Good day, everyone, and welcome to the Williams Sonoma Incorporated First Quarter 2015 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. The call is being recorded. And now I would like to turn the call over to Gabrielle Rabinovich, Vice President of Investor Relations to discuss non GAAP financial measures and forward looking statements.
Please go ahead.
Thank you, Tulare. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. This call contains non GAAP financial measures that 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 these non GAAP financial measures are useful are discussed in our release.
This call also contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, 95, which address the financial condition, results of operations, business initiatives, trends, guidance, growth plans and prospects of the company in 2015 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 ks 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 Q1 fiscal 2015 results. Thank you, Gabrielle.
Good afternoon, everyone, and thank
you for joining us today. On the call with me are Julie Whelan, our Chief Financial Officer and Pat Conley, our Chief Strategy and Business Development Officer. We're pleased to be discussing our Q1 2015 results with you. In the Q1, we delivered comp brand revenue growth of 4.6 percent and EPS of $0.48 Our first quarter earnings results were better than we expected driven by West Elm and our new businesses as well as strong operational and financial execution across all of our brands. Our supply chain and inventory teams did an excellent job managing through the logistical complexity created by the West Coast port disruption.
That said, we did incur additional costs in shipping and fulfillment, as well as lost demand, especially in our Pottery Barn brands due to lower than normal inventory levels. This short term issue will continue to impact us to a lesser extent in the Q2 as Julie will explain in a few minutes. But we are pleased to see sales trends improving as stock levels rebound. Our growth strategies, consistent execution and operational discipline put us on track to deliver another record year. We believe we have a strong lineup for the back half with product introductions and innovative collaborations in all of our brands.
We believe that our recently completed supply chain initiatives will give us greater flexibility to be more competitive on price and deliver greater value to our customers that our technology initiatives will improve customer order visibility and further differentiate levels and that we have significant opportunity to improve our peak season execution this year. Our strong brands and profitable multi channel strategy create a competitive advantage and we remain focused on executing our long term growth initiatives. Our mission is to enhance the quality of our customers' lives at home. Our customers are at the center of everything we do and all of our initiatives are developed with this service mindset. 1 of our key initiatives is inventory optimization.
The West Coast port slowdown has further validated the importance of being in stock. We are focused not only on improving our inventory stock levels to be well positioned for the back half of the year, but also for the long term. We also remain focused on driving growth through business development initiatives. In 2015, we'll extend the reach of our brands globally with more stores in Australia and the launch of our Mexico franchise operations. And we continue to be excited about opportunities for our emerging brands Rejuvenation and Mark and Graham.
I would now like to discuss key developments in each of our brands starting with Pottery Barn. In the Q1 of 2015, Pottery Barn delivered 2.4% comparable brand revenue growth. While it is hard to quantify exactly, the West Coast port disruption materially impacted Pottery Barn. The good news is that toward the end of quarter sales and customer service levels improved as delayed shipments were received. Performance in the quarter was driven by the success of our outdoor furniture and textile collections.
Our proprietary print and pattern designs in both outdoor and indoor pillows were well received. We're also seeing strength in our furniture collections. We are continuing to enhance our interior design services as we believe they represent a significant competitive advantage as our customers look for design assistance. We are serving more customers with trained design studio specialists and we are adding new services that we believe are game changing. We are building on our foundation of multi channel marketing and featuring and distributing more content to drive customer acquisition, connect with our community and increase engagement with Pottery Barn.
Additionally, we're excited to launch a new product collaboration strategy in Q2 and we'll provide more details to you on our next call. We feel strongly that collaborating with other influential brands and innovative design leaders will expand the reach of the brand. Lastly, I want to tell you about an important organizational change in Pottery Barn. Recently promoted Marta Benson to Executive Vice President, GMM Pottery Barn Merchandising. Marta is a proven leader who has a passion for product and brings deep retail and e commerce experience with her to this role.
She has more than 25 years of retail experience and joined Williams Sonoma Inc. In 2011 as Senior Vice President Strategy and Business Development. Marta will have responsibility over the e commerce and retail merchandising organizations and will report directly to the President of the Pottery Barn Brands Sandra Stengel. We're excited about the year ahead for Pottery Barn. We have innovative product introductions and our scale allows us to offer our customers exceptional quality at a great price.
Next, I would like to discuss Pottery Barn Kids. In the Q1, Pottery Barn Kids' comparable brand revenue increased 0.8%. Unfortunately, the West Coast port slowdown had a larger effect on Pottery Barn Kids because of the mix of goods that were held up by the disruption. During the quarter, inventory in our textiles department was negative to last year. We also have lower than anticipated inventory levels in bedroom furniture.
And because we didn't receive our normal flow of fashion in the beginning of the season, we oversold our core inventory. Now while summer fashion is in and is selling, we are out of stock on key core assortments. In addition, customer purchases in Pottery Barn Kids are highly interrelated. And when bedding or cribs are out of stock, entire orders are more affected and we may lose that demand entirely. As a result, we expect Pottery Barn Kids to be the most impacted brand in the short term until we are able to get back in stock, which we expect will occur by the end of the second quarter.
Looking to the second half of the year, we are focused on our product strategies including aesthetic diversification, customization and collaborations. We are innovating and expanding our product lines to address our customers' needs as well as introducing more accessible opening price points to attract new customers. Also, we have further developed our back to school lineup with a more extensive assortment of desks and desk chairs and we are building on the success of our proprietary prints and patterns with our expanded high quality gear collections. Finally, Pottery Barn Kids recently announced its first product collaboration with Jenny Kane, a fashion designer, blogger and mother of 2. The collection will debut in June and includes more than 50 pieces offering a beautiful mix of modern and antique inspired looks reflecting Kane's relaxed and Kane's relaxed and timeless California influence sensibility.
In PV Teen, comparable brand revenues increased 3% in the Q1. High back orders impacted the brand early in the quarter, but we saw an improved flow of inventory in April and began to realize better net sales recovery. Collaborations continue to be an important product and marketing strategy for PVTEAM. A highlight in the Q1 was the successful launch of PVTEAM's exclusive collaboration with 11 time world surfing champion Kelly Slater. This capsule collection is the most eco conscious assortment that PBteen has ever offered and marks Kelly's introduction into the world of home furnishings.
Today, media coverage has generated over 88 articles with 265,000,000 impressions and our top syndicated Kelly Slater video has generated more than 435,000 views on YouTube. In the second quarter, we have more new product introductions in PBteen from our collaborations and we are launching our new dorm assortment. We are focused on providing inspirational decorating solutions across our tween, teen and dorm life stages. We are supporting our new product collections with social media strategies to align with influencers and content creators and provide an authentic voice to our tween and teen customers. Now I'd like to discuss Williams Sonoma.
In the Q1, the Williams Sonoma brand delivered 2.7% comparable brand revenue growth. We saw growth across many of our core categories including cookware and cutlery. Also tabletop glassware and dinnerware continued to outperform. In addition, we saw an acceleration in the Williams Sonoma home business. Williams Sonoma branded product growth is a major area of development and innovation.
Proprietary product introductions include non stick cookware, stoneware, wood utensils, seafood tools and an expanded silicone line. And we are growing our assortment of exclusive product as a result of collaborations with our key partners. Another area of growth in the Williams Sonoma brand is Williams Sonoma Home. We are seeing momentum across core categories including outdoor furniture programs. And this year we are featuring a broader assortment of furniture, textiles and decorative accessories.
In addition, we are highlighting and integrating more of the Williams Sonoma home collection in our retail stores. Lastly, we are extending the reach of the Williams Sonoma brand by providing new ways for customers to experience it across all channels. Continue to be more involved in the food community. For example, this spring we sponsored the South Bites dinner at South by Southwest in Austin. And later this month, we are sponsored Bottle Rock, a 3 day food and music festival in Napa, where we'll be hosting the Williams Sonoma culinary stage.
This month, we are also launching our Chefs Collective, a culinary advisory board of 9 strategically selected chefs to advise on product development and industry trends and to help develop rich content. Now I'd like to discuss our West Elm brand, which saw an increase in comparable brand revenue of 15.3% in Q1, another quarter of double digit comparable brand revenue Growth continues to be broad based across categories with particular success in furniture, decorative accessories and lighting. The diversity of aesthetic and ranges of prices we offer in the West Elm assortment continues to appeal to a a broad range of customers, helping the brand to appeal to people of all ages and income levels. West Elm engages its customers across all channels. Our new stores fuel market share growth.
When we enter a market, we don't just pick up the new retail volume, we also drive our online business. In Q1, we opened 2 stores in Palm Beach, Florida and Virginia Beach, Virginia as well as 1 outlet store in Lancaster, Pennsylvania. Our plan is to open a total of 19 stores this year, including expanding our international footprint with 2 stores in Australia and 1 in Calgary. In stores, West Elm remains focused on its localization strategy, creating diverse assortments that reflects the local consumer and layering on West Elm local collections featuring artists and makers from the store areas. Our stores continue to embrace their role as community centers creating environments and relationships that foster creativity and empower customers.
In the Q1, we hosted a number of successful Etsy and blogger events at our stores and we believe the unique relationships that our stores are developing with their communities are a further point of differentiation for the brand. Finally, West Elm is excited to announce the expansion of the brand's impact sourcing programs and Fairtrade certified product offerings. Fairtrade at West Elm launched with 6 rug collections made in India for holiday 2014. We have now expanded Fairtrade into Nepal, Pakistan and Vietnam as well as our 1st furniture factory in India. This fall the brand will launch 30 collections of fair trade certified rugs and 13 textile collections including our most popular bedding collection.
West Elm's commitment to choice, community and consciousness continue to differentiate the brand and fuel its growth. Now I'd like to discuss our emerging businesses. In 2015, we are continuing to extend the reach of our brands globally. In Australia, we plan to open 6 additional stores this year. As we build scale in country, we are making operational improvements reducing costs and we are starting to see better margins.
Another key component of our global expansion is our franchise development. We are very pleased with our current partnerships in the Middle East and the Philippines and we see great opportunity with our new partner in Mexico. We also plan to expand in additional geographies with other high quality partners around the world. I'm now going to talk about Rejuvenation. We're excited about the growth and new opportunities in our Rejuvenation brand.
Current results indicate the long term potential for Rejuvenation to be a significant multi channel lifestyle brand. We are developing aesthetic that is unique in the marketplace and differentiated from our other brands that we are calling internally Northwest Modern. The brand tenants are quality, timeless design, craftsmanship, customization and functionality. In the Q1, we introduced significantly more lighting and hardware collections and have increased our core functional categories such as mailboxes, address numbers and ceiling fans. We're also expanding our marketing strategy and investing in catalog circulation and e marketing.
Additionally, we recently launched our new contract and hospitality business with a boutique at with a booth at the boutique Design West Trade Show in San Diego. Participation in this event provided us with an opportunity to connect with high value clients and we are pleased to win the distinction of best exhibit at the show. Lastly, performance in our rejuvenation stores is exceeding our expectations. We plan to open our 6th store in several months at Pawn City Market in downtown Atlanta. Successful retail expansion in key markets is an important step in developing this brand and we look forward to sharing the results with you.
Our other emerging business is Mark and Graham. Mark and Graham had a better than expected Q1. Our Q1 business was driven by our successful Mother's Day assortment and improved marketing. We've seen a strong response to our newness and in 2015 we'll have product releases each month. Mark and Graham's classic high quality aesthetic is relevant and is working.
We are offering our customer a great experience in personalized gifts. And in the Q2, we'll be celebrating summer holidays and milestones and we recently introduced our dads and grads gift assortments. In closing, I'd like to reiterate that across our brand portfolio and our channels, we see significant runway for growth. We see opportunities to strengthen our brands, further differentiate our product offering, access new markets, drive continuous improvement in our operations and improve our service levels. And we look forward to updating you next quarter on the progress of our brands and strategies.
I will now turn the call over to Julie to review our financial results in detail. Thank you, Laura, and good afternoon, everyone.
We are pleased with our Q1 results. Strong operational execution and financial discipline allowed us to deliver these better than expected results as we absorb the reduction in revenue and additional costs attributable to the West Coast port slowdown. Before I review our financial details, I would like to give you an update on what we experienced in the Q1 and what we are seeing early in the Q2 as it relates to our inventory positions and the financial effect of the West Coast port slowdown. As expected, in the Q1, we lost sales demand and saw higher back order creation as a result of the port disruption. We also incurred incremental shipping and fulfillment related costs.
While our inventory flow improved throughout the Q1, we did not see meaningful improvement in our in stock and available for sale inventory positions until April. And we have seen our sales trends get better as we improve our in stock positions particularly in the Pottery Barn brand. That said lingering effects exist from the port slowdown that are continuing to impact our business in the Q2 particularly due to higher shipping costs from fulfilling out of market demand as we rebalance inventory levels across our distribution centers. Our view of the financial impact of the West Coast port slowdown has not changed. In March, we estimated the impact of the ports to be a reduction in net revenues of approximately $30,000,000 to 40,000,000 a reduction in EPS of approximately $0.10 to $0.12 in fiscal year 2015, predominantly impacting the Q1.
The vast majority of the sales and earnings impact was sustained in the Q1 with some residual impact to be realized in the Q2. Though it is difficult to estimate the actual impact, we believe the West Coast port slowdown negatively impacted our Q1 revenues by $25,000,000 to $30,000,000 and our earnings by $0.08 to $0.10 per share. Now I would like to comment further on our Q1 performance. For the Q1, net revenues increased 5.8 percent to $1,031,000,000 with comparable brand revenues increasing 4.6% on top of 10% last year. In our e commerce channel, net revenues grew 8.4% to $533,000,000 with growth across all brands and represented 52 percent of total company net revenues for the quarter versus 50% in the Q1 of 2014.
Our retail channel net revenues increased 3.1% to 4.90 $8,000,000 in the Q1, primarily driven by West Elm and our international franchise operations. Gross margin for the quarter was 36.8% versus 37 8% last year. The decline in gross margin resulted from lower selling margins, primarily from the increased shipping and fulfillment related costs associated with the West Coast port disruption. Occupancy costs in the Q1 of 2015 were $151,000,000 or 14.7 percent of net revenues, leveraging 30 basis points. In the Q1, we generated 40 basis points of SG and A leverage.
SG and A improved to 29.8 percent of net revenues in 2015 versus 30.2% in 2014, resulting from advertising efficiencies and employment leverage. Strong expense control and productivity gains from our disciplined approach to marketing effectiveness allowed us to help mitigate the lower selling margins within the gross margin. This resulted in a remaining net 60 basis point decline in operating margin to 7%, which was due to financial impact of the West Coast port slowdown. By channel, the operating margin in the e commerce channel was 24% versus 24.7% in 20 14. The operating margin in the retail channel was 5.6% versus 6.3% in 2014.
And corporate unallocated expenses as a rate represented 8.1% of revenues versus 7.9% in 2014. In the e commerce channel, the 70 basis point decline in operating margin was driven by lower selling margins from higher shipping costs, partially offset by advertising efficiencies as well as the leverage of employment and occupancy costs. In the retail channel, the 70 basis point decline in operating margins resulted from lower selling margins, partially offset by the leverage of occupancy expenses. Corporate unallocated expenses as a percentage of net revenues increased 20 basis points, primarily from higher year over year employment and employment related costs as well as higher occupancy costs associated with incremental investments in our IT infrastructure to support our strategic long term growth initiatives. Excluding the estimated impacts in the West Coast port disruption, corporate unallocated expenses as a percentage of net revenues would be essentially flat to last year.
Q1 2015 diluted earnings per share including the financial impact of the West Coast port disruption were $0.48 Moving to the balance sheet. Cash at the end of the quarter was $79,000,000 versus $113,000,000 last year. In the Q1, we returned $85,000,000 to stockholders through share repurchases and dividends, comprising $53,000,000 in share repurchases and $32,000,000 in dividends. Merchandise inventories increased 10.9 percent to $943,000,000 at the end of the Q1. A substantial portion of this inventory, however, was in transit and not available for sale as of the end of the quarter.
Excluding our newer businesses and the inventory associated with our global expansion, inventory on hand and available for sale was up 1%, which includes a year over year decrease in both the Pottery Barn and Pottery Barn Kids brands of 3.2% and 0.1% respectively. Substantial progress has been made since year end. And by the end of the second quarter, we expect our in stock inventory to not only be replenished, but to grow faster than our revenue growth as we are investing in inventory to set us up for the back half of the year. I would now like to discuss our Q2 fiscal year 2015 guidance. As previously mentioned, we do expect there to be some residual impact from the West Coast port disruption throughout the Q2 of approximately $5,000,000 to $10,000,000 in reduced revenues and $0.02 to $0.04 in reduced earnings per share, which is reflected in our guidance.
For the Q2 of 2015, we expect to grow net revenues to a range of $1,085,000,000 to $1,105,000,000 with comparable brand revenue growth in the range of 4% to 6 percent. We expect our 2nd quarter operating margin to be below last year and we expect diluted earnings per share to be in the range of $0.53 to 0 point 5 $7 For the full year, we expect to deliver another record year our shareholders. We are reiterating all of our guidance ranges. We expect to grow net revenues to a range of $4,950,000,000 to $5,020,100,000 with comparable brand revenue growth of 4% to 6%. We expect our operating margin to be in the range of 10.2% to 10.5% and our diluted earnings per share to be in the range of $3.35 to 3.4 $5 All other financial guidance within the press release remains unchanged from the previous guidance.
This guidance on the year excluding the short term impact from the West Coast port disruption reflects revenue and earnings guidance that is in line with our 3 year outlook of mid to high single digit revenue growth and low double digit to mid teens EPS growth, with revenues growing 8%, including comparable brand revenue growth of 5% to 7% and earnings growth of 12% at the high end of the range. The underlying health of our brands and channels remains strong and we believe our long term growth initiatives remain on track to allow us to more than double our business. We are also reiterating our commitment to maintaining a balanced capital allocation strategy in fiscal year 2015. We plan to utilize our operating cash flow to invest in the business in support of our ongoing growth initiatives in the range of $200,000,000 to $220,000,000 and we remain committed to returning cash to our shareholders in the form of share repurchases and dividends. We now have $234,000,000 remaining and available for share repurchases on our $750,000,000 multi year share repurchase authorization and expect to buy back $200,000,000 to $250,000,000 of our shares in fiscal year 2015.
We are also committed to continuing to pay dividends targeted at 35% to 40% of net income and in line with the S and P 500 dividend yield. In summary, we are confident in the year ahead and in the underlying health of our business. Our competitive advantages have not changed. We have strong brands that are delivering innovative products and outstanding service, a multichannel platform with superior e commerce capabilities resulting in more than 50% of our business already coming from e commerce and profitably and many opportunities for continued growth and market share gains as well as a commitment to financial discipline and returning capital to shareholders. These allow us to remain confident in our ability to deliver sustainable long term profitable growth.
I would now like to open the call for questions. Thank you.
Thank We'll take our first question from Daniel Hofkin with William Blair and Company.
Good afternoon.
Hey, Dan.
Hi. Just wanted to talk a little bit about some of the expanded client tellingservice offerings in your furniture businesses and then just hear a little bit more about that and then find out kind of how some of the similar initiatives that you've been rolling out over the last year in the Williams Sonoma brand, how that's progressing and what you're learning there? Thank you.
Hi, this is Laura. We really believe that relevant offers are are the most effective. And so we're so lucky that we have such a robust history of our customers' purchase behavior and the portfolio of brands that we have allow us to understand what the more clearly more clearly what the different customers have already previously purchased and what they're looking for. And we really believe in building that 1 on 1 connection in our stores and using our stores for that really high touch service. And then of course, they go online and they often they go to the store, they visit it in the store and then they go online and make the purchase.
And so it's a very effective way to target and give our customers offers that are relevant in a sea of I think a lot of offers out there that are less relevant. As it relates to our initiatives in Williams Sonoma, we've been working hard over the last several years to really develop much more proprietary products, both within our own Williams Sonoma branded product line, but also with our vendor partners who have been amazing with us in developing those lines. And we've made very good progress as you see by the positive comps we've been running consecutively. And we also recognize that there's a lot more that we can do and we're testing a lot of new things. We talked last call about our wonderful South Coast Plaza store and the integration of Williams Snohom into that store.
And we see that as an interesting opportunity. We're testing a few different things in that space. It's competitive, so I don't want to go too much into it. But we think there's something very exciting there about that interaction.
Okay. Thank you very much.
We'll move next to Peter Benedict with Robert Baird.
Hey, guys. I guess, so one question. How are you planning the advertising expense, Julie, within your full year outlook. I mean, it's been if
you look back, I mean,
the last 5 or 6 years, it's been a nice source of leverage. I think it's gone from like 10% of sales to about 7% last year. I know that's part of the strategy and how you guys play. But how much further can you go on that? And is that something that you think will continue to be a source of leverage over the next couple of years?
Thank you.
We're going to let Pat Connolly actually answer that question.
Great. Peter, I think we've made improvements as you say over the last couple of years actually over a pretty sustained period of time. And I think we've made fairly significant investments here over the last 12 months in improving the functionality in our websites, which has really helped improve conversion. Our mobile site sales are almost up 80% year over year and a big part of that has been improving our mobile site experience. We're continuing to make strides in personalization and improving in the post purchase experience for our customers with a focus on order tracking and visibility.
We're in the marketing specifically, we have made strategic decisions to drive customer acquisition across the entire conversion funnel. We're spending more on digital, particularly in acquiring new customers. And we've increased our content syndication and grown our blogger outreach to support the brands. But I think it really begs the bigger question is how are you able to do that and still be so profitable. And that's what's probably the most unique about us.
Growing to this size, we're 21st largest e commerce retailer over 50% and yet very, very profitable. I think we have a 20 year head start. We have a 50,000,000 household customer base that have bought from us. But I think fundamentally across the company, we understand that e commerce first and foremost is a retail business. And it just happens to
be conducted online. And lastly, brands matter and the
strength of your brand is conducted online. And lastly, brands matter and the strength of your brand is remeasured by the trust and customers trust us. They've built that trust over many years in many cases through experiences in our stores and through buying through the catalog. So I think all of
those together are going
to allow us to continue to
move next to Matthew Fazler with Goldman Sachs.
Thanks a lot. Good afternoon.
Good afternoon, Matt.
The question I want to ask relates to the impact of the port strike and measuring it financially, particularly on the margin side. If you do the math on the numbers that you gave us with the sales hit and the EPS hit, you get essentially implied 50% margin flow through, which I would imagine is pretty close to your merchandise margin, your pure merch margin on the sales that you lost. Is there a way for us to understand the impact to gross margin rate from the extra shipping costs and other additional expenses associated with the pork strike?
Sure. Matt, this is Julie. I'll take that. I think the way to think about it, obviously, we hadn't quantified it necessarily or closed it by line item. But the reality is the biggest impact is to gross margin.
And so when I said in my prepared remarks that our gross margin is effectively down due to lower selling margins primarily from the increased shipping and fulfillment related costs due to the West Coast port disruption, it's primarily due to that. So that's one way to quantify it. I think the other way to think about it is that the pure merchandise margin was down year over year. This was also due to the fact that we had fill a promotional holiday product that was held up
at the
port at the end of the year. And so we basically didn't get to recognize that for Q1, which also impacted the margin. So really the story is that the gross margin was almost entirely impacted by the West Coast port.
And how do you feel about the merch the pure merch margin trajectory, which I know started to make headway in Q4? And I know you have some initiatives that are directed at shoring that up. Do you feel like those initiatives are still on track and that number can ultimately start to flatten out?
Absolutely. So I mean we expect that there'll be short term shipping pressure of course as we go into Q2 given that there's still the residual impact from the port that will happen in Q2. But as we move longer term throughout the balance of the year and obviously post this year, all of the initiatives that we've been working on, in particular the in sourcing of our foreign agents and the regionalization of our distribution centers, lower cost for us. So I mean the in sourcing as you know that was completed last year in June. So this is our 1st full year of that.
And just alone by the fact that we don't have the overhead structure with a 3rd party has reduced cost on that line. So we do expect longer term to see margin expansion.
Thank you.
And next we have Greg Melich with Evercore.
Hi, thanks. I think my question really followed on I think from the last one. When you think about that in sourcing and how the inventory is growing even though we're we've had the port problems and not been in stock. What should we expect a normal merchandise inventory number to be now that once we get the port thing cleared should we still be growing it at say 10% to 12%, but that the in stock or the available inventory is now 10% or 12% or how should we think about that?
So I mean obviously we don't guide per se inventory levels. Other tend to say which I think Laura mentioned on the call that to be in stock this whole West Coast port slowdown is really validated for us the criticality of being in stock. And so we are going to be focused on improving our in stock inventory levels obviously throughout Q2, but to set us up really the back half of the year. And so we expect that our inventory will not only be replenished by the end of the second quarter, but that will grow faster than our revenue growth, as we are investing in inventory to set us up for the back half of the year and longer term.
So inventory is up 11% year over year, we should expect it to still be up 11% at the end of the second or third quarter and just that the in stock availability is better?
So obviously I'm not going to be able to give you a number. Your expectation should be higher than that if I'm referencing in stock inventory is going to be growing higher than revenue growth because the 10.9% relates to the balance sheet inventory level.
Got it. And the payables that haven't been growing, I guess, should we expect payables to start to grow as you as that inventory normalizes so that the working capital cost isn't as great?
Absolutely. Okay. Thanks.
Next we have Jessica Mayce with Nomura Securities.
Hi, good afternoon.
Good afternoon.
My question is on West Elm. I was wondering if you could talk about in the strong results you saw this quarter, what initiatives have gone into place that are beginning to impact that? And maybe some of the timing on some of the other initiatives such as contract or the partnership with Inscape that we should expect throughout the rest of the year?
Thanks for the question. We've talked about choice, consciousness community. What does that mean? Choice is in the product offer and we have great aesthetic choices for our customer mid century and industrial aesthetics continue to work well. And we are seeing growth across all continue to work well.
And we are seeing growth across all categories honestly with outsized growth coming from furniture. We continue to bring in new flows of product. In fact in Q2, we're really excited. We have a pre fall assortment we've never had before. It helps us break the monotony of the end of season sale and buoy the margin up when a lot of other people are on sale.
We also as you think about the other two initiatives, we realized that customers don't just want to buy things, they want to know where they're from, they want people to source products sustainably and West Elm has really embraced this idea and has such a big footprint in the area of consciousness because of all the wonderful things that they're doing. Jim Brett and his team actually were the number one people to raise money for the AIDS Walk last week in New York, which we are very, very proud of. It's just one small example of how involved West Elm is in every single local community. And as far as it goes to new initiatives in West Elm, Workspace is a big one right around the corner. We're going to launch at NeoCon on June 15 in Chicago.
For those who don't know NeoCon is the largest commercial interior show in North America takes place in Chicago and it's the premier platform for connecting learning and doing business in the industry. And we're going to be opening in conjunction with our permanent 2,500 square foot showroom at the Merchandise Mart and we're on track to have dealer representation in all key metropolitan areas. So West Elm Workspace is more than on track and it includes more than 75 furniture pieces for offices, cross desks, benching systems, private office and common lounge spaces. And we see this area as one that is really underserved in the market.
Great. Thanks very much.
And next we'll move to Simeon Gutman with Morgan Stanley.
Thanks. Good afternoon. One follow-up to Matt's question and then a separate one. If we look at the financial impact maybe a slightly different way just in terms of what the EBIT margin would have expanded, our math is getting to us about 20 basis points, Julie, and I don't know if there's anything wrong with that math. And then if that's right, is that largely is that mostly gross margin driven?
I think it
would be higher. I'm not going to give you that number exactly, but it would be higher margin expansion on the bottom and it is largely predominantly gross margin.
Okay.
That's helpful. And then just one maybe for Laura. Can you remind us if you comment on this how big the outdoor furniture category is for you, the time frame that the bulk of sales get done and then any early read on how that business is performing?
It is so competitive. I'm sorry that I'm not going to give you the number. I will tell you that it is off to a great start.
Okay. Thanks.
Next we'll move to Seth Sigman with Credit Suisse.
Great. Thank you. Can you guys update us on the international business? I think you mentioned improving margins there this quarter. Can you elaborate what's driving that?
And I realize you're probably still somewhat in investment mode there, but how do you think about the potential to close the margin gap with that business and your U. S. Business?
Okay. I'll take that. It's Julie.
Yes, we're very excited about this opportunity. As you know, we believe this could be a huge growth opportunity for us long term. And I think if we said to many of you that this is a long term model to get to be the level we want it to be anywhere from 3 to 5 years from when we enter the country. And so we're just starting to get to a level of scale that we can start to see some of these benefits. But it's still in the beginning stages.
And one of the biggest we did as an example that's improving the margins is we renegotiated our distribution center deal there and that generated some substantial savings. And so it's little things like that one after another that we're looking at and pulling apart and just becoming more operationally efficient. And so as we move through and get more scale, we're going to see more of those opportunities.
Great. Thank you.
And we'll move on to Michael Lasser with UBS.
Good evening. Thanks for taking my question. I'm wondering about the competitive landscape, presumably since you are bigger and have a little more muscle in the marketplace. You were less impacted although you're still very impacted by the port issues, you're probably less impacted maybe some of the smaller players out there. And so do you think that as a result some of the smaller players or even medium sized players were less promotional because they didn't have the inventory to promote and so that made the environment a little less intense because it seems like you were less promotional if all of the merchandise margin pressure was related to the West Coast part?
I would just say it is still promotional out there, but I wouldn't read too much into the comparative number of promotions we run. There are promotions that we didn't comp obviously and there's ones that we changed and it's part of doing executing our strategy. And I wouldn't say it's an elevated level per se in the marketplace. But I think the things that really set us apart in our categories where we compete are that first of all, we're vertical. We create design and contract most of what we sell.
If you want to buy our products, you have to buy them from us. And this model not only gives us
exclusivity and pricing power to eliminate
layers of cost that we exclusivity and pricing power to eliminate layers of cost that we can pass on to the customer in the form of outstanding quality at a great value. The other major difference is our model, obviously. We really do operate a different model than most of the people that, are out there trying to compete with us. And it's really, I think, beyond multichannel or omnichannel. I think what we're creating is a three-dimensional experience.
And when you close your eyes and you think of our brands and you think of our stores and our catalogs, they bring our brands to life. And in our categories, I think that's the catalogs, they bring our brands to life. And in our categories, I think that's the magic. You can visualize how your home would look, how the meal you will serve to your family and friends will look, and then you can go to one of our websites and you can quickly order. And I think that's what makes us different.
And I think that is what is a big part of our continuing success.
That makes sense. And that's helpful. Just a quick follow-up on the margin question. Do you Is it should we expect as we're forecasting the P and L that you should get most of the margin pressure that you saw in the Q1 back in the Q1 of next year?
In the Q1 of next year? Well, we're not providing that.
Yes. So just as you anniversary, there's nothing that really should be ongoing. It's all kind of one time ish, correct?
Well, obviously, we have next quarter as well with the residual impact that we're going to be experiencing with higher shipping costs that will hit the gross margin as well. Yeah. To the extent we've quantified how much is worth the port in that range, that is what we expect is worth in the port in Q1 this year.
Okay. Cool. Thank you so much. Welcome.
We have time for one last question and that will be from David Magee with SunTrust.
Yes. Hi, everybody. Hi, David. I just had a 2 part question. One is, can you give us an update in terms of what you expect to do this year in reducing custom furniture delivery times?
And at the same time, I'm curious what's happening with regard to your ability to recognize e commerce visitors and how that's changing this year as well? Thank you.
Could you repeat your second part of your question?
Sure. Just the your ability to recognize unique visitors to your site and it's my understanding that that capability has been improving and which is obviously a nice competitive advantage. Any color there would be helpful.
Thank
you. Thanks. On the first one, when you think about our competitive advantages, certainly one is our supply chain. And we believe that speed is another really important new currency in the furniture marketplace. As you know, we've invested in our own furniture, upholstered furniture manufacturing unit and we are making some strategic changes so that we can significantly improve wait times on our furniture, which I think is really a game changer because so many other people who are cropping up, they don't even hold they don't even it's not their product.
They're in a marketplace model. And they don't control the supply chain. And we know that we can provide superior service and higher touch service by controlling the whole thing. And this opportunity to reduce the wait time substantially is one that we're extremely focused on. And Pat, I think maybe you should take the second part.
Sure. I think Dave you're referring to our ability to identify customers when they come to the site and then offer then give them personalized offers based on that. And that's really a function of new technology that we implemented last year. And we've gone from recognizing 25% of site visitors up to now 60% or 70%. We're actually recognizing and knowing about 15% to 20% of site visitors who've never been to the site before and then being able to understanding that give them the right kind of offer and to serve up this personalized content based on their experience with us up to yesterday and do that in less than 20 milliseconds.
So it's a big technology enhancement. And I think we're still in the early innings. And you'll see throughout this year and in coming years just our ability to personalize virtually every page of the customer. We're pretty excited about not only what we've been able to do, but what we think we can do in the future.
Great. Thanks and good luck. Thank you.
That concludes our question and answer session for today. I'll now turn the conference call back over to Ms. Elber for any additional or closing remarks.
Well, thank you all for joining us this afternoon. We appreciate your time and continued support and we look forward to speaking with you again in August.
Thank you everyone. And that does conclude our conference call for today. We thank you for your participation. You may now