Earnings Call Transcript - WSM Q1 2024

Operator, Operator

Welcome to the Williams-Sonoma, Inc. First Quarter Fiscal 2024 Earnings Conference Call. I would now like to turn the call over to Jeremy Brooks, Chief Accounting Officer and Head of Investor Relations. Please go ahead.

Jeremy Brooks, Chief Accounting Officer and Head of Investor Relations

Good morning, and thank you for joining our first quarter earnings call. Before we get started, I'd like to remind you that during this call, we will make forward-looking statements with respect to future events and financial performance, including our updated guidance for fiscal '24 and our long-term outlook. We believe these statements reflect our best estimates. However, we cannot make any assurances these statements will materialize and actual results may differ significantly from our expectations. The company undertakes no obligation to publicly update or revise any of these statements to reflect events or circumstances that may arise after today's call. Additionally, for the first quarter of last year, we will refer to certain non-GAAP financial measures. These measures should not be considered replacements for and should be read together with our GAAP results. A detailed reconciliation of non-GAAP measures to the most directly comparable GAAP measure appears in Exhibit 1 to the press release we issued earlier this morning. Also, for the first quarter of this year, we will refer to our GAAP results, both with and without the benefit of an out-of-period adjustment that we recorded during the first quarter. We believe providing these disclosures is useful to understanding our quarterly financial results. Jeff will share the details of this adjustment later in his prepared remarks. This call should also be considered in conjunction with our filings with the SEC. And finally, a replay of this call will be available on our Investor Relations website. Now I'd like to turn the call over to Laura Alber, our President and Chief Executive Officer.

Laura Alber, President and Chief Executive Officer

Thank you, Jeremy. Good morning, everyone. Thank you for joining the call. Before we review our Q1 results, I want to take a moment to thank all of our teams around the globe for their consistent contributions to our company. We could not continue to produce strong earnings without their cross-functional collaboration and dedication. We are pleased to deliver strong results in the first quarter of 2024, driven by an improving top line trend and continued strength in our profitability. In Q1, our comps came in above expectations at negative 4.9%, and we exceeded profitability estimates with an operating margin of 19.5% and earnings per share of $4.07. It is important to note that the results of the first quarter include a benefit of $49 million, resulting from the reversal of freight-related accruals that we determined were not required, which contributed 290 basis points to our operating margin and $0.59 to our EPS. Jeff will walk you through this in more detail, but it is worth noting that even without the impact of this benefit, we significantly exceeded profitability expectations. As a result of our outperformance, we are raising our outlook on operating margin to now be in the range of 17.6% to 18% or 17% to 17.4% when excluding the impact of the freight accrual reversal. The strong results for the quarter are a result of our focus on our 3 key priorities in 2024: returning to growth; elevating our world-class customer service; and driving margin. I'll start first with returning to growth. We are pleased with the improvement in our top line trends and our market share gains in Q1. We are keenly focused on innovation in our product line across brands. And our unique in-house design capabilities and vertically integrated sourcing organizations allow us to offer this high-quality design innovation at compelling price points. Another key component of our return-to-growth strategy is our marketing capabilities. Our in-house digital marketing optimization backed by our world-class customer analytics and our first-party data collection serves as a competitive advantage for our company. In the quarter, we increased our ad spend and invested in both our paid marketing and our proven social strategy. This investment allowed us to drive sales improvement to acquire new customers and to gain market share. Additionally, we are continuing to improve our online experience through our investment in our proprietary e-commerce technology. From product discovery and selection to personalization to concept to customer care and to the final mile, our team is constantly thinking about how we can improve our best-in-class e-commerce experience. And one way we do this is through AI. We believe our leadership in AI will be another competitive advantage. And it's important to not forget that as focused as we are on our digital capabilities, we are passionate about our service and our best-in-class retail business. We have improved our in-store experience with inspirational products, improved in-stock inventory levels and next level in-store services. Our teams are the best in retail, and our retail optimization efforts are transforming our fleet to be positioned in the most profitable, inspiring and strategic locations. Moving to our second and third key priorities in 2024, which are inextricably intertwined. We continue to make progress improving our world-class customer service and driving margins. The customer is at the center of everything we do, and their satisfaction is key to our operating performance. We are pleased with our high Net Promoter Scores, both in-store and at home, but we see more opportunity to improve. We know that providing our associates with new tools and training has a direct impact on our customer experience. And we are thrilled to bring back our annual store manager conference in Q2 of this year. This multi-day offsite meeting is an opportunity for all of our store managers to participate in strategic training. The improvement in customer service also comes from supply chain efficiencies. We are reducing costs by limiting out of market and multiple shipments, fewer customer accommodations, lower returns and damages and reduced replacements. These improvements will continue to contribute meaningfully to our profitability in 2024 and beyond. And our ongoing commitment to not running site-wide promotions and the reduction of our promotional offerings have also improved margins. We are focused on delivering our compelling value equation to our customers, which in turn, maximizes our full price selling. Now I'd like to update you on the performance of our brands. Pottery Barn ran a negative 10.8% comp in Q1. We continue to see softness in higher ticket furniture sales in Pottery Barn, but we've seen quarter-over-quarter improvement. We're having success in our proprietary print and pattern across textiles and easy decorating updates continue to drive sales. Highlights include newness in our Bloom shop, frames and decor. Our strength in seasonal celebrations also continues to resonate with our customers. In March, we launched our first ever global collaboration with international icon, Deepika Padukone. Her popularity drove 1 billion impressions for the Pottery Barn brand. Customers also embrace the launch of our Coastal Lookbook, and they positively engaged with our newly developed apps. In the back half of this year, we're excited to introduce new innovation, both in-store with compelling new floor sets and online with improved digital shopping experience. The Pottery Barn children's business ran a positive 2.8% comp in Q1. Across these life-stage businesses, we drove widespread comp trend improvement in the business. We've seen excellent customer response to our new product introductions with collaborations being a particular highlight. Our recent launches with partners such as LoveShackFancy and Lilly Pulitzer have driven sales and attracted new customers by tapping into relevant fashion and home decor trends. In Baby, we're seeing double-digit registry growth and excellent customer response to our expanded essentials and gifting. In dorm, we recently launched our biggest collection to date with expanded XL twin bedding options, new no-nails wall decor and innovative storage solutions. In addition to the expanded assortment, we are excited to roll out improved dorm product selection functionality. And customers can also ship dorm products to any one of our company-owned stores near their college campus. Moving to West Elm. In Q1, West Elm drove sequential improvement in its top line trend, running a negative 4.1% comp in the quarter. We're encouraged to see improvement in West Elm's demand trend even as we materially pull back on promotions. We are seeing strength in our new product sales with our spring units driving positive comp to last year, with particularly strong performance out of furniture, kids and decorative accessories. Summer newness is also off to a great start with double and triple-digit newness comps. Given the positive trends in newness, we have a sizable opportunity in West Elm as it rebalances more inventory into these new products. The Williams-Sonoma brand ran a positive 0.9% comp in Q1. This is the second consecutive quarter the Williams-Sonoma brand ran a positive comp with the Williams-Sonoma Kitchen business running a positive comp for the fourth consecutive quarter. During Q1, we inspired customers with exclusive and innovative products. We benefited from new introductions of Williams-Sonoma branded products in categories like bakeware, cutlery and food. The favorable customer response to these items continues to reinforce the opportunity we have with the Williams-Sonoma branded business. In March, our co-branded collaborations drove media attention and results. Our popular collaboration with Aerin Lauder was expanded to include new items for both Williams-Sonoma and Williams-Sonoma Home. We also partnered with Trisha Yearwood to make our best-selling cocktail collaboration the official drink of our new 55,000 square foot bar and restaurant in Nashville that she built with her husband, Garth Brooks. Now I'd like to update you on our other initiatives. Business-to-business grew 10% in Q1, driving record-breaking demand in the quarter. We saw improvement in our trade business, running a positive 6% on the quarter, along with continued momentum in our contract business, which represents about 1/3 of the B2B business up 18%. We're encouraged by our diverse book of businesses ranging from sofas for UT San Diego dorms to corporate gifting for Pebble Beach Company. We also saw continued growth for our existing large project customers such as Marriott, Dave & Buster's and Jamestown properties. Now I'd like to talk about our global business. Despite ongoing macroeconomic pressures impacting our global business, we're pleased with the performance in key markets, including India, Canada and Mexico. In India, we are continuing to see strong growth from increased marketing and brand awareness campaigns across the brands. In Canada, our business is thriving in both the retail and direct-to-consumer channels, driven by enhanced omnichannel strategy, wider product selection and the expansion of our business-to-business program across all brands in the market. And in Mexico, the market showed strength driven by a focus on the design business and expanded assortment fueled by our improved stock position. We will continue to leverage the knowledge gained from these markets to enhance the global customer experience in our new and emerging markets. Lastly, I'd like to update you on emerging brands. Rejuvenation delivered another double-digit quarter. We saw all categories drive growth and continue to see success with both consumer and trade customers. The brand remains focused on delivering high-quality products that support home remodel and refresh projects. The strongest performance comes from bath, hardware and lighting, while we also see strength in several of our new growth categories like textiles, organization, window hardware and outdoor. Customers continue to update their homes, specifically in the kitchen and bath spaces and add the finishing touches with Rejuvenation. We are excited by the momentum in this brand and the growth potential this year and beyond. Mark and Graham, our monogram gifting business, also drove double-digit comp growth in Q1. The brand is increasingly recognized as an inspirational lifestyle brand experiencing continued growth as a go-to destination for gifts, including graduations and weddings. Q2 has started strong with a positive reception to the brand's Mother's Day and Father's Day gift selections. And finally, GreenRow, our newest brand, continues to grow and expand its assortment of vintage-inspired colorful furnishings that are sustainably sourced and designed to last. The second catalog dropped this month with a focus on print and pattern. We are seeing a very positive response to its unique offerings in the market and look forward to seeing additional assortment expansions and partnerships in the coming months. Being successful in exciting emerging brands demonstrates our ability to develop new businesses that expand our portfolio and address white space in the market. In summary, we are extremely proud of our results. During the last few years, we, as a company, have navigated, learned, optimized and built all in preparation for our next chapter of growth. We have a strong omnichannel platform with an exclusive lifestyle offering and a sophisticated distribution network with additional capacity. We recognize that there is continued uncertainty with the environment and the consumer. But because we operate in a highly fragmented market, we will continue to gain share by inspiring and servicing our customers. We remain committed to driving our 3 key priorities in 2024: one, returning to growth; two, elevating our world-class customer service; and three, driving margins. And with that, I will turn it over to Jeff to walk you through the numbers and our outlook in more detail.

Jeff Howie, Chief Financial Officer

Thank you, Laura, and good morning, everyone. We are pleased to deliver these strong Q1 results. We've seen sequential improvement in our top line trend and we continue to exceed expectations on the bottom line. As Laura said, our results this quarter reflect 3 keys we've laid out for fiscal year '24. First, returning to growth, fueled by our brand strategies, emerging brand opportunities, business-to-business expansion and global footprint; second, elevating our world-class service, which drives both customer retention and expense savings; and finally, third, driving earnings as we continue to deliver strong profitability. These 3 themes resonate across our earnings today. And given our strong Q1 results, we're confident we can deliver long-term growth and even stronger earnings as the customer shifts back to home. Now let's dive into the numbers. I'll start with our Q1 results and then provide an update on guidance for '24. Net revenues finished at $1.66 billion, in line with our expectations. Our comp of negative 4.9% sequentially improved quarter-over-quarter. We saw better performance across both furniture and non-furniture categories even as we reduced our overall level of promotions from last year. From a cadence perspective, our trends were relatively consistent across the quarter. Moving down the income statement. Gross margin came in at 48.3%, which includes a $49 million or 290 basis point benefit from an out-of-period adjustment. Subsequent to filing our 10-K, we identified that we over accrued freight expense across fiscal years 2021, 2022 and 2023 by $49 million. Following the prescribed accounting rules, we determined the over accrual was not material to any prior period and not material to our projected full year '24 results. Therefore, we recorded the correction in Q1 as an out-of-period adjustment that benefited our results this quarter. Without the out-of-period adjustment, gross margin came in at 45.4%, 680 basis points higher than last year and substantially exceeding expectations. There were 3 drivers to the 680 basis point improvement. First, merchandise margins improved 470 basis points, driven by lower ocean freight as we benefited from lapping last year's pandemic-related ocean freight runoff and our ongoing commitment to full-price selling. Second, supply chain efficiencies contributed 240 basis points, driven by lower than pre-pandemic returns, accommodations, damages, replacements, out-of-market shipping and multiple deliveries per order. These supply chain efficiencies are yielding a notable improvement in customer service and cost savings. And third, occupancy costs, although down 3% from last year, deleveraged 30 basis points. We continue to optimize our retail fleet while we invest in our world-class technology stack and our supply chain. Wrapping up our gross margin, we delivered substantially higher gross margin this quarter, driven by better merchandise margins, supply chain efficiencies and lower occupancy costs. Turning now to SG&A. SG&A expense came in at 28.8% of revenues or 310 basis points higher than last year, driven by higher advertising spend and incentive compensation. Advertising expense deleveraged 170 basis points as we continue to invest into higher levels of advertising spend to drive sales at an efficient return. Our multi-brand portfolio allows us to test the return of this incremental spend. Our own hands-on-keyboard approach allows our investment to go further, keeps our learnings in-house and gives us a competitive advantage in the home furnishings industry. Employment expense was 100 basis points higher year-over-year, driven entirely by higher performance-based incentive compensation. Without incentive compensation, employment was flat year-over-year on a rate basis. In Q1, we continue to manage variable employment costs across our stores, distribution centers and customer care centers in accordance with top line trends. On the bottom line, our earnings significantly exceeded expectations. Including the benefit from the out-of-period adjustment, operating income came in at $323.8 million; operating margin was 19.5%; and diluted earnings per share was $4.07. The out-of-period adjustment increased operating income by $49 million; operating margin by 290 basis points; and earnings per share by $0.59. Without the out-of-period adjustment, our earnings still significantly exceeded expectations. Operating income came in at $274.8 million; operating margin was 16.6%, 370 basis points above last year; and diluted earnings per share was $3.48, up $0.84 or 32% year-over-year. On the balance sheet, we ended the quarter with a cash balance of $1.3 billion with no debt outstanding. This was after we invested $40 million in capital expenditures supporting our long-term growth, and we returned $107 million to our shareholders through quarterly dividends and share repurchases. Merchandise inventories ended the quarter at $1.2 billion, down 13% to last year. Overall, our inventories are well positioned to support our business. Summing up our Q1 results. We're proud to have delivered another quarter of earnings substantially exceeding expectations. I'd like to thank our talented dedicated team at Williams-Sonoma, Inc. for delivering these outstanding results. Now let's turn to our '24 outlook. Given our Q1 results, we are reiterating our revenue guidance and raising our operating margin guidance for fiscal year '24. On the top line, we continue to expect full year '24 net revenues to be in the range of down 3% to up 3%, with comps between down 4.5% to up 1.5%. We anticipate sequential improvement across the year, with the first half tougher than the second half as our top line comparisons get easier and our growth drivers accelerate. On the bottom line, we are raising our guidance based upon our Q1 results, but anticipate our operating margins going forward will be relatively in line with '23 results. We are raising our operating margin guidance to a range of 17.6% to 18%, which includes a 60 basis point benefit from the full year impact of the out-of-period adjustment. Without the out-of-period adjustment, we expect our full year operating margin will be in the range of 17% to 17.4%, a raise of 50 basis points due to our strong Q1 results. Additionally, we expect our full year interest income to be approximately $40 million and our full year effective tax rate to be approximately 25.5%. As a reminder, 2024 is a 53-week year for Williams-Sonoma, Inc. So the fourth quarter will consist of 14 weeks. We anticipate the additional week will contribute 150 basis points to revenue growth and 10 basis points to operating margins, both of which are embedded in our guidance. We will report comps on a 53-week versus 53-week comparable basis. All other year-over-year compares will be 53 weeks versus 52 weeks. Our capital allocation plans for '24 remain unchanged. We expect to spend $225 million in capital expenditures to invest in the long-term growth of our business. 75% of this capital spend will be dedicated to drive our e-commerce leadership and supply chain efficiency. We remain committed to returning excess cash to our shareholders in the form of increased quarterly dividend payouts and ongoing share repurchases. For dividends, in March, we announced an increase in our quarterly dividend payout of 26% or $0.23 to $1.13 per share. Fiscal year '24 will be the 15th consecutive year of increased dividend payouts, which we are both proud of and remain committed to. For share repurchases, we have $956 million remaining under our $1 billion share repurchase authorization through which we will opportunistically repurchase our stock to deliver returns to our shareholders. As we look further into the future beyond '24, we are reiterating our long-term guidance of mid- to high single-digit revenue growth with operating margins in the mid- to high teens. We're confident we'll continue to outperform our peers and deliver shareholder growth for these 5 reasons that remain consistent: our ability to gain market share in the fragmented home furnishings industry; the strength of our in-house proprietary design; the competitive advantage of our digital-first but not digital-only channel strategy; the ongoing strength of our growth initiatives; and the resiliency of our fortress balance sheet. With that, I'll open the call for questions.

Operator, Operator

Your first question comes from the line of Kate McShane with Goldman Sachs.

Katharine McShane, Analyst

I have one kind of bigger picture question and then one question with regards to the accounting that was stated today. So first, we wondered if you could talk a little bit more about the big ticket trends you're seeing. I know you noted better performance in furniture. But we're curious to build down on that a little bit more in terms of what you saw in Q1 versus maybe what you were seeing in Q4. And then with regards to the accounting, we're wondering with regards to the COGS change, why it's only '21 through '23 and why there's not an impact to Q1 '24.

Laura Alber, President and Chief Executive Officer

In terms of big ticket items, Q4 is generally not a peak time for furniture sales. However, we have comparable year-over-year numbers. We don't introduce many new products in Q4, but we are seeing some improvements in our furniture business. High ticket sales include not just furniture but also other categories like electrics. We're not noticing a significant decline in high ticket items, but there's a slight softness in furniture sales that seems to be improving. We anticipate strong sales of new products in the spring and summer, particularly in Pottery Barn and West Elm. Additionally, our kids' furniture segment is performing well due to the introduction of new finishes that enhance these collections. This segment, which includes dorm and baby furniture, benefits from life stage needs rather than being solely housing related, and we're experiencing increased demand there.

Jeff Howie, Chief Financial Officer

All right, Kate, I'll take the second question on the accounting. So you asked why it's only '21 through '23 and not '24. I think for some context, what really drove the out-of-period adjustment was the supply chain volatility that happened during the pandemic, which really hit years '21 through '23. And just to remind everyone, the pandemic put tremendous pressure on international supply chains. We faced disruption, delays, material cost swings, contract renegotiations, changes in terms by vendors, balance renegotiations, and all these pressures added a layer of complexity to the already imprecise process we use to estimate freight expense. So it was really pandemic-driven and it would not have impacted Q1 '24, because as we cleaned up our balance sheet and reconciled our approval, it would just cancel itself out in Q1.

Operator, Operator

Your next question comes from the line of Christopher Horvers with JPMorgan.

Christopher Horvers, Analyst

So my first question is, what your early reads are on the outdoor category. Obviously, that's a bigger portion of the second quarter versus Sonoma really shining around the Easter holiday and it looks like April was pretty tough on the weather. So would you expect some of that outdoor category to shift into the second quarter? And sort of related to Kate's question, as you think about like the sequential improvement in the business, mix will have an effect. So does the weather shift maybe to 2Q sort of offset the fact that the mix of Williams-Sonoma is lower in the second quarter?

Laura Alber, President and Chief Executive Officer

Chris, it's Laura. The outdoor category's performance aligns consistently with our furniture categories. It's about the same. If you're referring to the sales curve, it's more similar to the period before the pandemic rather than immediately after when there was a rush for outdoor furniture. Now it's a more normalized trend, and we have a solid understanding of where we believe this is headed, which is reflected in our guidance.

Jeff Howie, Chief Financial Officer

I would also just add, Chris, that I know there's been a lot of talk out there in the industry about the impact of weather. We're not really seeing that impact. I think because we are predominantly online, the weather doesn't impact us the same way. So we don't see that as an impact on a shift between quarters, as you alluded to.

Christopher Horvers, Analyst

Understood. Regarding margins, while you don't provide quarterly guidance, historically, the latter half of the year usually shows higher operating margins compared to the first half. However, based on your guidance for the year, it seems that this historical trend may not occur, suggesting that the margin improvement observed in the first quarter might simply be carried over. Is this an accurate interpretation of your guidance approach for the year? Additionally, was there anything specific in the first quarter that may not be sustainable?

Jeff Howie, Chief Financial Officer

Yes, Chris. I think you hit the nail on the head in that, there were some unique things in Q1, and it really comes down to what we're up against from a last year compare basis. Let's remember that in Q1 last year, Q1 '22 was the high point of our supply chain headwinds, which really benefited us the most in Q1, and we're quickly coming to the end of that benefit. And we're lapping starting in Q2 and even stronger in Q3 and Q4, more benefits that we had last year from those headwinds. Additionally, we also started to lap the benefit we saw last year from our focus on full price selling and supply chain efficiencies. And while we feel great about our results, let's remember, it's early in the year. There's a lot of uncertainty. So that's why we're guiding our full year operating margins to be essentially flat year-over-year Q2 through Q4.

Operator, Operator

Your next question comes from the line of Cristina Fernández with Telsey Advisory Group.

Cristina Fernandez, Analyst

Congratulations on the strong results. I would like to ask a broader question regarding demand. You mentioned that B2B trade is up 6%, which I believe hasn't happened in a few quarters. Given that furniture trends are beginning to improve, do you think this is due to consumers feeling more confident and willing to spend on their homes, or is it primarily a result of your company's specific initiatives?

Laura Alber, President and Chief Executive Officer

No, I think that we've been focused on what we can control. As we've mentioned at the start of this year and last year, we are not relying on the macroeconomic environment. We are concentrating on what we can manage, which is innovation. This involves having the right product at the right price and presenting it well. We've enhanced the photography for our brands and improved website functionality. We're also closely examining how to enhance the experience in our stores, which serve as billboards for our brands. When customers enter, they should be able to take items home immediately instead of waiting. To facilitate this, we've increased stock levels and introduced enough new products in our stores to generate excitement. These efforts are positively impacting our results. Regarding B2B, it's essential to remember that our business consists of trade and contract segments. The contract sector is less influenced by the housing market and consumer fluctuations. We have secured significant wins in our targeted verticals, like hospitality, sports, and entertainment. B2B represents a critical strategic initiative for us and is a substantial part of our future growth, given that the market is fragmented, with limited competition and considerable potential. It capitalizes on our brand strength, our capability to design for specific clients, our global sourcing resources, and our ability to provide single deliveries instead of relying on multiple suppliers. Therefore, we remain highly optimistic about B2B, as it is less impacted by housing market trends.

Cristina Fernandez, Analyst

And then as a follow-up, you called out some of the growth initiatives accelerating through the year, given your confidence to hit the full year guide. Can you talk about which initiatives are more impactful as we move through the year?

Laura Alber, President and Chief Executive Officer

Sure. Our brands are exceptional and high-quality. We create our own products and operate our proprietary website, West Elm, which is central to our focus on growth. I am thrilled with the positive reception we are receiving for new offerings at West Elm and the team's direction, along with the impressive collaborations we have executed this past year. We are concentrating on what is currently successful, restocking, and confidently presenting a new modern aesthetic to our customers. Importantly, West Elm has traditionally been a furniture-centric business, and to drive repeat purchases and excitement, we aim to offer items that can easily enhance a space, such as new pillows for a living room or decor for a dinner party. We are focusing on smaller, more accessible items that facilitate easy updates for homes and will continue to enhance their contribution to total sales, which aids in acquiring new customers. West Elm is a crucial aspect of our growth strategy moving forward. I am also very enthusiastic about our new launches at Williams-Sonoma. We have introduced a stunning navy Jura collection that is exclusive to our brand and partnered with Shondaland and Netflix on a Bridgerton collaboration that is performing very well, particularly as Bridgerton is currently the most-watched show on Netflix. Our kids and teen segments are driving comparable growth through collaborations, and we have plans for further expansions in these areas following the successful carve-out of Baby and dorm items. Additionally, in Pottery Barn, we are seeing strong sales from new collections, which we are building on for the upcoming fall season, along with beautiful floor sets for fall and the holidays, where we excel in decorating and entertaining in a quality manner that others cannot match. These are our main brands, and I also mentioned our emerging brands, which are gaining impressive momentum, offering a distinct aesthetic for entertaining and decorating. We are experiencing double-digit comparable growth in these brands and are committed to accelerating their growth in the future.

Operator, Operator

Your next question comes from the line of Michael Lasser with UBS.

Michael Lasser, Analyst

If you continue to outperform by the magnitude that you did in the first quarter, would you look to reinvest that back into demand-driving initiatives or would you let it flow to the bottom line?

Laura Alber, President and Chief Executive Officer

We consistently invest in initiatives that drive demand and are quite aggressive in this area. The key focus is on generating incremental sales rather than just exchanging sales or increasing expenditures. We maintain a disciplined approach to our investments, which is reflected in our industry-leading return on invested capital. A notable area of investment has been in advertising costs. Regarding major investments, our supply chain is designed to handle more volume than we currently have, and our proprietary e-commerce platform doesn’t require the same level of investment that others have made since we’ve been operating at this capacity for a long time. E-commerce already represents a significant portion of our business, so it’s not a new venture for us. We can continue to enhance customer experience with incremental improvements. When discussing short-term demand-driving investments, we primarily refer to advertising costs. Promotions are no longer part of our strategy; while we do take markdowns, we believe that approach is not sustainable for driving demand compared to how others may operate.

Michael Lasser, Analyst

Very helpful. Two follow-ups on that. Can you quantify how much you will be investing in advertising this year, either as a percentage of sales or the dollar amount? And where does full-price selling stand today across the different brands versus where that same percentage was prior to the pandemic?

Laura Alber, President and Chief Executive Officer

We're fighting over your question. Yes. So in terms of ad costs, I wish we knew. It's so dynamic and we're so lucky to have this amazing team that's so sophisticated at looking at the different ad cost streams and reading the results. And it's a lot about the bids from others and where the demand is going and where it's not because what is true today might not be true in a month. So we have a monthly long full-day meeting where we review every brand and every stream. And we put our investments down where we're seeing returns. We test in one brand and roll it out to others. Jeff can put this more in context, if you want, on the ad cost?

Jeff Howie, Chief Financial Officer

Yes. I think it's also just important to remember, as you know, we guide the top line revenues and bottom line operating margin because it gives us flexibility to respond to changes in the business. And as everyone's seen, we know the levers to pull to deliver results. So while we'll go through the year, it's a very uncertain environment, who knows how the year shapes out, but we can adjust our levers as we see the trends develop to deliver results for our shareholders.

Michael Lasser, Analyst

Yes, yes, for sure. Yes.

Operator, Operator

Your next question comes from the line of Steven Zaccone with Citi.

Steven Zaccone, Analyst

Laura, I wanted to ask a macro question. We've seen some improved data points in the furnishing space. and you've mentioned the furniture softness appears to be getting better. So I'm curious for your assessment of like replacement cycles in the industry and this concept of like easy wins with people purchasing on smaller ticket items. Do you think we're starting to see some glimpses of replacement cycle and spending on the home? Curious of your assessment.

Laura Alber, President and Chief Executive Officer

I have no idea. I think that everyone believes that the interest rates are never going to change, they're going to be more likely to buy than if they believe they're going to go down, they're going to wait. That's one theory I have. But that's just a theory. You can't prove anything. What I know is that where we have innovative products that's priced right, we're winning. And that's exciting to see because that makes me feel like we're more in control than at the whim of the macro. I mean, but imagine like right now, we produced these results in Q1 with the soft housing environment. Imagine what it could be like when it turns. But when that's going to happen, your guess is as good as mine.

Jeff Howie, Chief Financial Officer

Well, as you know, as I said before, we don't guide to specific lines and our overall operating margin guidance for the balance of the year is essentially to be flat year-over-year. There is more opportunity potentially in gross margin, particularly from supply chain efficiencies and higher full-price selling. But we are starting to lap the benefit we had last year from coming up against the headwinds I talked so much about. And as Laura mentioned, we have levers to pull, and there's a chance that if our gross margin was higher, then there's more opportunity to reinvest back in the business to drive the top line if we see efficient returns from that investment.

Operator, Operator

Your next question comes from the line of Seth Basham with Wedbush.

Seth Basham, Analyst

Congrats on continued strong results. My question is a follow-up on the last one. Just thinking about all the supply chain margin benefits that you've gotten over the last couple of quarters. Can you give us a little bit more insight into the key drivers there and the initiatives you have to further improve your outbound supply chain in the U.S.?

Laura Alber, President and Chief Executive Officer

Yes, absolutely. Our aim is to achieve perfect orders that are free of damage and delivered on time. While we've significantly improved since the pandemic and, in certain instances, set customer service records, there remains considerable room for further enhancement. This is the primary focus of our supply chain team. Last year, we faced substantial increases in costs related to inbound freight detention and demurrage, but we are no longer facing those excessive expenses. The team is concentrating on maintaining a very low return and replacement rate, and we are investigating every incident to ensure that issues do not recur. This effort will persist throughout the year and beyond. Proper inventory placement also helps minimize out-of-market multiple shipments, and we have the potential to improve this further by optimizing our inventory purchases by distribution center. Additionally, we are discovering redundancies and finding better shipping methods through our use of AI, which allows us to analyze orders and determine whether to prioritize speed or cost for each individual customer in an automated manner. We have made investments in our supply chain, including the opening of our Arizona distribution center, which is now operational and should provide us with an advantage during the peak season later this year, especially for our West Coast customers. In previous quarters, we have absorbed some of those costs. Many companies ship apparel and floor goods, but few can efficiently handle furniture shipping. This capability not only drives substantial margins for us but also greatly enhances customer service. I've always maintained that the company that can deliver furniture orders effectively will dominate the market because the experience of waiting for furniture to arrive on time and undamaged can be very frustrating, and executing this successfully is challenging. I'm pleased with our progress, but the reality is that we still have much work ahead to achieve that perfect order.

Seth Basham, Analyst

That's really helpful color. And then my follow-up question is just on the incentive compensation margin headwind this quarter. Was part of that accrual associated with the out-of-period adjustment or is it for the underlying results? And how should we think about incentive compensation year-over-year for the balance of the year based on your guidance?

Jeff Howie, Chief Financial Officer

Great question, Seth. So the incentive compensation did not include any benefit from the out-of-period adjustment. It was simply our beat in Q1 versus our budget, so we had to take up the accrual. And any additional results from incentive compensation are essentially embedded in our guidance.

Operator, Operator

Your next question comes from the line of Max Rakhlenko with TD Cowen.

Maksim Rakhlenko, Analyst

Congrats on the nice results. So first, can you speak to your level of confidence in Williams-Sonoma's ability to regain lost market share on the upswing? And if peers do remain promotional even when demand improves, how will that impact your own strategy as it could make regaining some of that market share tougher?

Laura Alber, President and Chief Executive Officer

No, Max, as you know, this is a highly fragmented market. There isn’t really anyone who possesses a significant share that hasn't changed much. However, I am very confident about the volume of transactions that still occurs in retail stores compared to online sales. It will be quite challenging for others to scale their online presence like we have already done. This is a key competitive advantage for us as we look toward the future because I believe that the online transaction volume will not remain low. When it increases, it will benefit us. Therefore, I am less concerned about other issues that people mention. I also recognize that no one else is designing their own products in a comprehensive way as we do in a lifestyle format, which is another major advantage for us. This gives us pricing power. We are not attempting to inflate prices; in fact, our value is exceptional. If you look at some of our new bestsellers, their prices are very competitive because similar products are either unavailable in the market or are only found in the most upscale designer markets. Without detailing our competitive bestsellers to everyone on the call, including our competitors, I can say that the products that are performing well have no comparable offerings in the market at our price points. Thus, I don’t worry much about fluctuating prices because I believe our consumers, particularly, are very discerning. They research their options, understand the quality difference, and know what they’re getting.

Jeff Howie, Chief Financial Officer

I would also just add in that we compete not just on price, we compete on quality as well. But even more importantly, we compete on service. And these investments we're making in service really resonate with the customer and help with customer retention and are as strong a driver of our customers' purchase decisions as price is.

Maksim Rakhlenko, Analyst

Got it. That's super helpful. And then just a quick follow-up, but any color on quarter-to-date, how has May gone for you guys? Is it more of the same with stability? Or are you potentially seeing any further improvement?

Laura Alber, President and Chief Executive Officer

Yes. So quarter-to-date, different than last quarter, we're only like 3 weeks in. So when we gave Q4, we had 6 weeks, and we were more confident talking about it. And our big weeks are ahead of us. So we're still very confident in our guidance, but I wouldn't read too much into the first 3 weeks, which is why I don't want to comment on it.

Operator, Operator

Your next question comes from the line of Brian Nagel with Oppenheimer.

Brian Nagel, Analyst

Congratulations on another strong quarter. Well done. I have a question that looks at the bigger picture. We're observing how your model is progressing. While sales and top line trends are still somewhat weak, showing signs of improvement, you continue to achieve increases in operating margins. With that in mind, as you consider the future, even though you can't predict when sales trends will return to normal growth rates for your company and brands, is there any reason to believe that, as that occurs, you wouldn't continue to see significant leverage reflected in your profit and loss statements?

Jeff Howie, Chief Financial Officer

I understand the question, Brian. Thanks for asking it. I wish it was easy to say that for every 100 basis points of comp, x basis points would drop to the bottom line. Certainly, my Monday morning meetings would go a lot easier. But it's just not that way, there's a lot of different levers in the business. And time will tell, which is why our long-term guidance is mid- to high-teens operating margins, and we still feel comfortable in that range.

Brian Nagel, Analyst

Okay. I appreciate that, Jeff. I have one more question, looking at the broader sector. You've managed your promotions very well. What promotions are you currently competing with? Is the competition still aggressive, or is it becoming more so? Any changes in that regard?

Laura Alber, President and Chief Executive Officer

Yes, it's very aggressive. When we look across the board, many of the smaller specialty brands are offering 20% off site-wide. I'm referring to everything. Additionally, some of the larger specialty brands have 20% off entire categories, not just specific items, but the whole category. Companies are experimenting with shipping options and offering double rewards. Department stores have email promotions providing 25% off in exchange for your email address. It's extremely aggressive out there, particularly in certain categories where promotions are the primary approach. This has been the norm throughout my career; I don't recall a time when it hasn’t been promotional, and it doesn't seem to be decreasing at all.

Operator, Operator

Your next question comes from the line of Oliver Wintermantel with Evercore ISI.

Oliver Wintermantel, Analyst

Yes. I would like to return to the long-term guidance along with this year's projection for your mid to high teens long-term operating margin and this year's estimate of 17% to 17.4% without any adjustments. That seems very consistent. Is that the message? Could you explain how you view your longer-term margin in relation to the current margin guidance for the year?

Jeff Howie, Chief Financial Officer

Yes. When considering our current operating margin guidance and our long-term expectations, the main point is that our operating margin is sustainable. Over the past 18 to 24 months, there has been some uncertainty about the direction of our operating margin. In 2023, we set a 15% operating margin floor and achieved 16.4%. This year, we initially guided for a range of 16.5% to 16.8%, and now we are guiding for 17% to 17.4% excluding the out-of-period adjustment. We are at a sustainable level, which is crucial as we have structurally improved our margins. Williams-Sonoma, Inc. can maintain margins in the mid- to high teens over the long term, which aligns with our guidance and what we have accomplished.

Oliver Wintermantel, Analyst

Got it. And then just to follow up on inventories down 13%. Was that mostly dollars or units?

Jeff Howie, Chief Financial Officer

Well, we report in dollars, in cost dollars. So it was a dollar metric. And overall, our message is our inventories are well positioned to support our business trends.

Operator, Operator

Your final question comes from the line of Simeon Gutman with Morgan Stanley.

Simeon Gutman, Analyst

My first question, it's back on gross margin. So you are lapping some supply chain savings. This quarter, you still had a significant gain in the merch margin? And just to clarify, there aren't supply chain or shipping in there. And what drove the merch margin? And if it is the fewer promos, why shouldn't that level hold and we see merch margin gains continue throughout 2024?

Jeff Howie, Chief Financial Officer

In the first quarter of this year, we faced 300 basis points of supply chain challenges from the prior year. This means there is a difference of about 380 basis points when comparing that to the 680 reported, not counting the out-of-period adjustment. The improvement was not solely due to merchandise margins; it included both merchandise margins and supply chain efficiencies. We did see a positive impact from lower ocean freight rates compared to last year within merchandise margins. Additionally, there was also full price selling, along with a continued reduction in promotions compared to last year during the quarter. While there is potential for further reductions in promotions, we are beginning to compare against our previous efforts. Regarding supply chain efficiencies, we exceeded expectations but also started to see that year-over-year improvement as the year progressed. However, we are aware of diminishing returns on margins. Overall, we are pleased with our performance. As we begin to face tougher comparisons in our bottom line, it's still early in the year and there remains a lot of uncertainty.

Simeon Gutman, Analyst

And then just a follow-up to that. The IMUs or the markups in some of the newness, if that over-indexes, is that a good guide to gross margin or about the same?

Jeff Howie, Chief Financial Officer

It's probably about the same. And there's puts and takes between gross margin and SG&A. But it goes back to how we give our guidance. We guide the top and the bottom line. We're guiding that the next 3 quarters will be essentially flat year-over-year and that there are levers we can pull within there to drive results.

Laura Alber, President and Chief Executive Officer

And the newness doesn't come in higher margins than something we've been running. Actually, when we rebuy a new product, we're able to often renegotiate their costs because we're buying more on those efficiencies in the supply chain when we buy more. So that would come a little bit later as we increase the orders. And I will just say another component that is in our numbers is the reduction in costs across the board from our vendors, our vendor partners and really focusing on our efforts to be more accurate on our inventory buys so they can be more efficient in their factories. So that's also been a component of what's been going on and one that should be stable through the back half of the year. Thank you. Well thanks to all of you for joining us. And I hope you have a wonderful summer, and we look forward to talking to you in the fall. Take care.

Operator, Operator

This concludes today's conference. We thank you for joining. You may now disconnect your lines.