Lululemon Athletica Inc (LULU) 2008 Q2 法說會逐字稿

Good day, everyone and welcome to the lululemon athletica's second-quarter earnings results conference call.

Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to Ms.

Jean Fontana of ICR.

Please go ahead, ma'am.

Thank you.

Good morning.

Thank you for joining lululemon athletica's conference call to discuss second-quarter results for fiscal 2008.

A copy of today's press release is available in the Investor Relations section of the Company's website at www.lululemon.com or alternatively as furnished on Form 8-K with the Securities and Exchange Commission and available on the Commission's website at www.sec.gov.

Today's call is being recorded and will be available for replay for 30 days shortly after the call in the Investor Relations section of the Company's website.

Hosting today's call is Chip Wilson, Founder and Chief Product Designer; Christine Day, the Company's President and Chief Executive Officer; and John Currie, the Company's Chief Financial Officer; and Sheree Waterson, the Company's Executive Vice President of General Merchandise Management and Sourcing.

All participants on today's call are advised that the discussion may include forward-looking statements reflecting management's current forecast of certain aspects of the Company's future.

In many cases, you can identify forward-looking statements by terms such as will, expects, plans, believes, potential or the negative of these terms or other comparable terminology.

These forward-looking statements are based on management's current expectations, but they involve a number of risks and uncertainties.

Actual results and the timing of events could differ materially from those anticipated in the forward-looking statements as a result of such risks and uncertainties, which include those described in the SEC filings.

You are urged to consider these factors carefully in evaluating the forward-looking statements herein and are cautioned not to place undue reliance on such forward-looking statements, which are qualified in their entirety by this cautionary statement.

And now I would like to turn the call over to Chip Wilson, lululemon athletica's Founder and Chief Product Designer.

Great, thank you very much.

Well, good morning.

Thanks for joining us to discuss our second-quarter results.

Christine and John will talk later about the details, but I just wanted to take a minute just to talk about our first year as a public company, which is now we are into that and very proud of what we have done and accomplished in the last year and I am thrilled about Christine Day as our CEO.

We just couldn't have anybody better and thanks for being with us, Christine, by the way.

As Christine will discuss, we have done incredible things, great strides this year on our key initiatives that we outlined at the beginning of the year.

What I hope you take away from this call and we will see in our results over the coming years is that we are on a nice steady pace of expansion and we just want to really build a world-class infrastructure, which I think we are well on our way to doing and to match that with our world-class product and our incredible in-store experience that our guests love.

And so I think I will just pass it on to Christine.

She is standing right here beside me.

Hi, Christine.

Good morning, Chip, and thanks.

Good morning, everyone and thank you for joining us to discuss our second quarter.

Following my opening remarks, I will turn the call over to John who will go over the financial details of the quarter.

We will then open up the call to any questions.

We have a lot of exciting things to celebrate this quarter in addition to delivering strong financial results.

As Chip mentioned, we are beginning to fill in some key areas that will support our future growth.

We are implementing systems, hiring great people and executing well against our key strategies.

We are also proud of our second-quarter results, particularly in light of the challenging retail environment in the US.

Our revenue and profit performance was driven primarily by a combination of our comparable store sales increase of 13% on a constant dollar basis and 32 net new store openings during the past 12 months.

As we entered the third quarter, we are very pleased with the content and level of our inventory and our new fall product has seen strong guest response since its recent arrival in our stores.

Before I speak about some of our key initiatives, I would now like to invite Sheree Waterson, our talented new Executive Vice President of General Merchandising Management and Sourcing, to give a brief update on product.

Sheree's role is to oversee the entire end-to-end business process for product.

Thank you, Christine.

I am so excited to be here.

Boy, time has flown.

I have been at lululemon for almost three months now.

My first 30 days were spent working in the stores.

The store experience was an invaluable part of my onboarding process as it allowed me to fully understand and appreciate the culture, community and the guest experience.

I am thrilled to be joining the lululemon team at such an exciting point in its growth and I am even more excited about delivering inspiring product.

And speaking of product, one of our core competencies is black stretch pants and the legend of the grooved pant continues.

Just as our bottoms business remains strong, our jacket business is stronger than ever.

When we flow the product to the store, the guest is really responding and buying.

In addition to core styles, our new novelty jackets, including the [Shevakna] Wrap, the Course-ette Jacket and the Dance Jacket are all top sellers in our initial fall collection.

Outerwear has also gotten off to a great start.

Our [Pocket Puffy], our Apres Yoga Jacket and the soft shell jackets for both men and women were strongly received by our guests.

This is only our second season doing true outerwear pieces and we believe it represents a great revenue opportunity and growth potential for the brand.

Another trending category for us is running.

Our ability to combine femininity and fashion with technical fabrics and construction has resulted in the success of our running line this year.

In the past seasons, we have treated it as a seasonal category and our guests are telling us that she wants running year-round.

I am very confident that as we scale our business, we have the ability to continue to deliver amazing product and create a great guest experience.

Thanks, Sheree.

To keep with product for a moment, another key initiative for 2008 was to update our strategies for clearing seasonal inventory to scale with our retail store growth.

Historically, we marked down our (technical difficulty) seasonal items in store or consolidated them for two events -- our January warehouse sales and the in-store postholiday markdown.

After analyzing the scalability and cost of these strategies, we made the decision this year to split the warehouse and markdown sales into two periods -- [preferably] July and January.

This reduces handling and clears the store for the new season.

For our US business, we will test two temporary outlet stores, which are more cost effective and require less diversion of key resources than the warehouse sales.

Consistent with this strategy, we opened a temporary outlet store in Mount Vernon, Washington in late August and plan to open an additional temporary outlet in Sawmills, Florida in October.

So for the next year's clearance strategy, we will use a combination of warehouse sales, limited in-store markdowns and temporary outlets.

It is important to stress that these refinements continue to support our gross margin strategy and that there is no change in the business model.

As Chip mentioned in his opening remarks, we continued to increase our execution capability in key areas.

We have refined our real estate strategy and store opening process with the addition of new tools such as demographic mapping and impression analysis and a successful outsourcing of our construction management process.

We have seen a smooth integration of our key executives in merchandising and logistics, as well as advancement in key system enhancements this past quarter and are moving forward with our e-commerce strategy.

Now some detail on each, starting with what we have accomplished during the quarter and what we have to look forward throughout the rest of the year and into 2009.

In the second quarter, we opened 10 new stores in Canada and the United States.

We continue to be pleased with our new store openings and our store productivity.

Our Chinook Centre store in Calgary, which opened on July 16, is trending to be one of our top 10 stores and our Troy, Michigan and Halifax stores, which opened the beginning of May, continue to perform exceptionally.

We also entered into a joint venture agreement with our Australian franchisees during the second quarter.

We have opened two additional stores in third quarter already, including our 66th and 3rd Avenue location in New York City, which has been a huge initial success in spite of the rain.

We expect to open 22 additional stores this year for a total of 35 stores in North America during fiscal 2008.

As I stated in our last conference call, our goal for this year is to focus on infilling our current markets such as New York, Southern California, Texas, DC, Chicago and Seattle.

We are beginning to benefit from the increased clout that our growing store base and brand equity bring to us in both existing and new markets.

Even so, we will continue to refine our real estate selection process to ensure that we are maximizing the productivity and return potential of our (technical difficulty).

Meaning that we open the right stores in the right markets with optimal locations and store opening sequences.

We have added more signs to our real estate process.

For example, through our work on the regression analysis model and demographic mapping tools, we have learned that we are most successful when we penetrate the heart of a city or region in hip urban areas and then work our way out to the suburbs and we will apply this strategy more consistently to our store openings in the future.

For 2009, we will target the best locations and best deals possible in this environment.

As (inaudible) adjust to the changes in the retail environment, we are provided with opportunities to reduce our initial investment, improve on these terms giving us more flexibility and reduce cost structure in the future.

We are closely watching the closures of other retailers and the impact on trade areas in malls and ensuring we have co-tenancy, occupancy rates and other protective clauses to protect our portfolio.

Moving on to new hires.

In July, we hired a new Head of Logistics, [Richard Kopkey], who has helped us make good progress towards the end of the second quarter in our supply chain visibility and distribution center productivity.

Richard comes to us from Chico's FAS and has more than 30 years experience in the retail industry, including previous jobs at Abercrombie & Fitch, Footlocker and Broadway stores.

Under his leadership, we have already made improvements in the DC's productivity through system enhancements and physical layout changes.

We are thrilled with Richard as an addition to our team and we look forward to seeing continued benefits from our efforts in logistics throughout the remainder of the year.

We are prepared to make an offer for a candidate as the Head of Planning and Allocation and are very excited about the prospect of filling this role.

We continue to see major opportunities from strengthening our execution and ensuring that we are getting the right product in the stores at the right time in order to maximize both the guest experience and our store productivity potential.

And we believe this hire will optimize our allocation processes substantially.

For my former role, EVP of Business Units, we are taking time to find the right candidate to complement the skills of the existing management team.

Next, our implementation of new systems is progressing very smoothly.

Our new merchandise and warehouse management system, which was implemented in the first quarter, is live and performing well.

In addition, our new POS system was successfully installed in all of our stores in the US during the quarter and the Canadian rollout remains on plan for 2009.

We have begun our phased rollout of JDA's advanced allocation system, which we will plan to have completed before the holiday season.

Our Maple Lake merchandise planning system is scheduled to go live in October and will enable more precise planning and forecasting for our fall 2009 line.

Finally, I am excited to say that we are officially moving forward with an e-commerce strategy, which we plan to launch in the second half of 2009.

We are developing an e-commerce business with the help of a consultant that will combine internal web development, merchandising and call center service with an outsourced platform and fulfillment.

We have assembled our internal team, which is being led by Bree Stanlake, an exceptionally talented former general manager from (technical difficulty) and remain on track to launch the site in the second half of 2009.

In summary, e-commerce is just one of the tremendous opportunities we see for lululemon brand in the future as it will enable us to reach incremental markets, generate new demand and [inconvenience] for our guests.

In spite of this very challenging macroenvironment, we continue to be excited about our tremendous growth potential and we will be ready to execute at all levels.

We are very pleased about our continued top-line momentum, as well as the people and processes that have added to this business in a short period of time.

We want to assure our shareholders that we are making the right decisions consistent with the long-term health of the business and brand.

Now John can give you some details on the second quarter and our outlook for the rest of the year.

John?

Thanks, Christine.

As Christine indicated, we are very pleased with the results we achieved in the second quarter of 2008.

After addressing our results in more detail, I will provide guidance for the third quarter and the full year.

Second-quarter total net revenue increased 48% to $85.5 million as compared to $57.9 million in the second quarter of 2007.

This increase was driven by a combination of 32 net new stores opened since the second quarter of 2007, including 10 new stores in the second quarter of 2008, coupled with a comparable store sales increase of 13% on a constant dollar basis.

Including the impact of a stronger Canadian dollar, comparable store sales were 18%.

As of the end of Q2, there were 49 stores in our comp store base, 35 of those in Canada and 14 in the United States.

Our corporate owned store sales represented 92% of total sales or $78.3 million versus 90% last year.

Franchise and other revenues, which include wholesale, phone sales and showrooms, totaled $7.2 million and represented the other 8% of total revenue in the second quarter.

We ended the quarter with 92 total stores versus 60 year ago, 80 of which we own.

During the second quarter, we closed three stores in Japan and opened one additional franchise store.

Our new store is not yet in the comp base, also continue to perform well in line with our expectations in the quarter.

Gross profit for the second quarter increased $13.6 million, or 44.4%, to $44.4 million.

Gross margin declined as a percent of revenue by 120 basis points to 51.9%.

Merchandise margins improved during the quarter, in part due to refunds of access duty payments and in spite of markdowns from the clearance activities in July that Christine spoke to.

However, higher occupancy and depreciation costs related to new stores opened during the quarter and those scheduled to open in Q3 contributed to the gross margin decline.

Remember, accounting rules require that rent and depreciation on new stores must be expensed commencing on the possession date even if there is a free rent period and even though the stores generate little or no revenue during this preopening period.

Higher costs associated with our production, merchandising and distribution departments also reduced gross margin as we continued to invest in people to enhance our capabilities.

SG&A expense increased 40.7% to $28.8 million for the quarter, or 33.7% of total revenues, compared to $20.5 million, or 35.4% of total revenues in the second quarter of last year.

The 170 basis point reduction in SG&A as a percentage of sales is due primarily to lower options expense and leverage on our corporate headquarters expenses versus last year.

So overall, operating income increased 51.7% to $15.5 million as compared to $10.2 million last year.

Operating margin leveraged year-over-year with an operating margin of 18.2% this year versus 17.7% in 2007.

Our tax rate for the quarter was 21.7% versus 46.5% in the same quarter a year ago.

As discussed in our previous calls, last year, our tax rate was inflated by our intercompany transfer pricing structure, which we amended at the end of 2007.

In addition, during the second quarter, the rate was favorably impacted by the recognition of deductions for stock option expense and for tax savings associated with the US company's NOL.

Although these deductions were anticipated in our guidance for a full fiscal year tax rate in the low 30%s, the benefit was fully recognized in our second quarter as opposed to the expectation of a more even recognition throughout the balance of the year.

Just to be clear, this shift in timing, which added approximately $0.02 earnings per diluted share in Q2, does not represent a change in our tax rate or earnings per diluted share expectation for the full year.

Net income from continuing operations rose to $12.3 million versus $5.5 million a year ago, or $0.18 per diluted share versus $0.08 per share a year ago.

Our weighted average diluted shares outstanding for the quarter were 70.4 million versus 68.9 million for the same period last year.

During the second quarter of fiscal 2008, we incurred a charge of approximately $1.2 million, or $0.02 per share, for discontinued operations resulting from the Company's closure of our stores in Japan.

Net income after deducting this loss was $11.1 million, or $0.16 per diluted share, as compared to $5.1 million, or $0.07 per diluted share in the same period last year.

Turning to the key balance sheet highlights, we ended the second quarter in a healthy cash and cash equivalents position, totaling approximately $44 million and as before, we've continued to have no debt.

Inventory at the end of the quarter was $43 million or up 82% from the end of the second quarter last year.

We are very pleased with the content and the quantity of our inventory as we enter the fall season and are confident that we have struck the right balance between planning for our growth and planning conservatively given the economic environment.

Capital expenditures were $19 million in the second quarter and primarily related to our new store buildout costs and IT capital expenditures.

I will now turn to the outlook for the balance of 2008.

For the full year, we continue to anticipate comparable store sales growth of high single digits on a constant dollar basis.

We now expect reported comparable store sales growth of low double digits versus our previous expectation of low teens for the year, assuming that the Canadian dollar continues to be weaker in the second half of the year.

We continue to plan 35 new store openings in North America for the year and are maintaining revenue guidance of $380 million to $385 million.

We continue to expect diluted earnings per share for fiscal 2008 to be in the range of $0.68 to $0.71 per diluted share.

Fiscal 2008 earnings guidance includes the $0.02 loss per share recorded in the second quarter resulting from the Company's closure of its four stores that operated in Japan.

The closure of Japan has been fully reserved for in Q2 and so there is no further earnings impact anticipated for the rest of the year.

As I mentioned in my earlier remarks, we expect the full-year fiscal tax rate in the low 30%s consistent with our previous guidance.

Finally, we expect 71 million diluted shares outstanding for the year.

For the third quarter of 2008, we expect comparable store sales growth in the mid to high single digits on a constant dollar basis and low to mid single digits on an actual reported basis, plus 15 new store openings in North America during the quarter.

We expect diluted earnings per share between $0.11 and $0.13 per share in Q3, which compares to $0.11 in the third quarter of fiscal 2007.

In our third quarter, we are opening a greater number of stores versus last year.

The majority of these openings are expected to take place in October, which causes us to incur nearly a full quarter of occupancy and other store-related costs with less than a month of sales from those stores.

While the timing of new store openings and related store expenses will cause fluctuations in our quarterly earnings guidance over the balance of the year, it averages out and we remain on plan.

Our fiscal 2008 guidance remains above the Company's previously stated long-term growth targets of net revenue growth of approximately 25% and diluted earnings per share growth in excess of 25%.

With that, we are ready to turn the call back to the operator for questions.

(Operator Instructions).

Lorraine Maikis, Merrill Lynch.

Hi, good morning.

It's Rick Patel in for Lorraine.

Thanks for taking the question.

Can you just quantify some of the metrics that caused the gross margin to drop in the second quarter, specifically the depreciation and higher occupancy?

And then perhaps comment on the implications for merchandise margins.

Yes, as I said, just going to my notes, gross margin declined in spite of the strong merchandise margins.

As I indicated, there was a benefit from excess duty repayments, but overall merchandise margins were strong and that was true in spite of the markdown activity in Q2.

So our merchandise margin is solid.

It really is primarily the occupancy and depreciation costs related to the new store openings because those costs do reside in our cost of sales.

And there is a bit more detail of that deleverage in the 10-Q, which was issued this morning.

The other piece being increased costs and production merchandising and distribution.

Those really represent the strengthening and deepening of the teams in those areas so that we are improving our supply chain.

And that primary investment was in our LLO office in Hong Kong, which is where we -- we've now moved closer to the market to do our quality control and manage our factories, which will benefit us long term.

Okay, great.

And as the new stores come online in the second half, should we expect to see a gradual improvement in the gross margin?

What you will see is, and in my remarks, I alluded to this, the timing of new store openings, especially a high number of new store openings against the fairly low base, has quite an impact on the timing of income and expense.

In Q3 for example, there is a very high number of store openings and as well several of the Q3 and early Q4 store openings are some of our higher productivity -- New York and other strong market locations.

So what you would expect to see in Q3 would be the same or more negative impact on gross margin coming from the timing of those new store openings.

Thank you very much.

Michelle Tan, Goldman Sachs.

Great, thank you.

I am sorry.

I got kicked off the call a second ago, so sorry if this was asked already, but a couple questions.

One is the new store productivity.

What are you seeing in terms of trend there?

It looked like it ticked down quite a bit from the first quarter.

And then secondly, on the inventory position, I know you mentioned at the outset it was clean, but you did also take some additional markdowns in the quarter.

The inventory position relative to sales looks higher than it was in the first quarter, so just a little additional color there.

In terms of new store productivity, as I said, we continue to see the new stores performing pretty much in line with our plan.

There were six new stores that entered the comp base in Q2, so that is the best measure of new store productivity because they have got a full year now under their belt and on average, they were well above the minimum of 750 per square foot that we have discussed in the past.

And stores that have been open less than a year, of course, it is too early to get specific about their performance.

But in general, on average, in line with our expectations.

In terms of our inventory levels, as we have said, we are very comfortable with our inventory level at the end of Q2.

It is up about 82% over inventory at the end of Q2 a year ago.

Though as you will recall, last year in Q3, we were continually out of stock and I think the Q2 '07 inventory position was a little bit low and that is part of what resulted in those out-of-stock positions last year.

The clearance activity that took place in July I think has freshened up our inventory, so we are comfortable with the content of the inventory.

And I think, as I said, we have got a good balance of being prepared, positioning ourselves for growth, but protecting the downside in a generally tough economic environment.

Okay, great.

That's helpful.

Thank you.

Paul Lejuez, Credit Suisse.

Thanks, guys.

Can you maybe refresh our memory about when you bought back those three Calgary franchisees?

Because I think that has been affecting, at least on the surface, the new store productivity numbers in previous quarters and make it look like it is a big decline.

Maybe you can -- a big decline his quarter.

Maybe can you share with us what the dollars were associated with those three stores?

And then also just a question on Japan.

How did that factor in in terms of the total sales number?

Were Japan's sales included in the prior quarters in the store revenues?

And I guess the second part is are they now no longer included in that number?

Can you maybe just give us some color on that new store productivity?

Okay, thanks, Paul.

You make a good point.

We bought back the three Calgary franchise stores at the start of April last year and those are, of course, very high productivity stores in the Canadian market where the brand is very well-established and in Alberta where the economy is very strong thanks to oil.

So those are high productivity stores and I think it is possible that some people would have been confused by average new store productivity if they failed to recognize the volumes of those stores.

Can you share with us what those volumes were just to help with the calculation?

Well, we don't comment on specific store productivity, but they are well above our overall average.

How about on Japan?

Japan, the revenue is really immaterial at well below $1 million last year I believe.

It was in last year's numbers.

This year, because Japan is in discontinued operations, what you see is just the net revenue less expenses on one line item, which is discontinued operations, but overall, it really isn't material.

Got you.

And then second, on expenses, it looks like, in dollars, expenses were lower in the second quarter relative to the first.

I am just trying to tie that together with how many stores you guys have open or have open during the quarter.

I am sure there are some currency impact.

Maybe just comment on how expenses would be down sequentially and how we should think about expense dollar growth as we go into the back half of the year.

I assume you are referring primarily to the SG&A.

Correct.

Probably the most significant timing shifts that you saw from Q1 to Q2 was in stock options expense and in particular, Bob Meers' performance vested options, which, previously under the accounting rules, were being expensed each quarter over the expected time to vesting.

As you will recall, those options vested in the first quarter and as a result, the stock option expense related to that was fully recorded in Q1 and therefore, there is no further ongoing expense in Q2 or beyond.

So that was a large item and then --.

(inaudible).

I beg your pardon?

How big was the dollars there?

That was about $700,000 additional expense in Q1.

And then generally, there were across-the-board variety of areas where spending was just more disciplined than in the past.

And then just last, can you maybe talk about the promotional cadence throughout the quarter?

What was planned at the beginning of the quarter versus how it played out in terms of promotions that were taken in stores?

And I believe, Christine, you mentioned the warehouse sales.

Did that all go according to plan?

Just trying to dig down into the promotional cadence a bit.

What we recognized was the stores weren't clearing as they normally had in the past, some of their end of seasonal markdowns and so they were getting PC and we kind of stored it up, which is why you don't see over the quarter any real degradation of the margin.

The other thing that historically we have done is we have moved the product to the warehouse and held it, particularly in Canada.

And with Richard coming on, we have seen the opportunity to reduce one of our secondary warehouses and bring the good straight in to reduce our cost structure, but that meant then we had to move the clearance items instead of holding them till January, which was costing us money, into July.

So we did the breakdown out of that.

It also allowed us to really prepare to flow the goods for holiday with everything that is coming in with the high volumes that we see.

So those were some of the inputs into the decision-making process that we made to go ahead and pull the trigger to clear the goods in July and do the warehouse sale then.

Thanks, guys.

Good luck.

Howard Tubin, RBC Capital Markets.

Thanks very much.

Hi, guys, great quarter.

John, can you piece out the inventory build or maybe give us the inventory per foot number or how much the inventory relates to new stores and how much relates to sales planned?

To be honest, our store model really is not an in-store inventory management model.

It is mostly a DC-based model.

So if you are asking about in-store inventory versus overall inventory, it is not really meaningful.

And it is also very difficult to talk about metrics of inventory per square foot when the growth in square footage is so dramatic.

So I guess what I can say though is what you are seeing is an inventory build that takes into account obviously the expected sales in the existing store base and sets us up for significant new store openings.

And as I said, for Q3 and early Q4, several very high productivity, high expectation stores.

Okay, just one other question.

Are the comps in Canada running consistently to the comps in the US?

Are they still kind of mirroring each other, or has there been any change there?

They are actually very close.

That's continued as it has in the past.

Very slightly higher comps than the US, I think because of the stronger economy.

But again, they are very close to each other.

Okay, thanks.

Sharon Zackfia, William Blair.

Good morning.

I had a couple of questions.

John, do you have what the inventories were up on a comparable store basis?

You know, I don't have that handy.

I can -- maybe we can follow that up on subsequent calls.

I don't have that information handy.

Okay.

Maybe separately for Christine, I think you mentioned buildout costs and better lease terms going forward.

Is there any way you can put some kind of quantifiable metrics behind what you are kind of expecting going forward on buildout versus historically, and how the lease terms are trending?

On the buildout, even though we have had some -- we are going to more street locations which are typically more expensive because you're not getting a clean vanilla shell from your landlord, we have been reducing our cost structure -- I don't know if John will let me give you a number there -- but pretty dramatically overall on the store cost basis by going to outsourced construction.

So, you know, one of the things I worry about is what if there is a slower economy and we don't see the growth rates, how do we make sure that we keep our cost structure in line.

So we have been doing everything we can on both the lease costs and the construction costs to make sure that we have a really healthy cost structure in case that does happen, even though I will again say we have seen no signs of that for us.

So it has been a key focus of ours, and I don't think John is going to let me give you an exact number here, but it is well below our historical run rate in the past year.

And then on e-commerce, it is good that you guys are going forward.

I guess I am just wondering kind of at this early stage do you think as you look out to '09, is it a relatively neutral impact to earnings or should we expect the e-commerce initiative to be dilutive a bit again in '09?

You know, it is really early to be giving -- of course, I am not giving any '09 guidance yet, and we really don't want to go so far as to try to give revenue or earnings guidance on e-commerce.

We will add additional information and guidance on e-commerce over the coming quarters as we move further.

I would just add that we are at the -- we are getting all of our final proposals in right now, so we will have a better idea of the costs going forward probably for the next call.

Okay.

And then lastly, John, are you just -- I heard what you were saying on currency.

Is there any thought about hedging the profit impact at this point, or do you think you are pretty naturally hedged?

It comes up every call, and we think about hedging a lot.

The impact of currency on us is -- overall, the biggest impact is on the Canadian company's profit, which is something I'd never look at hedging.

If we were to hedge and what we have considered hedging is the Canadian dollar's exposure to US dollar purchases.

And the policy on hedging would be when the Canadian dollar is trading above its expected near-term level, then that is the amount that we would consider hedging.

We haven't put any hedging contracts in place so far, and with hindsight that has probably benefited us.

But we do continue to look at it.

The other thing I would say -- I mean hedging, it is like an insurance policy.

It might smooth your very, very short-term earnings, but it has no real impact on the long-term viability or health of the business model.

Thank you.

Janet Kloppenburg, JJK Research.

Good morning, everyone.

Congratulations on a very nice quarter.

A couple of questions.

John, did you say that the comp outlook has changed just a tad, I think from low teens to low double digits?

I have only changed it to take into account that the Canadian dollar is running a little bit lower.

Lower than you had expected it.

Yes.

It had been running at very close to par, and it is a little bit lower over the past month.

That is the only change on a constant dollar basis.

We are not changing our outlook.

And that is reflective in the third-quarter comp change as well from maybe -- did you go to mid-single digits for the third quarter?

I am confused.

It is reflected in our comp guidance for Q3 and for the balance of the year.

But what is the comp guidance for the third quarter?

The third-quarter comp store sales in mid to high single digits, but because of the currency level versus a year ago on a reported basis, it would be low to mid single digits.

Okay, good.

I just wanted to be clear on that, okay?

And then I was wondering if the amount of store openings that you are going to incur in the next few months -- I think there is 22 more to go; is that right?

Will that give you any incremental benefit on the gross margin line, let's say in the fourth quarter maybe as you leverage some of these rents that you are paying for?

Or should we look for this pressure on the occupancy line to continue to hurt the gross margin?

The bulk of the timing fluctuation related to these new store preopening costs, you have seen some in Q3 and you will see it -- sorry -- in Q2 and you'll see it in Q3.

Q4, the stores are open, revenues coming in and of course, it is the highest --

Right.

-- [revenue] period of the year.

So the direction would be higher gross margin due to leverage in Q4 and without a distortion from these new store opening costs.

Right.

So we get it back in the fourth quarter.

[What] we might be pinching the gross margin line right now, we get it back then?

Right.

That is a fair way of looking at it?

Yes, it is.

Okay.

And then, Christine, I don't think this occurred with you guys, but for a number of the specialty retailers during July and August, their Canadian business began to slow.

We think because they were up against tough comparisons.

And I am wondering if you are seeing -- it sounds like it is still very strong and during the quarter, matched the level of the United States comp growth or was even a little better.

But I am wondering if you are seeing any deceleration there because I am seeing it at a number of other players in the business.

Not yet.

We watch that every day; we see what is happening.

Our variance in sales I will honestly tell you is still related to whether or not we get the deliveries to the store on time and we are working on smoothing that with our carriers and going to everyday delivery and we are seeing positive results from that in the business.

Okay.

And then I was wondering, on the inventory front, if there are new categories of business or a level of investment in new categories of business that weren't reflective or were at lower levels last year at this time that might be affecting the comp, might be affecting the inventory numbers?

In other words, the store [assortment]?

(multiple speakers).

-- planning investment is higher this year than last.

Yes, some of the value of the inventory is higher because we have leveraged more, which I think we will see reflected in next quarter as we brought in these sales for the outerwear garments.

Yes, I see more outerwear in the stores right now than I did last year at this time.

Right.

And as we mentioned, it is performing.

This is only our second season of doing the outerwear business.

So we are looking at this and obviously this is a really positive response from our guests.

Okay.

I also wanted you guys to know that the new store on 3rd Avenue just looks fabulous.

Congratulations on that opening.

That's good.

So I will talk you soon.

Thank you.

Richard Jaffe, Stifel Nicolaus.

Thanks very much, guys.

Just I guess two questions.

One is regarding the clearance stores, the temporary locations, will those be simply a pop-up store for 30 days or will you have an ongoing location, a continuing lease in those two locations?

What we have been able to work with the landlords there is that we have the right to operate it up to six months, but to close it at any time that we want to.

More of a month-to-month relationship?

Yes.

So what we have done is we have taken over -- like the first one is a former J.

Crew and we left the fixtures that they had in there and brought in rolling racks and some great seats for the men to wait in and it has been very popular.

And so there is no incremental buildout cost for us doing those and we treat them almost more like we are doing an in-place warehouse sale and creating the same kind of energy and fun we did.

But it really takes far less resources as we look to try and scale warehouse sales across the US.

So we are really trying to create the same level of energy in just a very efficient way.

Sure.

Just a question on some of the enclosed mall locations you have opened recently in the past year and how you are seeing them perform both in terms of sales, but also in terms of their product needs, the differences between those stores and some of your highly successful street locations.

I think that's tough.

I would tell you that we also have malls that are in the top of our productivity range, particularly where there is inclement weather.

So I think it is hard to generalize that pattern.

I think it is also where you have a successful brand and where we have built it the right way, you really see then the malls performing.

Some of the lessons we have learned from the real estate strategy is when we go to the suburbs and open the mall, they are a little bit slower to ramp than [when] we have done and penetrated the cities faster.

And so now by going in and re-penetrating those cities, we see those pop when the ramp changes.

So we know we are doing the right thing from a real estate strategy.

It is less I think to do with anything that we have seen from a product mix or really even weather.

Got it.

Thank you.

Liz Dunn, Thomas Weisel Partners.

Hi, good morning, thanks for taking my call.

I guess my first question -- I don't know.

Is Chip still with us on the line?

Yes, I am.

My question related to your plans.

You own a lot of stock.

I see that you are transferring some to some employees and understand that, but do you have any plans for the balance of your holdings to sell at this point?

No.

The real thing is that I probably took a couple hundred million out through selling to private equity people and then a little bit at the IPO.

I don't know what I would do with the extra money.

I am in the Company every day.

I am in Washington today, went to three stores yesterday and took all the educators out for breakfast and design meeting last night.

It is what I love to do and I don't know what else I would do in the world if we have all our goals set up around our Company for every employee and mine are up there loud and clear that I am in it.

I am a neophyte at this to a great extent.

Definitely my wealth investors are telling me that a smart person would diversify.

And I think at some point in the future, maybe I will listen to them, but I don't see anything for the next three years anyway.

Okay, great.

Thanks for clearing that up.

Just to clarify on that point.

As hopefully most of you saw, there was a second press release issued today that did talk about the transfer by Chip of some shares.

And again, just to be clear, those related to stock incentive programs that were put in place by Chip back in 2005 before the private equity investors came in before the IPO and this is simply fulfilling on those plans.

Okay, great.

And then my second question just relates to sort of the markdown versus occupancy pressure.

John, is there any way you can provide specifics on how much pressure was in the second quarter and how much to expect in the third quarter and with the change in promotional strategy, did that mean that some markdowns shifted into the second quarter from the third quarter?

Actually, it is more -- if you look at last year, really the bulk of markdowns took place in Q4.

So what you saw is a shift of those annual markdowns from Q4 into Q2.

I think you will see that in the future.

Q2 and Q4 will be where you see some markdown activity, but more evenly spread between the two of them.

But in addition to that, more of a level markdown experience throughout the year through these temporary outlet locations.

Having said that, we think the overall approach to markdowns and clearance of excess inventory, even though we are evolving the strategy, it doesn't change our expectation for overall markdowns and it doesn't change our target or expectation on our overall annual gross margin.

Okay, great.

Thank you.

Dana Telsey, Telsey Advisory Group.

Good morning, everyone.

Can you talk a little bit about -- in terms of John and Christine.

John, in developing the business, what are the key metrics that you are monitoring as a growth company to make sure you are on track?

And Christine, now that you have been there a while, what new processes have you put in place as the business grows and what metrics do you see them impacting?

How has it evolved relative to your initial thoughts?

Thank you.

Do you want me to go first, John?

Sure.

My team would probably tell you too many because I really do believe in financial discipline and rigor and business processes.

So we have been doing a lot of work around that as a team, a lot of bottom-up forecasting.

We have gone through a very detailed strategic planning process as a team and including all of the initiatives, program costs and detail for really the next anticipated three years because you never -- you complain for three years and you get enough to do for five is the way that I always look at that and really managing the timing of those investments and spending against the revenue.

So I feel very comfortable with where we are with our strategic plan and how we have built the numbers going forward.

In terms of the monthly business disciplines, we are busy reinventing all of our internal reports so that we are really watching the business in the right way.

And I can tell you watching Sheree at work over the last three weeks, I have found my soul mate in that in Sheree.

So she is putting a tremendous amount of rigor and discipline around managing the inventory, the sales reporting, how we manage our flow of goods to the store.

And Richard has already brought a whole new set of KPIs and reporting to the warehouse and given us a tremendous amount of visibility all the way back in the supply chain to where the product is flowing and what dates things leave.

So we have had just remarkable, frankly, improvement in our financial metrics and clarity to look at what this is doing in the last quarter.

So I am really proud of where the team has come with that.

And in terms of metrics, no surprise, of course.

We look at comp store sales growth as a measure of the overall health of the business year-over-year.

But I think what we focus on more than most retailers and most in the market is the importance of the new store ramp rate and productivity because our comp store sales -- again, they are important, but so much of the story, even on a quarter-to-quarter basis, is how well are the new stores going and of course, longer term, it is the successful execution of the new stores that are going to drive our growth.

Of course, we monitor gross margin leverage because, as I have talked about before, there are several positive and negative levers.

Everything from making sure that our production and sourcing team are getting the best possible product cost to managing the occupancy and depreciation charges on stores that are coming through in the cost of sales line.

And then we are at a point now where, as we have talked about, we do see us generating leverage on SG&A and we are at a point where that has really got to be the focus.

We have continued to build the team both at the executive level and up through the ranks and we are increasing our efficiency and it is important to make sure that we are pacing the growth in the platforms and the G&A spend that drives, but pacing it with the growth of the Company and getting that positive leverage.

And John, how many new stores are flowing into the comp base in the third quarter and fourth quarter?

That is a good question and I don't think I got it on my cheat sheet.

Hold on.

Let's just see.

Q3 -- sorry I do have it.

Q3, there will be 12 new stores in the comp base and Q4, there will be a further six in the comp base.

Terrific.

Thank you very much.

(inaudible) metric that we have talked about in the past and that is really the people at the store and we have already completed all of our hiring through the balance of this year, including down to the assistant managers and the program we have put in place has put us in the position where, even through Q1, we have most of our people in place in the system through the assistant manager rank program that we have done for opening our stores for Q1.

So we feel really good about our people pipeline as well.

Terrific.

Thank you very much.

Thank you, ladies and gentlemen.

This does conclude our Q&A portion.

I'd now like to turn the call over to Ms.

Christine Day for any additional or closing remarks.

Well, thank you and thank you for joining us on the call this morning.

We just want to reiterate again that we have tremendous confidence in where the business is.

The infrastructure that we have been building, the results that we are seeing, the guest response to our product.

And I think we stand in this quarter more confident than we have been I think in really any quarter about our ability to grow this company into a tremendous brand and business that we can all be proud to be a part of.

So thank you for joining us on the call.

Once again, ladies and gentlemen, thank you for your participation.

This does conclude today's conference call.

Thank you and have a good day.