Williams Sonoma Inc (WSM) Q1 2021 Earnings Call Transcript

Welcome to the Williams-Sonoma, Inc. earnings call. This call is being recorded. I would now like to turn the call over to Elise Wang, Vice President of Investor Relations, to discuss non-GAAP financial measures and forward-looking statements. Please go ahead.

Thank you. Good afternoon. This call should be considered in conjunction with the press release that we issued earlier today. Unless indicated otherwise, our discussion today will relate to results and guidance based on certain non-GAAP measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why the non-GAAP financial measures may be useful are discussed in Exhibit 1 of our press release. This call also contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which address the financial conditions, results of operations, business initiatives, trends, growth plans and prospects of the company in 2021 and beyond and are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements. Please refer to the company's current press release and SEC filings, including the most recent 10-K for more information on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. I will now turn the conference call over to Laura Alber, our President and Chief Executive Officer.

Thank you. Good afternoon, everyone, and thank you all for joining us. We are proud to report another record quarter of accelerating revenue and profitability with over 40% comp growth and a 950 basis point expansion in our operating margin. These results were driven by strength across all of our brands. We are seeing strength in our core businesses and our new growth initiatives have outperformed. As reopenings accelerate across the country, a record number of customers continue to shop with us as they invest in their homes. We are honored to be our customers' destination for their entertaining and home furnishing needs as they welcome friends and family back. As a result, we are raising our full year guidance from mid- to high single-digit revenue growth to low double-digit to mid-teen revenue growth and year-over-year operating margin expansion. We believe our business is uniquely positioned to gain market share given our growth strategies and our three key differentiators, which are: one, our in-house design; two, our digital-first channel strategy; and three, our values. These differentiators are more relevant than ever with our customers and are setting us further apart from our competition. Starting with our in-house design capability. We know that ultimately, everything starts and ends with product. Our in-house designers, combined with our vendor partners, create proprietary products that are high quality, sustainable and aesthetically unique. The strength of our value proposition has given us the opportunity to pull back on promotions. We see this as a sustainable change in our model and a game changer for the longer-term strength of our margins. In addition, our world-class design capabilities are driving new product launches across our brands. In Q1, we saw strong indicators of growth in these new initiatives. For example, in Pottery Barn, our rustic modern casual point of view in furniture, home furnishings and decorating are driving double-digit growth in all categories. Growth in our bath renovation business accelerated to nearly 50% in the quarter, and our marketplace business gained momentum, growing over 70% in the quarter and reaching over 6% of our total Pottery Barn brand sales. In Pottery Barn Kids and Teen, we continue to amplify our leadership in the children's home furnishings market with our emphasis on design and sustainability. We are proud that 100% of our children's furniture is GREENGUARD Gold certified and our in-house design furniture collections are distinctive in the market. Furniture continues to be a key growth driver for the brand. We also saw outsized growth in key initiatives such as baby, which grew over 30%, and our aesthetic expansion into modern, which comped nearly 70% over last year. In West Elm, in addition to broad-based strength, our aggressive expansion in the outdoor category has been successful and incremental. This quarter, our outdoor furniture business grew at a comp of nearly 140%, driven by line extensions and our top-performing collections and new product introductions. We've expanded our year-round assortment and plan to introduce several new collections over the next year that will nearly double our outdoor business. Another exciting growth initiative is the expansion of our West Elm Kids business, including the launch of a dedicated e-commerce site. In the Williams-Sonoma brand, cooking-at-home and now entertaining-at-home are driving our customers' purchases. This quarter, we saw significant growth in all areas of entertaining, particularly outdoors, and Easter gatherings. As the momentum builds with people coming back together and celebrating, we are well positioned to meet their cooking and entertaining needs as we head into the back half of the year. Additionally, in our Williams-Sonoma Home business, we delivered a 40% comp for the quarter. Our decision to reposition the brand as a furniture destination is paying off and customers are responding very favorably to our high-end sustainable casual aesthetic. Our outdoor collections, for example, are delivering over 200% growth. We continue to believe that Williams-Sonoma Home is one of our biggest growth opportunities as the high-end luxury furniture market remains significantly underserved, especially online. Our cross-brand growth initiative, B2B, delivered another record-breaking quarter, up nearly 165% or $100 million in revenues and is on track to reach over $0.5 billion by year-end. The momentum in our contract business accelerated throughout the quarter as the businesses started to reopen, and our win rates on large projects continue to improve. One example of a high-profile project is with the Austin Football Club. Over the past 16 months, we have been furnishing the club state-of-the-art Q2 stadium that's set to host its first international game next month. We are also thrilled that we continue to see repeat business from some of our key customers like Salesforce, and we have a growing number of new projects currently underway. Now I'd like to discuss our digital-first positioning as a key differentiator. E-commerce is and will continue to power our growth, demonstrated by our sustained step-ups in top and bottom line results. We have built our e-commerce platform over decades of investment, including a supply chain custom built to ship directly to customers, industry-leading in-house digital marketing capabilities, a digital-first house file and a sophisticated tech stack. This quarter, our in-house tech platform and rapid experimentation program continued to deliver strong results. We introduced new features and improvements across the digital experience in site navigation and personalization, PIP experiences and in our proprietary product recommendations platform, all of which drove double-digit growth in engagement and a significant lift in revenue per visitor. More of our customers are also utilizing our 3D design tool, the Design Crew Room Planner, with total plans created in Q1 up nearly 50% compared to last year. As a reminder, customers who utilize this tool continue to generate twice as many sales as the average customer. We also have the advantage of being digital-first, but not digital-only. Our stores helped drive our online growth and are a key competitive advantage. They give our customers the ability to experience our products in person, to access our convenient omnichannel services and to take advantage of our free in-store or in-home design services. This operating model allowed us to generate strong e-commerce growth, maintaining over 65% of our revenue mix, while delivering some of the highest retail growth we have seen on both a 1-year and a 2-year basis. As a reminder, on our channel performance, we are up against store shutdowns from March 18 through the end of June last year and limited retail traffic due to COVID restrictions through the balance of the year. We are thrilled to see both our retail and DTC channels outperforming expectations. Our results this quarter also demonstrate the effectiveness of our digital marketing investments. We continue to focus on high ROI advertising vehicles. We manage our advertising spend in-house and have developed a robust test-and-learn agenda across our portfolio of brands, allowing us to find efficiencies and to reinvest. The margin upside we have seen from fewer promotions also enables us to invest more in incremental high ROI marketing initiatives to drive the top line. We've also identified a large growth opportunity in cross-brand migration. We've seen a significant change in behavior since we launched The Key, our free loyalty program that allows customers to earn points across our brands and to use their rewards at any one of our brands. New customers are increasing their cross-brand spend at record levels, and we have just begun to tap into this opportunity. This year, we'll be implementing new cross-brand programs, messaging and events that will further accelerate this cross-brand shopping behavior. We believe this is one of our key incremental growth opportunities, and we look forward to sharing more with you as we have some very exciting launches coming this fall. We are also proud to have made progress in the area of values, which is our third key differentiator. Last month, we became one of the first in our industry to commit to a science-based target for emissions reduction by 2030, including the goal of carbon neutrality across our own operations by 2025. We underwent an extensive year-long data gathering process using third-party experts and independent research alongside our company data to measure our carbon footprint and to arrive at this carbon reduction target. We are also proud to be gaining traction on our goal to plant 3 million trees in 3 years with 1 million trees already planted since the campaign's inception at the beginning of 2021. In addition, we have recently been included in the top 100 companies of Forbes' Best Employers for Diversity, which honors our progress in creating a diverse and inclusive workplace for associates. We also continue to build on our relationships with our Black Equity Action Partners, the NAACP, The Jackie Robinson Foundation and The National Urban League. And we have just established our new partnership with Asian Americans Advancing Justice, Asian Law Caucus. Hate-motivated attacks against the Asian community are simply unacceptable. We stand with the Asian community and our Asian associates, and we will continue to use our collective power to fight against hate, racism and inequity in all forms. I would now like to discuss our outlook for the balance of the year and provide some insight into what we are currently seeing in our business. Quarter-to-date, our business remains strong. We are seeing top line growth and strong margin continue. This is particularly important because we are now comping a substantial spike in home category demand last year as a result of the pandemic lockdown. This trend further confirms our confidence in our growth outlook in a more normalized environment. From a supply chain perspective, although backorders remained high, we are working to restore our in-stock levels. We continue to do all that we can to expedite inventory flow, and we are proactively extending our product lead times where necessary and reaching out to customers with timely updates as we work through these delays. The situation, however, remains difficult, especially with the heartbreaking COVID crisis in India, which is impacting production. Our current estimate is that we should be back in stock during the third quarter. As it relates to cost increases that continue to pressure the industry, i.e., shipping costs and raw material increases, we are confident that we can achieve our profitability goals due to our strong product margin expansion and occupancy leverage. From a macro perspective, we believe trends will continue in our favor. High consumer confidence, the spending shift to e-commerce, the continuation of remote and hybrid work and a robust housing market provides a strong backdrop to our strategies. Also as kids return to school, we've seen a significant recovery in our gear and dorm businesses and expect this will continue and be material as we move into the fall. In addition, the outsized growth across all of our entertaining-related categories, such as outdoor, dining and tabletop, gives us confidence that the entertaining trend will further accelerate as we move throughout the year and as people welcome friends and family back into their homes, especially for the holidays. We also see a big opportunity in gift-giving this year as people gather and reconnect to give gifts in person this holiday. As far as other parts of our business, our B2B sales are accelerating week after week as our project pipeline continues to expand with the reopening of businesses across the country. And our global operations are also gaining momentum with the reopening of our company-owned stores and strong franchise business across the world. As we look ahead, we are confident in our runway for growth and profitability. The goals we have set are driving incremental growth faster than anticipated. Our brand differentiators continue to accelerate and favorable macro trends should continue to benefit our business for the long term. We are the only home furnishings retailer that's able to serve customers at scale online and provide the experience and convenience of physical retail with exclusive sustainable products, giving us the unique advantage to gain share for many years to come. Before I pass the call to Julie, I want to thank our associates for their ongoing hard work and dedication. Their resilience and innovation are a key part of our success and our ability to continue to deliver profitable market share gains for the long term.

Thank you, Laura, and good afternoon, everyone. We are pleased to report another outstanding quarter of financial results. Revenue growth, margin expansion and earnings per share all accelerated and exceeded expectations, demonstrating the power of our three key differentiators and the great execution by our team. The strength we saw across all of our brands reinforces that the consumer has a continued appreciation for the home, resulting in a shift in consumer spending to our category which should continue to benefit our business for years to come. Let's now review our first quarter results in more detail. Our net revenues reached approximately $1.75 billion with comparable brand revenue growth accelerating to 40.4%. We saw strong sequential acceleration across all brands, starting with West Elm at a comp of 50.9%, Pottery Barn at 41.3%, Williams-Sonoma at 35.3% and Pottery Barn Kids and Teen at 27.6%. Our emerging brands, Rejuvenation and Mark and Graham combined, delivered comp growth of over 35%, and our global business grew over 81% to approximately $100 million. Moving down the income statement. Gross margin expanded a record 850 basis points to 43%, driven by substantially higher selling margins and occupancy leverage. Selling margins expanded for another consecutive quarter, up over 440 basis points year-over-year and 310 basis points from the fourth quarter, driven by higher merchandise margins and ship cost leverage, which reflects the higher mix of retail sales versus last year. Higher merchandise margins were driven by a significant pullback in promotions. Our continued focus on marketing our proprietary design, sustainability and value in lieu of site-wide promotions allowed us to deliver another quarter of strong merchandise margins. Occupancy leverage of approximately 410 basis points in the quarter resulted from higher sales and another quarter of relatively flat year-over-year occupancy dollars at approximately $176 million as compared to $175 million last year. Our ongoing efforts to optimize our retail fleet by either renegotiating rent or closing less profitable stores has enabled us to minimize our occupancy dollar growth and to deliver this occupancy leverage. As a reminder, we closed a total of net 33 stores last year and expect to close 25% of our total retail fleet in the next five years. SG&A in the first quarter was 27.1% of net revenues compared to 28.1% last year, leveraging 100 basis points year-over-year. This was primarily driven by leverage in employment and other general expenses resulting from higher sales and overall cost discipline, partially offset by higher advertising as compared to our significantly reduced ad spend last year. As you may recall, as part of our initial financial response to COVID, we substantially reduced our spend across the business, particularly in advertising at this time last year. Since then, we have been incrementally investing back into advertising to drive our profitable top line growth and we expect this to continue as we move throughout the year. Given the strength of our business, including our record profitability levels, we are pleased that we are able to incrementally invest in high ROI advertising to drive top line growth and market share gains while still delivering another quarter of SG&A leverage and substantial operating margin expansion. Operating income grew over 250% to $278 million and resulted in operating margin expansion of 950 basis points to 15.9%, a record high first quarter operating margin. This resulted in diluted earnings per share of $2.93 or nearly four times last year at $0.74. On the balance sheet, we ended the quarter with almost $640 million in cash and over $238 million in operating cash flow, a significant increase over last year. This strong liquidity position allowed us to fund the operations of the business, including $42 million in capital expenditures and to provide accelerated shareholder returns of over $361 million, consisting of increased quarterly dividends of over $45 million and a substantial increase in share repurchases of over $315 million. These accelerated returns, combined with a full paydown of our $300 million term loan during the quarter, along with the recent expiration of our 364-day $200 million line of credit facility, reflect our confidence in the long-term strength of our business and our commitment to maximizing returns for our shareholders. Moving down the balance sheet. Merchandise inventories were $1.088 billion, an increase of 1.6% over last year. While our inventory levels have sequentially improved, they continue to be impacted by our stronger-than-expected demand across all brands, as well as supply chain disruptions such as the West Coast ports congestion and Suez Canal blockage earlier in the quarter, the container shortage out of Asia and the COVID-related delays coming out of India. As a result of these challenges, we expect backorder levels to remain elevated until at least the third quarter of this year. We are also experiencing delays in our upholstery furniture production from the recent foam shortage which is currently causing our upholstered furniture quote times to be longer than usual. Now let me turn to our expectations for the rest of the year. As Laura mentioned, we are raising our 2021 outlook from mid- to high single-digit revenue growth to low double-digit to mid-teen revenue growth, along with year-over-year non-GAAP operating margin expansion. We are confident in our ability to deliver this higher revenue outlook given the strength of our business year-to-date, the strong housing environment and people's deeper appreciation for the home, the accelerating momentum in our growth initiatives, B2B marketplace and our global operations, and a planned sequential improvement in our inventory, enabling us to fill our significant backorders as we move throughout the year. Now I would like to talk about profitability. Although there are ongoing cost pressures from freight and raw materials, as Laura mentioned, we believe our operating margin expansion will be driven by overall sales leverage, continued occupancy leverage from the renegotiation of our lease agreements and store closures, continued expansion in our merchandise margins due to our differentiated positioning with design-led value-engineered and sustainable products as well as from overall strong financial discipline. As far as our capital allocation in 2021, we are maintaining our balanced approach to first investing in the business and then returning excess cash to shareholders. We are on track to invest approximately $200 million to $250 million in the business this year, with spend prioritized on technology and supply chain initiatives that primarily support our e-commerce growth. We also plan to return excess cash to our shareholders in the form of quarterly dividend payouts and increased levels of share repurchases compared to last year. Our total share repurchase of over $315 million in the first quarter reflects our continued belief that our stock is undervalued, given our growth and profitability outlook. As a result, we believe investing more in our own stock will also drive long-term financial returns. Longer term, we remain well on track to reach $10 billion in net revenues and maintain at least 15% operating margins in the next five years. In summary, our results in the first quarter and the progress we have made across our key growth initiatives reinforce our ability to drive long-term sustainable growth and increase profitability. We believe we are in the best position to take market share, especially in an environment where consumers are investing more in their homes, shifting increasingly online and are prioritizing design, value and sustainability in their purchases more than ever before. All of this gives us the confidence to deliver on our long-term outlook and to drive strong financial returns for our shareholders for years to come. I would now like to open the call for questions.

And we will go first to Oliver Wintermantel of Evercore ISI.

Laura, I'm looking — you said the strength continued into the second quarter in revenues and margins while lapping the spike from last year. Could you give a little more detail on that? And then secondly, the raise of the guidance that you provided today: if I look at the really strong outperformance in the first quarter versus expectations, that would probably get you there without touching the rest of the year. Is there anything that you learned during the first quarter that applies to the second half or the last three months of the year?

Sure. In terms of the quarter-to-date, it's early in the quarter, but we are seeing strength and the stores are amazing. Traffic is still under where it was in 2019, which shows how much more room there is as traffic really comes back, as people feel even more comfortable shopping in our stores, and e-commerce continues to be a strong driver. We are running a really regular-priced business. That said, we will run markdowns where we have seasonal issues. There is substantial upside with the margin throughout the back half of the year, and it's an important change for us. It allows us to do a lot of other things that create that virtuous cycle where you can invest in other things that drive top line like ad costs, which is very effective. So in terms of the guidance, Julie, do you want to talk a little bit about that?

Yes. I would say, Oliver, I wouldn't read too much into that. We are very confident in where we are today, both because of our Q1 performance, which is phenomenal, and where we are quarter-to-date. If you look at it on the high end, we are guiding to a mid-teen level on top of the 17% last year with operating margin expansion on top of last year's outperformance that was above 560 basis points over the year before. We feel very confident in the future of our business, both this year and in reaching our five-year $10 billion targets. I wouldn't read anything more into it than that. It's early in the year. We gave the previous outlook two months ago. Now we've completed one quarter, and we've got three big quarters to go. As we move through the year, we will update you accordingly, but we feel very confident in our business.

And we'll go next to Adrienne Yih of Barclays.

Good. Another great quarter, so congratulations. Laura, my question is on something that you had just said earlier in the Q&A session. It was about ad spend. When we look at last year, ad spend as a percent of sales fell to around 5%, but it's historically been at about 7%. As you move more and more to a pure-play e-commerce model, how do you look at that line item? Where do you think the right number should be? And then, Julie, one quick one for you. With the total store closures of 25% over the horizon, that implies you will be closing less profitable stores. How do you think about closing four-wall positive stores that others might want to keep because of their four-wall contribution, but because e-commerce is so much more accretive, it's the right move?

It's an interesting question and one that requires flexibility as we see different things happen in our business. We have Felix here. Felix, do you want to make some comments about our ad cost approach?

Yes. Absolutely. Thank you for the question. We continue to invest in advertising where we see the ROI. As Laura mentioned, we've taken all of our online media buying in-house. We manage a cross-brand learning agenda across our seven brands, which allows us to test and learn on one brand and roll it to the others. Our legacy and performance marketing dating back to our catalog days gives us a competitive advantage when it comes to identifying top ROI tactics. To answer your question, we continue to see investment in online pay back. We are still dedicated to the operating margin goals for the company. But we are passionate about investing where we see the ROI.

Adrienne, on the store closures, you're right. We are closing less profitable stores, but under anybody else's framework, they'd like the four-wall. The difference is we want our stores to rival our e-commerce in profitability, and we think that's possible. There are some malls we don't want to be in anymore; they're not good for the brand. We also have markets with too many stores. We never overstored, but there's room for consolidation and room to have bigger, better stores rather than many small, dated ones because we are a destination and people will drive to us. In some cases, we're moving from one place to the next. We just opened a few great Williams-Sonoma and Pottery Barn stores in new centers and I'm thrilled with the results. You'll see us improve the retail portfolio, prune the bottom and take total profitability up.

And we'll go next to Maksim Rakhlenko of Cowen and Company.

Congrats on a very strong quarter. First, can you discuss a framework for what EBIT margin could look like this year? Maybe the lower end to the higher end of what's achievable and the most pertinent factors that could get you there? And then separately, longer term, as we think about your $10 billion revenue outlook, how do you think that could shake out in the core versus some of the newer businesses? Ultimately, when we sit in 2025, what would it take for the core to be at the lower or higher end of what is feasible?

From an EBIT perspective, we are very bullish on our ability to drive profitability. We have not seen this level of merchandise margin expansion to this degree for a while. We've been driving it since 2018 because of our change in operating model and pulling back on promotions, which is a fundamental shift. To this level, it's been incredible. Combine that with occupancy leverage and SG&A leverage, and it gives us confidence in a very profitable operating margin like we delivered last year. I think everyone was surprised by 14.2% last year, and we said we'd expand on top of that this year. We're committed to driving at least 15% in five years, and it could be higher. We have puts and takes like raw material and freight increases, but we are best positioned to offset that and drive very strong profitability for the foreseeable future. On the revenue side, we are very confident about our $10 billion in five years. The core is a big base and a big driver, but our growth initiatives should not be underestimated. B2B is on fire; we are on track to well over $500 million this year and think it could go higher quicker than we thought. Marketplace and global operations, Williams-Sonoma Home as a luxury opportunity — many of these initiatives are just getting started and give us confidence to reach $10 billion.

And we'll go to our next question from Cristina Fernández of Telsey Advisory Group.

My congratulations on the quarter. I had a follow-up on operating margin. If you look at this quarter, there was a much higher gross margin but also higher expenses. Are these levels sustainable for the rest of the year? Should we think about gross margin in that 40-plus percent range and SG&A at this level? Also, the merchandise margin has been increasing for the past couple of quarters. Is this a peak level or do you think it can go higher?

We are very confident in our ability to drive operating margin expansion and be a profitable company. We expect to continue to drive merchandise margin expansion, though we won't provide a quarter-by-quarter level of disclosure such as gross margin consistently above 40% at this time. We have no reason to believe the pullback on promotions will discontinue. You shouldn't model this quarter's exact levels every quarter, but we believe there is strength left because of our fundamental shift on promotions and our differentiators. We design our product in-house and engineer it for value and sustainability while maintaining high quality. Because of that, we can lead with content-led marketing and deliver product people want at a very good price. We don't see that changing anytime soon and believe we can maintain strong margins going forward.

And we will move to our next question from Steven Forbes of Guggenheim Securities.

Congrats on a great quarter. I wanted to focus on the cross-banner or cross-brand migration strategy. Can you update us on the number of cross-brand customers and how that's evolved? Any color on their behaviors relative to the average: spending trends, frequency? What gets you excited about the potential to continue to lean into that strategy?

Great. I'm going to let Felix take that one.

Thank you. We are very excited about the cross-brand opportunity; we think it's one of our biggest opportunities. It's not just about customer acquisition but increasing share of wallet with each customer. We've seen a record number of customers migrate across our brands. Particularly exciting, our new customers are participating in one or more brands at record levels since we launched The Key. Almost 80% of our customers are enrolled in The Key, which bodes incredibly well for lifetime value and customer profitability. We will increase cross-brand activity through the customer shopping journey from the homepage to in-store, from shopping by category to inspirational ideas. We think it's key to owning share of wallet for existing customers and are focused on it. We have announcements coming in the fall. Ultimately, our excitement comes from the KPIs we see for customers migrating across brands.

A quick follow-up: when you mentioned stores and consolidation in regions, is part of that going to come in the form of larger stores that merchandise across the banners? Any thought on consolidation of banners within one store?

We run a wide range of store sizes. We're not planning to open stores larger than our largest today; rather, we have many smaller, dated stores we'd trade up to more optimized standards for each brand. We don't have plans to change our overall optimized standard at this point. I will add that our omni services, particularly BOPUS and BOPIS, are showing outsized growth with a two-year comp of almost 90%, highlighting how important stores are to the online business.

We will go next to Curtis Nagle of Bank of America.

Not to belabor a point, but thinking about promotional cadence and the industry: you say you don't have to promote right now for obvious reasons. What do you think happens when things settle down? Might you have to step back into promotions at some point? How should we think about that once the operating environment normalizes?

Think about our three key differentiators and our growth drivers. We have incremental and real growth drivers that are still in early innings and will continue to help us drive growth at regular price. Our pricing strategy focuses on giving the customer great value with new products, opening price points and products that can't be rivaled for quality and design. We're relentless in pursuing gorgeous sustainable design. Customers understand that if they want something from us, they won't find it elsewhere. If we give them a fair price and great quality, they will come back repeatedly. That's why we see very high average order size and strong repeat rates. I don't see any reason why this should abate, especially given the pipeline of growth initiatives we have.

And we'll go next to Seth Basham of Wedbush Securities.

Congratulations on great results. First, thinking about the sales outlook by brand, based on your growth initiatives, which brands do you expect to outperform in comparable store sales growth for the balance of the year?

We are seeing broad-based strength across brands. We are not disclosing by brand where we think comps will be. Q1 results were phenomenally strong and we are seeing strong results in the second quarter. Whether it's kids returning to school driving gear and dorm items, Williams-Sonoma and entertaining outdoors, or the other brands driving home furnishings for outdoor and entertaining, each has positive contributions for upcoming quarters. We believe the performance will be broad-based.

They are competitive with each other and each has incremental growth strategies as well as core growth strategies. We expect a strong year across the board.

When you think about cadence of growth through the year, you're facing tough comparisons. Are you expecting growth in each quarter?

Yes.

And we'll go to Simeon Gutman of Morgan Stanley.

I'll stick with margins. Have you discussed assumptions related to promotion or this merchandise margin environment for the back half of the year? How do you balance structural improvement versus a promotional cycle that could return at some point?

We haven't given specific back-half merchandise margin levels, except to say we continue to believe we can drive merchandise margin expansion and occupancy leverage. We are confident in our ability to drive gross margin expansion. You can't assume you'll see this quarter's exact expansion every quarter because we'll have pressures like raw material and freight increases, but we are best positioned to handle those given our scale, unique offering and financial discipline. We expect to continue delivering merchandise margin expansion and gross margin expansion.

Anything you can provide on the marketplace in terms of margin structure? How should we think about it?

On the gross margin line, marketplace items are typically lower than our regular retail margins, but they offer breadth, new customer counts and the ability to give customers what they want. Ultimately, with that volume, they are operating margin accretive, so we want to deliver those assortments consistently.

We apply the same standards for sustainability, design and quality to marketplace products and often offer an additive assortment, sometimes exclusive to us. This is particularly important in categories we don't previously offer — for example, ceiling fans — allowing us to enter those categories in a capital-light way.

And we'll go to our next question from Chuck Grom of Gordon Haskett.

On occupancy dollars, Julie, $176 million — down about $5 million sequentially. How should we model that line item in the coming quarters? Is this a good run rate or could it continue to drop? And a follow-up on B2B: I think it was $400 million last year and you said $500 million this year. Does it make sense to invest more now to grow? It seems to be coming in stronger with the economy reopening.

I wouldn't assume this quarter's occupancy run rate will continue unchanged. We closed net 33 stores mostly at the end of last year, which gives benefit from lower rent. But we are adding distribution center square footage — we're adding about 2 million square feet to support e-commerce growth — and the timing and size of capital expenditures hit depreciation, so occupancy can be lumpy. You shouldn't simply take this quarter's run rate forward, but we will drive occupancy leverage given high sales and our ability to mute costs through lower store rents. On B2B, I think the number last year was closer to $300 million, but it's a very strong business and we are bullish. It's an $80 billion business and we are on track for $500 million this year. The trajectory week-over-week has been phenomenal. We've been building infrastructure from people, systems and supply chain perspectives and it is really gaining momentum. We will invest what we need to because we believe it's a significant growth opportunity.

We will hear next from Chris Horvers of JPMorgan.

Two questions. Can you talk about the sequential improvement in gross margin relative to the fourth quarter? How much was fading shipping surcharges versus taking price increases on existing inventory as raw material and shipping costs accelerated? And to clarify on the guidance raise, was it driven just by the first quarter beat or also by expectations around the second quarter?

Relative to the fourth quarter, the gross margin outperformance was broad-based. Merchandise margin expansion was significant and we did see shipping cost leverage due to both coming out of peak rates and a sizable shift to retail sales. With more POS sales, there are fewer shipping costs for the sales we drove on the top line. We also shut net 33 stores toward the end of last year, where we started to get benefits on lower occupancy in the first quarter. That, plus significant sales growth, delivered the results you saw. On the guidance raise, we took everything into consideration: Q1 performance, what we are seeing quarter-to-date in Q2 and the benefits we expect ahead, particularly from a strong housing market which tends to bode well for us for years. We also have accelerating category adoption online and increased interest in companies that stand for values and sustainability. All of these factors, plus expectation of filling backorders in the back half of the year, give us confidence. We gave the outlook two months ago and have now raised it substantially after completing one quarter and seeing strong early trends.

And we'll move to our next question from Brian Nagel of Oppenheimer.

Another great quarter, congratulations. Two quick items merged: with regard to sales trends through the quarter and into Q2, are you seeing any divergence in markets that opened or reopened sooner than others? And the second question: did you see any acceleration across your brands as stimulus checks hit?

I'll give it to the data person, Felix, for details on markets.

We looked at many points — state-by-state vaccination, mask requirements, etc. — and found no clear correlation tied to those factors. More important is the two-year comparison, and we are seeing strength across all states regardless of vaccination rate, which gives us confidence for the balance of the year. From a demographic perspective, younger customers continue to show strength. This isn't just driven by stimulus but by millennial and Gen Z growth and our positioning, including PB Apartment and West Elm aesthetics and opening price points. Our kids and baby business is benefiting from that and we plan expansions accordingly.

And we'll move on to our next question from Steven Zaccone of Citi Research.

Congrats on the strong results. Question on SG&A outlook: the amount of leverage you saw on a 40% comp seemed to moderate versus prior quarters. As sales growth moderates and you continue to prioritize advertising, how should we think about the cadence of SG&A spending and your ability to drive leverage?

This time last year we substantially pulled back spend when everything was shutting down. Given our performance, we've continued to invest in advertising. This quarter reflects higher advertising investment, which drives future sales. It's important to continue these investments and it's a competitive benefit we can exercise given our merch margin expansion and occupancy leverage. Most companies can't afford advertising now; we can and will invest to gain market share. You'll see pressure on SG&A mostly from advertising. There are some higher hourly wages that we're lapping, and last year we had COVID-related SG&A expenses we may not comp again, which could provide benefit in the back half. Regardless, we are confident in delivering merch margin expansion and occupancy leverage and are committed to operating margin expansion.

To add, you can see our results over the last year and even before that we've had acceleration in our comps and are now a growth company again. That means we will improve operating margin but also reinvest to drive top-line sales because we have the opportunity. We're still relatively small given how strong our brands are. With our differentiators and growth drivers, we expect to reach $10 billion faster than people expect and do it more profitably than others in our space.

At this time, I would like to turn the call back to Laura Alber for any additional or closing comments.

Thank you. Good questions. I really appreciate your interest, and I look forward to talking to you again after the next quarter.

Ladies and gentlemen, that concludes the call. Thank you for your participation. You may now disconnect.