Lululemon Athletica Inc (LULU) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen and thank you for standing by.

Welcome to the lululemon athletica first quarter 2010 results.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions).

As a reminder, this conference is being recorded.

I would now like to introduce your host for today, Ms.

[Melissa McKay].

Ma'am, please go ahead.

Good morning, thank you for joining lululemon athletica's conference call to discuss first quarter 2010 results.

A copy of today's press release is available on the Investor Relations section of the Company's website at www.lululemon.com, or furnished on Form 8-K with the SEC 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 Christine Day, the Company's President and Chief Executive Officer, and John Currie, the Company's Chief Financial Officer.

Before we get started, I would like to remind you the Company's Safe Harbor language.

Statements contained in this conference call which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Actual future results might differ materially from these projected in such statements due to a number of risks and uncertainties, all of which are described in the Company's filings with the SEC.

Now I'd like to turn the call over to Christine Day, lululemon athletica's Chief Executive Officer.

Thank you, Melissa.

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

With me today are John Currie, our CFO, Sheree Waterson our EVP General Merchandise and Production Manager, Delaney Schweitzer, our EVP of Stores and Deanne Schweitzer, Head of Strategy and eCommerce.

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

We are very pleased with our first quarter results, as our momentum from the fourth quarter continued into 2010.

Our comparable store sales were 35% for the quarter, on a constant dollar basis, and we delivered $0.27 in diluted earnings per share.

This was our Company's best ever first quarter, as we were able to generate very strong same store sales growth in both the US and Canada.

In the first quarter, we saw our trailing 12 month average sales per square foot reach 1,428, an improvement from last quarter's 1,318.

All age classes are comping positively with our 2008 US age class leading the way.

We also added incremental profits from our eCommerce business, leveraged our strategic investments in infrastructure, and managed our inventory and our margins for a strong flow-through of earnings.

We believe we took the right amount of inventory risk to drive sales and used our rapid response strategies to respond to incremental sales opportunities.

Our inventory levels now match sales trends with opportunities to continue to refine channel allocation to eCommerce and to chase smaller sizes to meet market demand.

Our yoga and run lines continue to lead sales demand as well as strong growth in our equipment and accessories.

As discussed previously, we work toward a target profile of at least 50% gross margin and 20% operating margin, and as you can see we have achieved these targets in the first quarter.

As a growth Company, we will continue to make strategic investments to protect our iconic items such as the hoodie, while scaling our infrastructure and people capacity as part of managing our brand and business model.

As you have seen in the past quarters, we have made these investments while keeping the overall business model at a relatively stable level, near our long-term targets.

As we strategically manage our brand and business for the long-term, from quarter to quarter there will be incremental flow-through or occasionally contractions in gross margin or operating margin.

The flow-through this quarter was very strong due to a combination of market factors, such as strong demand for our product, leverage on sourcing, limited markdowns, and timing of investments towards the back half of the year, as well as leverage on stronger sales.

Looking forward, we do see some sourcing pressure from materials and labor costs and reductions in out-of-stock.

Turning to revenue growth, our first priority remains growing existing stores.

Our second is eCommerce, and our third is new store openings.

We have opened four stores in the first quarter in North America.

We have also opened 14 showrooms in Q1, and will open 30 more between Q2 and Q3, for 44 new showrooms being added this year to the 14 existing at the end of 2009.

We have closed one in St.

Louis, upon the opening of our new store in the same market.

We continue to be very excited about our eCommerce opportunity.

Our direct to consumer business is now 6.6% of our revenue, and a key growth vehicle for the Company.

We are investing in additional site performance and online community web strategies in the second half of the year, as well as additions to our merchant and planning team to ensure better inventory flow to this channel.

We are on track to achieve our stated objective of 10 to 12% of sales.

Our new distribution center in Sumner, Washington, is up and running in parallel and will begin deliveries to our US stores next week.

It will support all of our channels of business in the US, retail, eCommerce, and strategic sales.

As announced in an earlier press release, we are now the majority shareholder in our Australian business.

While this is not material to earnings, it is a great opportunity to test our ability to grow and support a strategic international expansion, as one of our longer term growth opportunities.

We are very fortunate to have David Lawn, the former CEO of Rip Curl, as our CEO in the market.

He and his team have done a great job building our brand in this key athletic market.

So while it was a great quarter, we were not perfect.

Going forward, we can do an even better job flowing product to a multi-channel business, especially our eCommerce channel.

We also delayed showroom openings to divert product to our retail stores and to secure the right locations.

And while we have made strong progress in our system and people capacity, we are still at the early stages of building the infrastructure for a multi-channel business that is responsive and nimble as we need to be to outperform in today's macro environment.

So it is now my pleasure to turn the call over to John to go through the details of our financial results and give you our outlook for the second quarter.

John?

Thanks, Christine.

I'll begin by reviewing the details of our first quarter 2010 results, and then I'll update you on our outlook for the second quarter and the full fiscal year 2010.

For the first quarter of fiscal 2010, total net revenue rose 69.3%, to $138.3 million, from $81.7 million in the first quarter of 2009.

The increase in revenue is driven by comparable store sales growth of 35% on a constant dollar basis, boosted in particular by strong momentum in our 2008 age class of US stores.

The addition of 11 new corporate-owned stores and three franchise stores in Australia since Q1 of 2009, eCommerce sales which increased revenues by $8.1 million, and a stronger Canadian dollar, which had the effect of increasing reported revenues by $13.5 million or 11%.

During the quarter we opened four corporate owned lululemon stores.

We ended the quarter with 128 total stores versus 114 a year ago, 114 of which are corporate owned, and 14 which are franchises, including the nine in Australia.

There are now 97 stores in our comp base, 38 of those in Canada, and 59 in the United States.

Corporate-owned stores represented 83.6% of total revenue, or $115.6 million versus 89.3% or $72.9 million in the first quarter of last year.

Revenues from the direct to consumer channel, which includes eCommerce and phone sales totaled $9.1 million, or 6.6% of total revenue, versus $0.9 million or 1.1% of total revenues in the first quarter of last year.

Other revenue, which now includes franchise as well as wholesale, showrooms, and outlets, totaled $13.6 million or the remaining 9.8% of revenue for the first quarter.

Gross profit for the first quarter was $74.4 million, or 53.8% of net revenue, compared with $35 million or 42.9% of net revenue in Q1 of 2009.

The perfect storm of factors contributing to this 1,090 basis point increase in gross margin included the following.

Merchandise margin improvement of 480 basis points, which was driven by improved product costing on our spring merchandise and strong sell-through, which resulted in very low markdowns, leverage on non-merchandise costs such as occupancy, depreciation, and product and supply chain team costs contributed 410 basis points of improvement.

And foreign exchange improvement of 200 basis points due to a stronger Canadian dollar.

SG&A expenses were $41.9 million or 30.3% of net revenue.

Compared with $25.2 million or 30.8% of net revenue for the same period last year.

The SG&A dollar increase is due to a natural increase in store labor and operating expenses associated with new stores, showrooms, outlets and growth at existing locations.

An increase in administrative costs and service provider fees associated with our eCommerce website.

Higher legal fees associated with employment matters and legal settlement costs.

An increase in professional fees and other corporate head office costs as we reinvest into our support functions in response to the increase in demand.

Higher management incentive based compensation.

And finally, a strengthening Canadian dollar, which increased our reported SG&A by $3.5 million.

Nonetheless, we were able to achieve a 50 basis point reduction in SG&A as a percentage of revenue, contrary to our expectation when giving guidance for the quarter that we would see SG&A deleverage as a percent of revenue against Q1, 2009.

This was largely due to leverage gained through improved store productivity, delay in timing of new showroom preopening costs and some delay in new hires in support functions at the store support center.

As a result, operating income for the first quarter was $32.5 million or 23.5% of net revenue, compared with $9.9 million or 12.1% of net revenue a year ago.

Tax expense for the quarter was $13 million, recorded at a rate of 40% versus 34.4% in 2009, and our previously expected tax rate of approximately 35%.

Our strong operating performance has resulted in the continued accumulation of significant undistributed earnings in our Canadian operating subsidiary.

Accounting rules require an additional tax expense to be accrued to reflect the future tax, which may be incurred if and when excess funds are repatriated to the parent Company by way of dividends.

As we discussed on our last call, we've been reviewing our tax rate assumptions in light of this potential additional future tax.

While we are comfortable with the taxes accrued on our accumulated Canadian earnings through fiscal 2009, and we continue to investigate planning opportunities which could reduce or eliminate this additional tax on future earnings as well, we've decided to take a conservative stance, and increase our tax rate to 40% for 2010, commencing in Q1, to account for this potential future tax.

Net income for the quarter, reflecting this higher tax rate was $19.6 million or $0.27 per diluted share.

This compares with net income of $6.5 million or $0.09 per diluted share for the first quarter of 2009.

Our weighted average diluted shares outstanding for the quarter were 71.6 million versus 70.3 million a year ago.

Turning to the key balance sheet highlights, again this quarter we generated strong positive cash flow and ended the quarter with cash and cash equivalents totaling $173.6 million.

We continue to have a healthy working capital position and no debt.

Inventory at the end of the quarter was $50.8 million, which was $6.1 million or 13.7% higher than at the end of the first quarter in 2009.

This inventory level is more in line with our expected sales productivity, and should support our planned growth in the second quarter with less reliance on our rapid replenishment strategies.

Capital expenditures were $5.9 million in the quarter, resulting from new store build-outs, existing store renovations and IT capital expenditures.

Now I'll turn to our outlook for the second quarter.

This outlook assumes a Canadian dollar at $0.95 US compared to an average exchange rate of $0.88 in Q2 of 2009.

Also as previously announced, the acquisition of a majority interest in our Australian licensee will result in the full consolidation of the Australia results in our financial statements commencing from the May 12th, 2010 date of acquisition.

On acquisition, we operated nine stores and four showrooms in Australia, and the operation is expected to be slightly profitable in 2010, although not material to our overall results.

The second quarter, we anticipate net revenue to be in the range of $140 million to $145 million.

We expect comparable store sales percentage increase in the mid-20s on a constant dollar basis compared to the second quarter of 2009.

After opening four stores in the first quarter, we expect to open one in North America in the second quarter, that being The Grove at Shrewsbury in New Jersey.

In addition, we already opened one additional store in Australia in the second quarter.

We expect gross margin as a percentage of sales to improve over Q2 2009, as we continue to benefit from leverage of strong sales productivity, as well as improved product costing and favorable impact from currency.

However, overall we expect some gross margin compression compared to Q1 2010, with the key differences being the anticipation of a return to more normalized markdown rates in the second quarter, as we have successfully increased our inventory levels to be more able to satisfy expected guest demand.

A seasonal shift in the latter part of the quarter towards the lower margin fall product assortment, and investment to add depth and additional talent to the product teams in the second quarter.

Turning to SG&A, even with our expected strong revenue for the quarter, second quarter SG&A as a percentage of sales is expected to deleverage against 2009's second quarter, due to a number of factors.

Incremental showroom operating costs and preopening costs incurred in approximately 30 showrooms that we anticipate opening in the second and third quarters.

Administrative costs and service provider fees associated with our eCommerce channel.

The inclusion of Australian head office costs.

And a stronger Canadian dollar, which will increase reported SG&A costs, both at Canadian stores and at our store support center in Vancouver.

Assuming our adjusted tax rate of 40% as discussed earlier, and 72.1 million diluted average shares outstanding, we expect earnings per share in the second quarter to be in the range of $0.21 to $0.23 per share.

So looking now to our outlook for the full fiscal 2010, we currently have 12 new stores confirmed in North America, with the possibility of up to 15.

In addition, we expect three new stores in Australia this year, including the one which already opened in Q2.

Our outlook assumes that comps in the second half of the year will begin to moderate, as we lap the stronger results we experienced as 2009 progressed, and for the year we expect our overall comp to increase in the mid-teens.

We now expect net revenue for the year to be in the range of $620 million to $635 million.

For gross margin, we expect margin compression compared to Q1.

For the full year, productivity leverage and efficiency in distribution and logistics will be partially offset by higher markdowns as we have returned to more balanced inventory levels, further investment in the product teams that support growth and execution, and in the latter part of the year, higher product costs due to inflationary pressures on fabric, labor and transportation.

For SG&A, we expect some deleverage during the back half of 2010, as we will partially reinvest the strong operating profit flow-through from the first half to build our platform to support our long-term growth trajectory.

SG&A for the year will also be impacted by the factors mentioned with respect to Q2, Including showroom openings, eCommerce service provider fees, and Australia G&A costs.

We will also incur some one-time costs associated with our planned move in Q3 to a consolidated premises to house our head office or our store support center which is presently split between two locations in Vancouver.

For those of you who have visited our modest premises here, you'll be pleased to hear that our new location will be equally modest.

However, we expect to incur approximately $1.4 million in moving costs, write-off of improvements at our existing space, and a double up of rent during a short period of overlap.

We continue to expect capital expenditures to be between $27 million and $30 million for fiscal 2010, reflecting new store build-outs, renovation capital for existing stores, IT and other head office capital.

Overall we expect 2010 fiscal year earnings per share to be approximately $1.05 to $1.10, which now assumes the 40% tax rate versus our previous guidance that had incorporated a 35% tax rate.

This is also based on 72.2 million diluted weighted average shares outstanding.

With that, I'll turn it back to Christine.

I'd just like to add that we're very pleased with these results and we couldn't have this be possible for the organization without the extreme dedication that we see every day on our front lines from all of our educators, our store managers, and the passionate people we have at the support center.

And with that, we're going to open it up for questions.

(Operator Instructions).

And our first question comes from the line of Michelle Tan of Goldman Sachs.

Thanks.

Hey, Christine, I was wondering if you could give us any early learnings from the showrooms.

I know it's really recent as far as the timing, but any kind of clues as to the brand's level of resonance across different markets and any markets that you're particularly excited about out of the gate with some of these openings?

And then John, a quick question on the tax rate.

Should we be thinking about 40% as the ongoing rate beyond 2010 as well?

Thanks.

Let me just take that one quickly.

Yes, you should be modeling 40% going forward.

I think on the showroom strategy, we're very excited.

Both in the openings that we saw this year which have been very strong openings for the stores which tells us we're very much on track with that strategy, and overall the whole portfolio is exceeding our expectations in terms of sales, particularly on the community side.

There are a few we're learning but we're testing three different models, stimulating existing growth in markets, testing new markets so you have a little bit of varied performance based on the different models for showrooms.

Such a safe way for us to test market opportunities, test our managers, and make sure that we're really ready when we open that store.

So it's exactly on strategy and producing those results.

Great.

Thanks and good luck.

Thank you.

And our next question comes from the line of Lorraine Hutchinson of Banc of America-Merrill Lynch.

Hi, thank you, this is Paul Alexander for Lorraine.

Could you guys give us a little more color on what you're seeing for product costing.

We heard about cotton prices increasing.

How much of your product is cotton.

What's happening with prices for synthetic fabrics and what are you seeing on cut made cost and labor and such.

This is Sheree Waterson.

We are seeing an increase in cotton pricing.

We're seeing an increase in nylon and there's also Chinese labor which has gone up a bit.

There have been prior to this mitigation strategies that we've been employing to really minimize the impact on the margins there.

So everything from further leveraging and smart planning of our raw materials to actually diversification of our supply base, so that we are manufacturing in some lower cost countries at this point.

Thank you.

You bet.

Thank you.

And our next question is from the line of Paul Lejuez of Credit Suisse.

Thanks.

It's Tracy Kogan filling in for Paul.

I had a question on your eCommerce business.

I was wondering how the performance of the business has been different in different geographies and do you find it's performing best in areas where you have a store or you just opened a showroom or where you don't have a store and has it helped you determine future locations for stores?

Thanks.

This is Deanne.

And basically yes to all of the above.

So we do see our sales populated definitely around our brick and mortar and when we open up a showroom, again we see our sales pop up in that area.

So our brick and mortar are working together exactly as we expected.

Is it helping you in locating future stores?

Definitely.

So yes, definitely.

We watch it every week and in -- what am I going to say, piece of the pie, along with the showrooms, so they're both giving us an indication as to where we should head with our real estate strategies.

You guys also mentioned you're testing three different showroom models.

Could you give a little more information there?

So we see longer term brand-new markets where we might be open for a couple of years so that would be part of our new market entry strategy.

Then looking at extensions, specifically we're going to put an additional store in a market and some are in those hip little urban communities that we might not target opening a store but they're really critical to the brand strategy for attracting that target guest and increasing our reach in a market area.

Great.

Thank you.

Thank you.

And our next question comes from the line of Edward Yruma of KeyBanc.

Thanks very much and congratulations on a nice quarter.

Thanks, Ed.

Can you talk a little bit about -- you indicated that inventory, you're more comfortable with our current in stock levels.

At this point going forward, should we expect inventory to increase at the same rate of sales and then secondarily in terms of the gross margin impact from not doing -- not chasing inventory, what kind of lift does that give you?

Thank you.

I think answering the first question, as I said, we're comfortable with our inventory level at the end of Q1, closer to being in line with our expected sales for Q2.

So the answer to your question is yes, increases in sales would match increases in revenue or in inventory ideally going forward.

In terms of gross margin, you're right, being more in stock does mean that we're more likely to have more markdowns, as I said.

There is a partial offset because we won't be employing chase strategies to the same extent.

It will be too granular to give you precise guidance on that.

But I would say the markdown impact is greater than the savings from not chasing.

So net-net, there's some deleverage on gross margin.

Got you.

Thank you.

Thank you.

And our next question comes from the line of Liz Dunn of Thomas Weisel Partners.

Hi.

Good morning.

Let me add my congratulations.

My question related to the new distribution center.

You mentioned I believe it was supposed to open at some point in May.

You mentioned that some of the employee costs were delayed.

Can you just give us an update on that?

It actually has been running in parallel and officially starts shipping to all of the stores this coming Monday.

So it's up and running and I think we're through the double costing of having the outsource plus the -- getting ready for the new.

So we'll be turning that over next week, winding down our existing partnership, and be ready to go for the rest of the year.

We're very excited about having that up and running.

Just one follow-up he request question on inventory.

Having the online business, is it giving you better visibility as to where you need to be in terms of stock-outs, because I would imagine you get better data as to where you're not in stock.

There is a difference between what guests buy online and what they buy in the stores, and I think there's a combination of factors in there.

We have guests that shop both and then we do see some of what they're really looking for and we do see what the hot items are.

Actually we learn more about that on Facebook and through social media, what are the guests really screaming for and so we actually use that I think to get a little bit more indication.

As we talked about in I think it was the last call, what we've really seen by the addition of the run line is it's really shifted our guest size profile down to the smaller sizes because we're attracting a more athletic fit guest which is perfectly in line with our target and we've now adjusted a lot of our buys and in terms of allocating to the stores, you can have an aggregate number right or even to eCommerce, but be wrong between the two markets of Canada and US on product or many of our buys are fully allocated so the work that Sherree and her team are doing are the much more sophisticated getting right size profiles at right stores and that's -- even if we have the right product in the warehouse in the original buy, it's getting it down to the stores at the right mix and that's really been our focus and what will continue to be our focus through I'm sure the rest of this year and into next year.

Okay.

Thanks.

Good luck.

Thanks.

Thank you.

And our next question comes from the line of John Morris of BMO Capital.

Thanks.

Hey, congratulations on a great quarter.

Let me throw a couple questions at you.

John, I think in your prepared remarks, maybe it was kind of a small point, I think you had mentioned when you were discussing the SG&A comments there was a delay -- part of what was going on in SG&A was there was a delay in spending related to showroom and I think related to some of the other expenses.

So maybe if you can elaborate on that, I don't know if it was that meaningful, kind of where that delay was coming from and why.

And then in terms of the new distribution center for you guys, I would imagine that would probably help in terms of speed, speed to market.

Do you have any idea yet about how many days you might be cutting out of the delivery time and how much it would help your freight expense and thoughts directionally in terms of putting you guys in a better position to be in stock in the stores.

And then any quick update on Aviva would be great.

Thanks.

Maybe I -- want me to do the first one on showrooms.

Sure.

We made the decision as we saw we were pretty light on product and we really wanted to take our time with locations to delay some of those showroom openings.

But then we already had hired some of the managers and kept them in training so we did see some of that expense flow through but the actual cost of opening the showroom, the rent commencement, some of those dates did delay and that will change going forward in the second quarter.

And other delay in SG&A spend, we're not talking about large amounts but we always budget for new hires at the start of the year and it sometimes takes a bit longer to add those key positions.

It's not that material, though.

Want me to answer the DC?

Hi, this is Sheree Waterson.

You're absolutely right, we tend to be more efficient when we fully own our distribution center.

Rich Koske and his team are world class efficiency experts.

But to be honest, they will cut off a day or so in their shipping across the country and so forth, but the primary factor in speed is really flow from the marketplace or flow from our manufacturers.

So that is something that we continue to improve.

We flow core product several times a month and we flow obviously our initial allocations several times as well.

So we've made the improvements there and Rich has made improvements, but the primary factor for speed to market is really ex-manufacture.

And is that going to help you guys with your in stock positioning, I would imagine quite a bit.

It will.

Do you have any tracking?

Yes, that plus some of the other initiatives that we've talked about on other calls, like we actually stock cut and sewn goods in Asia about six weeks worth in certain categories and we also take a position in raw materials both here in Canada and in Asia so that we quick turn.

John, do you have any kind of quantification about how much it would help your freight costs?

I think it would be premature to try to predict that but we'll know more next quarter after we've been operating for a few weeks.

I think it's more going to be -- the short-term is going to be on the operating efficiency of the DC in cost per unit out the door and less on the freight itself, because we're still using an outsourced carrier to get to the store.

So it's really the time from the boat to the store in the distribution process, not in the shipping to the store process.

And then efficiency of labor costs in the DC.

Okay.

Great.

And update on Aviva?

Yes.

Deanne, why don't you --

Deanne here again.

We're really -- we're happy with our increased brand awareness of the brand.

I believe we've mentioned before, we have opportunity to right-size this brand so as much as -- sorry, the apparel, the clothes themselves.

So as much as we are seeing an increase in brand awareness and traffic to the stores, we will stifle our sales ever so slightly until August when we have the right size in the store throughout the whole line.

We are continuing to look at opportunities to open up locations in 2010, but we don't have anything signed yet, so that's where we're at with Aviva but still continued very positive and happy with today's results.

Hey, thanks.

Thank you.

And our next question comes from the line of Janet Kloppenburg of JJK Research.

Hi, everybody and congratulations.

I had a couple of questions for Christine.

I was wondering if the acquisition of the Australian business and I think of a top management team will provide a platform for international growth and if there's eCommerce development going on in Australia and internationally as well.

For John, I wasn't quite sure if you meant that we should be looking for gross margins to be down in the second half vis-a-vis the second half of 2009 or whether you thought that the increases would not be as great as they will be in the first half of fiscal 2010.

And for Sherree, I was wondering if you could talk a little bit about your opportunity to move sourcing to other markets perhaps to help with cost pressures and if you could give us some highlights on new product introductions or focus for the second half.

Thanks.

Sure.

I'll start with the gross margin.

What I meant was not year-over-year.

What I was indicating is we see some gross margin compression compared to what you saw, the 53 plus percent that we saw in Q1.

But we could still feasibly see some increases on a year-over-year basis?

You should see year-over-year increases, yes, definitely.

Okay.

Thanks.

For international on the eCommerce side, we already do ship internationally and what we're working on behind the scenes is putting an additional modules in place that make it easier for the guests to pay for the duty and taxes and the shipping and for us to do credit card verification.

So that work is under way right now which should actually increase our international reach.

Australia actually is one of the markets where we see the most demand internationally from eCommerce because of the work that David and his team have done there.

So we don't necessarily need to build out fulfillment or a unique face in our eCommerce just to reach that guest there or frankly anywhere else.

We will start to next year focus on additional languages on our eCommerce platform as well.

What about further expansion internationally, given the platform now in Australia?

Yes, I think we have a lot to learn.

It's now treated as a Company operated or owned market.

But still a very small team there on the ground because it wasn't done with another partnership, so it's a pretty grass roots operation there that works closely with our team.

And we've been learning a lot.

But I think one of the things we're really careful about is adding a lot of complexity to our business, especially because they're still very small in size and we already added the complexity of the eCommerce channel.

So that I think is what we're really trying to make sure that we work through to do things well and optimize both our US strategy and our eCommerce strategy before we take on any additional complexity.

We have a small business development team here that we're working with to help us build the model but that's really -- we're at the very early stages and there was a false rumor that we were going to London.

Let's just get that on the table now, it was a false rumor.

We don't have a real estate partner signed in that market.

Would that be a market you would consider in the short term?

I think it's tempting because of the Olympics and the success we had here but I think for us it's really about managing the complexity and that's going to be the thing that guides us and I'd like to really get through this eCommerce transition with the next platform before we take on any additional complexity.

Good luck.

Hi Sheree.

Hey.

I'll answer first your question regarding sourcing.

Our primary strategy is that we are shifting from about seven to about 27% of our goods being manufactured in southeast Asia and that goes for raw materials as well as cut and sewn goods and those countries are primarily Vietnam, Cambodia and Bangladesh that we'll be diversifying to.

In terms of new product innovations or introductions, so for first quarter you saw more hot yoga and we had the introduction of the mat as part of our equipment and then for summer we introduced UV sun protection in running which has been a run-away hit, no pun intended, along with lightweight running swift fabric in our running shorts, our tops and our running skirts and then you will see a great introduction at the early part of Q3 which will be reflective running fabric where we actually have the reflective yarns woven into the fabric and of course there's more but we can't tell you that just yet.

We'll have to surprise you later.

That's fine.

Christine, would you reiterate again what your sales per square foot levels were?

I wasn't sure.

Was it 1350?

I'm going to have to put my glasses back on for that one, Janet.

It's 1428, which was improvement from last quarter's 1318.

Okay.

Perfect.

Thanks so much.

Good luck.

Thank you.

Thank you.

And our next question is from the line of Ty Lee of Morgan Stanley.

Hi, good morning everybody.

Sherree, if I could ask one more follow-up question just on sourcing itself.

Maybe a little more directly.

I think you guys were 75% China exposed on sourcing last year.

Where could we see that number go to by the end of this year?

And what pricing strategies are you guys looking at in light of the inflationary pressures?

Okay.

The first thing is you were asking about China.

I can tell you this.

Strategically, we are looking to bring China down to just over half of our total sourcing, our total manufacturing.

And the second thing was price pressures and how we see that in terms of retail.

You won't.

You won't.

We are a premium manufacturer.

We are a premium brand and the way we price goods is through the right value equation for our guest and we like exactly where we are right now.

Okay.

And that target to really get China down to sort of 50%, how long do you think it would take you to get there?

Over the next several years.

Okay.

Great.

Then could we get a little bit more color just in terms of the drivers behind the comp traffic conversion and ASP?

We're definitely seeing traffic up and that's probably the leading indicator.

We're also seeing stronger conversion rates and stronger ticket.

So it's coming from all three, but in that order.

Okay.

Helpful.

Thank you very much.

Thank you.

And our next question comes from the line of Claire Gallacher of CapStone Investments.

Thank you.

Just a quick question about the performance that you saw in the US versus Canada.

Did you see any notable differences in traffic or buying patterns?

Any kind of difference in the consumer between the US and Canada?

I think the best way to answer that, overall, as Christine said in her remarks, the real stand-out was the class of stores that we opened in a lot of new markets towards the end of 2008, which overall the comp store increase in that class was well above the already high average that we posted.

And that's definitely traffic, primarily, because those are stores in markets that the guest is finally discovering the brand.

Okay.

Great.

And then so my follow-up really was going to be about any kind of regional differences in the US and I'm guessing the answer really is where the 2008 stores are located is really where you saw a nice lift within the US?

I think it's still very much for us an age class story as we've been saying all along.

It's just driven by the ramp in new stores.

Overall we see healthy markets across the board but some really strong growth of brand awareness like in the DC market has been really exciting for us to see and I think it was a lot of the work we did on things like the cherry blossom festival where we had 1700 people show up and Yoga at the White House which we anticipated in and then the Florida market as we increased our store penetration and community there, markets we used to worry about like Texas no longer worries whatsoever.

That team down there has done an amazing job and that combined with our real estate strategy, opening in North Park, so we feel -- the really good news is there isn't a weak spot.

Great.

Thank you so much.

Good luck.

Thanks.

Thank you.

And our next question comes from the line of Richard Jaffe of Stifel Nicholas.

Thanks very much.

Now that you have or about to have your DC fully operational, is there a thought of bringing eCommerce in-house to take greater control of that piece of the business, not only the distribution and planning but the functionality of the site and to make it a wholly owned and totally controlled enterprise?

I don't think we'll go to wholly owned.

We are working on a new really kind of online strategy, the very, very formative stages, really leveraging where we're going in the social media and online presence and then we are working on increasing the web, the creative design and the speed of the system, and a more scalable backside but that would still be outsourced even though we will do did distribution piece our self in the US as we do in Canada already.

So I think you'll see a lot of improvements in the site but we also want to focus really on the creative and social side and I think from an IT complexity right now, I don't see us in the short-term taking on the commercial side of that site for another few years.

And is there an opportunity to take the site and make it available to other countries, Euro denominated, perhaps.

Yes.

And that's part of the move we'll make and by adding different paces and languages.

So we definitely see that as part of the shorter term strategy within the next year.

Within the next year.

Thank you.

Our next question comes from the line of Howard Tubin of RBC Capital Markets.

Thanks.

Just a -- what are your thoughts on warehouse sales during the summertime frame or in the winter.

Are those a thing in the past or could we expect them to pop up again as you're building your inventories a little bit.

We've typically only done them in Canada and one or two a year, so we do see probably doing one, coming up, but we haven't quite a agreed on the site or timing of that.

So it could either be the end of second quarter, beginning of third.

And we're still pulling together what inventory we have for that so we haven't made the final decision.

But I think definitely as we go through the balance of the year, we do expect to return to kind of a more normal accumulation.

I mean, our outlet stores have been underperforming because we haven't been shipping a lot of merchandise to those.

I'm not really that worried about that underperformance, frankly.

So I think you'll see some additional revenue generate from those as we return to fuller product lines.

Got it.

Thanks.

And just any thoughts on all the cash that's piling up on your balance sheet, any kind of extraordinary, out of the ordinary uses for that coming up.

I think we have to save it for taxes at this point.

It's a wonderful problem to have.

I think with any retailer that's accumulating cash, it's a topic.

And at some point I think all companies end up with strategies to return to shareholders.

But we're still so early in our growth cycle that I think it's a good strategy to retain that cash to fund our growth.

That is great.

Thanks.

Thank you.

And our next question comes from the line of Taposh Bari of Jefferies.

Hi.

Good morning.

Congratulations.

We were just wondering how and if weather variability has any impact on your business, given the large amount of outdoor and street type locations that you have.

We heard California had unseasonably cool weather in April and May.

Just trying to get a sense if you saw any changes in buying patterns as a function of that volatility?

Go ahead.

We didn't really -- frankly, the thing that really drives our guest to our store is her passion for the brand.

So if you know much about our guest, she's willing to go to any lengths to experience our brand and to buy her components, to live a healthier life.

So I think that there's really fun stories in our stores where we even have guests that come in that they can't wait to see the educators, so they're part of their network, so we're very lucky in that way and frankly, there was minimal impact with weather.

Great.

Well, thanks and best of luck in the second half.

Thanks.

Thank you.

And our next question comes from the line of Jennifer Black of Jennifer Black & Associates.

Hi.

Let me add my congratulations as well.

I have a couple questions.

I wondered if you have any incredible strategies for gift giving for the holidays?

And then it seems like you are still light on accessories and I wondered what your longer term plans were there.

And then lastly, looks like you made some progress on the smaller size issue.

Any thoughts would be great.

Thank you.

Great.

So the first thing we talked about was gift giving and yes, we started our gift giving strategy last year and it was very successful.

We learned from that and we will be continuing that for Q4 of this coming year or this year.

The second thing was light in accessories in general.

Yes, we are.

We have finally gotten back into stocking bags which has been tremendous for us.

We've had a lot of work to do on our sock delivery, which finally now looks like we've got our flow going.

We actually have a new strategic partner there, so we're excited about that.

And the other categories I think we're back-filling nicely.

So we had a tough time there for a while.

And our mat sales are finally -- we're seeing that even out quite a bit.

We've finally gotten our flow there.

So that's all good.

In terms of sizing, we've been continuing to tackle for 12 months now.

Just as we were getting a handle on it, we continue to have work to do regarding our shifting guests.

As we introduced -- as Christine was mentioning before -- the run line, we're seeing a more athletic, more slender body adding to our guest mix.

We're now actually looking at that further and breaking that down to the -- not just the style level but the style, color level.

So we're getting traction there and have made improvements for each buy that we do.

So -- And I think you'll see the continued improvement in the core and black assortment but in the seasonal, some of the seasonal styles, color ways, our strategy is a scarcity model.

You know, so if you like that size 6 or 4 in one of the color ways or seasonal styles, it's never our strategy to be fully at demand level there, so there will always be a certain amount of noise that we expect but that helps keep the product and the brand strong which is also part of our strategy.

Great.

And then I guess lastly, any thoughts on men's and men's in the US versus the men's in Canada?

Our men's business is continuing to gain momentum.

To date, we're about 40% over last year, which is great.

Our adoption has continued to increase in the US, and we're getting a lot of traction there.

So we're excited about that.

The US market is giving us some clues about how we can optimize our business in Canada, and with the onset of some things that we're doing for our bottoms in terms of fit logic and other things, I'm really looking forward to some of the results that we're going to be getting in the future.

Fantastic.

Thank you very much and good luck.

Yes.

Thank you.

And our next question comes from the line of Kristine Koerber of JMP Securities.

Yes, hi.

A couple of questions.

First, can you talk about the trends throughout the quarter and maybe comment on trends into May because a lot of retailers are saying they saw a slowdown.

Through the quarter we're pretty consistent.

If anything, things picked up a bit towards the end of the quarter.

May is really reflected in the guidance I've given.

May was a bit odd because of just the shift of the long weekend in both Canada and in the US, but generally continuing quite strong.

Okay.

Great.

And then you mentioned your operating margin, how you hit your operating margin target in the first quarter.

How should we think about the operating margin over the long term?

Because I know your goal was the 20s.

Yes.

We said, we've always worked on sort of a model of a 20% operating margin.

Clearly, and you saw it in Q1, the business has the potential to produce an operating margin above 20%.

The caution really is we are still very early in our growth and as we grow, we will flow through additional profit to fuel future growth.

So even though a forecast might show an operating margin getting up into the mid-20s, you should expect that we'll take some of that flow-through and reinvest it in future growth and that's why we talk about 20% is a level we like to maintain and possibly exceed, but the real variable is our discretionary investment in growth.

Okay.

And then just lastly, on your new distribution center, will we see efficiencies flow through immediately?

Well, we certainly hope so.

I think in the short term you've got some cost overlaps so it will probably show up more in the Q3, Q4, yes.

Okay.

Great.

Thank you.

Thank you.

And our final question in queue comes from the line of Laura Champine of Cowen.

Hi, guys.

And I noticed in the 10-Q that you changed the way that you break out segments, which is great.

But do you -- will you be releasing data for the remaining three quarters last year so that we can get a good sense of your year on year trends and how to project the business?

I believe as we go forward, just to clarify, we have changed our segments.

We've moved franchise, which is a decreasing percent, moved that into other, and we've broken out direct to consumer, which is eCommerce and phone sales, because that's a growing percent.

My controller will pick his head up and kick me, but I believe, as we go forward will have to provide year-over-year comparisons based on the new segments as we're now reporting them.

So if you don't show them until the quarter, can you just kind of talk to us about how much the Australian revenues that shift out of franchises, how much those were on an annualized basis and then maybe -- you obviously had huge growth in the direct to consumer, how sustainable is triple digit growth year on year this year?

I'm sorry.

There are a number of questions in there.

Starting with the franchise, there's more to it of course than just Australia.

We have beyond Australia, we have five other franchises remaining.

As we said in the past, the plan is over time to eventually acquire all those franchises back.

In terms of Australia, I think the best thing to do is to look at the press release that we issued on May 12th announcing the acquisition and it does break out the revenue of that operation from last year.

And then on -- I'm sorry, I'm not sure what your question was on eCommerce, triple digit growth of course coming from zero a year ago.

We're running at 6 to 7% of total revenues today.

We still believe that over some modest period of time that should rise to 10 to 12% of revenues.

Got it.

Thank you.

Thank you.

And we have to further questions in queue at this time.

All right.

Thanks, everyone.

And we'll talk to you next quarter.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program.

You may now disconnect.

Everyone have a great day.