UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM10-Q

(Mark One)

For the quarterly period ended July 29,October 28, 2018.

or

For the transition period from    to    

Commission File Number:001-14077

WILLIAMS-SONOMA, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:(415) 421-7900

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of RegulationS-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company” and “emerging growth company” in Rule12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of August 26,November 25, 2018, 80,554,86680,155,276 shares of the registrant’s Common Stock were outstanding.

WILLIAMS-SONOMA, INC.

REPORT ON FORM10-Q

FOR THE QUARTER ENDED JULY 29,OCTOBER 28, 2018

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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WILLIAMS-SONOMA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See Notes to Condensed Consolidated Financial Statements.

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WILLIAMS-SONOMA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE A. FINANCIAL STATEMENTS - BASIS OF PRESENTATION

These financial statements include Williams-Sonoma, Inc. and its wholly owned subsidiaries (“we,” “us” or “our”). The Condensed Consolidated Balance Sheets as of July 29,October 28, 2018 and July 30,October 29, 2017, the Condensed Consolidated Statements of Earnings, the Condensed Consolidated Statements of Comprehensive Income for the thirteen andtwenty-six thirty-nine weeks then ended, and the Condensed Consolidated Statements of Cash Flows for thetwenty-six thirty-nine weeks then ended, have been prepared by us, without audit. In our opinion, the financial statements include all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position at the balance sheet dates and the results of operations for the thirteen andtwenty-six thirty-nine weeks then ended. Intercompany transactions and accounts have been eliminated. The balance sheet as of January 28, 2018, presented herein, has been derived from our audited Consolidated Balance Sheet included in our Annual Report on Form10-K for the fiscal year ended January 28, 2018.

The results of operations for the thirteen andtwenty-six thirty-nine weeks ended July 29,October 28, 2018 are not necessarily indicative of the operating results of the full year.

Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been omitted. These financial statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in our Annual Report on Form10-K for the fiscal year ended January 28, 2018.

Reclassifications

Certain amounts reported in our Condensed Consolidated Balance Sheets as of January 28, 2018 and July 30,October 29, 2017 and our Condensed Consolidated Statement of Cash Flows for thetwenty-six thirty-nine weeks ended July 30,October 29, 2017 have been reclassified in order to conform to the current period presentation. These reclassifications impacted prepaid catalog expenses, prepaid expenses, goodwill, other long-term assets, accounts payable, accrued expenses, gift card and other deferred revenue and other current liabilities. There was no change to total current assets, total assets, total current liabilities, or cash flows as a result of these reclassifications.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”)2014-09,Revenue from Contracts with Customers, to clarify the principles of recognizing revenue and create common revenue recognition guidance between U.S. GAAP and International Financial Reporting Standards. We adopted the ASU on a modified retrospective basis in the first quarter of fiscal 2018 and applied the guidance therein to all applicable contracts that were not complete as of the date of application. As a result, we recorded an increase to opening retained earnings as of January 29, 2018 of approximately $17,862,000, net of tax, for the cumulative effect adjustments of adopting the ASU. These adjustments primarily related to the acceleration in the timing of recognizing breakage income related to our unredeemed stored-value cards, the acceleration in the timing of revenue recognition for certain merchandise shipped to our customers, and prepaid catalog advertising costs, which were capitalized and amortized over their expected period of future benefit prior to adoption, and are now expensed as incurred. Prior period balances were not retrospectively adjusted as a result of adopting the ASU. See Note L for further discussion related to the impact of the adoption of the ASU on our Condensed Consolidated Financial Statements.

In February 2016, the FASB issued ASU2016-02,Leases,which will require lessees to recognize aright-of-use asset and a lease liability for virtually all of their leases (other than short-term leases). This ASU, as amended, is effective for us beginning in the first quarter of fiscal 2019. We plan to apply the provisions of this ASU at the adoption date, instead of to the earliest comparative period presented in the financial statements, with a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We are currently assessing the impact of this ASU on our Consolidated Financial Statements, but expect that it will result in a substantial increase in our long-term assets and liabilities, however, we do not expect it to materially impact our Consolidated Statement of Earnings.

In August 2017, the FASB issuedASU 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities (Topic 815), which expands and refines hedge accounting forboth non-financial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. The guidance also makes certain targeted improvements to simplify the application of hedge accounting guidance and ease the administrative burden of hedge documentation requirements and assessing hedge effectiveness. This ASU is effective for us in the first quarter of fiscal 2019

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NOTE B. BORROWING ARRANGEMENTS

Credit Facility

We have a credit facility which provides for a $500,000,000 unsecured revolving line of credit (“revolver”) and a $300,000,000 unsecured term loan facility (“term loan”). The revolver may be used to borrow revolving loans or request the issuance of letters of credit. We may, upon notice to the administrative agent, request existing or new lenders to increase the revolver by up to $250,000,000, at such lenders’ option, to provide for a total of $750,000,000 of unsecured revolving credit. The revolver matures on January 8, 2023, at which time all outstanding borrowings must be repaid and all outstanding letters of credit must be cash collateralized. We may, prior to the first and second anniversaries of the closing date of the amendment of the credit facility, elect to extend the maturity date for an additional year, subject to lender approval.

During the secondthird quarter and foryear-to-date fiscal 2018, we had no borrowings of $60,000,000 under the revolver.revolver (at a weighted average interest rate of 3.28%). During the secondthird quarter andyear-to-dateof fiscal 2017, we had borrowings of $70,000,000 and $115,000,000, respectively,$55,000,000 under the revolver both atrevolver. Foryear-to-date fiscal 2017, we borrowed $170,000,000 (at a weighted average interest rate of 2.24%.2.25%), all of which was outstanding as of October 29, 2017. Additionally, as of July 29,October 28, 2018, $13,574,000$11,728,000 in issued but undrawn standby letters of credit waswere outstanding under the credit facility. The standby letters of credit were issued to secure the liabilities associated with workers’ compensation and other insurance programs.

As of July 29,October 28, 2018, we had $300,000,000 outstanding under our term loan (at a weighted average interest rate of 3.00%3.10%). The term loan matures on January 8, 2021, at which time all outstanding principal and any accrued interest must be repaid.

The interest rates under the credit facility are variable, and may be elected by us as: (i) the London Interbank Offer Rate plus an applicable margin based on our leverage ratio ranging from 0.91% to 1.775% for revolver borrowings, and 1.0% to 2.0% for the term loan; or (ii) a base rate as defined in the credit facility plus an applicable margin ranging from 0% to 0.775% for revolver borrowings, and 0% to 1.0% for the term loan.

As of July 29,October 28, 2018, we arewere in compliance with our financial covenants under the credit facility and, based on current projections, we expect to remain in compliance throughout the next 12 months.

Letter of Credit Facilities     

We have three unsecured letter of credit reimbursement facilities for a total of $70,000,000. On August 24, 2018, we renewed all three of our letter of credit facilities for an aggregate of $70,000,000, and extended each of these facilities’ maturity dates untilwhich matures on August 24, 2019. The letter of credit facilities containcontains covenants that are consistent with our credit facility. Interest on unreimbursed amounts under the letter of credit facilities accrues at a base rate as defined in the credit facility plus an applicable margin based on our leverage ratio. As of July 29,October 28, 2018, an aggregate of $6,049,000$6,330,000 was outstanding under the letter of credit facilities, which represents only a future commitment to fund inventory purchases to which we had not taken legal title. The latest expiration possible for any future letters of credit issued under the facilities is January 21, 2020.

NOTE C. STOCK-BASED COMPENSATION

Equity Award Programs

Our Amended and Restated 2001 Long-Term Incentive Plan (the “Plan”) provides for grants of incentive stock options, nonqualified stock options, stock-settled stock appreciation rights (collectively, “option awards”), restricted stock awards, restricted stock units (including those that are performance-based), deferred stock awards (collectively, “stock awards”) and dividend equivalents up to an aggregate of 36,570,000 shares. As of July 29,October 28, 2018, there were approximately 7,404,0007,465,000 shares available for future grant. Awards may be granted under the Plan to our officers, employees andnon-employee members of the board of directors of the company (the “Board”) or any parent or subsidiary. Shares issued as a result of award exercises or releases are primarily funded with the issuance of new shares.

Option Awards

Annual grants of option awards are limited to 1,000,000 shares on a per person basis and have a maximum term of seven years. The exercise price of these option awards is not less than 100% of the closing price of our stock on the day prior to the grant date. Option awards granted to employees generally vest evenly over a period of four years for service-based awards. Certain option awards contain vesting acceleration clauses resulting from events including, but not limited to, retirement, merger or a similar corporate event.

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Stock Awards

Annual grants of stock awards are limited to 1,000,000 shares on a per person basis and have a maximum term of seven years. Stock awards granted to employees generally vest evenly over a period of four years for service-based awards. Certain performance-based awards, which have variable payout conditions based on predetermined financial targets, vest three years from the date of grant. Certain stock awards and other agreements contain vesting acceleration clauses resulting from events including, but not limited to, retirement, merger or a similar corporate event. Stock awards granted tonon-employee Board members generally vest in one year.Non-employee Board members automatically receive stock awards on the date of their initial election to the Board and annually thereafter on the date of the annual meeting of stockholders (so long as they continue to serve as anon-employee Board member).

Stock-Based Compensation Expense

During the thirteen andtwenty-six thirty-nine weeks ended July 29,October 28, 2018, we recognized total stock-based compensation expense, as a component of selling, general and administrative expenses, of $13,637,000$14,427,000 and $26,526,000,$40,953,000, respectively. During the thirteen andtwenty-six thirty-nine weeks ended July 30,October 29, 2017, we recognized total stock-based compensation expense, as a component of selling, general and administrative expenses, of $13,012,000$7,335,000 and $22,829,000,$30,164,000, respectively.

Stock-Settled Stock Appreciation Rights

A stock-settled stock appreciation right is an award that allows the recipient to receive common stock equal to the appreciation in the fair market value of our common stock between the grant date and the conversion date for the number of shares converted.

The following table summarizes our stock-settled stock appreciation right activity during thetwenty-six thirty-nine weeks ended July 29,October 28, 2018:

Restricted Stock Units

The following table summarizes our restricted stock unit activity during thetwenty-six thirty-nine weeks ended July 29,October 28, 2018:

NOTE D. EARNINGS PER SHARE

Basic earnings per share is computed as net earnings divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share is computed as net earnings divided by the weighted average number of common shares outstanding and common stock equivalents outstanding for the period. Common stock equivalents consist of shares subject to stock-based awards with exercise prices less than or equal to the average market price of our common stock for the period, to the extent their inclusion would be dilutive.

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The following is a reconciliation of net earnings and the number of shares used in the basic and diluted earnings per share computations:

Stock-based awards of 17,1796,000 and 15,98616,000 were excluded from the computation of diluted earnings per share for the thirteen andtwenty-six thirty-nine weeks ended July 29,October 28, 2018 as their inclusion would be anti-dilutive. Stock-based awards of 1,638,306994,000 and 1,048,5471,052,000 were excluded from the computation of diluted earnings per share for the thirteen andtwenty-six thirty-nine weeks ended July 30,October 29, 2017, respectively, as their inclusion would be anti-dilutive.

NOTE E. SEGMENT REPORTING

We have two reportable segments,e-commerce and retail. Thee-commerce segment has the following merchandise strategies: Williams Sonoma, Pottery Barn, Pottery Barn Kids, West Elm, PBteen, Williams Sonoma Home, Rejuvenation and Mark and Graham, which sell our products through oure-commerce websites and direct-mail catalogs. Oure-commerce merchandise strategies are operating segments, which have been aggregated into one reportable segment,e-commerce. The retail segment, which includes our franchise operations, has the following merchandise strategies: Williams Sonoma, Pottery Barn, Pottery Barn Kids, West Elm and Rejuvenation, which sell our products through our retail stores. Our retail merchandise strategies are operating segments, which have been aggregated into one reportable segment, retail. Management’s expectation is that the overall economic characteristics of each of our operating segments will be similar over time based on management’s judgment that the operating segments have had similar historical economic characteristics and are expected to have similar long-term financial performance in the future.

These reportable segments are strategic business units that offer similar products for the home. They are managed separately because the business units utilize two distinct distribution and marketing strategies. Based on management’s best estimate, our operating segments include allocations of certain expenses, including advertising and employment costs, to the extent they have been determined to benefit both channels. These operating segments are aggregated at the channel level for reporting purposes since our brands are interdependent for economies of scale and we do not maintain fully allocated income statements at the brand level. As a result, material financial decisions related to the brands are made at the channel level. Furthermore, it is not practicable for us to report revenue by product group.

We use operating income to evaluate segment profitability. Operating income is defined as earnings (loss) before net interest income (expense) and income taxes. Unallocated costs before interest and income taxes include corporate employee-related costs, occupancy expenses (including depreciation expense), administrative costs and third-party service costs, primarily in our corporate administrative and systems departments. Unallocated assets include corporate cash and cash equivalents, prepaid expenses, the net book value of corporate facilities and related information systems, deferred income taxes and other corporate long-lived assets.

Income taxes are calculated at an entity level and are not allocated to our reportable segments.

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Segment Information

NOTE F. COMMITMENTS AND CONTINGENCIES

We are involved in lawsuits, claims and proceedings incident to the ordinary course of our business. These disputes, which are not currently material, are increasing in number as our business expands and our company grows. We review the need for any loss contingency reserves and establish reserves when, in the opinion of management, it is probable that a matter would result in liability, and the amount of loss, if any, can be reasonably estimated. In view of the inherent difficulty of predicting the outcome of these matters, it may not be possible to determine whether any loss is probable or to reasonably estimate the amount of the loss until the case is close to resolution, in which case no reserve is established until that time. Any claims against us, whether meritorious or not, could result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. The results of these lawsuits, claims and proceedings cannot be predicted with certainty. However, we believe that the ultimate resolution of these current matters will not have a material adverse effect on our Consolidated Financial Statements taken as a whole.

NOTE G. STOCK REPURCHASE PROGRAM AND DIVIDENDS

Stock Repurchase Program

During the thirteen weeks ended July 29,October 28, 2018, we repurchased 2,409,437742,508 shares of our common stock at an average cost of $56.90$61.15 per share for a total cost of approximately $137,105,000.$45,403,000. During thetwenty-six thirty-nine weeks ended July 29,October 28, 2018, we repurchased 3,141,3673,883,875 shares of our common stock at an average cost of $55.65$56.70 per share for a total cost of approximately $174,818,000.$220,221,000. As of July 29,October 28, 2018, there was $344,302,000$298,898,000 remaining under our current stock repurchase program. In addition, as of July 29,October 28, 2018, we held treasury stock in the amount of $258,000,$205,000, which represents the cost of shares available for issuance to satisfy future stock-based award settlements in certain foreign jurisdictions.

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During the thirteen weeks ended July 30,October 29, 2017, we repurchased 1,160,3811,301,373 shares of our common stock at an average cost of $47.41$46.84 per share for a total cost of approximately $55,011,000.$60,960,000. During thetwenty-six thirty-nine weeks ended July 30,October 29, 2017, we repurchased 1,924,9243,226,297 shares of our common stock at an average cost of $48.50$47.83 per share for a total cost of approximately $93,361,000.$154,321,000. As of July 30,October 29, 2017, we held treasury stock in the amount of $805,000.$725,000.

Stock repurchases under our program may be made through open market and privately negotiated transactions at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, capital availability and other market conditions.

Dividends

We declared cash dividends of $0.43 and $0.39 per common share during the thirteen weeks ended July 29,October 28, 2018 and July 30,October 29, 2017, respectively. We declared cash dividends of $0.86$1.29 and $0.78$1.17 per common share during thetwenty-six thirty-nine weeks ended July 29,October 28, 2018 and July 30,October 29, 2017, respectively. Our quarterly cash dividend may be limited or terminated at any time.

NOTE H. DERIVATIVE FINANCIAL INSTRUMENTS

We have retail ande-commerce businesses in Canada, Australia and the United Kingdom, and operations throughout Asia and Europe, which expose us to market risk associated with foreign currency exchange rate fluctuations. Substantially all of our purchases and sales are denominated in U.S. dollars, which limits our exposure to this risk. However, some of our foreign operations have a functional currency other than the U.S. dollar. To mitigate this risk, we hedge a portion of our foreign currency exposure with foreign currency forward contracts in accordance with our risk management policies. We do not enter into such contracts for speculative purposes. The assets or liabilities associated with these derivative financial instruments are measured at fair value and recorded in either other current or long-term assets or other current or long-term liabilities. As discussed below, the accounting for gains and losses resulting from changes in fair value depends on whether the derivative financial instrument is designated as a hedge and qualifies for hedge accounting in accordance with Accounting Standards Codification (“ASC”) 815,Derivatives and Hedging.

Cash Flow Hedges

We enter into foreign currency forward contracts designated as cash flow hedges (to sell Canadian dollars and purchase U.S. dollars) for forecasted inventory purchases in U.S. dollars by our Canadian subsidiary. These hedges have terms of up to 18 months. All hedging relationships are formally documented, and the forward contracts are designed to mitigate foreign currency exchange risk on hedged transactions. We record the effective portion of changes in the fair value of our cash flow hedges in other comprehensive income (“OCI”) until the earlier of when the hedged forecasted inventory purchase occurs or when the respective contract reaches maturity. Subsequently, as the inventory is sold to the customer, we reclassify amounts previously recorded in OCI to cost of goods sold. Changes in the fair value of the forward contract related to interest charges (or forward points) are excluded from the assessment and measurement of hedge effectiveness and are recorded immediately in selling, general and administrative expenses. Based on the rates in effect as of July 29,October 28, 2018, we expect to reclassify a netpre-tax gain of approximately $846,000$595,000 from OCI to cost of goods sold over the next 12 months.

We also enter intonon-designated foreign currency forward contracts (to sell Australian dollars and British pounds and purchase U.S. dollars) to reduce the exchange risk associated with our assets and liabilities denominated in a foreign currency. Any foreign exchange gains or losses related to these contracts are recognized in selling, general and administrative expenses.

As of July 29,October 28, 2018 and July 30,October 29, 2017, we had foreign currency forward contracts outstanding (in U.S. dollars) with notional values as follows:

Hedge effectiveness is evaluated prospectively at inception, on an ongoing basis, as well as retrospectively using regression analysis. Any measurable ineffectiveness of the hedge is recorded in selling, general and administrative expenses. No gain or loss was recognized for cash flow hedges due to hedge ineffectiveness and all hedges were deemed effective for assessment purposes for the thirteen andtwenty-six thirty-nine weeks ended July 29,October 28, 2018 and July 30,October 29, 2017.

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The effect of derivative instruments in our Condensed Consolidated Financial Statements during the thirteen andtwenty-six thirty-nine weeks ended July 29,October 28, 2018 and July 30,October 29, 2017,pre-tax, was as follows:

The fair values of our derivative financial instruments are presented below according to their classification in our Condensed Consolidated Balance Sheets. All fair values were measured using Level 2 inputs as defined by the fair value hierarchy described in Note I.

We record all derivative assets and liabilities on a gross basis. They do not meet the balance sheet netting criteria as discussed in ASC 210,Balance Sheet, because we do not have master netting agreements established with our derivative counterparties that would allow for net settlement.

NOTE I. FAIR VALUE MEASUREMENTS

Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

We determine the fair value of financial andnon-financial assets and liabilities using the fair value hierarchy established by ASC 820,Fair Value Measurement, which defines three levels of inputs that may be used to measure fair value, as follows:

The fair values of our cash and cash equivalents are based on Level 1 inputs, which include quoted prices in active markets for identical assets.

Long-term Debt

As of July 29,October 28, 2018, the fair value of our long-term debt approximates its carrying value and is based on observable Level 2 inputs, primarily market interest rates for instruments with similar maturities.

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Foreign Currency Derivatives and Hedging Instruments

We use the income approach to value our derivatives using observable Level 2 market data at the measurement date and standard valuation techniques to convert future amounts to a single present value amount, assuming that participants are motivated but not compelled to transact. Level 2 inputs are limited to quoted prices that are observable for the assets and liabilities, which include interest rates and credit risk ratings. We usemid-market pricing as a practical expedient for fair value measurements. Key inputs for foreign currency derivatives are the spot rates, forward rates, interest rates and credit derivative market rates.

The counterparties associated with our foreign currency forward contracts are large credit-worthy financial institutions, and the derivatives transacted with these entities are relatively short in duration, therefore, we do not consider counterparty concentration andnon-performance to be material risks at this time. Both we and our counterparties are expected to perform under the contractual terms of the instruments. None of the derivative contracts that we have entered into are subject to credit risk-related contingent features or collateral requirements.

Property and Equipment

We review the carrying value of all long-lived assets for impairment, primarily at an individual store level, whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We measure these assets at fair value on a nonrecurring basis using Level 3 inputs as defined in the fair value hierarchy. The fair value is based on the present value of estimated future cash flows using a discount rate that approximates our weighted average cost of capital.

There were no transfers between Level 1, 2 or 3 categories during the thirteen andtwenty-six thirty-nine weeks ended July 29,October 28, 2018 or July 30,October 29, 2017.

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NOTE J. ACCUMULATED OTHER COMPREHENSIVE INCOME

Changes in accumulated other comprehensive income (loss) by component, net of tax, are as follows:

NOTE K. ACQUISITION OF OUTWARD, INC.

On December 1, 2017, we acquired Outward, Inc. (“Outward”), a3-D imaging and augmented reality platform for the home furnishings and décor industry. Outward’s technology enables applications in product visualization, digital room design and augmented and virtual reality. Of the $112,000,000 contractual purchase price, approximately $80,812,000 was deemed to be purchase consideration, $26,690,000 is payable to former stockholders of Outward over a period of four years from the acquisition date, contingent upon their continued service during that time, and $4,498,000 primarily represents settlement ofpre-existing obligations of Outward with third parties on the acquisition date. Certain key employees of Outward may also collectively earn up to an additional $20,000,000, contingent upon achievement of certain financial performance targets, and subject to their continued service over the performance period. Both of these contingent amounts will be recognized as post-combination compensation expense as they are earned.

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The purchase consideration has been allocated based on estimates of the fair value of identifiable assets acquired and liabilities assumed, as set forth in the table below.

During the second quarter of fiscal 2018, we finalized the valuation of intangible assets acquired, which primarily represent3-D imaging data and core intellectual property which are being amortized over a useful life of four years. Goodwill is primarily attributable to expected synergies as a result of the acquisition, which include the leverage of acquired technology and talent to drive improved conversion, cost savings and operating efficiencies. None of the goodwill will be deductible for income tax purposes.

Outward is a wholly-owned subsidiary of Williams-Sonoma, Inc. Results of operations for Outward have been included in our Condensed Consolidated Financial Statements from the acquisition date. Pro forma results of Outward have not been presented as the results are insignificant to our Condensed Consolidated Financial Statements for all periods presented and would not have been significant had the acquisition occurred at the beginning of fiscal 2017.

NOTE L. REVENUE

The majority of our revenues are generated from sales of merchandise to our customers, either in our retail stores or through oure-commerce channel (websites or direct-mail catalogs) and include shipping fees received from customers for delivery of merchandise to their homes. The remainder of our revenues are primarily generated from sales to our franchisees and other wholesale transactions, breakage income related to stored-value cards, and incentives received from credit card issuers in connection with our private label andco-branded credit cards.

We recognize revenue as control of promised goods or services are transferred to our customers. We record a liability at each period end where we have an obligation to transfer goods or services for which we have received consideration or have a right to consideration. We exclude from revenue any taxes assessed by governmental authorities, including value-added and other sales-related taxes, that are imposed on and are concurrent with revenue-generating activities. Our payment terms are primarily at the point of sale for merchandise sales and for most services.

See Note E, for disaggregation of our net revenues by reportable segment.

Merchandise Sales

Revenues from the sale of our merchandise through oure-commerce channel, at our retail stores, as well as to our franchisees and wholesale customers are, in each case, recognized at a point in time when control of merchandise is transferred to the customer. Merchandise can either be picked up in our stores, or delivered to the customer. For merchandise picked up in the store, control is transferred at the time of the sale to the end customer. For merchandise delivered to the customer, control is transferred when either delivery has been completed, or we have a present right to payment which, for certain merchandise, occurs upon conveyance of the merchandise to the carrier for delivery. We have elected to account for shipping and handling as fulfillment activities, and not as a separate performance obligation.

Revenue from the sale of merchandise is reported net of sales returns. We estimate future returns based on historical return trends together with current product sales performance. As of July 29,October 28, 2018, we recorded a liability for expected sales returns of approximately $30,432,000$25,555,000 within other current liabilities and a corresponding asset for the expected net realizable value of the merchandise inventory to be returned of approximately $11,036,000$9,567,000 within other current assets in our Condensed Consolidated Balance Sheet.

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Stored-value Cards

We issue stored-value cards that may be redeemed on future merchandise purchases at our stores or through oure-commerce channel. Our stored-value cards have no expiration dates. Revenue from stored-value cards is recognized at a point in time upon redemption of the card and as control of the merchandise is transferred to the customer. Revenue from estimated unredeemed stored-value cards (breakage) is recognized in a manner consistent with our historical redemption patterns over the estimated period of redemption of our cards of approximately four years, the majority of which is recognized within one year of the card issuance. Breakage revenue is not material to our Condensed Consolidated Financial Statements.

Credit Card Incentives

We enter into agreements with credit card issuers in connection with our private label andco-branded credit cards whereby we receive cash incentives in exchange for promised services, such as licensing our brand names and marketing the credit card program to end customers. Services promised under these agreements are interrelated and are thus considered a single performance obligation. Revenue is recognized over time as we transfer promised services throughout the contract term.

Customer Loyalty Programs

We have customer loyalty programs which allow members to earn points for each qualifying purchase. Points earned enable members to receive certificates that may be redeemed on future merchandise purchases at our stores or through oure-commerce channel. This customer option is a material right and, accordingly, represents a separate performance obligation to the customer. The allocated consideration for the points earned by our loyalty program members is deferred based on the standalone selling price of the points and recorded within gift card and other deferred revenue within our Condensed Consolidated Balance Sheet. The measurement of standalone selling prices takes into consideration the discount the customer would receive in a separate transaction for the delivered item, as well as our estimate of certificates expected to be redeemed, based on historical redemption patterns. This measurement is applied to our portfolio of performance obligations for points earned, as all obligations have similar economic characteristics. We believe the impact to our Condensed Consolidated Financial Statements would not be materially different if this measurement was applied to each individual performance obligation. Revenue is recognized for these performance obligations at a point in time when certificates are redeemed by the customer. These obligations relate to contracts with terms less than one year, as our certificates generally expire within 6 months from issuance.

Deferred Revenue

We defer revenue when cash payments are received in advance of satisfying performance obligations, primarily associated with our stored-value cards, merchandise sales, and incentives received from credit card issuers. As of July 29,October 28, 2018, we held $263,546,000$275,567,000 in gift card and other deferred revenue on our Consolidated Balance Sheet, substantially all of which will be recognized into revenue within the next 12 months.

Adoption of ASU2014-09

The adoption of ASU2014-09 most significantly impacted our Condensed Consolidated Financial Statements as follows:

The following summarizes the impact of adopting ASU2014-09 on our Condensed Consolidated Statement of Earnings for the thirteen andtwenty-six thirty-nine weeks ended July 29,October 28, 2018.

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Second QuarterThird quarter of Fiscal 2018 Financial Results

Net revenues in the secondthird quarter of fiscal 2018 increased by $73,568,000,$57,647,000, or 6.1%4.4%, compared to the secondthird quarter of fiscal 2017, with comparable brand revenue growth of 4.6%3.1%. The increase in net revenues was driven by an 8.9%8.2% increase in oure-commerce net revenues primarily driven by West Elm, Pottery Barn and Williams Sonoma, with growth across all brandsparticular strength in furniture, and a 3.1%0.2% increase in retail net revenues (primarily drivenprimarily due to growth in West Elm partially offset by a decline in our franchise operations and Pottery Barn Kids and West Elm), with particular strength in furniture.Teen. Total net revenue growth for the secondthird quarter of fiscal 2018 also included a double-digit net revenue increase in our company-owned international operations, as well as the favorable impact of the adoption of ASU2014-09 primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues (see Note L to our Condensed Consolidated Financial Statements). Net revenue growth was unfavorably impacted by an unexpected delay in product receipts from China, which impacted our ability to fill customer orders placed in the third quarter, as well as a higher than expected amount of drop-ship sales which take longer to fulfill.

In the secondthird quarter of fiscal 2018, diluted earnings per share was $1.00 (which included a $0.13 benefit associated with U.S. tax legislation, a $0.06 impact related to Outward, a $0.02 impact related to employment-related expense associated with aone-time special equity grant, and a $0.01 impact primarily associated with impairment and early termination charges) versus $0.84 in the third quarter of fiscal 2017. We also returned $80,726,000 to our stockholders through stock repurchases and dividends.

In the third quarter of fiscal 2018, we also made progress on our four strategic priorities of digital leadership, product innovation, retail transformation and operational excellence.

In digital leadership, we are leveragingcontinued to leverage the power of our multi-brand portfolio, launching two new cross-brand initiatives, the customer-facing version of our professional design tool, Design Crew Room Planner, as well as our cross-brand platform throughregistry program that allows customers to create a registry across our brands all in one place. In addition to these initiatives, and technology including our cross-brand loyalty program, The Key, which continued to gain momentum. We continued to make progress onalso expanded our integration of Outwardcross-channel shopping capabilities with Buy OnlinePick-up in Store in the Pottery Barn and launched our photo-realistic space planning experience, “Ensemble” earlier this month. We also improved the digital customer experience through content creation including updating our shop path with more engaging content, and enhanced product information pages. Further, we are optimizing catalog mailings to focus on more profitable digital channels that drive more reach, more efficiently. West Elm brands.

In product innovation we expanded our partnership with the Harry Potter franchise and coordinated the releases of our One Home collection to all three Pottery Barn brands. We also introduced Design Crew Basics, a proprietary collection of low price, high quality essentials for the home. In addition, our incremental growth initiatives, such as PB Apartment and Modern Baby, continued to have exclusive designs, high-impact collaborationsattract new customers. In Williams Sonoma, our customers continued to respond to unique innovations only available through our brand, and category expansions. We also built incremental businesses, including PB Apartment, Pottery Barn Modern Baby, as well as a cross brand collaboration between West Elm continued to see customers respond positively to the brand’s aesthetic, scale and Pottery Barn Kids. We made progressprice point.

Under our strategic priority of retail transformation, we continued to execute on our retail transformationremodel strategy during the quarter by reducing our fleet of underperforming stores andwhile selectively investing in new stores, remodels and relocations, while elevatingstores. In our global business we continued to expand our presence with the store experience. introduction of Pottery Barn Kids in three newshop-in-shop locations as well ase-commerce in the United Kingdom. We also entered into a new franchise partnership in India for entry in early 2020.

We also remain committed to operational excellence. During the secondthird quarter, we continued to makedrive efficiency improvements and cost reductions throughout the supply chain. Production shipments from our domestic manufacturing facility increased during the quarter, and we further reduced company-wide damages. We made progress againston our inventory initiatives. We reduced overstocks and clearance in stores, bringing our inventory growth downmulti-year transition to 2.5%, while revenues grew 6.1%. We continueOne Inventory, which will allow us to focus on managing inventory more effectively, including morein-timere-engineer inventory flow processes, better allocate inventory cross-channel, optimize inventory levels, improve our distribution center efficiency and frequent flow from our overseas vendors. In addition to inventory management,bring down costs in the supply chain. And, despite tightness in the labor market, we drove further cost reductions across our supply chain, including improved efficiencyare ahead in our personalization operationsseasonal hiring compared to last year, helped by the recent increase in hourly wage and our domestic upholstery manufacturing facility. Andincentive pay in our global business, we saw another quarter of double-digit revenue growth in our company-owned operations. In addition, our existing franchise partners added another six retail locations in the second quarter.

In the second quarter of fiscal 2018, diluted earnings per share was $0.62 (which included a $0.05 impact related to impairment and early lease termination charges, a $0.05 impact related to Outward, a $0.03 impact associated with U.S. tax legislation and a $0.02 impact associated with employment-related expense) versus $0.61 in the second quarter of fiscal 2017. Our second quarter of fiscal 2018 results also included the impact from the adoption of the new revenue standard, ASU2014-09. We also returned $173,355,000 to our stockholders through stock repurchases and dividends.distribution centers.

NET REVENUES

Net revenues consist ofe-commerce net revenues and retail net revenues.E-commerce net revenues include sales of merchandise to customers through oure-commerce websites and our catalogs, as well as shipping fees. Retail net revenues include sales of merchandise to customers at our retail stores and to our franchisees, as well as shipping fees on any products shipped to our customers’ homes. Shipping fees consist of revenue received from customers for delivery of merchandise to their homes. Revenues are presented net of sales returns and other discounts.

Net revenues in the secondthird quarter of fiscal 2018 increased by $73,568,000,$57,647,000, or 6.1%4.4%, compared to the secondthird quarter of fiscal 2017, with comparable brand revenue growth of 4.6%3.1%. The increase in net revenues was driven by an 8.9%8.2% increase in oure-commerce net revenues primarily driven by West Elm, Pottery Barn and Williams Sonoma, with growth across all brandsparticular strength in furniture, and a 3.1%0.2% increase in retail net revenues (primarily drivenprimarily due to growth in West Elm partially offset by a decline in our franchise operations and Pottery Barn Kids and West Elm), with particular strength in furniture.Teen. Total net revenue growth for the secondthird quarter of fiscal 2018 also included a double-digit net revenue increase in our company-owned international operations, as well as the favorable impact of the adoption of ASU2014-09 primarily associated with the reclassification of other income from selling, general and administrative expenses into net revenues (see Note L to our Condensed Consolidated Financial Statements). Net revenue growth was unfavorably impacted by an unexpected delay in product receipts from China, which impacted our ability to fill customer orders placed in the third quarter, as well as a higher than expected amount of drop-ship sales which take longer to fulfill.

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STORE DATA

COST OF GOODS SOLD

Cost of goods sold includes cost of goods, occupancy expenses and shipping costs. Cost of goods consists of cost of merchandise, inbound freight expenses,freight-to-store expenses and other inventory related costs such as shrinkage, damages and replacements. Occupancy expenses consist of rent, depreciation and other occupancy costs, including common area maintenance, property taxes and utilities. Shipping costs consist of third-party delivery services and shipping materials.

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In thee-commerce channel, cost of goods sold as a percentage of net revenues decreased foryear-to-date fiscal 2018 compared toyear-to-date fiscal 2017, primarily driven by higher selling margins.

In the retail channel, cost of goods sold as a percentage of net revenues decreased foryear-to-date fiscal 2018 compared toyear-to-date fiscal 2017, primarily driven by higher selling margins and the leverage of occupancy costs.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES