think back, even before the emergence of new start-ups, Macy's and several other major players have always been involved in the home business. Amazon and Wayfair have consistently prioritized price. What sets us apart is that we design our own goods, which we've been doing for many years. We often lead with new trends and can introduce finishes that others struggle to replicate. Even when they try to imitate us, they fall short. If you compare our furniture and other categories to theirs, you'll notice a significant difference in quality and pricing, and even with their markdowns, our value remains superior. We keep looking at that, whether it’s the sofa, the coffee table, or the rug. I mean, when you take a product down like-for-like and you really look at it in person, at the price, I feel good about where we sit. There are always a few exceptions. There are always a few opening price points that I wish were sharper. The opening price points are the places I want to get back to be more competitive as we were pre-pandemic. Those are areas where I think everybody got a little too high. In total, I don't think it's a competitive pricing issue because it's hard to match our goods against anyone else's goods. In terms of inventory in the channel, Bed Bath & Beyond has a ton of inventory that they're pressing and going to continue to press at deep markdowns. That one might be the biggest factor. Wayfair and Amazon, those guys are the biggest out there, but it’s just a very different business. You might buy one thing from them for your garage or something, but you're not going to furnish your living room from some of those brands. Our customer wouldn't anyway because they’re looking for a much higher quality level and design sensibility. They want someone to help them put it together. Fascinatingly, even with this different hand than we expected to be dealt right now, it's an exciting time to think about what the company we want to look like and again, make improvements to. If this is a recession, what are we going to look like on the other side of it? When you saw us come out of '08, we were stronger. We're much stronger coming out of the pandemic, and whatever this will be, we're going to be much stronger coming out of this, too.

Operator, Operator

Your next question comes from the line of Chuck Grom with Gordon Haskett.

Charles Grom, Analyst

Historically, there's been a nice lead, lag relationship between housing turnover and furniture sales. I'm curious, Laura, do you think that relationship still exists? Or has it been decoupled? If you listen to the home improvement names over the past week, they're seeming to suggest that this time is different and that we are seeing some decoupling, which could indirectly be good for your business over the next couple of years.

Laura Alber, President and Chief Executive Officer

Yes. I mean, I just think this is more of a people being nervous situation. As I said earlier, Lowe's, Home Depot, they're really very optimistic. I'm sure everybody listened to their calls, and people still love their homes. The sentiment is still I want a nicer home. I want a second home, a bigger home. Now, they aren't buying one because nobody wants to buy right now. That doesn't mean you don’t still love your home or you don’t want to spend money on it. A lot of those renovation projects are still lagging from the pandemic when you couldn’t even get a refrigerator, right? You still can’t get a refrigerator. You're not done with your kitchen, so you're not finished yet. Those projects are still lagging and should be a big upside as they finish those projects and spruce up the furnishings. If you spend a lot of money on your new bathrooms and your new kitchen, which are generally where people go first, you usually buy furniture next. It should be a positive thing for us. What I think is happening is, right now, is more fear than reality, and we'll see what happens.

Charles Grom, Analyst

And then I know directionally, B2B is more accretive than the traditional retail business. But clearly, some of the optimism, I think on the longer term, margin structure is in B2B, particularly as it ramps. Could you or Jeff just maybe speak to some of the buckets of why that B2B business is so much stronger on the margin front because I think it would help bridge the gap from some of the fears on some of the costs starting to come back into the P&L as an offset.

Jeff Howie, Chief Financial Officer

A couple of things there, Chuck. First of all, B2B is slightly accretive to our op margin. The dynamic there is you don’t have the overhead of some of the retail and not as much advertising costs. This will lend some accretion from that standpoint. But I think when you think about the costs that are hitting the P&L, the second part of your question, we have to think about that in two phases. The first is the near term, which is Q4 and the first half of '23, where we're seeing higher product costs, higher inbound shipping costs and all of our additional costs as we work through our backlog. That will become a tailwind for us. As we turn the corner and head in the back half of '23 and '24, I think in and of itself will support our margins long-term. B2B will really just be the icing on the cake on top of it.

Operator, Operator

Your next question comes from the line of Seth Basham with Wedbush Securities.

Seth Basham, Analyst

My first question is around merchandise margins. You guys have been doing a great job holding the line on merchandise margin despite some of the pressures. As you move forward, could you help us understand the puts and takes the arc of merchandise margins in the fourth quarter and through the first half of 2023?

Jeff Howie, Chief Financial Officer

Thanks, Seth. We don't guide specific line items like that, but we are giving you guidance on the overall direction of gross margin, with merchandise margin being one component. We do see headwinds there in Q4 and in the first half of '23 for all the reasons we've talked about: product costs, ocean costs and our own challenges with getting through our backlog with out-of-market shipments and multiple shipments to customers. Again, I think that becomes a huge tailwind. As we look to the back half of '23 and '24, that gives us optimism for the long-term sustainability of our margins.

Seth Basham, Analyst

Got it. Just to frame the question differently then, Jeff. Thinking about the merchandise margins and how you've been able to hold them flat year-over-year given the level of inventory that's rising and the likely higher level of clearance and discontinued lines that you'll have going forward, would you expect to be able to offset those pressures on merchandise margins with things like product costs and inbound shipping cost reductions?

Jeff Howie, Chief Financial Officer

I think one thing to think about with our inventory that's different from, say, an apparel or fashion retailer, is we have a much higher penetration of the core. We don't have that seasonal pressure to move like other companies in the retail industry do. From a long-term perspective, again, looking to the back half of '23 and into '24, these headwinds we're experiencing become tailwinds, and we will have opportunities to improve the margin from a long-term standpoint.

Operator, Operator

Your next question comes from the line of Brad Thomas with KeyBanc.

Bradley Thomas, Analyst

Two financial questions, if I could. The first just thinking about sales for the fourth quarter, I know you reiterated the full-year guidance, but technically, if we back into what's implied, it's a pretty wide range. Wondering if there's any more color you could share with us with how to think about the fourth-quarter revenues. And then we get a lot of questions about the structural margins of Williams-Sonoma, and it does seem to me that you've done some great things with the brands and probably deserve a higher merchandise margin than pre-pandemic levels. Similarly, you've done a great job of getting more efficient with occupancy expense and having a greater mix of e-commerce sales, and perhaps that should support a higher margin. But I would love to hear your latest thoughts on perhaps what structural margins look like as we think about maybe slower trends ahead.

Jeff Howie, Chief Financial Officer

Okay. Let's start with Q4 implied sales. Yes, it's a wide range. As I spoke to in my prepared remarks, we saw a tremendous amount of choppiness in Q3. The result of that choppiness is there’s a wide range of estimates. Our guidance is a blend of those ranges of estimates and reflects our best estimate of what we see potentially happening in Q4. In terms of the structural margin, there's been a lot of change within the structural margin. Here, there's been quite a bit of change in how we've really improved our operating model. The elimination of site-wide promotions is really buttressing our merchandise margins and giving us a lot of opportunity to sustain that. It reflects something we learned during the pandemic: our proprietary differentiated product that our in-house design produces commands its own price in the marketplace. The second thing is, throughout the pandemic, we really improved the profitability of our retail stores, and as mix has shifted to e-commerce, which by nature is more profitable for us. A combination of those different factors helps us sustain the margin. Over the long term, we see additional opportunities to take costs and drive efficiency throughout our P&L.

Operator, Operator

This concludes our question-and-answer portion for today. I now turn the call back to management for closing remarks.

Laura Alber, President and Chief Executive Officer

Yes. Thank you all for joining us. I want to wish you a very happy holiday season and look forward to talking to you next year.

Operator, Operator

This concludes today's conference call. Thank you for attending. You may now disconnect.