Ladies and gentlemen, please stand by. We are about to begin. Welcome to this Williams-Sonoma, Inc. second quarter 2017 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 Beth Potillo-Miller, Senior Vice President of Finance, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.
Thank you, Shannon. Good afternoon, everyone. This call should be considered in conjunction with the press release that we issued earlier today. During the first quarter of 2017, we incurred severance-related charges of approximately $6 million, or $0.04 per diluted share. These charges were recorded as SG&A expense within the unallocated segment. Also, during the first quarter, we incurred tax expense of approximately $1 million, or $0.02 per diluted share, associated with the adoption of new accounting rules related to stock-based compensation. The remainder of the discussion today will reference full-year guidance related to diluted EPS and operating margin on a non-GAAP basis, excluding these unusual items. 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 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 2017 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, and thank you all for joining us today. On the call with me are Julie Whalen, our Chief Financial Officer, and John Strain, our Chief Digital and Technology Officer. Our second quarter results reflect the strength of our brands and our competitive advantages, as well as our relentless focus on driving innovation and operational excellence. The acceleration of our revenue growth to 3.7%, with comp growth of 2.8%, demonstrates that the investments and actions we are taking are driving improved top-line performance. Our success with our key initiatives is centered upon delivering value, quality, and excellent service to meet our customers' changing needs. We are aggressively building upon these initiatives to further differentiate ourselves and to drive growth. Digital leadership is one of our highest priorities. We are increasing our investments to improve the customer experience and engagement and to drive profitable top-line growth.
As you're aware, one of our key areas of focus this year is an investment in new customer acquisition through increased digital advertising. Year to date, we have significantly increased our digital advertising investment. As a result, we are seeing strong new customer counts with higher traffic trends and increased orders. Our commitment to increasing our top-of-funnel digital advertising spend has allowed us to reach more customers. We've also experienced strong new customer growth in the key channels of paid search, display, and social advertising. In an effort to drive engagement with our customers through relevance across all of our brands, we are expanding our one-to-one personalization efforts. We've experienced an uplift in engagement and higher margins with our new personalization-based emails, and we are seeing these same results translate to our sites.
By the end of the fiscal year, we anticipate tripling the number of personalized impressions delivered on our websites, enabled by both an expansion of personalization campaigns and improved customer identification. We have several high-impact e-commerce initiatives going live throughout Q3. We are re-platforming our mobile experience, leveraging the latest progressive web app technology that will feature a highly engaging, fast-performing app-like experience. We are launching a redesign of our product information pages, introducing improved functionality, product information, and storytelling. We are taking our key loyalty programs to the next level with an improved in-store experience, customer self-service options, and capabilities that will enable us to introduce new and enhanced services for our key members. We are also testing various digital innovation initiatives in specific brands, and based on our findings, we'll implement best practices across the portfolio.
For example, in PBteen, we improved the ship-to-store experience, specifically for our PBdorm customers. While the pilot is still in flight, early results are very positive, both for the customers in terms of convenience and for our stores in terms of driving traffic. This has been a great test in advance of our Buy Online, Pick Up in Store program that will be first launching in the Williams Sonoma brand this fall. On our Pottery Barn site, we've introduced a new feature called Favorites that allows our customers to bookmark their favorite products across our desktop and mobile sites. We've already seen great response, with over 600,000 Favorites in less than six weeks, and the directly attributable revenue has exceeded our expectations. We'll be rolling this feature out to all brands this quarter. Our West Elm team launched the Pinterest Style Finder tool in July.
This visual search tool is just one example of the artificial intelligence-based solutions that we are working on. It is a great complement to the efforts we are driving on the augmented reality visualization front across our brands, where we already have over 130,000 SKUs encoded in 3D that we are using both on our sites and in conjunction with our app. Second, our supply chain remains a primary focus for us, and we are continuing to invest in those initiatives that directly improve our customers' experience and value perceptions and that position us even further ahead of the competition. Order visibility is a key area of focus for us. We've been working aggressively to both improve the customer experience and drive efficiencies at our stores and care centers. We want our customers to know precisely where their furniture is in the delivery process.
In Q3, we'll be enhancing our customer order visibility platform, enabling customers to better track the status of their furniture orders and even receive text alerts when the driver is en route. As it relates to damage-free and speed of delivery, we've seen significant improvements in our metrics and are aggressively challenging ways to find further advancements. On speed of delivery, our ongoing process optimization efforts have yielded improvements in both our furniture home delivery and our conveyable parcel delivery network. Productivity increases have not only driven shorter delivery times but have also resulted in a reduction in operating expenses. In our upholstery manufacturing operations, we've increased productivity to an all-time high. From a cost efficiency perspective, we've realized savings in several areas as a result of our optimization efforts, including order consolidation improvements, increased pieces per delivery, and meaningful reductions in returns and replacements.
Also in the quarter, we launched a new international direct ship solution that combines our advantages of direct sourcing in Asia with our domestic logistics network. This also allows us the ability to strategically expand our assortments without impacting our regional distribution centers. While we have just launched the program in Q2, we are enthusiastic about the incremental opportunity that this represents. Our supply chain efforts are yielding results, as indicated both by our improved customer metrics and the feedback we are receiving from our customer service surveys on some of the most critical customer touchpoints, including our home delivery network and care center. In Q2, we expanded our survey capability to allow us to directly solicit feedback from customers on every in-home delivery and every call.
The insights from this research not only validate our progress to date, but most importantly, allow us to identify opportunities to better service our customers in the future. We'll continue to prioritize these customer-centric initiatives as our supply chain is a competitive advantage for us and a critical component of the customer experience. Finally, in retail, we know that our stores are a competitive advantage and that our multi-channel model, especially in our industry, will allow us to lead. As a result, we have been working on several opportunities to maximize this competitive advantage. Across all brands, our retail presence offers customers an important source of inspiration, and having experienced sales associates and in-home designers working through the complexities of an in-home design experience is a competitive advantage for us.
We recently took our leading in-home design services to the next level with the launch of Design Crew, a new complementary cross-brand design service. The Design Crew initiative will offer our customers personal assistance from design professionals to find products and services for a variety of unique needs, leveraging our portfolio of brands in an integrated way. Our experts are specially trained to help customers with many home requests, such as decorating, renovating, entertaining, cooking, and gift-giving. This service further reinforces our commitment to provide outstanding service to our customers and deepens our relationship with both new and returning shoppers. Additionally, to enhance the customer experience in all of our stores, we've been investing in point-of-sale technology and scheduling tools, which will provide operational efficiencies and elevated service levels.
We've also been focused on retail optimization across our brands and have driven improved financial results from both closing underperforming stores and successfully remodeling or relocating existing stores. I'd like to discuss the performance of our brands and their progress on their product initiatives. I'm excited to talk to you about the progress in Pottery Barn, which delivered a 1.2% revenue comp in the second quarter. The Pottery Barn team has been working very hard on the repositioning of the brand and has developed a roadmap of initiatives to implement across all areas of the business from product to value to marketing. As a result of these initiatives, we're seeing positive response in customer satisfaction metrics, customer counts, and increased sales. We're driving improvements in multiple categories.
Our new furniture collections are strong. Most exciting is that our decorative accessories, entertaining, and textile categories, where we are driving growth with our focus on easy decorating and seasonal ideas that convert new customers. In our fall collection, we launched a broader assortment of opening price points, small space solutions, and a wider range of aesthetics. We are just getting started. We recently launched a collaboration with Emily and Merritt after very successful initial customer reaction has been strong. Also, we announced an exclusive collaboration with designer Monique Lhuillier, which will debut in the holiday season. Our brand repositioning is working. Our new product introductions, opening price points, merchandising strategy, improved store experiences, and fresh approach to marketing are all resonating with our customers.
The Pottery Barn team has made significant progress on these strategies to increase brand relevance and acquire new customers. We believe we will continue to see further acceleration in growth in Pottery Barn. In Pottery Barn Kids, while comp revenues declined 3.9%, demand revenue was positive in the second quarter. Our customers are responding favorably to our back-to-school assortment, our textiles, and our furniture collections. In particular, nursery furniture continues to grow double digits, and we continue to make progress transitioning all nursery and bedroom furniture to GREENGUARD certification. We remain focused on expanding our baby business. We're seeing a favorable response to our curated line of baby gear launched in April, which is attracting new customers to the brand and drove a double-digit increase in registry creations in the quarter.
During the quarter, we introduced our back-to-school gear collection featuring innovative designs, new personalization options, and waste-free lunch solutions. The customer response has been excellent. We recently launched our fall and Halloween collections and are also encouraged by the early response to those. These results, along with the performance we are seeing in our back-to-school collection and the increased level of assortments we have built in these important seasonal categories, give us the confidence in the success of our Q3 and Q4 strategies. PBteen posted a 0.2% revenue comp, a significant turnaround from Q1 results of -14.3%, with improvement across all major categories, as well as in our inventory position and our ability to serve our customers. We launched our fall collection during the quarter and are encouraged by the customer response to our increased aesthetic diversity, revamped offerings across many categories, and our focus on value.
Furniture continues to deliver positive results, driven by introductions in our bedroom furniture business and expanded lounge seating options. In the textile and accessory categories, we saw a dramatic improvement with our fall launch, giving us confidence for the upcoming seasons. In our back-to-school business, we are seeing breakout results in our dorm offerings, which feature innovative and stylish solutions for small space living. Our collaborations remain an important strategy, and we continue to see exceptional response to our new Emily and Merritt collection. We will continue to build upon these successes and are joining forces with top talent and beloved brands to deliver next-level product exclusivity and compelling digital content. We recently announced our licensed collaboration with Harry Potter. The collection is designed with iconic Harry Potter references across a range of home decor, including furniture, bedding, and decorative accessories to transform any bedroom into a magical space.
The collection will launch in September. We have other exciting product launches scheduled for fall and holiday, including a collaboration with iconic fashion designer Anna Sui. With the recent improved trends in PBteen, we are optimistic about the quarter ahead. Our fall offering is strong. Our back-to-school businesses are delivering meaningful volume. The pipeline is full of new launches, new collaborations, and a compelling holiday assortment. The Williams Sonoma brand ended the quarter with a 1.9% comparable brand revenue growth. We continue to execute on our strategies of high-quality merchandise at great values, elevating the experience across all channels, and acquiring new customers. From a merchandising perspective, we continue to see growth by offering our customers exclusive products available only at Williams-Sonoma. We continue to expand our own Williams-Sonoma-branded lines while at the same time deliver exclusive innovation from our strategic vendor partners.
We had a strong summer season with introductions of exclusive outdoor cookware and innovative products that capitalized on current cooking trends. We launched several key collaborations in our food business, including a line of food products with The New York Times best-selling cookbook author, TV personality, and country music singer Trisha Yearwood, which were among some of our most popular-selling food items this season. In our marketing efforts, we continue to interact with existing and new customers with a variety of initiatives. For the third consecutive year, Williams-Sonoma presented the culinary stage at BottleRock in Napa, California. Chefs and celebrities, including Martha Stewart, Jesse Tyler Ferguson, José Andrés, Chef Morimoto, and Ayesha and Steph Curry, partnered in culinary-themed performances to entertain audiences throughout the entire event.
We also participated in the Atlanta Food & Wine event and hosted a wide array of events and book signings across our entire retail fleet with chefs and personalities, including Giada. Also, Williams Sonoma Home continued its strong performance in the second quarter. We expanded our retail presence in Williams Sonoma Home, adding product into seven additional locations in the quarter, bringing the total to 51 store locations with Williams Sonoma Home products. In the third quarter, we will be placing Williams Sonoma Home into 13 more stores, as well as converting a Pottery Barn store in Chelsea, New York, to a freestanding home location. Looking to fall, we are already seeing great consumer response to our fall seasonal lineup. We are excited about new product collaborations and a number of new exclusive launches.
Additionally, we'll be launching a key strategic program, Buy Online, Pick Up in Store, that we believe will be transformative in driving incremental sales. I'd like to talk about West Elm. As we announced at the beginning of June, Alex Bellos has returned to West Elm to lead the brand after four years of driving the Rejuvenation transformation and growth strategy. His deep experience at West Elm before moving over to Rejuvenation allowed him to drive quick results at the brand, and his transition to the brand is a great demonstration of the power of our multi-brand strategy and deep bench of talent across our organization. In Alex's first quarter with West Elm, growth has re-accelerated to 14.3% with comp brand revenues of 10.1%.
The West Elm team has quickly worked to focus on promotional messaging, streamline pricing strategies, and to reassert the key brand differentiators of product choice, community building, and consciousness in sourcing. We drove a very successful outdoor season with additional depth in key collections and breadth across new materials and functions. The launch of our new Italian modern furniture collection in June is a great representation of our market leadership and design, and the strong customer feedback to the collection builds a solid foundation for continued launches and growth throughout the year. On the sourcing front, we continued our leadership with launching and scaling Fair Trade in the home industry. We certified the first Fair Trade furniture factory in Vietnam in the quarter, bringing our top-selling furniture collection and over 2,500 more workers into a program that now benefits over 5,000 workers in four countries.
We're also promoting economic development here in the U.S. with a focus on local sourcing, expanding our local showcase program to over 800 artisans and designers across all of our store markets. Our focus on conscious sourcing at home and abroad continues to be a major differentiator for the brand and drives benefit not only for our vendor partners, their workers, and their communities, but also for our overall supply chain and customers. We continued our focus on expanding the brand's footprint to new geographic areas and market segments. We opened two new stores in Phoenix, Arizona and Portland, Maine within the quarter, and both stores are performing above our expectations. We have seven additional store openings throughout the remainder of the year and continue to see our profitable expansion of West Elm's retail fleet as a major competitive advantage to build sales and brand awareness.
We also continue to build our business into new market segments. We debuted more than 20 new products and solutions in our West Elm Workspace line at NeoCon in Chicago, including a new collaboration with a world-renowned design firm, Gensler, and product design innovators, Qdesign, where we won three coveted Best of NeoCon awards and Interior Design Magazine's HiP Award. We also announced two new locations for West Elm Hotels, offering us a unique and powerful tool to expose new customers to the West Elm brand and to deepen our relationships with the current customers. I'd like to discuss our newer businesses, Rejuvenation and Mark and Graham, as well as our global business. Rejuvenation delivered another quarter of double-digit comp growth driven by expansion online and a national store rollout that continues to be effective at driving profitable multi-channel sales and customer acquisition.
Greater depth in the core lighting and hardware categories are important to growth, accelerated by new businesses in furniture, textiles, and furniture accessories. Our commitment to our manufacturing roots in Portland, as well as our partnerships with domestic manufacturers across the country, is fundamental to the growth and strategic direction of this business. As previously announced in July, we welcomed Ryan Ross back to Williams-Sonoma, Inc. to lead Rejuvenation. This is a return to our company for Ryan, where from 2000 to 2008, he held positions of increasing responsibility in the company's Pottery Barn brand, culminating in the role of Vice President of e-commerce. Ryan most recently served as Executive Vice President of Marketing, Creative, and Digital Commerce at HSN. Ryan has great multi-channel expertise. We're excited about his ability to lead our Rejuvenation management team and their continued efforts to drive accelerated and profitable growth in this brand.
Mark and Graham continued its profitable double-digit growth in the second quarter, also driven by successful execution of Mother's Day and Father's Day, both of which were important gifting opportunities for the brand. We also recently launched a new lifestyle marketing campaign, which is contributing up to triple-digit comps on core programs. We believe Mark and Graham is well-positioned for Q3 and Q4 with new product innovation, an exciting new creative campaign, and emphasis on digital marketing. Is on track for continued success as an emerging brand. In our global business, our company-owned businesses in Australia and the U.K. continued to deliver strong performance with over 10% revenue growth. We continue to be convinced that we have a tremendous opportunity for a global, multi-channel, multi-platform, high-quality home furnishings business like we have in the United States.
We have made progress towards the goals that we have set this year, entering the dynamic retail market of South Korea with our franchise partner, Hyundai Livart. Expanding further with our existing partners in the Middle East and Mexico. In our company-owned retail and e-commerce operations in Australia and the U.K., our continued focus on operational excellence along with double-digit growth has resulted in further cost structure leverage and improved profitability in each of these markets. Because of the positive impact that retail stores have on our e-commerce business, later this year, we'll be opening an additional West Elm store in the Kingston area of London. As we continue to improve our global operations to support our existing business and partnerships, we are exploring opportunities for franchise expansion into new markets and to build our e-commerce business around the globe, both company-owned and with our franchise partners.
In summary, the acceleration in our Q2 top-line performance reflects the positive customer response to our key strategic initiatives. We know that we are successful when we offer our customers differentiated, high-quality products at a great value and superior high-touch customer service. Our focus on innovation and operational excellence is grounded in our ability to understand and adapt to the changing desires and behaviors of our customers. We believe our relentless focus on our strategic initiatives and customer service, along with our competitive advantages and opportunities for growth, will enable us to drive long-term industry-leading profitable growth, resulting in sustainable shareholder returns. I will now pass the call over to Julie to discuss our financial results and our guidance.
Thank you, Laura, and good afternoon, everyone. During the second quarter, our results demonstrated overall sequential improvement from the first quarter and that we were able to once again deliver on all of our financial commitments, including meeting the high end of our EPS guidance range while continuing to invest in our long-term initiatives. On the top line, total revenues for the second quarter increased 3.7% over $1.2 billion, with comp brand revenue growth of 2.8%, a 270 basis point acceleration from the first quarter, further demonstrating the continued progress we are making on our initiatives to drive positive momentum across the business.
During the quarter, we saw e-commerce revenue growth re-accelerate to 5.2%, growing to 52.5% of total revenues, an 80 basis point increase over last year and a historical high, with growth primarily Williams-Sonoma, our newer businesses, Rejuvenation and Mark and Graham, and our company-owned international operations, almost all of which had double-digit growth. The retail channel grew 2.1%, driven primarily by strong growth in West Elm and Pottery Barn, reflecting the continued success we are seeing across our various retail initiatives, including our in-home design services and store remodels. The Pottery Barn brand returned to positive growth with a revenue comp of 1.2%, a sequential improvement of 260 basis points from the first quarter. The Pottery Barn Kids comp accelerated 180 basis points from the first quarter, and they also saw sequential improvement in their demand comps, which turned positive in the second quarter.
In PBteen, we delivered a positive comp of 0.2%, a significant turnaround from the negative 14.3% comp in the first quarter, and they also saw a sequentially better demand comp at a positive 1.3% versus a negative 3.7% in the first quarter. Williams-Sonoma, at 1.9%, had its highest second quarter revenue comp in several years and has now delivered positive comps for 15 out of the last 16 quarters. West Elm, which we continue to believe will be our largest brand over time, re-accelerated back to double-digit revenue growth of 14.3% this quarter, with revenue comps of 10.1% on top of 15.8% last year. Our newer businesses, Rejuvenation and Mark and Graham, once again delivered double-digit growth of over 25%.
Our company-owned international businesses also delivered another quarter of double-digit revenue growth, primarily driven by the strong growth we continue to see in our e-commerce businesses in Australia and the U.K. Our execution across the company drove this overall broad-based improvement in our top line. Given the disruption in the retail industry overall, these results give us confidence so that our strategies to re-accelerate the business, along with our unique competitive positioning with a best-in-class multi-channel model, strong, well-known brands with high quality and proprietary products provided to our customers with superior customer service, will allow us to long-term outperform and maintain our leadership position in the industry. Moving down the income statement, gross margin for the second quarter was 35.2% versus 35.4% last year.
The 20 basis points of gross margin deleverage was driven by lower selling margins, primarily resulting from our investment in reduced shipping income to provide value to our customers. Occupancy costs were $168 million in the second quarter of 2017 as compared to $165 million in the second quarter of 2016, leveraging 20 basis points in the second quarter. This leverage, along with the ongoing benefits we are seeing from our supply chain initiatives, allow this to only incur a 20 basis point gross margin impact after investing in reduced shipping income and providing overall value to our customers. SG&A for the second quarter was 28.4% of net revenues in 2017 versus 28.2% in 2016.
The 20 basis points of deleverage was primarily driven by higher digital advertising costs from our decision to invest in new customer acquisition, which was partially offset by strong financial discipline across our general expenses. As a result, operating margin for the second quarter was 6.8% versus 7.2% in the second quarter of 2016. By channel, the operating margin in the e-commerce channel was 21.4% versus 22.1% in 2016. The 70 basis point decline in operating margin was primarily driven by lower selling margins as a result of our investments in reduced shipping income, as well as higher digital advertising costs as a result of our increased focus on new customer acquisition. This decline was partially offset by strong expense management across occupancy, employment, and general expenses.
Our investments in reduced shipping income and higher digital advertising helped drive the improvements we are seeing in our top-line performance across the company. Our higher digital advertising has driven improvement in customer counts, particularly in Pottery Barn, where we saw improved active, new, and reactivated customer counts year-over-year. The operating margin in the retail channel was 6.1% versus 5.9% in 2016. This increase in operating margin primarily resulted from higher selling margins and lower general expenses, partially offset by higher employment, primarily to support our growth initiatives, which include additional West Elm stores and our new Southeast distribution center that wasn't fully up and running until the end of the second quarter last year.
Corporate unallocated expenses as a percentage of net revenues were 7.3% in the second quarter, compared to 7.1% in 2016, reflecting the incremental depreciation costs associated with various technology capital investments to support the future growth of our business. The effective income tax rate in the second quarter was 34.8% versus 37.7% last year. The year-over-year tax rate improvement was driven by the overall mix and level of earnings, as well as the incremental benefits we continue to see from the improved profitability across our international operations, which are taxed at a lower tax rate. Diluted earnings per share for the second quarter of 2017 was $0.61 versus $0.58 last year. On the balance sheet, we ended the quarter with a cash balance of $103 million versus $111 million last year.
We had $115 million outstanding under our revolving credit facility at the end of the quarter, versus $125 million last year. During the second quarter, we invested an additional $51 million in our business and returned $89 million to stockholders through share repurchases and dividends. Merchandise inventories at $1.073 billion increased 11.4% compared to Q2 2016. A large portion of this inventory growth, however, was associated with inventory that is in transit and not yet received at our distribution centers. The biggest drivers of our inventory growth are associated with our higher growth brands, particularly West Elm. We also saw higher growth in PBteen, where sales had previously been most impacted by lower in-stock inventory levels.
We are continuing to evaluate the balance between inventory and customer service levels. At this point, we still expect our inventory levels to be relatively in line with our sales growth by the end of the year. I would now like to discuss our third quarter and fiscal year 2017 guidance. For the third quarter of 2017, we expect to grow net revenues to a range of $1.270 billion to $1.310 billion, with comparable brand revenue growth in the range of 2%-5%. We expect our third quarter operating margin to be relatively in line with last year. We expect diluted earnings per share to be in the range of $0.80-$0.87. For the full year, we are reiterating all of our guidance ranges.
We expect to grow net revenues 2%-4%, to a range of $5.165 billion to $5.265 billion, with comparable brand revenue growth in the range of 1%-3%. We expect operating margin to be 9.4%-9.6%, and our diluted earnings per share are expected to be in the range of $3.45-$3.65. All other financial guidance within the press release remains unchanged from the previous guidance. This guidance will have us delivering at the high end of our ranges, 4% growth in revenues to almost $5.3 billion, with a flat year-over-year operating margin and EPS growth in the mid to high single digits, despite substantial investments in the business to support our future growth. From a capital allocation perspective, we remain committed to a disciplined capital allocation strategy.
We plan to utilize our strong annual operating cash flow to continue to invest approximately $200 million-$220 million in the business in support of our ongoing initiatives to improve the customer experience and to drive further operational efficiencies. We also intend to return capital to our shareholders in the form of share repurchases and dividends. By the end of the second quarter, we had invested approximately $83 million in the business, paid over $68 million in dividends, bought back over $93 million in our stock, leaving approximately $317 million remaining under our current share repurchase authorization. We are continuing to monitor our rate of buybacks. If lower valuation levels persist, we are prepared to continue to opportunistically increase our rate of buybacks like we did in the second quarter through the back half of the year.
With our strong cash flow generation, strong balance sheet, and strong financial discipline, along with the improved momentum we are seeing in the business, our long-term growth opportunities, our well-known and loved portfolio brands delivering superior customer experiences and inspiration, and our leading multi-channel model with over 52% of our business already transacted online, give us confidence in our ability to lead our industry and to deliver long-term sustainable growth for our shareholders. I would now like to open up the call for questions. Thank you.
Yes, ma'am. Thank you. Ladies and gentlemen, if you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We would like to request that you ask one question. If you have additional follow-up questions, please return to the queue. Again, as a reminder, it is star one to ask a question. We first go to Kate McShane with Citi.
Hello, thanks for taking my question. With regards to the merchandising changes you've made at the Pottery Barn brand, which sounds like they're very effective, I wondered if you could quantify at all how much of your overall offering in Pottery Barn you've touched and changed with your new merchandising initiatives, and by holiday, how much do you think those merchandising changes will touch as a percentage of products sold?
It's an interesting way to look at it. We haven't really measured it that way, Kate. What we've tried to do is really listen to what our customer is asking for. We have a broad base of customers and want to make sure that we're both delighting our current customers, but also attracting new ones. Where we were more specifically addressing from a percentage basis, a change was in the value offering in the small spaces. While that's a competitive number, I would tell you that we've just begun in tapping into that market. We're seeing nice response already, but we think we have a lot more opportunity in that area without affecting or turning off our current customer either.
Thank you.
You're welcome.
We'll go ahead and take our next question from David Magee with SunTrust.
Yeah. Hi, everybody. Good afternoon.
Hello.
Hey, David.
Hi. You mentioned BOPIS as being a big opportunity, and I'm curious as to what you all might be doing differently there to make it maybe more distinctive than your competition?
I think the big thing is that we have a wide offer. We have incredible stores and great sales associates in the stores, and we've continued to look at ways to have the channels work together, and it's natural. It's not so much that it's a different execution. It's that we have, I would argue, a better platform to execute it on.
Great. Just one other question, if I could. You mentioned the lower shipping income this quarter. I'm curious, when was the last time that you all correctly reduced that?
Beginning in Q3 of last year, we started with the Pottery Barn brand. The rest of the Pottery Barn brands began in the first quarter of this year.
Okay. Not the Williams-Sonoma?
Yeah. Williams-Sonoma has always had above $49 ships free.
They also do have the flat rate that was something we put into place last year as well.
Okay, great. Thanks. Good luck.
Thank you.
Next question comes from Matt Fassler with Goldman Sachs.
Thanks a lot. Good afternoon. I also want to focus on the shipping piece. Can you describe the elasticity you've seen, the response that you've seen brand by brand as you've reduced shipping, whether it's evident at different ticket sizes or different kinds of transactions? I did note, I think that Pottery Barn was really highlighted from a retail perspective more so than from an e-commerce perspective, and I'm wondering how that dovetails with the shipping efforts there. Thank you.
Sure. It's obviously really competitive to go into too many details around the economics of our new shipping model. I will say that the customer is responding to it, and we keep measuring to make sure that we're getting the return we're looking for. Also looking at the future and saying, how can we really increase our average order size and most importantly, better serve our customers? As you, I think all know, the market is filled with lots of different shipping models. Some people put it in the price, some people charge restocking. What we're trying to do is make it really simple and fair for our customers. We're not landed with what the future will hold for our shipping model in terms of specifics, because each brand is very different with different AURs.
They are responding slightly differently, and we're going to keep measuring and then changing our model based on what we're seeing.
The by-channel comment, Matt, I think there's a couple things you have to think about there. First of all, we did re-accelerate to 5.2%, and a big piece of that is because Pottery Barn got better from Q1 to Q2. They're obviously not back to where they were. That's a big driver of it. You can't say that the shipping income then isn't "working" quote unquote in that channel. From a retail perspective, a significant piece of what we do is in-home. A lot of that is what we call RTC, retail to customer, and a lot of that involves shipping. The success we're seeing there doesn't mean that the shipping obviously is only working or not working in e-commerce. It's also working in retail.
Understood. Thank you so much.
Next question comes from Christopher Horvers with J.P. Morgan.
Thanks. Good evening. I want to follow up on PB. You had a bit of a soft brand relaunch in July, the Shop by the 7 Aesthetics effort. [inaudible] Place in the merchandising front. Do you actually step up the advertising investment year-over-year? I know you started last year in the fourth quarter about, do the dollars that you're seeing momentum on merchandising and new customer acquisition.
You bleeped out a little bit, I think I got your question. Yes, we did a relaunch with the fall assortment, more distinct aesthetics, testing new aesthetics, some of which are very successful, and we're building on those, obviously, and then reducing the ones that are less successful. We're clearly seeing a resurgence in our decorating categories. The things that people come in more frequently to buy, which also happen to be the areas that drive new customer acquisition. We're very pleased with the effect of the new merchandising strategy on customer acquisition. Also, at the same time, we did step up our digital marketing. We reduced some of our catalog marketing, the total amount of spend was higher than last year.
Does that step up take another leg up in the back half, given where you are?
It depends on the return. We look at it every week. If we continue to see good returns, we'll fund those brands with the best returns, and we reduce those brands that have lesser returns. It's very dynamic. We assume so, though. Our plan is now, because it's working, to keep investing there.
Thank you very much.
You're welcome.
Next question comes from Michael Lasser with UBS.
Good evening. Thanks a lot for taking my question. I wanted to touch a little further on that very topic. Your sales were up about 4%. Your operating income dollars were down about 2%. It seems like some of the investments that you're putting in place are working. Should we expect that operating income dollars are going to continue to hover around this level or the year-over-year change in operating income dollars are going to continue to hover around this level as long as you're seeing an effective return on those investments? I'm talking over the next couple of years.
From an operating income/operating margin perspective, obviously, we've guided to be directionally in line with last year for Q3. Obviously, if you do the math, if we're holding on the year, that means we're going to be better in Q4. Part of that is because our expectation is we're going to have higher revenues, which have a higher flow-through. We expect that we're going to continue with this accelerated momentum as we move throughout the year. Also, as we mentioned earlier, the investments in reduced shipping income and in higher digital advertising, we began last year. We had Williams-Sonoma Home. It was a small piece, but in Pottery Barn, we had begun with that in Q3 and Q4, that alleviates some of the year-over-year quarterly impact relative to Q1 and Q2.
There's still going to be incremental, to Laura's point, we're going to invest if we see the return, you should see improvement in the op margin as we move throughout the year.
Thank you.
Next question comes from Simeon Gutman with Morgan Stanley.
Thanks. Good afternoon. Back on advertising for a second. You mentioned digital channel is up. Can we put it all together? Can you talk about advertising dollars in the quarter? What were they and how it compares versus last year and any commentary on ROI? I think Laura suggested you're continually monitoring and looking at it, but curious what you can share on the ROI. Thanks.
A couple of things from a financial perspective, I'll turn it over to John to give a little more color. From a financial perspective, we have said, obviously, that the biggest driver for our SG&A increase was our digital advertising, and it was obviously even more than that because we offset it with general expense improvement and so forth. It's a significant investment. It will come down slightly relative to Q1 and Q2 into Q3 and Q4. It's still something that we are investing in and has an impact on the total.
It's working. We're really excited about the results we're seeing from the digital investments. Visits, revenue directly derived from digital marketing channels have improved solidly, we're going to continue to optimize catalog spend where we can, shift dollars into digital channels. The numbers reflect actually planned incremental investments there. Specifically, we're seeing strength in non-brand search terms, affiliates, remarketing, social programs, these are more than offsetting any declines we're seeing in the email. Just Q2 Pottery Barn brand alone, we saw a year-over-year positive order growth and customer growth. We're seeing both order frequency and units per order improvement. In general, these are all indications that strategy investing this top of funnel digital marketing channels really is working.
We're encouraged by this and some other further top of funnel marketing tests that we're doing as we're seeing strong incremental lifts in places like Instagram, Pinterest, and the new Google PLAs that really are upper funnel. The strategy's working. We plan to continue to optimize spend and take advantage of it.
Okay. Thank you both.
Next question comes from Peter Benedict with Robert W. Baird.
Oh, hey, guys. Thanks. I just want to clarify on the comment on the margins, Julie, I guess the fourth quarter seems to imply if you use the midpoint implies maybe up 50 basis points or so year-over-year. Just the primary drivers of that, I think you said, is it that you expect revenue growth to accelerate and you'll get leverage off of that? Or are there other dynamics that would drive across the inflection in operating margin in the fourth quarter?
There's obviously a lot of moving parts. The biggest player is revenue. We obviously aren't giving Q4 guidance today, but I know effectively we give implied guidance, and if you look at the high end of the implied guidance, it's a 4% growth versus last year. When you get to the higher level of revenue, it flows right through to the bottom. That is the biggest driver of the increase. The second piece is the fact that we are lapping some of that investment in our reduced shipping income and higher digital advertising because we implemented it with Pottery Barn at the back half last year. Those are the two big drivers.
Yeah. Okay. That's great. Just on the occupancy, which grew, I think about 2% year-over-year in the second quarter, that's been slowing down. I think it was up around 5% in 2016. What's driving the lower occupancy growth rate, and is that something that we should expect to persist over the balance of this year and into next? Thank you.
Yeah, the occupancy did grow 2.2. It's one of the lowest in a while. That's correct. I think there's a lot of moving parts in there. You have to remember the depreciation flows through there, too. It's both the fact that we're getting more effective with the renegotiation of our leases, and you're seeing some of that benefit come through, and it's also the fact of the timing of when and what goes into service from a depreciation standpoint. It has moved around a bit. I am really pleased to see the occupancy has returned to leverage this quarter for the first time in almost two years. I think that's also a play on the fact that we have higher revenue. I expect that to continue.
Okay, thanks very much.
Next question comes from Daniel Binder with Jefferies.
Hi, it's Daniel Binder. Thanks. You talked about supply chain savings, we've been hearing about that for probably at least a couple of quarters now. Just curious if you could sort of size that up and give us a sense of how much is still in front of us and where it's coming from.
Yeah, we haven't disclosed the amount of the supply chain benefits. What I did say, effectively with merch margins down because of the ongoing promotional environment, we were able to completely offset that with the ongoing supply chain benefits we had. The lower selling margins were predominantly due to the investment in reduced shipping income. We are once again pleased to be able to have these benefits continuing to come in to offset that in the merch margin line. We had said, I think that we'd gotten pressure before in Q4 of last year, we had 100 basis point gross margin expansion. We said, "Guys, this isn't going to continue going forward." The amount of benefits has come down because part of that was from lapping some of the higher costs in the prior year.
We are at a pretty sizable amount that continues to move forward as we move throughout the year, we don't expect that to change. We see significant opportunities for ongoing supply chain benefits that we're just getting started with. Whether it's continuing with reduced returns, damages, replacements, freight, you name it, there's still a lot of opportunities to move that needle.
Great. Thanks.
Next question comes from Bradley Thomas with KeyBanc Capital Markets.
Good afternoon. Thanks for taking my question. A follow-up on the digital advertising as it relates to Amazon. In the last few months, we're seeing more and more home furnishings companies, brands listing their products on Amazon. Maybe Laura, could you give us an update on what you're hearing from your customer in terms of how much they're looking at Amazon for a purchase like what you offer and perhaps your willingness to consider selling through them?
Sure. Thank you.
Really been listening to our customer a lot, what they're telling us is how much they appreciate our stores and the service that we offer is a huge differentiator. While Amazon does so many things really well, have you ever tried calling them and asking them if they could please come refurnish your living room? It's a big thing that we do, and our customers really love that service. That is where we're focused. We may have a lot of initiatives, but they're all centered around our customer and what our customer is looking for. Our service levels cannot be easily replicated, and we think it's a huge differentiator.
There's no doubt in my mind that what we're doing at retail and our relentless obsession with customer service is the reason for the success that we're seeing, and we're going to continue to focus on that.
Thank you so much.
We'll take our next question from Brian Nagel with Oppenheimer.
The question I have is if we look at the revenue, because clearly revenue really across the business improved in Q2 from Q1. You talked about a number of the internal initiatives. Are you seeing overall improvement in the environment too, as you look at your various brands, the overall economic environment?
There's a lot of mixed information. I think you guys probably know better than even we do, there's housing metrics solid, unemployment numbers lowest levels in July. There's still a slight pullback in customer sentiment since its peak and retail traffic in the malls is down 9. There's a lot of mixed news out there. We're, in my mind or my perspective, definitely outperforming those numbers. We've always said that we think there's opportunity for us to do better regardless of the environment and to really focus on what our customer is telling us about whether there's something we're not offering them in product or pricing or service. As I said in my earlier comments, that is our focus, is just continuing to improve what we're doing, make it better for our customers.
I don't think necessarily the success is related to any environmental improvements.
All right. Well, thank you.
You're welcome.
Our last question comes from Charles Grom with Gordon Haskett.
Hi, thanks. Good afternoon. As we think about the second half and the improvement you guys saw at Pottery Barn, you mentioned further acceleration and growth in your prepared remarks. I'm just wondering if that implies better than expected rate than you did in the second quarter, which I believe was up 1.2. My follow-up is, you spoke about shorter delivery times, lower split shipments, and reduced damages. Just could you quantify that for us to some degree so we have a sense of the opportunity that lies ahead? Thank you.
Yeah. Unfortunately, we don't disclose by brand comps for the future. Obviously, if you look at the high end of our range, it assumes that Pottery Barn continues on their trajectory, and we have no reason to believe they can't, and we have no reason to believe they can't return to their historical growth levels. As far as quantifying any of the supply chain benefits, we also don't disclose that except to say if you look back, you've seen they've been significant, and they're continuing on that path. Supply chain is one of the biggest expenses we have in our P&L, and it's a huge opportunity for us to continue to fine-tune it and get a lot of savings out of it, and that's what we're focused on.
Thank you.
Ladies and gentlemen, that concludes our question and answer session for today. I'll now turn the conference back over to Ms. Alber for any additional or closing remarks.
Yes, I want to thank you all for joining us, and I'd also like to thank all of our associates. Their passion and commitment to outstanding customer service and to driving our strategies is a key component of the success we are seeing, and we really want to say thank you to them on this call. Talk to you all next time and looking forward to continuing to report on our business in the future.
Thank you, ladies and gentlemen, that does conclude today's conference. We thank you for your participation. You may now disconnect.