Please stand by. Welcome to the Williams-Sonoma Incorporated first quarter 2016 Earnings Conference Call. I would now like to turn the call over to Beth Potillo-Miller, Senior Vice President, Finance and Corporate Treasurer, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.
Thank you, Wesley. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. Our discussion will contain non-GAAP results and guidance, including non-GAAP EPS, SG&A, and operating margin, all of which exclude the impact of unusual business events. A reconciliation of these 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. During the first quarter of 2016, we incurred a one-time reorganization charge related to the reduction of headcount, primarily in our corporate functions of approximately $13 million or $0.09 per diluted share. This charge was recorded as SG&A expense within the unallocated segment. The remainder of the discussion today will reference our results and guidance related to EPS, SG&A, and operating margin on a non-GAAP basis, excluding this unusual item.
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 2016 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 releases and SEC filings, including the most recent 10-K and 10-Q 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, to discuss our first quarter 2016 results.
Thank you. Good afternoon, everyone, and thank you for joining us today. On the call with me today are Julie Whalen, our Chief Financial Officer, and Pat Connolly, our Chief Strategy and Business Development Officer. In the first quarter, our brand portfolio delivered comp-brand revenue growth of 4.5%, with total revenue growth of 6.5% and EPS of $0.53. These results reflect the multiple growth engines that our portfolio approach provides and the progress we are making on the key initiatives we outlined in March. On the revenue side, West Elm reported 19% comp revenue growth on top of 15% last year, and we saw improvements from Q4 across the Pottery Barn brands. Williams-Sonoma delivered a 3.5% comp revenue growth. Our global business grew 27%, and we had strong growth in our Rejuvenation and Mark and Graham businesses, which together grew 25%.
In March, we shared with you the opportunity we saw to do business differently. We outlined key strategic initiatives that we would focus on to drive improvements across the organization. I would like to begin by updating you on the progress we have made against several of these initiatives during the first quarter. We are committed to these strategies and are encouraged by the results we are seeing. First, we said that we are focused on product leadership. Across our portfolio of brands, we offer purposeful products with a superior price-quality relationship, design aesthetic, and functionality. Our multi-brand, multi-aesthetic, multi-price point strategy allows us to cover a wide range of choices in a coherent and organized way that allows our customers to create a home that is a reflection of their personal style.
We know that consumers are becoming increasingly concerned about where their products are made, the working conditions under which they were made, the toxicity of materials used, and the reputation of the company standing behind them. At the same time, the consumer is keenly focused on value and is very price sensitive. Our direct sourcing advantage, with over 1,000 associates working on the ground with our vendor partners around the world, eliminates layers of cost. This also allows us to deliver superior value for the money to our customers. At the same time, it gives us a level of visibility and control over global compliance and quality assurance. Across all of our brands, we are committed to offering innovative products that are also responsibly sourced and manufactured. This is being manifested in each of our brands. In Pottery Barn, we are launching our Healthy Home and Fair Trade initiatives.
Pottery Barn is also in the pilot phase of the HERproject, a factory workplace education initiative that promotes gender equality, health education, and financial literacy. In Pottery Barn Kids, we are also offering products that are good for kids and also good for the planet. Over the past year, we've more than doubled our organic cotton bedding programs, and recently, we introduced GREENGUARD-certified furniture. As you may recall, West Elm was the first home retailer in the Fair Trade USA network. We launched this important program in holiday 2014. West Elm is also one of the largest purchasers of handcrafted product, which represents more than 20% of our total assortment for this brand.
West Elm is now a founding member of a coalition of leading fashion and home brands working with the nonprofit Nest to develop a universal set of standards to ensure craftspeople are working in safe environments and being paid fair wages. In Williams-Sonoma, in addition to all the healthy products we already sell, such as our all-natural paraben-free soaps and lotions and our high-quality clean ingredient foods, we just successfully introduced Williams-Sonoma-branded ceramic cookware. This cookware is one example of how we can deliver a commercial-grade product at a good value that is PFOA-free, non-stick, and can be used on any cooktop from gas to induction. Across our brand portfolio, we are committed to offering products that are good for our customers, their homes, and the environment. Second, we said that we are revolutionizing our approach to the supply chain and inventory.
In the first quarter, we made progress on our initiative to deliver the best customer experience in furniture delivery to the home. There are three areas where we're seeing significant improvement. First, in our operations, we are measuring performance across every aspect of the supply chain, and we are pushing for improvement on every metric. During the first quarter, our on-time delivery of in-home items improved dramatically. These results have come from a strong focus on operational execution and process optimization from our supply chain logistics team and the deployment of new delivery scheduling and final mile systems. As a result, our on-time delivery rate has substantially improved. Second, as you know, we've been on a continuum to improve our customers' ability to know when they can expect delivery of large items into their home.
During the first quarter, we've continued to deploy additional technology to gain control and visibility of inventory at every step. We've been able to promise delivery dates to our customers with better accuracy. We are proactively monitoring for orders that might be getting close to missing promised dates and reporting on orders that might have shipped but have not been delivered. On the care center front, we are working hard to resolve any issue with the first call. As a result, we are seeing a year-over-year decrease in total call volume, with decreases in service calls and escalations. Third, we have been working diligently to get our inventory in the right locations. We have implemented new demand forecasting software and re-engineered our processes to improve the allocation of inventory to match regional demand.
This ability to position inventory in the correct DC drives better in-stocks and decreases the delivery time to our customers. Ultimately, more of our customers are receiving multiple item orders on time and in a single delivery. All these efforts have resulted in increased customer satisfaction. As these metrics improve, our shipping costs are coming down. Looking toward the future, we see significant opportunity to further improve service and lower costs. As we mentioned in March, we are planning inventory growth this year to be lower than sales growth. In the first quarter, with revenues increasing 6.5%, our inventory was flat to last year. During the second quarter, we will continue the rollout of our inventory optimization solution with the launch of a new core replenishment module that will further improve our regional in-stock positions.
We plan to continue to add functionality and modules to better match our assortments and regional inventory to our customer demand for the future. We're also focused on developing and buying fewer, more differentiated products, as well as a rigorous SKU optimization program. We've made initial progress in this regard and see further opportunity with our upcoming assortments. Finally, we have begun receiving and shipping from our new regional distribution center in Georgia. As this facility ramps up by the end of the second quarter, delivery times to Southeast customers will improve, and we expect to see a reduction in outbound freight expense, as well as a decrease in costs associated with off-site storage facilities in the back half of the year. Now I'd like to highlight key results within our brand portfolio, beginning with West Elm.
West Elm continued its rapid growth with its 25th consecutive quarter of double-digit revenue increases and record contributions, with 19% brand revenue growth over last year's 15%. We believe that no other brand in the home furnishings business is delivering this level of profitable growth. In the quarter, West Elm delivered strong performance across both channels and all categories. Customers are responding well to our outdoor business, and we believe that this historically seasonal business will continue to grow into a year-round focus. West Elm continues to build an emotional connection with its customers. In March, it launched a cross-channel campaign celebrating local communities across America. This campaign included a digital experience on westelm.com that further connects our customers with the stories of entrepreneurship and creativity behind our more than 500 local makers and designers.
West Elm first announced plans for the Maker Toolkit at the White House National Week of Making in 2015. In addition to artist profiles, studio visits, and neighborhood tours, the local hub introduces this advice series or Maker Toolkit that includes expert guidance to help entrepreneurs grow and scale their work. West Elm has incredible momentum. It is clear to us that this brand and its positioning are resonating with a wide range of customers. We have a number of exciting initiatives on our roadmap that we believe will continue to fuel the growth and profitability of West Elm, making it an increasingly larger contributor to our company. Williams-Sonoma started out strong in 2016, delivering a 3.5% comp brand revenue growth on top of a 2.7% comp last year, including double-digit growth in e-commerce.
This is the 10th positive quarterly comp out of the last 11 quarters. We believe these results are indicative that our strategies in Williams-Sonoma are working. These strategies include delivering the best product at the best value, growing Williams-Sonoma Home, increasing our online business, aggressively acquiring new customers, and enhancing the retail experience. In the first quarter, we saw gains in our Williams-Sonoma-branded product. As I mentioned before, we introduced our exclusive ceramic cookware, and we have additional strong introductions planned throughout the balance of the year. We're also expanding our Open Kitchen line, which appeals to a broader demographic. We have the strongest vendor partnerships that we believe we've ever had, and in Q1, we saw growth in exclusive products across our key vendors. Additionally, we plan to increase the number of new exclusive products from our strategic vendor partners throughout the remainder of the year.
Williams-Sonoma Home performed well during the quarter and is driving incremental sales both online and at retail. We added Williams-Sonoma Home product to six stores during the quarter and have plans to be in 30 stores by the end of the year. From a marketing perspective, we are focused on customer acquisition, including registry. These efforts are paying off. At retail, we are creating an even more engaging and easy shopping experience for our customers and have reengineered how the stores are run with new tools to better manage our workforce and simplify processes throughout the store. We're excited about our new store models. In Q2, we will be opening two stores with our new formats in high-profile locations.
Across the Pottery Barn brands, including Pottery Barn Kids and PBteen, comp revenues grew 0.6%, with Pottery Barn at a 0.2 comp, Kids at 1.7 comp, and PBteen at a 1.9 comp. In Pottery Barn, during the first quarter, we built on the momentum of growth in our upholstered and furniture collections. Also in Q1, we benefited from improved stock levels and customer service metrics have improved, and we are returning to our high standards of service. We have also amplified content marketing, focusing on innovation, quality, and value as the primary pillars of our product strategy. Areas that were softer included more consumable businesses, tabletop, and decorative accessories. As we look ahead, we are focused on creating exceptional experiences in our stores and online.
In our stores, we are highlighting our differentiated design services, and we are excited to be opening two store remodels in two of our highest profile locations in Northern and Southern California. Online, we are focused on continuous improvement to the customer experience by enhancing our imagery, product content, and inspirational ideas, site usability, and user-friendly mobile sites. As we look to the fall season, we see clear opportunity in several key categories and are refocused on growth against many of the product initiatives that we identified last year. In Pottery Barn Kids, strength in furniture was a key driver of results as sales in bedroom, nursery, and playroom furniture remained robust in the first quarter. We saw softer business in the textile and decorative accessory categories.
A highlight in the quarter was the launch of our collaboration with fashion and bridal designer Monique Lhuillier, which was met with excellent customer response. This collection is elegant and playful, inspired by Monique's sophisticated aesthetic, details from her own home, and her experience as a mother of two young children. In the second quarter, PBK will launch its biggest ever back-to-school collection, which represents substantial opportunity. As part of this collection, we will include an assortment of products and gear to give back to the World Wildlife Fund. The brand will also celebrate little learners with products that inspires children to learn, imagine, and grow. In PBteen in Q1, results improved across all key areas of the business. As I mentioned in the last call, we have made several improvements in product strategy, marketing, digital execution, and we believe these changes contributed to the results.
We are encouraged by the initial response to our recently launched PBteen Dorm collection, and in June, we'll launch back to school with new study solutions and our largest gear offering to date. Our most recent collaboration is with Lennon & Maisy, where we have teamed up with the sister singer-songwriter duo to create a dynamic collection of bedding and decor. While performance across the Pottery Barn brand improved over Q4, we are working diligently to return to our historical growth trends and are aggressively looking at everything from value to product, marketing, and aesthetic. Now I'd like to discuss our global expansion and our emerging brands. Our global business delivered strong performance during the first quarter.
We're pleased with the continued acceleration in our company on retail and e-commerce operations in Australia and the U.K., which delivered substantial growth in the quarter. Our focus on operational excellence is resulting in improvement in our profitability across these markets. Our franchise and John Lewis partnerships continue to exceed our expectations. Last quarter, we shared that our shop-in-shop partner with John Lewis was delivering significant gains to both our direct and retail business in the U.K. Based on this success, we are pleased to announce that John Lewis will be expanding this concept to three additional retail locations in the month of June. We expect to be in a total of eight locations by the end of the year. We'll continue to explore additional opportunities for wholesale expansion with other partners.
We plan to build upon our business in Mexico, the Middle East, and the Philippines by opening at least 20 new locations this year. Our newest franchise partner, Ram Brands, expects to launch in Chile in the latter half of 2017. We continue to actively engage with leading retailers around the world to secure partnerships in key regions. We expect to announce additional partnerships throughout the year. We believe our continued focus on global growth, operational excellence, and infrastructure will result in sustainable and profitable expansion. We look forward to updating you on our progress throughout the year. Our Rejuvenation brand continued its strong growth, achieving this at our very own factory in Portland, Oregon.
We're also excited to announce additional ways Rejuvenation is expanding its national reach, including a new partnership with Pirch, the innovative home retailer that showcases the world's most admired kitchen, bathroom, and outdoor appliance brands within a one-of-a-kind experiential environment as their strategic lighting partner. Also in Q4, we'll be opening a new Rejuvenation store in Chicago, which marks our sixth store for the brand. We're pleased with the online and store performance at Rejuvenation. We see opportunities to accelerate growth both at retail and online. Now I'd like to talk about Mark and Graham. Mark and Graham continues to grow as a classic accessory and gift brand, delivering quality design and innovative gift items at affordable prices. We had a strong Q1 driven by successful launches of high-quality products. Mark and Graham is an example of our ability to grow new brands profitably by leveraging our core assets.
Together, these two businesses, Rejuvenation and Mark and Graham, grew 25% in the first quarter. We see substantial opportunity for future growth of business. Our West Elm Workspace and hospitality business continues to grow. This past quarter, we opened new dealer showrooms in New York, L.A., Seattle, and Tampa. Several more are slated to open in major metro areas over the coming months in the lead up to NeoCon, the industry's premier trade show. We're also pleased to announce a partnership with Marriott International, a global leading lodging company. West Elm and SpringHill Suites by Marriott have collaborated on an exclusive line of room furnishings and decor packages to be featured in hotel rooms and lobbies nationwide. We'll keep you posted on this exciting new relationship and future innovation as West Elm continues its rapid growth and evolution in the contract space.
Based on West Elm's success in the contract and hospitality areas, we are pursuing similar opportunities with our other brands. In summary, we are executing against our growth and operational strategies that we spoke with you about in March, and we believe we are on track to deliver on both our near and longer-term goals. The combination of our multi-channel business model, trusted brands, and strong execution positions us well to continue to deliver increases in shareholder value well into the future. I will now turn the call over to Julie to discuss our Q1 results in more detail.
Thank you, Laura. Good afternoon, everyone. We are pleased with our first quarter results, which demonstrate our ability to execute against our growth and operational initiatives while at the same time maintain strong financial discipline during a challenging retail environment. For the first quarter, net revenues increased 6.5% to $1.098 billion, with comparable brand revenues increasing 4.5% on top of 4.6% last year. Growth was driven by West Elm, our international businesses, and our emerging brands, all of which experienced year-over-year revenue growth in excess of 25% and contributed to our total company revenue growth exceeding our comparable brand revenue growth by 200 basis points. In our e-commerce channel, net revenues grew 8.2% to $576 million and represented 52.5% of total company net revenues for the quarter, an 80 basis point increase over last year and an historical high.
This growth was driven by West Elm and the Williams-Sonoma brand, which generated double-digit e-commerce growth. Our retail channel net revenues increased 4.7% to $522 million in the first quarter, primarily driven by West Elm and our international businesses, which continue to gain momentum. Gross margin for the first quarter was 35.8% versus 36.8% last year and includes occupancy costs of $162 million in the first quarter of 2016 as compared to $151 million in the first quarter of 2015. Merchandise margins were once again only slightly down to last year, further demonstrating that having a direct sourcing advantage allows us to continue to bring higher quality product to market at a lower cost and to pass that along to the customer.
The gross margin deleverage was primarily related to our supply chain and inventory initiatives, fulfillment-related costs, and higher franchise and wholesale revenues, which are dilutive to gross margin but accretive to the operating margin. Although we incurred some incremental costs associated with our supply chain and inventory initiatives, it is clear that these investments we are making are working. We have seen significant improvement across all of our customer service and shipping-related metrics, and our inventory initiatives are already driving substantially reduced inventory levels, as well as improved efficiencies across our supply chain. SG&A for the first quarter was 28.8% of net revenues in 2016 versus 29.8% in 2015. The 100-basis point improvement primarily resulted from employment leverage, further advertising efficiencies, and overall general expense discipline.
The improvement in our employment costs, despite absorbing higher labor costs associated with our fulfillment operations, was primarily a result of cost leverage from increased international operations, as well as employment savings from a corporate reorganization that we implemented during the first quarter. As a result of this reorganization, we did incur a one-time charge of approximately $13 million or $0.09 per diluted share, which has been excluded from our operating results. As we discussed on our last call, this reorganization allowed us to reduce corporate employment costs in the short term that can be reinvested into our long-term strategic initiatives, our supply chain operations, and e-commerce. As a result of strong financial discipline throughout SG&A, our total company operating margin was 7%, flat to last year. By channel, the operating margin in the e-commerce channel was 22.8% versus 24% in 2015.
The 120 basis point decline in operating margin was driven by the investments in our supply chain and inventory initiatives throughout gross margin and SG&A, including higher occupancy and employment costs, partially offset by further advertising efficiencies. The operating margin in the retail channel was 5.8% versus 5.6% in 2015. The 20 basis point improvement in operating margin primarily resulted from the leverage of employment, occupancy, and advertising expenses, substantially driven by an increase in our international operations. Corporate unallocated expenses as a percentage of net revenues improved 40 basis points from 7.7% in the first quarter of 2016 versus 8.1% in 2015. This improvement resulted from lower year-over-year employment and employment-related costs primarily resulting from the corporate reorganization. As a result, first quarter 2016 diluted earnings per share grew 10.4% to $0.53.
On the balance sheet, we ended the quarter with a cash balance of $99 million versus $79 million last year. We had $100 million outstanding under our revolving credit facility. In the first quarter, we returned $75 million to stockholders through share repurchases and dividends, comprising $41 million in share repurchases and $34 million in dividends. Merchandise inventories at $945 million were up 0.2%, or essentially flat to Q1 2015. As we mentioned in our March call, we are planning inventory growth in 2016 to be lower than sales growth. We are already seeing the benefits from our inventory initiatives that are driving substantially reduced inventory levels as well as improved efficiencies in our supply chain. I would now like to discuss our second quarter and fiscal year 2016 guidance.
For the second quarter of 2016, we expect to grow net revenues to a range of $1,145,000,000-$1,175,000,000 with comparable brand revenue growth in the range of 1%-4%. We expect our second quarter operating margin to be relatively in line with last year. We expect diluted earnings per share to be in the range of $0.54-$0.60. It is important to remember that last year's second quarter earnings per share of $0.58 included an approximate $0.03 benefit from a reduced tax rate. Additionally, the incremental supply chain costs we absorbed last year are more than offset this year with our investments in our new Southeast distribution center and the required offsite storage locations until this new distribution center is fully up and operational.
For the full year, we expect to deliver another record year for our shareholders and are reiterating all of our guidance ranges. We expect to grow net revenues 4%-6%, to a range of $5.15 billion-$5.25 billion, with comparable brand revenue growth in the range of 3%-6%. We expect operating margin to be 9.8%-10%, and our diluted earnings per share are expected to be in the range of $3.50-$3.65. All other financial guidance within the press release remains unchanged from the previous guidance. This fiscal year guidance puts us on track to deliver on our longer-term outlook over the next three years of mid to high single-digit revenue growth and low double digits to mid-teens earnings growth.
With West Elm on a strong growth trajectory to $2 billion in revenues, our global and new businesses gaining momentum and scale, our continued growth in our profitable e-commerce channel, and our continued growth across our brand portfolio, as well as further supply chain efficiencies from reduced shipping costs, reduced offsite distribution centers, and improved labor productivity, we have a clear path to longer-term sustainable earnings growth of low double digit to mid-teens. From a capital allocation perspective, there are no changes to our plan. We plan to utilize our operating cash flow to invest in the business in support of our ongoing growth initiatives in the range of $200 million-$220 million. We also plan to continue to return capital to our shareholders in the form of share repurchases and dividends.
We have $521 million remaining and available for share repurchases, which we intend to repurchase over the next three years. We are also committed to continuing to pay dividends targeted at 35%-40% of net income and relatively in line with the S&P 500 dividend yield. In summary, we are confident that with our competitive advantages, strong brands, compelling product at a great value, a multi-channel business, superior customer service, many opportunities for growth, a strong balance sheet, and an experienced leadership team, we will maintain our leadership position. These competitive advantages, combined with our strategic growth and operational initiatives and the progress we have made to date on those initiatives, give us confidence in our ability to deliver long-term, sustainable, profitable growth. I would now like to open up the call for questions. Thank you.
If you would like to ask a question, please signal by pressing *1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We'd like to request that you ask one question. If you have an additional follow-up question, please return to the queue. Again, press *1 to ask a question. We'll take the first question from Chris Horvers at JPMorgan.
Thanks. Good evening, everybody. Chris, can you talk about, obviously, you've heard a lot of retailers talk about the cadence of the quarter and the weather and the consumer, you have a lot of companies guiding lower sequentially for the second quarter. Can you talk about your experience and as you think about the second quarter, is that simply a function of, hey, the comparison's a couple of 100 basis points harder, or is there something else behind it?
Hi, Chris, it's Julie. We don't typically give any sort of cadence color on the quarter where we're coming into that. Weather has never been a substantial issue for us. We did see a little bit of that in Texas with the floods towards the end of Q1. That isn't a big driver for us. From a revenue guidance perspective, our second quarter revenue guidance reflects obviously our best estimate of the possible range of outcomes across our portfolio brands. It's early in the quarter, and there's also a Memorial Day shift this year, which actually, believe it or not, that holiday is very big for us. It makes it extremely more challenging to get a good read on the business at this time. Like all of us, we are seeing the relatively negative retail results out there.
At this time, we think our guidance is appropriate. It reflects our best estimate this early in the quarter. Of course, with that said, as we all know, we're focused on the year and our longer term growth rate. On the year, we reiterated our guided revenue growth, which is the high end of the range of 6% and is relatively in line with current industry growth, with a three-year outlook of mid to high single-digit growth.
Thank you.
We'll go next to Matthew Fassler at Goldman Sachs.
Thanks a lot. Good afternoon.
Hello.
Hi. I want to focus on gross margins. It sounds like merch margin's down very slightly. You've got some supply chain costs that are higher. Can you try to parse out as best you can, the piece of the incremental supply chain cost that represents investments that you think will recede, and then talk about the pace at which they will recede through the year. Do you expect them to be even through the year? Do they get smaller in Q2, smaller in the second half? How should we think about the cadence of those incremental expenses?
Okay, Matt, I'll take that. Obviously, the gross margin, you can see, is down 100 basis points. We are pleased that our merch margins, as we said, were once again only slightly down to last year. From Q4, the gross margin year-over-year reduction actually improved 80 basis points. We have seen some improvement there. The reason for the gross margin deleverage was primarily related to those supply chain and inventory initiatives, as well as higher franchise and wholesale revenues, which we can't underestimate. They are, of course, dilutive to gross margin but accretive to the op margin. As we mentioned in our last call as far as timing and so forth, we are incurring these incremental costs, particularly in our distribution centers, as we open up our newest regionalized DC in the Southeast.
At the same time, we are incurring the incremental cost associated with offsite storage locations until that new DC is fully up and operational. We are also incurring inventory and fulfillment related costs associated with the movement of more inventory through our outlets, and our shipping costs on our home delivery, though substantially improved, are also still not back to historical levels yet. As we said on the last call, as we move through the first half of the year, our expectation is that the new DC should be up and fully operational by the end of the second quarter. Ideally, we'll be out of offsite as a result of that. We should start to see some of that improvement in the back half of the year.
Obviously, if you've got pure merch margins that are essentially slightly down to flat, you've got occupancy that should improve and has pretty much been leveraging for quite a while, as in Q4 and Q1, but should improve with the reduction of the offsite locations. We've got shipping costs that are improving, and we've seen incredibly improved shipping metrics. All of that should indicate that we should start to see improvement in the gross margin in the back half of the year.
That's great. Just a very quick follow-up. Hopefully, this counts as part of the same question. If ex occupancy or with the occupancy leverage or ex occupancy leverage, we're down like 120 basis points year-on-year, and merch margin is a very small piece of that. Could you just roughly dimensionalize the impact of the international revenue at lower margin and then the shipping piece?
Well, first of all, the occupancy is actually deleveraged 10 basis points.
Fair enough. Sorry about that. Yep.
Yeah. If you can do the math, you come to a 90 lower selling margin. The biggest piece is the supply chain initiative. Merch margins are slightly down, so there's a piece of it that's associated with that. Ex that, your biggest piece is the supply chain and inventory initiatives, and then comes the higher international revenues.
Thank you.
The next question comes from Michael Lasser at UBS.
Good evening. Thanks a lot for taking my question. I think, Laura, you mentioned that two areas within the Pottery Barn business that were a little softer during the quarter were decorative and tabletop. Do you think those are categories that are a little bit more sensitive to the competitive landscape, whether it's at the lower end or at the higher end, and that may be influencing the business?
Thanks for the question. Those categories are also related to retail traffic, I believe. Furniture is a more considered purchase, and we all know that retail traffic has been softer than it was in the past. That said, we are focused on working to return to our historical growth rates in Pottery Barn, are aggressively looking at everything we can do that's in our control in both those categories and other categories, where we see open space. You're going to see us go after them in a dominant way through the balance of the year. We're also going to significantly improve the brand's voice and content to better highlight the difference between our quality, our value proposition, and our initiatives to responsibly source materials.
We're testing, as I said in my prepared remarks, and we're going to be proving new store models to increase profitability and improve the customer's experience. We're doing the same in our digital experience, in particular in our mobile experience, to make it easier for our customers to shop anytime, on any device. While we know that the environment is certainly more competitive. We're focused on what we can do about it and how we can be the winner, not only in 2016, but well into the future.
That makes sense. Good luck with the second quarter. Thank you.
Thank you.
We'll go next to Peter Benedict at Robert W. Baird.
Thanks, guys. It's Matthew Larson on for Peter. Wanted to dig into the complexion of the sales results. Obviously, very strong results within West Elm, Williams-Sonoma Home, and some of the emerging brands like Rejuvenation. Curious, are these efforts at a point where they might be pulling customers away from the Pottery Barn brand? Is there a way you can track or understand if this shift is happening in that you're perhaps more engaged with your customer file, but they're just shifting to some of the hotter aesthetics in the other brands?
Yeah. Such a good question. It's really fascinating to us, and we just had that information pulled exactly as you asked it. Not only did we not see cannibalization, we're actually seeing that the different brands help each other. They are very different in their aesthetic. When the customers talk about what they like about each brand, they reflect on the individuality of the brands. There are people who have a wide range in their homes, and they buy for one room of the home from West Elm and the other from Pottery Barn. We have not seen cannibalization at all. Trust me, I'd be the first to tell you if we did, and we'd be correcting it. We're not seeing it in our stores either when we open.
That's great. Just one quick follow-up. On the Williams-Sonoma exclusive product initiatives, can you remind us where you're at as far as exclusive product penetration within the Williams-Sonoma namesake brand, and where you think this can go to?
Yeah, absolutely. Our Williams-Sonoma branded product allows us to deliver superior quality at higher margins. We continue to introduce it across multiple categories. We continue to increase it as a percentage of sales. We have never given that percentage because it's highly competitive, but we're going to continue to grow it over the next three years. We also see other opportunities to attract new customers with things like our Open Kitchen line, which we've talked about appealing to a broader demographic. That's had considerable success. Finally, our vendor partnerships, as I said, are very strong, and our vendors are working with us to give us many more exclusive products. What we're after is the best and making sure that we're giving the customer a great value and the best service in the market as well.
Thank you. Good luck.
Thank you.
The next question comes from Jessica Mace at Nomura Securities.
Hi, good afternoon, everyone.
Hi, Jessica.
My question is about the inventory optimization, and I was wondering if you could give us a little bit of information or color on how, with inventories growing slower than sales, you don't put yourself at risk for not being able to meet demand. Thanks.
As part of our supply chain and inventory initiatives, we have actually been working on inventory optimization for a while now. We've been speaking to you about it, and what we're really pleased to be able to see is that we're finally able to demonstrate it. The results are definitely becoming more apparent as we enter into 2016. As far as what have we been doing, we've been more aggressively managing the level of weeks on hand for each SKU, which has allowed us to not only reduce our inventory buys, but also allows us to liquidate our less productive SKUs and aggressively push more inventory to our outlets.
This has allowed our inventory levels to be reduced, obviously, substantially and will allow us to ultimately generate supply chain savings by freeing up space in our distribution centers, reducing the ops sites that we're trying to get out of and improving our labor productivity throughout our network. We were waiting for this question to see now if we're going to be asked, do we have too low of inventory? As a retailer, you know that we are always balancing between improving our in-stock inventory levels and reducing overstocks. The good news is, with the inventory optimization efforts we've been doing, we've been able to maintain higher in-stock levels to support our customer demand, while at the same time, we're aggressively managing level of weeks on hand, which allowed us to reduce our inventory buys, et cetera.
Our inventory levels have come down, but we are focused on maintaining in-stock inventory levels to ensure great customer service. Since year-end, we have seen back orders reduce, and year-over-year, we have seen order fulfillment rates improve. At this time, we believe we have the right inventory levels to meet our customer demand.
Great. Thanks very much.
We'll go next to Dan Binder at Jefferies.
Thanks. Good afternoon. My question was on the contract furniture side. I was wondering if you could help us quantify the size of that market and what the opportunity is with Marriott in terms of sales over the next couple of years.
That's a good question. It's a big opportunity is what I would say. There's not a lot of people doing what we do, and we're able to provide Marriott and others better quality and better value. We're also giving them really a lot of help with design for the spaces. It's small now. We're just starting, we believe it's a large opportunity. We're not ready to quantify it. As you look around at how many hotels are opening and basically any space where you can see furniture, we think we have an opportunity to disrupt that market.
Would you have any interest in being acquisitive in, let's say, the office category where there's
Numerous contract furniture partners.
Yeah. I'm not sure if you're aware, but West Elm Workspace is just that. We have a full benching system. We have dealers located in all the major cities now that have showrooms with this furniture in it, and we've been very lucky to have some great partners with other companies who've let us do their whole office space with our benching and gather systems. They're in multiple different aesthetics. Depending on what you're looking for, we have it, and we tend to be much better priced than the competitive set.
Okay, thank you.
Welcome. It's on our website if you want to check it out, Workspace.
The next question comes from Simeon Gutman at Morgan Stanley.
Thanks. Good afternoon.
Good afternoon.
Laura, you mentioned a focus on customer acquisition. Can you share with us if that's specifically, it's a channel that's specifically being targeted or it's channel-agnostic? As part of that, how does the ROI change as more dollars are deployed into that acquisition, if there's any nuance by channel?
Yeah, I'm going to start the question, then let Pat take it.
Sure.
We acquire customers through all of our channels. The biggest recent percentage growth is coming out of our digital channel. We also know that when we drop a new store into a market where there wasn't a store previously, we grow the customer base a lot. The stores are definitely billboards for the brands. It's what you often remember about a brand, even in this digital age. I think we all see the store often first before we even see the digital store. We're able to acquire new customers mostly through our digital marketing work. Now I'll let Pat answer.
Sure. Simeon, I think that ROI question is really one of the things that we are known for, that's the discipline that we practice in our marketing spend. We don't chase after unprofitable sales, even in our customer acquisition efforts, we have great results there. Google will tell you we're one of the most disciplined companies that they deal with. I think it's really the function of attribution technology, which we've refined, so we really understand the incremental value of each of our marketing streams. If you spent $300 with the company, you visited a store, you clicked on a search term, you received a catalog, you got several emails, we know how much of the sale should be attributed to each one. At the same time, we continue to look for advances in our marketing practices. We're implementing a lot more personalization.
That really improves your ROI. We're a beta customer for a new Google program that's showing great results. We continue to build our web pages to get great SEO rankings, we've had great success in some of our social marketing efforts, particularly in Pinterest and video. The last thing is that because of our scale, we're able to bring a lot of the activities in-house that were previously contracted to others due to their complexity. They're now in-house, they're having a significant impact in not only improving our returns, but also reducing cost.
Thank you.
The next question comes from David Magee at SunTrust.
Hi, good afternoon and good quarter.
Thank you.
Thank you.
A couple of questions. One is, can you give some color regarding the returns on the West Elm business versus your older two brands? Maybe qualitatively, what the potential looks like for your newer businesses as well.
We don't provide returns by brand, but I think the way to think about it is clearly that brand in particular for the last 25 consecutive quarters has had double-digit growth, and they're incredibly profitable, and we've said that a few times. They have incredible opportunity, even further returns from that standpoint. Obviously, the other two businesses, if you're referring to Rejuvenation and Mark and Graham, they had 25% growth. They're very small still at this point, but we think there's a huge opportunity, especially in Rejuvenation, to grow to be a pretty significant brand. Everything we do in this company, we do profitably. If we're putting our investments in those brands and you're seeing their growth, they're definitely giving us the kind of returns that you would request.
Well, thank you. Secondly, with regard to the longer-term international business, how do you see the growth evolving or sort of divided between company-owned stores going forward and franchise stores, say, over the next three or four years?
I think what we've said before in the past is very true, that we see the franchise opportunity growing a lot faster than our company-owned stores. With that said, we've seen incredible growth with our company-owned stores and websites. We're continuing to pursue both paths. We are really pleased with the performance of our franchise opportunities and the fact that we have strong success with some really good partners having interest with us. As you all probably know how this works, the most important thing you can have is the strongest partner, and you want to lock that down and get exclusives. We are all over the world right now working on that as we speak, and I think you'll be pleased to see some of the exciting things that we have coming that we'll announce at a future date.
Great. Thank you. Good luck.
Thank you.
Thank you, David.
The next question comes from Seth Basham at Wedbush Securities.
Thanks a lot and good afternoon. My question's around merchandise margins. You mentioned that they were slightly down. Could you dimensionalize for us how much product acquisition costs were down relative to the other moving pieces within merch margins?
Part of it is product acquisition costs. I'd say the bigger piece of it, which is still a subset of that, is the fact that we have our insourcing of our foreign agents, which is driving incredible cost reductions across the board that allows us to pass that along to the customer. Those are probably the biggest pieces that are enabling us to not only still be promotional like everybody. It's not that the promotional environment hasn't changed. It's very promotional, but we are able to compete by the fact that we can lower our costs, both from a direct negotiation from the vendor, but also by the fact that we've got our own agents insourced in our company, and we can pass that cost along.
As you look at the benefits from insourcing foreign agents on a year-over-year basis, do you expect them to recede through the year?
No, not at all.
Very good. Thank you.
The next question comes from Cristina Fernandez at Telsey Advisory Group.
Hi, good afternoon. I wanted to ask about Williams-Sonoma Home. It seems like you're making a bigger push with catalog circulation for that sub-brand. I wanted to see how much is that contributing to the overall Williams-Sonoma Home, and how do the stores that have the assortment, I know it's only six, but how are those performing relative to the rest of the chain?
The stores are performing well. We did it in stores where we have the space, we don't want to be less dominant in kitchen. It was very important to choose it wisely and really understand the in-store experience. We also are using the stores as a showroom for the swatches, the furniture swatches, the rug swatches, and the textiles. The customer can come in, see the quality of our furniture, and then buy something that we obviously don't have the space to show, but buy it with more confidence because they've seen the swatch or the fabric. We haven't pulled it out. It's hard to pull out. We do look at it from a profitability perspective internally, but it's not something that's sizable enough to report on separately.
The next question comes from Laura Champine at Topeka Capital Markets.
Good afternoon. Julie, my question's really for you, and it's on the unallocated costs, which grew 60 basis points year-on-year, even stripping out the one-time items. How much of that is related to international expansion, and what's really driving that number higher?
There's not really much related to international expansion associated with that. I think what's important to remember is that we've got a mix of items in there. In particular, we've got a lot of our IT investments that go in there. All the depreciation associated with our IT investments roll through that corporate unallocated. I think even with that said, we still have seen improvement from a margin perspective of 40 basis points. We feel good about that.
No doubt, maybe you can walk us through what those investments have been that are driving that one line higher and just let us know if we should expect it to continue at about this pace.
I'm not going to walk you through all of the investments. Really, it's every single IT investment that is shared across the company that we've had that cumulatively adds up and depends on their life. Depending on whether we have more e-commerce investments that happen to be hitting here that have a shorter life, or we've got certain projects that have a longer life, it depends on how they roll out, how that relatively rolls out to the unallocated section. I wouldn't read much more into that.
Got it. Thank you.
We have time for one last question from Steven Forbes at Guggenheim Securities.
Good afternoon.
Hi, Steve.
Hi.
Maybe just a demographic question. Across your portfolio of brands, what are you seeing in demographic trends, age, income, et cetera? I mean, just in general, do you think your brands are resonating with a broader demographic base? Or is the growth really just gaining market share within your core demographic? How does that relate specifically right to the West Elm strength?
Yeah, I mean, we're focused on customer acquisition and then understanding in each brand what the opportunities are, and if there's a weakness, how do we fix it. We're constantly doing brand surveys to look at the different pieces. West Elm does continue to be uniquely positioned with millennial and millennial-minded customers who seek out brands that share their values and engage with brands through social media, word of mouth. Honestly, I think West Elm's engagement and participation in social media is unparalleled. Just to give an example, our customers at West Elm have shared more than 30,000 photos this quarter through our user-generated content campaign, and over a third of those photos are on our website. You can see there's great connection with our newest and fastest-growing brand, West Elm.
As we look at all of our other brands, we're focused on things like registry that drive customer acquisition and making sure that we're retaining our core customers and treating them really well and giving them outstanding service.
Just a quick financial follow-up just on D&A for the quarter. Obviously, a year-over-year slight decline. Anything to call out there as far as given your investments in IT and so forth? I would imagine we're going to roll off of this sometime soon. Is there anything to specifically call out in the quarter?
Are you talking about unallocated? Is that what you're talking about?
D&A as a whole.
D&A. Depreciation and amortization. Is that what you're asking?
Yes.
I'm sorry, repeat your question. Anything, been any big changes there as a result of the-
Anything to call out regarding, I guess, the lack of growth, right? Because year-over-year it's been essentially flat.
Yeah, no, I wouldn't read much into that. Obviously, as we have investments that are sort of holding around the same level every year, in theory, you should start to see that level off because you would think you'd have some depreciation drop off and then new depreciation drop on. It's never going to be perfect like that. It depends on which projects drop off and which ones drop on. As I was saying earlier, it depends on the life. At some points, you could have extra depreciation because you've got longer projects that are cumulatively in that bucket, and vice versa. I wouldn't read much into that.
Thank you.
That concludes our question and answer session for today. I will now turn the conference over to Ms. Alber for any additional or closing remarks.
Well, thank you all for joining us, and we look forward to talking to you again next quarter. Take care.
Thank you. That does conclude our conference call for the day. We thank you for your participation. You may now disconnect.