Lululemon Athletica Inc (LULU) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the lululemon athletica Q3 2010 results.

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

Later we will conduct a question-and-answer session with instructions following at that time.

(Operator Instructions).

As a reminder, this conference call is being recorded.

And now I would like to turn the call over to Joe Teklits, of ICR.

Please begin, sir.

Thank you.

Good morning, everyone.

Thanks for joining us again for lululemon's conference call to discuss third 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 10-K with the SEC available on the commission's website www.sec.gov.

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

Hosting today's call is Christine Day the Company's Chief Executive Officer; John Currie, the Company's CFO; and Sheree Waterson, EVP, GMM and Supply Chain.

Before we get started of course, we need to remind you of 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 and such statements due to a number of risks and uncertainties all of which are described in the Company's filings with the SEC.

With that, we will turn the call over to Christine Day, the Company's CEO.

Good morning everyone.

Our business momentum continued as we reported another strong growth quarter with total sales increasing 56% and our same-store sales improving by 29%.

All age classes are comping positive led by our 2008 and 2009 stores.

I am also very pleased with the quality of our growth and our disciplined approach to building a strong and sustainable business model as demonstrated by our healthy earnings flowthrough.

In Q3, we continued to focus on technical athletic product with yoga at our core and our success is evident in our latest results.

Our core technical products such as yoga pants and tops including our new hot yoga line as well as our run line drove sales as well as our gross margin.

This product carries higher merchandise margin when compared to categories like accessories and outerwear.

We believe this product class benefited from innovation and diversified fabrics in our tank lines and increased layers and technical features such as UV protection and reflectivity in our run line.

During the quarter, we increased the number of events and ambassadors at our stores and also our tenured store managers improved store level execution.

Our ability to stay focused on our brand strategy has resonated with our guests and is driving brand awareness and sales.

So again, we consider this to be a very high-quality increase in store productivity that validates our business model.

Another big part of our third quarter success was our e-commerce business.

E-commerce sales were up over 200% from the third quarter in 2009.

We improved our inventory position to support sales in the back half of the third quarter which allowed e-commerce to jump closer to a natural level for this early stage business.

And since our site carries and sells a larger mix of technical product and has proportionately fewer markdowns than do our stores, e-commerce also added to our gross margin and operating margin in the quarter.

We believe that we are just scratching the surface in e-commerce and that a level of 10% of sales is achievable in the short to medium term.

Our newer businesses, Aviva and Australia, also performed well.

The Aviva brand has evolved since its launch one year ago.

Sales have grown as we have begun to highlight general athletic wear with a focus on year-round athletic activities such as gymnastics, dance, and ice-skating as our target guest profile.

We also have two pop-up stores in place in Canada which is our way of using grassroots marketing to determine and build demand for permanent stores.

In Australia, our sales momentum neared the strong trend in the US due to our heightened focus on community.

Turning to our North American retail stores, our new class of stores had an outstanding quarter and we believe credit here should be given to our showroom strategy and our talented managers.

We continue to plan for 20 to 25 North American lululemon stores in 2011 in addition to two in Australia and two Aviva stores.

We will continue our successful showroom strategy across all geographies and concepts.

We also made some key hires to support our growth.

Kathryn Henry joined us as our CIO and Margaret Wheeler, our new VP of Human Resources, completed her training and is leading our initiatives on compensation, development, recruiting and systems to attract and retain a world-class management team.

We have added significant talent to our sourcing and production teams and have a strong candidate in the pipeline for a GMM role to support Sheree's merchandising and planning operations.

They are strategically developing our bench strength to support our future growth.

As we look to 2011, we will continue to execute against our strong brand positioning.

We will remain focused on our yoga and run lines to drive existing store sales.

We will also expand our sales reach through our e-commerce channel with our planned transition to a new platform in the first quarter.

We will continue to invest in building the infrastructure to support growth and high performance through initiatives such as inventory sourcing systems, processes, planning systems and a digital strategy to leverage our social media presence and human resource IT systems.

And finally, we will continue to build our roadmap to explore international expansion as a future growth opportunity.

We are excited about our current business trends, our brand positioning, and the structural initiatives we have in place to drive future growth.

With that, I will turn the call over to John to go through our financial results.

John?

Thanks, Christine.

I will begin by reviewing the details of our third-quarter 2010 results and then I will update you on our outlook for the fourth quarter and for fiscal 2010.

Keep in mind as I discuss our results that the acquisition of a majority interest in our Australian licensee early in the second quarter now results in the full consolidation of Australian financial results which has contributed to variances in operating results and balance sheet amounts compared to the prior year.

For the third quarter of fiscal 2010, total net revenue rose 55.7% to $175.8 million from $112.9 million in the third quarter of 2009.

The increase in revenue was driven by comparable store sales growth of 29% on a constant dollar basis; the addition of 13 net new corporate owned stores in North America since Q3 of 2009, which includes the Saskatoon franchise we acquired during the second quarter; the consolidation of the Australian operation which includes three showrooms and 11 stores of which three have opened since Q3 of 2009; the addition of 33 net new showrooms opened in the US since Q3 of 2009; e-commerce sales which increased by $9.2 million; a warehouse sale that we held in Hamilton, Ontario in September; and a stronger Canadian dollar which had the effect of increasing reported revenues by $4.1 million, or 2%.

During the quarter, we opened three corporate owned lululemon stores in the US and one store in Australia.

We ended the quarter with 134 total stores versus 119 a year ago, 130 of which are corporate owned including the 11 in Australia and four US franchise stores.

There are now 101 stores in our comp base, 38 of which are in Canada and 63 in the United States.

Corporate owned stores represented 81.5% of total revenue or $143.2 million versus 86.9%, or $98.1 million in the third quarter of last year.

Revenues from our direct-to-consumer channel which includes e-commerce and phone sales, totaled $14 million or 7.9% of total revenue versus $4.6 million or 4.1% of total revenue in the third quarter of last year.

Other revenue which includes franchise, wholesale, showrooms, warehouse sales and outlets totaled $18.6 million or the remaining 10.6% of revenue for the third quarter.

Gross profit for the third quarter was $96.8 million or 55.1% of net revenue compared to $56.3 million or 49.9% of net revenue in Q3 2009.

The factors which contributed to this 520 basis point increase in gross margin were leverage on non-merchandise costs such as occupancy, depreciation and product and supply chain team costs which contributed 340 basis points of improvement; foreign exchange improvement of 120 basis points due to a stronger Canadian dollar; product margin improvement of 60 basis points which was driven by a shift in product mix to our higher-margin core technical product; and outerwear deliveries shifting partially into Q4.

SG&A expenses were $54.5 million or 31% of net revenue compared to $35.4 million or 31.4% of net revenue for the same period last year.

The 54% SG&A dollar increase is due to a number of factors including 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 variable service provider fees associated with our e-commerce website; consolidation of store SG&A and head office costs from our Australian operations; corporate headquarters relocation expenses associated with our move that we completed in October; higher management incentive-based compensation of options expense and other corporate head office costs as we reinvest in our support function; and finally, the higher Canadian dollar which increased reported SG&A by $1 million or 1.9%.

Nonetheless, we were able to achieve a 40 basis point reduction in SG&A as a percentage of revenue.

This is better than our expectation when giving guidance for the quarter largely due to leverage gained through higher revenues.

Year to date, our strong revenue growth has allowed us to execute our strategy of funding investment and future growth while still producing SG&A leverage as a percentage of revenue.

As a result, operating income for the third quarter was $42.4 million or 24.1% of net revenue compared to $20.9 million or 18.5% of net revenue a year ago.

Tax expense for the quarter was $16.5 million recorded at a rate of 38.9% versus 32.8% in 2009.

Remember we increased our tax rate commencing the start of this fiscal year to take into account the additional deferred income tax liability for estimated future taxes attributable to undistributed earnings of the Canadian operating subsidiary.

We continued to analyze the level of unremitted earnings and evaluate planning opportunities which could reduce these future taxes.

Net income for the quarter was $25.7 million or $0.36 per diluted share.

This compares to net income of $14.1 million or $0.20 per diluted share for the third quarter of 2009.

Our weighted average diluted shares outstanding for the quarter were 71.8 million versus 71.1 million a year ago.

Turning to the key balance sheet highlights again this quarter, we generated strong positive cash flow and ended the third quarter with cash and cash equivalents totaling $224.8 million.

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

Inventory at the end of the third quarter was $73 million or 40% higher than at the end of the third quarter of 2009.

The increase is in line with our expected year-over-year increase in forward sales.

Capital expenditures were $10.4 million in the third quarter resulting from new store build outs, existing store renovations and IT capital expenditures.

I will now turn to our outlook for the fourth quarter of 2010.

This outlook assumes a Canadian dollar at $0.95 US which is the same as the exchange rate in Q4 2009.

For the fourth quarter, we anticipate net revenue to be in the range of $210 million to $215 million.

We expect comparable store sales percentage increase in the high teens on a constant dollar basis compared to the fourth quarter of 2009.

We have already opened four stores in the US during this fourth quarter which brings our total to 12 in North America as planned.

We expect our operating margin to expand by approximately 100 basis points over last year's fourth quarter.

This assumes an increase in gross margin versus the fourth quarter of 2009 driven by leverage on fixed costs such as occupancy and depreciation partially offset by higher production costs.

We also expect SG&A as a percent of sales to be relatively flat compared to last year.

We expect capital expenditures to be between $30 million and $31 million for fiscal 2010 reflecting new store build outs, renovation capital for existing stores, IT and other head office capital.

This is slightly higher than originally planned to reflect the capital expenditures of Australia which are now consolidated in these results.

Assuming a tax rate of 40% and 72.2 million diluted shares -- average shares outstanding, we expect earnings per share in the fourth quarter to be in the range of $0.46 to $0.48 per share.

This brings our 2010 earnings per share in the range of $1.39 to $1.41 compared to $0.82 in fiscal 2009.

With that, I will turn it back to Christine.

Thank you, John.

In closing, we want to wish you all a happy holiday season and thank our store managers and hard-working design, merchandising, supply-chain, and SSE teams for their contribution to our successful quarter.

With that, we will turn it over to questions.

(Operator Instructions).

Michelle Tan, Goldman Sachs.

Great, thanks.

Hi guys.

I was wondering if you could give us a little -- maybe dig a little deeper into the new CIO and maybe give me specific examples of key processes that you think you can enhance with systems?

And also some kind of sense of the timing, Christine, that you have in mind for some of these rollouts?

Well we put her to work right away.

So really the first project that she is focusing on are really our whole e-commerce transition.

So she is really making sure that that platform is going to be ready to go for us, making sure that we work through any security business processes as well across the whole organization.

So she has really been tightening up our risk management and just all the professional systems that you need.

But really the other big project that we have underway is our PLM project which is really critical to vendor management and the supply chain and really tracking everything from our fabric manufacturing forecasting base, tying all that together so that we can get even more efficient in our supply-chain and support Sheree with the information that she needs to continue to make great product decisions.

So those are some of the first ones.

We are also working on the next pieces will be business intelligence so that we are really just getting more accurate data across our organization as we grow.

We can't do everything by spread sheets anymore.

So that is another key focus of hers will be on that.

And then ultimately you know gearing up the next level of our financial system and then we also launch our HR IS system early next year as well so we have a lot of your basic infrastructure systems [building] built.

Great, thanks so much and good luck for holiday.

Lorraine Hutchinson, Bank of America.

Hi guys.

This is Paul Alexander for Lorraine.

Christine, you spoke a little bit about looking forward to international growth.

Can you give us an update on sales to customers in Europe whether it be online or in stores that have tourists or the Hong Kong showroom?

And are you doing anything proactive to drive brand awareness specifically in Europe and Asia?

We are not yet.

We are really just focused on serving the customers that come in to our e-commerce line which right now accounts for about 6%, 7% of sales kind of split between top markets are UK, Germany, Hong Kong, Singapore, Japan, are really kind of the top markets for us.

And so right now because our existing platform really doesn't facilitate very easy sales for those guests, with the new platform will be when we are ready to start handling orders in a way that I think will satisfy the guest.

And until we have that in place, it doesn't do much good to stimulate a bad guest experience in our mind.

So we will wait until we have that platform in a little more robust form.

And then we will work on local pages and currencies by targeted markets as we go forward with the e-commerce platform.

As far as showrooms, you know we are very pleased with the Hong Kong showroom performance.

It tells us there is a lot of market demand in that market but we are not ready yet to take it to a full store rollout and we really have just a very small presence in the UK with one primary wholesale account that we have there.

And we are just opening a few more wholesale accounts in that market.

But that is really about it right now.

Great, thanks.

And then just a follow-up, John, you had mentioned a little bit of costing pressure coming up and you alluded to it last quarter.

Can you give us an update on that if there is any change in outlook there?

Actually our outlook is still pretty similar to what we talked about at the end of Q2.

For 2011, we see compression of our gross margin of about 150 basis points coming from various inflationary pressures whether it is fabric, pricing, labor in China, etc.

And that is still our outlook for next year.

A little bit of that we will start to see that in Q4.

It didn't impact us very much in Q3 of this year though.

Thanks, guys.

Janet Kloppenburg, JJK Research.

I had -- I wondered, John, if you could talk a little bit about the parameters of the comp sales growth?

For instance, [AUR] trends (technical difficulty) value perhaps compare and contrast that to what is happening in the e-commerce channel.

Okay, looking at the comp again this quarter, it was driven by traffic and conversion.

With the limited accounting that we have, traffic was up in the low 20s.

Conversion was up a little below 10% and that is what is driving the comp.

Again, it was not driven by pricing.

The average transaction is about the same as it has been recently.

Units per transaction is up just slightly.

I think that is maybe because we are a little better stocked on accessories which are adding to the (technical difficulty) but no to the overall.

Okay.

And then in e-commerce channel, does it look about the same?

The average transaction was slightly higher on e-commerce.

In terms of product mix we tend to sell more of our core technical product online.

I think because on e-commerce people are discovering the brand and establishing their wardrobe as opposed to adding to their wardrobe.

Okay.

Christine, I was wondering about your (technical difficulty) expansion plans going forward and if those plans would include a new prototype or evolution of the store design as we now know it?

You know, I think we are always interested in changing our game.

I think we have begun a planning team for what we call store of the future.

We are really looking at future lines we will have and how many square feet to carry everything.

But that is so just basically the beginning of a concept team.

So it is going to be a couple of years before you see us do anything as we work through everything from the supply chain because it is not just about a store design, it is about how do you evolve your business?

And that takes a lot more time to plan.

So that is a very future thing for us but we are working off (inaudible) short-term fixturing and other things as we kind of incorporate new lines.

So we have hired a very talented designer who works in house with us as well and who is working on things like unique storefront.

We do outsource the majority of the construction documents.

So we don't do that part of it but definitely have increased our support for that future.

Okay.

And then as far as the sourcing pressure goes, I think John said 150 basis points gross margin pressure.

Could there be any offset to that John?

(technical difficulty) comps being better than expected or (technical difficulty) percentage or something like that?

Think of that as the unmitigated impact of inflation.

And yes, we continue to see opportunities for efficiency improvements.

I mean not material enough to call it in the comments but we do have our new US DC in place now which is delivering some savings.

So that is the maximum impact and of course leverage on occupancy and depreciation and other fixed costs dependant on what our comp store sales are going to be next year hopefully will largely offset that inflationary impact.

And just my last question, Christine.

Is there a new design of the website coming up?

I think you talked about some changes going on for the first quarter of '11.

Thank you so much.

I am pleased you have been on it.

You have noticed that we did post a new skin and we did a whole bunch of real (inaudible) testing on the existing site to make sure that we survived the Oprah onslaught that we got with a lot of visitors so we did some testing, put a new skin on there.

You can see already that we have a lot of new photography on the site because we have taken that in-house so we can really control the quality on the models are more like our models and in terms of how we want to project the brand and the product shows that so much better.

So we are really happy with these are some short-term changes and then have more planned once we launch the new site.

So we follow a execute what you can well strategy so we will phase in some of the changes rather than try to go live with a big bang.

Okay, great.

And lots of luck for a great holiday.

Thank you.

Liz Dunn, Friedman Billings Ramsey.

Hi, good morning.

I guess just one follow-up on the sourcing cost pressure as it relates to fourth quarter.

Are you expecting -- and I apologize if I missed it -- are you expecting gross margin to be down slightly in the fourth quarter?

And then just I wanted some update on running, where do you think it can go as a percentage of your business?

And how are you doing with the new sort of cold weather running product?

I have certainly a lot of friends that are purchasing it.

Let me take the gross margin question and then maybe Sheree can answer your other question.

In fourth quarter because of the seasonality, we expect to leverage on fixed costs to give us a stronger gross margin than Q3.

And sourcing cost pressures again, they are impacting some of the inventory buys now but because it takes an inventory turn for those to really come through the 150 basis points that we are talking about for next year, it might be a third of that that impacts Q4.

Okay.

How far out are you bought, John?

We are now buying for the third quarter, right, Sheree?

We just finished summer buy, so second quarter and we will be placing third quarter in December and January.

Okay, great.

So to your running question, Liz, I think your friends are sort of describing what is happening with run overall.

We are very happy with the run penetration at 20%.

What we currently have in stores has been very successful.

The power of cozy is winning at lululemon so the Running Luon tops that you see have been extremely strong at retail because of their wicking capability and because they are so comfortable to wear.

I think -- and that is both in men's and in women's.

And then the layering systems that our design team have created so that there is a layer close to the body that is generally silver so wicking anti-stink layer with a mid-layer and then also outerwear has proven to really satisfy our running guest needs.

We also have brushed running tights and so on and our running accessories to match for cold weather, caps, gloves, neck warmers, etc.

And so the guest is really responding to have the whole layered look and it functions best that way and I think that our serious running customer is really responding very well.

And the wool layer is fantastic if you haven't tried that yet, Liz.

Okay, thank you.

Sharon Zackfia, William Blair.

Good morning, I have to say I am calling from LA so I feel your pain at these early-morning calls.

Just a quick question.

You are growing SG&A at a very rapid clip this year.

And I know part of that is because you deferred a lot of SG&A expenditures last year in terms of infrastructure and growth expenses.

So I am just curious as we go into 2011 kind of what is a more normal rate of growth in SG&A and are there still key investments that need to be made and key members of management that need to be added?

I would say we are closer to having caught up on any underfunded areas that are the result of cutbacks in 2008, 2009.

But with the additions in 2010, just the run rate of the new members of the team will increase SG&A next year.

And beyond that, as I said, we are into the more discretionary investments and expenditures -- discretionary but necessary to continue to grow the platform for the future.

And again, we are just at the point of working on and finalizing our budget for next year so I don't want to give too specific guidance for SG&A levels next year but that is what we are dealing with.

We are trying to continue to leverage the business model but make the right investments to make sure that the growth continues.

I think in terms of your questions on key members of the management team, we are just kicking off a search for a Head of e-commerce.

We want to bring in somebody with some global experience in that position.

We have done it -- and to protect the brand and grow it from the brand's base with our internal talent.

And with out move, Deanne has been heading that has moved to head our global brand and we are very excited about that because she knows it.

And we don't as you know do marketing in the traditional way so we need somebody who understands how to do that internally.

And then we will continue -- we really feel like we have built a lot of our supply team out this year but we do have head of R&D coming in and a creative person in Sheree's team so that we are continuing to really create the vision for the future and have innovation as a regular part.

As you get bigger and the process part takes up a lot of your management time, you need to make sure that you have those center of innovations for the future.

So definitely a slowdown in terms of any kind of key positions at the executive level but you will see IT investments because we don't have a lot of the robust systems yet for the level of growth that we see coming in the complexity of the business.

And so those will be the major investments.

Okay, great.

Thank you.

John Morris, Bank of Montreal.

My congratulations as well.

Let me get a quick clarification out of the way for John and then a question.

Gross margin earlier you were talking about Q4 and I think you talked about it being up relative to Q3.

On a year-over-year basis, would you also anticipate as a clarification that it would be up year-over-year?

Yes, sorry.

Let me clarify.

Up slightly over last year.

I mean we are getting into a precision that is on the guidance that I want to give.

That's fine.

Margin for Q3 was 100 basis points or so higher than last year.

We will be in that range for Q4.

Okay, that's good.

And then, Christine, in terms of the nice growth that we are seeing in terms of new stores and the plan looking out into next year, can you tell us regionally, geographically, where we might see the store openings next year?

As you know, we have got approximately 48 show rooms out there right now and what we really do is watch them and we have got a very strong pipeline for next year for I think the majority -- is it about 50% or over 60% of the deals are in the pipeline.

But we actually wait and vet them until the strongest of the showrooms, we then execute.

But you will see about half of them will be from those new showrooms and about half will be infill in existing markets.

So kind of continuing with a strategy that you have seen us execute this year.

Okay.

And the Aviva stores, where are those opening?

We are -- I believe it is Edmonton and Toronto.

Okay, good.

And then finally, John, just quick thoughts about your inventory plans, inventory growth plans for Q4.

Where would we expect to see inventory finish out on a per square foot basis?

And as I said on the last call coming in to Q3, we were comfortable with our inventory level to forward sales.

I'd say the same thing about coming into Q4.

This kind of relationship between inventory and forward sales we would like to continue.

Of course it depends on whether we outperform we could end up somewhat short but we are pretty happy with the inventory position coming into this quarter.

That's great.

The stores look great, guys.

Thank you very much.

Erika Maschmeyer, Robert W.

Baird.

Thanks and congratulations.

On the gross margin front, could you provide a bit more detail around the mix shift to your higher-margin core products?

Was that a conscious decision or I guess where you saw the greatest strengths?

And then outerwear shipping partially in Q4, kind of talk a little bit about your reasons for that and then also your performance for outerwear?

And I know you don't normally talk about weather but was there any impact from the weather there during the quarter?

Thanks.

Yes, the mix shift I wouldn't say it was deliberate but we like it.

Not just because it was a shift towards our highest margin products but it was a shift towards our core technical product, the real foundation of the Company.

As I said earlier, I think it reflects the fact that we are attracting new guests.

The shift in outerwear again not anything dramatic or deliberate.

It is just the drop of our outerwear which is again this year for a brief period of time came a little bit later so some of it was Q3 and some of it will be Q4.

And the outerwear being a higher price point so it was a slightly lower gross margin.

You want to add to that, Sheree?

I would say that core is really where our guest is responding and just to echo what John was saying, our new guests that are adopting us particularly in the United States seem to love our core jackets and pants, like our groove pant or defined jacket and so on and so forth.

And so it is just a natural mix shift actually that is just responding to demand.

And the great news is it is a very healthy shift in the business.

Great.

And then could you talk a little bit about the new stores in showrooms that you have that are in smaller markets and secondary cities?

Are you seeing a different type of maturity curve for those markets or kind of any learnings there?

I would just maybe callout our Nashville store opening which some people would consider a more second market.

It is probably one of our record store openings for the year.

So having a showroom there, community response was fantastic.

We've just got a tremendous amount of loyalty in those smaller markets that makes the stores for us very, very productive.

Great to hear.

Thank you.

Chi Lee, Morgan Stanley.

Good morning, everybody.

John, I guess Sheree, it sounds like you guys are maintaining most of the outlook on the cost inflation front.

But are you still holding the line in terms of keeping average unit retails flat as you go into next year?

And at what point would you be willing to revisit that outlook?

Yes, we are.

We are holding our retail strategies constant.

We -- our strategy is to maintain optimal value to our guests and so that is what we are executing right now.

Got it.

And then John, can you quantify for us what the actual savings impact was in the third quarter from the new distribution center?

It was about 30 basis points in gross margin or somewhere around $600,000.

Got it.

And was that just a result of eliminating duplicative costs or was that inclusive of efficiency gains as well?

Again, we are moving from a third-party DC so we are comparing a per item per touch fee arrangement to our own operation.

We did have (technical difficulty) last quarter some overrun costs.

We had duplicate cost.

So yes, those actually ended in the last quarter, so this quarter would have been straight savings.

Straight savings, great.

And then my last question just on the Australia stores, how are you guys now thinking about the productivity curve of the Australia stores?

Can we start to see them narrow onto what we are seeing in the US currently?

It is typically about -- because it is earlier stage market growth story, they are very much following about the same curve as we saw in the US market and we've really focused this last year on addressing the counter seasonal issue, improving their kind of seasonal color and assortment and weight of fabric.

And that has really given them the ability to drive sales.

And once they have gotten to a certain level of sales, they have also now focused much more on their community initiatives which are also really driving that.

So it is a great market, it is a very athletic women's market and we just on a recent visit and very, very pleased with our operation there.

Perfect.

Great, thank you very much.

Paul Lejuez, Nomura.

Please check your mute button.

We will move to the next question.

Our next question is from Taposh Bari, Jefferies.

Good morning.

Just a question on your international expansion strategy.

Maybe if you can share your thoughts on -- it is probably a little preliminary, but what your preferred method of distribution would be whether it be something similar to what you are doing here in North America and Australia in terms of owned, operated retail stores?

Or would you consider maybe a franchise model or even possibly a wholesale method of distribution?

Thanks.

Definitely rule out wholesale.

I think that each market has particular circumstances where you would use a different model and our preference would be to be at least in a majority ownership, operator role in key markets and then there are other markets where I would prefer to have a licensed relationship with the right partner.

And that is the due diligence that we're working on now in terms of prioritizing markets, looking at the underlying business model.

But you know, we haven't made the decision to go yet.

That is a decision that our Board will make after we give them our roadmap and strategy.

And the reality is we still have tremendous growth in the US to focus on and that delivers the most short-term value to the shareholders.

So we want to make sure that we protect and execute that in our e-commerce strategy first before we get distracted by the complexity of managing international.

Then just a follow-up on the running piece of the business, I don't know if you already mentioned this and if you did I apologize but can you just remind us what running was as a percentage of the total assortment in the third quarter of this year versus last?

And do you see that changing going forward as we head into 2011?

Hi, this is Sheree.

Last year was when we rolled out run to all stores and so we have been maintaining it at about 20% and the guests are responding in a very healthy way.

Right now we are happy with that mix because yoga is still the core of our business and at any rate, we are going to hold steady for the time being.

Thanks.

Paul Lejuez, Nomura.

So this is Tracy Kogan filling in for Paul.

I had two questions.

The first is just looking at your fourth quarter guidance, it seems like you are looking for a spread of 15 points between total sales growth and comp growth.

And I am wondering what the driver is behind that being so much lower than the 27 point spread in 3Q.

And then my second question is just wondering how sales trended through the quarter and maybe if you could quantify the Oprah impact?

Thanks.

On your first question and again, I haven't done the math to check my answer but of course, e-commerce is a growing impact on the non-store part of our sales increase.

Australia is now in there where it was not last year.

Those are the big things that would be my answer without having a chance to think more about your question.

I guess I am just thinking why would it be lower than the spread and so much lower than the spread in 3Q unless maybe the growth in either of those categories was expected to be lower maybe?

I am not -- I am not sure on (multiple speakers).

Okay.

I will follow up.

(multiple speakers) sales trend through the quarter and Oprah?

Very little Oprah direct.

The huge hit you saw, a little bit of a bump in our e-commerce channel during that week but we already had a pretty strong ramp.

So I think it was hard to track the individual, we certainly did sell more of the relaxed fit pants during that week but we also saw sales of all pants go up so I think it had a halo effect.

But we also then had an equally strong week the next week so I think it is just part of the overall holiday ramp.

We of course only knew a few weeks in advance that we would be selected so we weren't able to certainly bring in any big product.

And she typically doesn't like it if you promote off of that which we didn't do and really honored the relationship we have with her which is important.

So it was nice but there reality was it was a very smooth growing sales ramp.

So healthy across the whole quarter.

And in terms of comparison to last year, we were expecting month-to-month within the quarter to be -- we were lapping more challenging comps because last year Q3, the sales ramped up each quarter.

What we found in the end though was that our comp was fairly level throughout the quarter.

Great.

Thanks a lot of good luck.

Howard Tubin, RBC Capital Markets.

Thanks.

Maybe just a question on men's.

What percentage is the men's business now and are you happy with the penetration or is there opportunity to increase men into the brand?

Hi, this is Sheree.

Men's is about between 10% and 12% of the business.

Men's is ramping at a slightly higher rate than women's currently.

But it is on a much lower base and some of that is due to our Canadian guests adopting at a more rapid rate than they have in the past.

The mix, particularly the technical mix in men's has improved considerably and will continue to improve going forward and we will base our judgment on our performance going forward.

I would have to say though that men's is -- although there is opportunity, we are primarily a retailer to women at this point in time and we can look at other opportunities for the future for that gender.

Okay, thanks.

Richard Jaffe, Stifel Nicolaus.

Thanks very much.

And just some follow-on to the e-commerce business and the rapid growth, if you could talk about some of the logistics behind it, inventory management, are you working with a single pool of inventory or is it with distribution centers in Canada and the US?

And the product offerings, do they duplicate what is in stores or is there an opportunity to test and have new product online in small quantities?

How do you see the Internet business developing for you?

Maybe I can start with the logistics question.

Currently we are with pretty much fully out serviced model although we do keep the inventory and do our own distribution out of our Canadian DC for the Canadian market.

In the US, it is a separate inventory held in a third-party DC.

So as a result, more so in Q2 than Q3 you saw stock outs online because we really couldn't shift inventory between channels very easily.

That will be addressed as we shift to more of an in-house e-commerce model, which as Christine mentioned, we will be doing in Q1 of next year.

So the inventory for e-commerce although we will buy for it separately, it will be held within the same DC as our inventory for store fulfillment so transfer between channels will become easier.

Regarding the product on the site, it is all of the core product and it does receive all of the seasonal (inaudible) as well.

The buys are separate so it goes through it at a different rate than we see in the stores.

There is a small -- and as you are leaning a mix shift a little bit more, core product on that channel than we see in the overall stores which we feel very good about.

We do do some occasionally some special things on the e-commerce site for that guest.

We did a unique hoodie for them that went really well and then we do carry some seasonal shoulder items a little bit longer available on those after we pull them out of the stores, some of the outerwear garments would be an example of that.

So there's minor differences but from time to time but the reality is it is probably about 98% of the core stock.

Great, thank you.

Laura Champine, Cowen and Company.

Good morning.

You mentioned that your e-commerce business is a focus for your new CIO.

What rate of revenues does that business need to achieve to be as profitable as your store channel?

It is already there.

So it is a very -- as we said I think earlier in my comments, a very strong contributor to gross margin and operating margin for the business.

And then, John, you mentioned that your two-year comp kept accelerating in the quarter.

Obviously you just beat guidance and gave revenue guidance for Q4 that was ahead of our expectations.

Anything more specific you can give us on what is driving that very strong -- I mean you are looking at a 40% two-year comp.

I don't have any other companies doing that.

So what are the key drivers there?

I think it is really goes beyond what is happening in the macroeconomy.

I think it is driven by more and more guests discovering the brand.

It is driven by great product that keeps getting better and it is very difficult to predict.

I think that the number one thing I would say is it is a great product but it is also the great guest experience that happens in our stores.

The community outreach that our managers do, our educators, they are so involved and I think if you go into our stores you really experience a different experience as a guest and very friendly, happy, animated, educators teaching you about the product and creating a great guest experience.

And people are looking for that.

And I think that is another big part of what is driving our business.

Great, thank you.

Jennifer Black, Jennifer Black and Associates.

Good morning.

Let me add my congratulations.

I have a few questions.

I wondered if you could talk about the incredible Silverescent line.

What kind of a start has it gotten off to?

Are you keeping the line tight or will you be expanding it to different silhouettes?

And I wondered what kind of price elasticity you have since it is higher priced?

That is my first question.

Sheree's favorite topic.

So I am going to let her talk about that.

We don't have enough time to talk about it as much as I would love to.

But anyway, Silverescent is a fantastic fabric for us.

The guest really understands the value of it and we are developing extensions of that line, some of which you're seeing in the store right now.

So if you go over to our Lincoln Square store in the front on the left, you can see we have a new Silver Luon, jacket, pants, tank tops etc., which are unbelievable performance garments.

And so we definitely see the possibilities there, Silver Luon and other extensions to follow which we will be able to announce in the future.

But the price elasticity there depending on what fabric it is, it obviously carries a premium and -- because it's a very special yarn.

It is yarn that is produced by a manufacturer that does hospital grade items and so it is of the very highest quality which is why it is so difficult to find.

I think we are the only people that actually carry this yarn.

Wow.

Okay.

It is a fantastic line.

And then I wondered if you could just speak to your limited edition product and special edition product.

Are you happy with that?

Will you be doing more of that throughout the year?

Just any comments?

Sure.

Every year at this time we do special edition product.

Our guests absolutely look forward to it and it also carries a premium in price because there is very special design that goes into it and it is a very, very successful part of our line.

Will you be doing more throughout the year or is it just going to be holiday?

We will in our hoodies for sure and there's other core items that we are going to be doing special edition on.

One of them was in the store if you could have gotten it in time which would have been -- we have a cool Razorback tank with ruffles on the back which has been superb and really a defined jacket with ruffles and one of our other jackets also which has been unbelievable.

And have pretty much sold out.

Fantastic.

I think that is it for my questions.

Good luck.

Thank you so much.

Thank you.

Ladies and gentlemen, we have no further time for questions.

I would like to turn the call over to management for any closing remarks.

I just want to thank everyone for joining us today and again just thank everyone who contributed to our success for the quarter and wish you all a happy holiday season.

Thank you.

Happy holidays.

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

This concludes the program.

You may now disconnect and have a wonderful day.