Good day, ladies and gentlemen. Welcome to the Williams-Sonoma first quarter 2018 earnings conference call. At this time, all participants are in a listen-only mode. We will conduct a question and answer session after the presentation. This call is being recorded. I would now like to turn the call over to Elise Wang, Vice President of Investor Relations, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.
Thank you. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. Our discussion today will relate to results and guidance based on certain non-GAAP measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why the non-GAAP financial measures may be useful are discussed in exhibit one of our press release. We adopted the new revenue recognition standard, ASU 2014-09, effective January 29, 2018, using the modified retrospective method. As a result, our Q1 2018 results and forward-looking guidance are provided using the standard. For additional details, please see exhibit two of our press release.
This call also contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which address the financial condition, results of operations, business initiatives, trends, guidance, growth plans, and prospects of the company in 2018 and beyond, and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the company's current press release and SEC filings, including the most recent 10-K for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. I will now turn the conference call over to Laura Alber, our President and Chief Executive Officer.
Thank you. Good afternoon, everyone. On the call with me are Julie Whalen, our Chief Financial Officer, Felix Carbullido, our Chief Marketing Officer, and Yasir Anwar, our Chief Technology Officer. Following a robust fourth quarter, we saw continued strength in the first quarter. We achieved strong results against our guidance range across all metrics with our e-commerce revenues outpacing to almost 54% of our total revenues. These results speak to the power of our multi-channel model, distinctive brand portfolio, and world-class customer service heritage, all of which are our company's competitive strengths. Based on the strong start to the year, we are raising our full-year revenue guidance by $20 million and our EPS by $0.03. Now let me provide an overview of Q1 results and discuss some of our accomplishments this quarter against our strategic priorities.
In the first, our revenue and comp growth exceeded the high end of our guidance range at 8.2% and 5.5% respectively, driven by strong performance across all of our brands. The Pottery Barn brand delivered another strong quarter with broad-based growth, particularly in customer demand and e-commerce. Our Williams-Sonoma brand drove an outstanding comp of 5.6%, while our Pottery Barn Children's business substantially improved to deliver a comp of 5.3%. In West Elm, comp was up 9% year-over-year, and revenues continue to grow double digits. Our emerging brands, Rejuvenation and Mark and Graham, achieved another quarter of double-digit comp growth. Our EPS of $0.67 for the quarter also surpassed the high end of our guidance range. Now I'd like to talk about our strategic priorities.
We've always put the customer at the center of everything we do, and hence we continue to focus on execution and digital leadership, product innovation, retail transformation, and operational excellence. Starting with digital leadership, we are enhancing the e-commerce experience through two key differentiators, content and convenience. Leveraging our strong heritage and product storytelling, we are updating our shop path across all brands with more accurate and compelling content that inspires confidence in our customers to furnish their homes with us. To make online shopping more convenient, we've added PayPal and Venmo as mobile wallet options, which have driven measurable improvements in conversion and checkout abandonment rates. We also introduced online self-service scheduling capability for in-home delivery to give customers more visibility and control over the delivery process. This new feature has already reduced care center calls and hold times at our distribution hubs.
In Q2, we'll be launching SMS notification of order status to further improve customer visibility at all stages of the shopping experience. Across brands, we launched the next phase of our loyalty program, The Key, which now enables customers to enroll directly in store, as well as view and manage their rewards on any of our brand websites. Since the launch of this new phase, we've seen a threefold increase in the pace of customer enrollment and more frequent engagement with our loyal customers. Combined with our leading-edge customer data and analytics, we are able to personalize our marketing efforts more efficiently and reinvest in other brand awareness activities. Looking ahead to Q2, we'll be rolling out buy online, pickup in store in our Pottery Barn and West Elm brands, following strong customer response in the Williams-Sonoma and Pottery Barn Kids brands.
With regards to Outward, which is our recently acquired 3D imaging and augmented reality platform, we have developed a roadmap for integration over the next two years. We are currently deep in the process of loading all of our assets, with over 85% of our core assets already completed. This will allow us to introduce more design tools in the coming months to support our customers with their home decorating needs, including digital room planning and new product visualization experiences. In parallel, we are leveraging the same platforms to support our associates in providing best-in-class design services in retail. Combined, these initiatives will enable us to deliver a new standard of photorealistic, content-rich online experiences. In digital advertising, we are continuing our transition from catalog mailings to higher-impact digital channels as we further refine our marketing mix to drive short-term ROI and long-term gains in customer growth.
We're already seeing payback on our investments from last year. In Q1, our customer traffic and revenue growth in e-commerce reached their highest level since 2014. We continue to see more opportunity in top-of-funnel vehicles, and we plan to make incremental investments across the digital marketing ecosystem that focus on delivering inspiration and personalized content across various digital touchpoints. As far as testing new channels, West Elm launched its second round of addressable TV in April, building on the momentum and success of its House Proud campaign from late last year. We also began testing augmented reality in digital advertising on key advertising platforms. From search to banner advertising, initial customer engagement and feedback have been positive.
Looking ahead to the rest of the year, we will continue to be aggressive in identifying high-impact tactics across brands and platforms to accelerate the momentum in customer growth across all of our brands. Our history of performance-driven marketing is perfectly suited to today's digital advertising platforms, and we're confident that this advantage will drive continued growth in customer metrics and our e-commerce channels. I would now like to discuss our strategic priority of product innovation. Our customers come to us for great quality products shown in inspiring ways. Our exclusive in-house design team has allowed us to stay ahead of trends, while our vertically integrated supply chain has enabled us to produce superior quality products that are also sustainably sourced and ethically made.
In the first quarter, we continued to expand our core offerings with compelling newness and aesthetic diversification, while growing brand concepts to new and focused customer categories in collaborations and partnerships. We saw a tremendous response to our Lilly Pulitzer collaboration, which is the first of our one-home coordinated releases across the Pottery Barn brands. This collaboration has been successful in reaching and converting younger customers, as well as driving a significant increase in e-commerce traffic. Our PB Apartment collection continued to perform strongly, growing double digits and attracting new customers to the brand. Our Williams-Sonoma brand saw success in exclusive product launches with key vendor partners such as GreenPan, Staub, Zwilling, Philips, and SMEG. We also partnered with celebrity chef, Giada De Laurentiis, and social media personality, Gaby Dalkin, on their book tours, which attracted new and loyal customers to our Williams-Sonoma stores.
In West Elm, we continue to lead in design and expand into new product and customer categories. In Q1, we built upon the success of our new modern aesthetic with product introductions across multiple categories, including casual seating and decorative accessories. One of the most creative things that I think we've done this year is the launch of our cross-brand collaboration between West Elm and Pottery Barn Kids. This 50+ piece collection marks West Elm's first foray into the baby and kids category and distinctively combines the brand's signature modern aesthetic with Pottery Barn Kids' industry expertise and craftsmanship. We see significant opportunity in the children's home furnishings market for a collection that's modern, high quality, and sustainably made. We look forward to expanding this collaboration throughout the rest of this year.
Looking ahead to Q2, we have an exciting pipeline of product introductions and innovative collaborations across our brands. We look forward to sharing more with you next quarter. Third, continuing with our retail transformation, we believe the store experience is a critical differentiator in new customer acquisition, establishing brand loyalty and driving sales across retail and e-commerce. In Q1, both our retail revenue and comp growth accelerated from last year, which speaks to all of our efforts to enhance the retail experience. We believe our secret sauce is the people in our stores and the service they offer, and they continue to inspire all of us. We're also gaining momentum in our cross-brand design service, Design Crew, which is driving increasing sales in-store and in our customers' homes.
In terms of our fleet optimization, we are making progress in reducing unproductive store footprints, while at the same time investing in high-impact store remodels and relocations, which are driving significant outperformance in those stores. For example, our most recent Pottery Barn store relocation from Fort Lauderdale to River Market is currently trending at double-digit growth compared to the prior store location. We also continued the expansion of Williams-Sonoma Home in the first quarter. We added six more locations in Williams-Sonoma stores, bringing the total to 67 locations, which contributed to another quarter of double-digit growth in the brand and increased traffic and sales in those Williams-Sonoma stores. Lastly, we are committed to operational excellence to further improve customer service and reduce costs. In Q1, as a result of all of our inventory initiatives, our inventory growth stalled at + 1.5%, which was significantly lower than our sales growth.
As you know, inventory management is a top priority across all of our brands and a key driver of customer satisfaction and more efficient operations. To reduce inventory levels as well as backorders, aged inventory, and out-of-market shipping costs, we are working with our overseas vendors for more in-time inventory and frequent flow. We've also implemented a new inventory planning software, which should improve our inventory position in each of our regional DCs. In other parts of the supply chain, we reduced production lead times in our manufacturing facilities by 11% and further improved our packaging and order consolidation in our distribution centers to provide a quicker and more efficient order processing and fulfillment experience for our customers. Our regionalization and hub excellence continue to drive improvements in returns and replacements, as well as a 28% reduction in total damages company-wide.
Despite this progress, there is still significant opportunity for us to further improve the customer experience and further drive cost efficiencies. We will continue to take down our inventory levels while improving our in-stocks through all of our inventory initiatives, including the transition to one inventory, which will allow us to manage inventory across channels and improve productivity and throughput across our regionalized distribution network. We'll also focus on increasing order visibility and speed of delivery to the customer while further reducing returns and damages and the number of escalation calls to our care center. We consider the move to one inventory to be one of the most strategic breakthroughs of the last several years. Now let's turn to our global business, which is one of our key growth initiatives over the long term.
We are pleased to deliver another quarter of improved profitability and double-digit revenue growth in our company-owned operations in Australia, the U.K., and Canada, with our e-commerce business being particularly strong in the quarter. We continued our retail expansion in the U.K. with the opening of our third company-owned West Elm location and a wholesale location in the John Lewis department store in the premier Westfield London Shopping Centre. We are focused on driving brand awareness in that market as we prepare for the launch of Pottery Barn Kids in the second half of the year. Across Mexico, South Korea, and the Middle East, our existing franchise partners added another eight retail locations in the first quarter. We remain committed to our long-term global strategy of multi-channel expansion into larger size markets, particularly Asia and Europe.
Our success to date underscores the potential of our businesses in these large global markets. In summary, we're pleased with our start to fiscal 2018. In addition to driving top line and EPS growth, our customer satisfaction continues to improve, our customer counts continue to increase, and our inventory growth is declining as we continue to drive efficiencies throughout our business. Customers are at the center of everything we do, and we remain firmly focused on delivering both the inspiration and superior service to transform their houses into homes. We are very optimistic about our growth prospects ahead. We look forward to updating you on our progress next quarter. Before I turn the call over to Julie to discuss our financial results, I want to take this opportunity to thank all of our associates.
It is with their passion and commitment that we are able to continue delivering superior quality products and services that are truly unrivaled in the industry.
Thank you, Laura. Good afternoon, everyone. We are pleased to start the year with a strong quarter of operational and financial performance. We outperformed on both the top and bottom line with high single-digit revenue growth, strong comps across all brands, a return to double-digit e-commerce growth, an operating margin above last year, and EPS above our expectations. These results demonstrate our ability to once again execute against our growth and operational initiatives while at the same time maintain strong financial discipline. Before I review our performance in more detail, I would like to remind everyone that our first quarter 2018 results include the financial impact from the implementation of a new accounting standard associated with revenue recognition.
This standard primarily requires us to reclass other income from SG&A into net revenues to accelerate the timing of our revenue recognition for certain merchandise shipped to our customers and to accelerate the timing of our gift card breakage income. As a result, our Q1 2018 results include an approximate year-over-year benefit of $13.6 million in net revenues and $1.6 million, or $0.01 in earnings associated with this change in accounting. From a rate perspective, this amounts to a benefit of approximately 130 basis points of revenue growth, including 150 basis points in e-commerce and 120 basis points in retail, 30 basis points of comparable brand revenue growth, 70 basis points of gross margin improvement, 60 basis points of SG&A deleverage, and 10 basis points of operating margin improvement, including 40 basis points of leverage in e-commerce and 10 basis points of deleverage in retail and corporate unallocated.
Now I would like to review our first quarter results in more detail. During the first quarter, net revenues were $1,202 ,000,000 for a year-over-year growth of 8.2%, and comparable brand revenue growth was 5.5%, an improvement of 540 basis points over last year. Growth was strong with significant year-over-year accelerations across all brands. Our Williams-Sonoma brand delivered a 5.6% comp on top of a 3.2% comp last year, which was their best quarterly comp performance in four years. The Pottery Barn brand delivered another quarter of strong performance with a revenue comp of 2.7% and demand comp accelerating sequentially to the strongest we've seen since Q2 of 2015. This demonstrates the effective execution of our strategic initiatives and the continued momentum in the brand. Both Pottery Barn Kids and PBteen saw substantial improvement in their businesses from last year, resulting in a 4.3% comp and an 8.2% comp respectively.
Combined, our Pottery Barn Children's business drove an accelerated comp of 5.3%. In the West Elm brand, revenue comp was up 9% versus last year, and revenues continued to grow double digits, resulting in another quarter of strong performance. Our newer businesses, Rejuvenation and Mark and Graham, as well as our international business, all delivered profitable double-digit comps. By channel, revenue growth continued to accelerate in both retail and e-commerce. E-commerce net revenues grew by 11.2% to a record high of 53.7% of total company revenues, compared to 52.2% last year. This growth was a significant acceleration over last year, as well as sequentially, with all brands delivering net revenue growth.
In our retail channel, net revenues increased 4.9%, which reflects our ongoing focus on our retail transformation and the continued success we are seeing across our various retail initiatives to elevate the customer experience, including our value-added in-home design service and our high-performing store remodels. Moving down the income statement, gross margin for the first quarter was 36% compared to 35.6% last year. The year-over-year gross margin improvement of 40 basis points was primarily driven by the benefit we saw from the reclass of other income into revenues from the implementation of the new revenue recognition standard, as well as overall occupancy leverage and supply chain efficiencies. Occupancy costs of $173 million, or 14.4% of net revenues, leveraged 70 basis points, which includes an approximate 20 basis point benefit from the adoption of the new standard.
This was partially offset by lower selling margins resulting from our strategic decision to provide more value to our customers through more competitive product pricing as well as higher year-over-year shipping costs. Shipping costs were impacted by higher rates associated with our new UPS contract, which we've discussed in previous quarters, and a higher demand for furniture during the quarter, which is more expensive to ship. We were pleased to see another quarter of strong occupancy leverage and supply chain efficiencies, which allowed us to more than offset these increased costs. SG&A for the first quarter was 29.7% this year versus 29.5% last year. This 20 basis point deleverage was associated with the reclass of other income out of SG&A and into net revenues due to the adoption of the new accounting standard.
This was partially offset by advertising and employment leverage due to the outperformance we saw on our top line and overall strong financial discipline. As a result, our operating margin for the first quarter was 6.3%, which was 20 basis points over last year. We delivered operating income of over $75 million, an increase of 10.3% over last year. As we said on our last call, we are committed to operating income dollar growth relatively in line with revenue growth. We are pleased that even excluding the benefit from the change in accounting, we were able to achieve operating income growth that exceeded revenue growth in the first quarter. By channel, the operating margin in the e-commerce channel was 23% versus 22.7% last year.
This 30 basis point improvement was primarily driven by the accelerated timing of revenue recognition for certain merchandise shipped to our customers from the adoption of the new accounting standard, as well as overall advertising and occupancy leverage, primarily due to the outperformance we saw on the top line and the continued optimization of our advertising spend. This was partially offset by lower selling margins. The operating margin in the retail channel was 4% versus 4.1% in 2017. This 10 basis point deleverage was primarily driven by lower selling margins, partially offset by employment and occupancy leverage from higher year-over-year revenues. Corporate unallocated expenses as a rate represented 7.9% of net revenues versus 7.7% last year.
The 20 basis point increase was primarily driven by higher year-over-year employment and employment-related costs, as well as lower other income that was reclassed to net revenues within the e-commerce and retail channels from the adoption of the new accounting standard. The effective income tax rate in the first quarter was 23.8% compared to 34.5% last year. The lower year-over-year tax rate primarily reflects a reduced federal tax rate associated with the 2017 Tax Cuts and Jobs Act. First quarter 2018 diluted earnings per share were $0.67 compared to $0.51 last year, growing $0.16 or 31.4%. Moving to the balance sheet, cash at the end of the quarter was $290 million versus $94 million last year.
In the first quarter, we invested $34 million in the business and returned $72 million to stockholders through share repurchases and dividends, comprising $38 million in share repurchases and $34 million in dividends. Merchandise inventories at the end of the first quarter were $1,053,000,000 , or 1.5% growth on last year, which was significantly lower than our revenue growth. As Laura mentioned, inventory optimization continues to be a key area of focus for us, and we are pleased to see that our initiatives to reduce our inventory levels and improve customer metrics are working. Now I'd like to discuss our second quarter and fiscal year 2018 guidance. We are confident in the strength of our business and are therefore raising our fiscal 2018 full year guidance.
Based on our strong execution so far and the momentum we have seen across our business, we now expect net revenues to grow to a range of $5,495,000,000-$5,655,000,000 from our previous guidance range of $5,475,000,000-$5,635,000,000 . We now expect our diluted earnings per share to be in the range of $4.15-$4.25, compared to a range of $4.12-$4.22 previously provided. All other financial guidance within the press release remains unchanged from the previous guidance. As a reminder, fiscal 2018 includes a 53rd week.
For the second quarter of 2018, we expect to grow net revenues to a range of $1,250,000,000-$1,275,000,000 , with comparable brand revenue growth in the range of 3%-5%. We expect diluted earnings per share to be in the range of $0.65-$0.70. As a reminder, our guidance reflects the reporting benefit from the adoption of the new revenue recognition accounting standard, which we estimate going forward will be approximately 50- 100 basis points of revenue growth, 60 - 70 basis points of margin shift between gross margin and SG&A, and an immaterial impact on earnings. We are also reiterating our commitment to maintaining a balanced capital allocation strategy in fiscal year 2018.
We plan to utilize our strong operating cash flow to first invest in the business in those areas that will fuel our growth and provide the highest returns, and we remain committed to returning excess cash to our shareholders in the form of share repurchases and dividends. In summary, we are excited about our strong start to 2018 and the momentum we are seeing in our business. These results, combined with our long-term growth opportunities and our competitive advantages, including a portfolio of well-known and loved brands delivering superior customer experiences, our leading multi-channel model with almost 54% of our business already transacted online, our commitment to operational excellence, and our proven track record of strong financial discipline, give us confidence that we will be able to deliver long-term sustainable growth for our shareholders. I would now like to open up the call for questions. Thank you.
Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star one on your telephone keypad. We do ask that you limit yourself to one question. You may re-enter the queue for any additional or follow-up questions. Once again, that's star one for questions, and we'll pause for just a moment. Our first question comes from Kate McShane with Citi.
Hi, good afternoon. Thanks for taking my question. It's encouraging to see your guidance for the second quarter. Just looking at it on a two-year stack, even at the low end of your comp revenue guidance, it does imply a noticeable acceleration. Just wondered if you could walk through some of the factors that are going to exist in Q2 that maybe didn't exist in Q1, which would drive that faster comp revenue growth on a sequential basis.
Hi, Kate. It's Laura. We are seeing great momentum in both our customer numbers, but also in sales on programs that are just getting started. With that, we also have an exciting pipeline of new product introductions and innovative collaborations across all of our brands. We also have a pretty robust e-commerce release plan for the second quarter and a real focus on content, which we're testing and seeing a lot of great response from our customers. We have some, as I said, technology rollouts that are substantial from BOPIS . W e continue to further optimize our inventory to not only take down the levels of overstocks, but also to get better in stocks, which we've been seeing simultaneous to taking down the total levels.
Usually, you see us take down the levels and then back orders and all those things climb, and actually our back order create rate is one of the best numbers we've seen in a long time. There's a lot of good things happening. I also mentioned in my script the next phase of loyalty with The Key, we're just getting started on that. It's a combination of product and operational and technology improvements that I think should really benefit the second quarter and further for that matter.
Okay. Thank you. That's helpful. If I could just follow up with one question with regards to the remodels. I know you gave one dimension of a change in relocation and the conflicts you saw. Could you talk about the lift that you're getting from the remodels, and what is the commitment to how many stores you're remodeling this year?
We have different store model strategies in each of our brands. We've really seen great response, particularly in the Pottery Barn brand. All the brands have been successful. Pottery Barn, as our largest brand, is one where we see a lot of opportunity because we've done enough of them now to see that it's sustaining. We're being aggressive about doing it where we re-up the lease and where it makes sense in the markets that are strong. I don't believe we've given those numbers.
I think we said up to 10 before. I think as it continues to outperform, that we might do more, given the results that we've seen today.
Thank you.
Thank you. Our next question will come from Matt Fassler with Goldman Sachs.
Thanks so much. Good afternoon, everyone. I have two questions. The first relates to the Williams Sonoma business. This is, in a sense, your most mature business, but it's putting up among your two big businesses, the better comp and a very good comp at this moment. Kind of high level, if you think about the merchandising culture of the organization, any kind of merchandising or marketing themes that are helping to lift the results here, what would you have us really focus on?
Yeah. I would say that we continue to offer really differentiated product strategies. We continue to introduce exclusive products with key vendor partners. We've expanded our offerings substantially in the Williams Sonoma branded professional quality cookware, our Open Kitchen value line. We continue to increase the collaboration with celebrity chefs and style icons to further grow our brand reach. In addition, Williams Sonoma Home continues to perform strongly, and it's material in terms of dollar per square foot in our stores. We added more to retail. In addition to that, we have a thriving e-commerce business, which has been a key driver of brand growth. We've directed more of our marketing spend to digital. We've strengthened our content and messaging and improved the level of personalization we deliver.
We're really excited about also BOPIS and how it's attracting new customers and driving traffic and additional spend in store. There's the great DNA of the brand that we've always had as the premier multi-channel retailer of high-quality housewares. We continue to see strength in our ability to grow despite a competitive backdrop.
My follow-up, we spent a lot of the fourth quarter call talking about real estate and the message that you're essentially sending that there are a lot of renegotiations to be done, and that you are willing to walk from quite a few sites as leases came up for renewal. Any update on what you're seeing from the landlord community as you go to market here?
We have great partnerships with some landlords, and we're making progress against that initiative. You saw us close some stores this quarter. We will continue to do that where the stores aren't strategically appropriate or where the landlords are not willing to be flexible and long-term focused. Our stores remain one of our key competitive advantages, and they're critical to driving new customer acquisition. At the same time that we're closing, you also see us investing in the experience for our customers.
Thank you so much.
Thank you. Ladies and gentlemen, as a reminder, in order to allow everyone the opportunity to ask a question, we do ask that you limit yourselves to one question. Our next question comes from Michael Lasser with UBS.
Good evening. Thanks a lot for taking my question. There's a lot of moving pieces with the guidance and the update to the guidance, both from the revenue classification perspective and then also in terms of the outperformance for the first quarter. Julie, can you just walk us through mechanically what's changed from your previous guidance to where it stands today?
Sure. Basically, the simple way to answer that is we took half of the beat from Q1 on the top and the bottom line and rolled it through. Obviously, it's early in the year. There's a lot of 2018 ahead of us. We thought that was prudent at this time. If you look at the outperformance, you can do the back math and see that's how we came up with it.
Your margins in the first quarter, ex the reclassification, came in basically where you thought they were gonna be? Did you change any of your assumptions between the geography of your gross margin and your SG&A, excluding the reclassification for the rest of the year?
No. Excluding the reclassification for accounting for the rest of the year, no. We still should be coming in about 60 - 70 basis points of a margin shift between gross margin and SG&A. We did not, obviously, based on our guidance for Q1, assume that we would come in, if you're talking about operating margin, above operating margin. That's because we outperformed in the top line and it allowed us to leverage and flow through.
Okay. Thank you very much, and good luck.
Thank you.
We'll continue on to Peter Benedict with Baird.
Oh, hey guys. First question, the move to one inventory. Can you just give us some benchmarks or milestones over the next 12 months, 24 months, that we should be looking for? Just remind us the key benefits that you're expected to get as you execute that.
As I said, it's one of the biggest breakthroughs. We've been working on this for a couple of years. Our Pottery Barn brand is moving first on this initiative. We've been building the tools to look at it this way and getting the teams trained, and it's gonna be a multi-year process, but it's one that we're very excited about, and we will report each quarter on how we're doing. You'll see it both not just in our total inventory levels, but also how we do with our in-stock.
Okay, thanks. Just on the Outward business, can you talk a little bit more about the strategic value of that asset, how you're leveraging it within the business today? You alluded to some stuff in your prepared remarks, Laura, but I'm just trying to think about that. As we think about the hit to earnings, I know that's backed out of the adjusted earnings, but is that first quarter run rate something we should just think persists as we look through the balance of the year? Thank you.
Yasir's here, and I'm gonna pass the question over to him on Outward.
Yep. I think Outward is our strategic, in my mind, strength in the world of 3D visualization, and we strongly believe that we will be industry leaders in this space given our business of decorating homes, which is so difficult. Outward is gonna allow us and our customers to have a seamless experience to do that. Two, three things which are tactical in my mind, and then there are a lot more to come in the long term. One is, as Laura mentioned, that we are gonna digitize our assets. If you look at the benefit of Outward comes is in the part of scaling that thing. Because having an augmented reality experience with 1,000 products, 2,000 products, 10,000 products is doable, and I think everybody's doing it in the market.
The key is, can you have hundreds of thousands of your product digitized in a 3D way very quickly and fast, and then can you make them available for a customer experience? That's where I think we want to put Outward to work. That's the first basic foundational thing which Laura talked about.
How can we build great d esigning room planning, home planning experiences with all kind of angles of where somebody can even visualize long-term in terms of the lighting arrangements, the places they are. They can pick themes of their homes and their rooms. That's what we're working on, and that's not too far out. If you will watch us in June and July, we would be launching products and experiences which will be much better than what's available in the market and what we even did ourselves. Where we would provide customer-facing as well as designer-facing experiences, and we will be able to connect the two experiences together to make sure the customer experience is very frictionless there.
From a financial perspective, we obviously believe that all that Yasir just spoke to will help with conversion and improve return rates, so drive sales. We also believe there is synergies and cost reductions that they can drive through various areas such as product development, samples, and photography, and creative costs and a whole host of other opportunities. You mentioned the backout from the non-GAAP perspective. You should expect that run rate going forward. I think what's important to make crystal clear about that backout is that the majority of it has to do with the amortization of the transaction costs and how we have to account for it. The smallest piece of it has to do with their ongoing operations.
Once again, ladies and gentlemen, in order to give everyone the opportunity to ask their question, we do ask that you limit yourself to one question. We'll take our next caller, Greg Melich with MoffettNathanson.
Hi. Thanks. I think I'll stick on SG&A, particularly advertising and marketing. I think, Laura, you mentioned, or Julie, you mentioned that helped on the SG&A side, getting more effectiveness out of advertising. It also sounds like the move to digital and more targeted is giving more lift on the top line. I'd love to hear what's really changing there. Any sort of metrics in terms of how much of advertising now is digital versus traditional, where the catalog is to help understand that dynamic, because it seems to be able to spend less and leverage it and get more on the top line seems to be like a real shift. If you could walk us through, that'd be great.
Sure. Most of the spend, as we've been telling you guys for a while now, has been shifting more towards digital. It's tipped over to be greater than 50% of our total spend for the company, and we're continuing to optimize our catalog spend. You saw that continue into this quarter. We did heavily invest in digital as part of our reinvestment of our tax savings. We believe that will continue going forward. The big difference this quarter was the outperformance on the top line. It was a great reminder as we return to outperforming on the top line, it leverages all, including advertising, and allows us to outperform on the bottom. I'll turn it over to Felix to walk through a little more detail as to what our investments are and how they're working.
Sure, thank you for the question. Our media mix spend is in the channels where customers engage with us most, and more and more, that's online. It's not just about spend in digital. It's also about finding efficiencies. While our investments are aggressive in the digital space, we're also finding efficiencies to deliver strong ROIs. As of last year, we insourced over 90% of our marketing campaigns and media spend. We now have a team of Williams-Sonoma Inc employees with our own hands on our own keyboards, ensuring our spend is most efficient. I would say secondly, with seven brands in our portfolio, we're able to develop a cross-company test and learn strategy where we can test on one brand and quickly roll to the other brands in a very efficient manner if the tactic makes sense for each brand's key initiatives.
That's great. Thanks.
We'll continue on to Chris Horvers with JPMorgan.
Thanks. Good evening.
Hi.
Can you talk about trends in operating income? Last year, EBIT dollars declined 3%, down 4% in 4Q. This quarter, you turned it up sharply, up 10% year-over-year ex NOIs, e x the accounting change. What changed there? Looking at the guidance, it does look like you're expecting operating income to turn down in 2Q again. Was there something unique to the first quarter that helped drive that higher, or are there unique costs that hit in the second quarter?
It's a little bit of both. The first quarter, truly, it's the outperformance and the leverage that creates throughout the P&L. When you drive that kind of revenue on the top line, especially in the e-commerce channel, you leverage advertising, you leverage occupancy, you leverage just about everything, employment as well. All of that roll-through helped us on the bottom line from an earnings perspective. Going forward, the difference is that we have more investment from the tax savings we receive in the second quarter. We mentioned last call that we're going to be investing in our associates and taking our hourly associates up to $12 per hour. That kicks in in the second quarter, so it does put more pressure on the operating margin and operating income for the second quarter, different than the first.
Understood. A quick follow-up on the selling margins. Selling margins down 90 basis points, it looks like, ex the accounting change in the first quarter. This comparison gets a lot easier going into the back half of the year as you start to lap the price and shipping investments. Can you lay out the timing of those investments, and do you think the shipping margin or selling margin degradation moderates and flattens out in the back half?
First of all, I want to make sure we're clear on how we performed on the gross margin this quarter. We did have the benefit from the accounting, but we also had 50 basis points. It's 70 basis points of leverage but 50 basis points, ex accounting for occupancy. Plus, we had supply chain benefits. We had incredible leverage that came through the P&L. We then did, yes, have some investment in merchandise margins and higher shipping costs. From how that's going to play out moving forward, we absolutely expect to have occupancy to continue to leverage as it has. We expect supply chains to continue as they have. I've mentioned that we'll have the accounting impact. Shipping costs, we said we'll lap that in Q3 when we lap the higher UPS shipping costs, so we should get some pressure off of that.
We lap West Elm in this second quarter from the flat rate shipping that we started last year. We should get some pressure removal from some of those levers, but it obviously depends.
Our next question will come from Simeon Gutman with Morgan Stanley.
Thanks. Good afternoon. I wanted to follow up on that, the EBIT margin guidance as well. Julie, you mentioned, you flowed through about half the beat, which makes sense. I did also want to ask about the move to the flat rate shipping, because I would expect that to improve, meaning accelerate, the benefit would accelerate as the year goes on. Occupancy improvements, that too was great this quarter, but also would improve. Bigger picture, you mentioned our goal was to grow EBIT dollars roughly in line with sales. I don't know, you don't have long-term guidance out there, but is that still the goal long term in that you keep reinvesting back into sales, or do you try to get the margins up over time?
Our definite goal is to have operating income dollars be relatively in line with revenues. Certainly, we believe over time, our margins will stabilize, and I think this quarter is the perfect example of the second we start to outperform, it drops straight down to the bottom, and look where we landed above last year. That is where we expect to be over time. Certainly, in the short term, we believe that having operating income dollars in line with revenue growth is where the short-term target is.
Our next question will come from Chuck Grom with Gordon Haskett.
Hi, thanks. Good afternoon. Just wondering if you could just break out for us new customer acquisitions across your banners. Also, if you look at exhibit two, in terms of the cadence of the gross margin and SG&A changes over the balance of the year, I think you called out 70 basis points of a swing to the grosses and about 60 basis points to SG&A. When we think about our models for 2Q to 4Q, does that seem like a good proxy for the rest of the year?
Well, what I can tell you, and we don't disclose the customer numbers by brand, but what I can tell you is that they're positive across the board. Where we are most excited about is in our direct channel, where we saw double-digit increase in all of our brands. That gives us, again, more confidence in our marketing strategy, being more invested into the digital space.
As far as your question, if I understood it correctly, on SG&A and gross margin, yes, I believe throughout the rest of the year, due to the accounting adoption of the new standard, that we will have a shift of 60-70 basis points between gross margin and SG&A. I didn't say specifically that it would be 70 basis points for gross margin and 60 basis points for SG&A, but it'd be between those two numbers for either one.
We'll continue on to Brad Thomas with KeyBanc Capital Markets.
Good afternoon, congratulations on the strong first quarter. I want to follow up on the momentum that you have here in the direct business, the strongest quarter in a number of years. It was against a bit of an easier comparison. Could you maybe talk about how confident you are in maybe keeping up this elevated performance and the ability to drive more share gains within the direct channel?
Sure. We are quite pleased to raise our full-year guidance today. When we last spoke to you, we were excited about the momentum in our business and the strong finish to the year. With the momentum continuing to accelerate in all of our brands and in both channels, by the way, we feel very confident in raising our full-year outlook to reflect this strong start. As I said before, we have a large number of exciting initiatives that we're executing against. We've made great progress, and we have strong trends in the customer metrics. Combined with all of the products and operational initiatives we have in the pipeline, we're very optimistic about our ability to maintain this momentum.
We'll continue on to Brian Nagel with Oppenheimer.
Hi, good afternoon. Thanks for taking my question. Very nice quarter.
Thank you.
My question, I guess it's for Julie, a bit of a follow-up to a prior question, but with regard to shipping costs, we've called this out now as a headwind for a while, including today. You mentioned that later this year, you'll lap certain pricing dynamics, which would help that, I guess, alleviate that headwind. Bigger picture, are there other factors that could, over time, limit, so to say, the impact of shipping costs on your overall business beyond just simply lapping these pricing dynamics?
Yeah, I'll take that question because I'm passionate about the opportunities we have. It 's Laura, by the way. I know that we made improvements in our inventory. I think it's going to be very interesting to see, as we continue forward in our operational improvements to our customer, how much we can further reduce our costs. As good as we are doing with large cube, we want to be number one in large cube delivery, and we have that as a goal. There's a lot of cost to continue to take out of the supply chain, frankly. We're very excited about going after that. That's a big chunk of money from returns, damages, and we're set up really well with this network of regional distribution centers so that we can be as close to the customer as possible.
That allows us to be faster and cheaper than our competition. We know that the more you haul furniture, the more damage you get. We see a lot of other vectors that will give us improvement over the long haul.
Our final question from today goes to Cristina Fernández with Telsey Advisory Group.
Hi, thank you, and good quarter. I wanted to follow up on the shipping topic. It looks like during the quarter, you used free shipping more as a promotional tool than in the past. How is the customer responding to that versus other types of promotions, such as pricing? Based on the competitive landscape, where do you think your dollars are better spent?
I mean, the customer always loves free shipping. In fact, I don't think we've done more promotions this quarter year-over-year. Certainly, it's something that's effective. It's just another promotion tool that we use. We're going to continue to do that.
Can I just say that in terms of total promotional activity, we actually have seen positive trends in reducing and streamlining what we're doing and really focusing on where we have overstock. As much as you might see a few more free ship days, it's not material.
At this time, I'd like to go ahead and turn the conference back over to our speakers for any additional or closing remarks.
Well, I want to thank all of you. I appreciate, we all appreciate your interest in Williams-Sonoma and your support, and we look forward to talking to you again next quarter.
Thank you. Ladies and gentlemen, again, that does conclude today's conference. Thank you all again for your participation. You may now disconnect.