Lululemon Athletica Inc (LULU) 2011 Q2 法說會逐字稿

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

Welcome to the lululemon athletica second-quarter 2011 results conference call.

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 may be recorded.

I would now like to introduce our host for today, Mr.

Joe Teklits, with ICR.

Sir, please go ahead.

Okay, good morning.

Thanks for joining us today for lululemon's second-quarter 2011 results conference call.

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 and available on the Commission's website at www.SEC.gov.

Also available in the investor relations section of the Company's website will be a recording of today's call, which will be available for 30 days as a replay shortly after we end.

Hosting the call today is Christine Day, the Company's CEO and John Currie, the Company's CFO.

We would like to remind everyone, of course, that 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 results might differ materially from those 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.

And with that we will turn the call over to Christine Day.

Thank you, Joe.

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

With me today is John Currie our CFO.

Following my opening remarks, I will turn the call over to John to review the financial details for the quarter and outlook for the third quarter and full year.

Our business remained very healthy through the second quarter, and in the first half of 2011 we have achieved milestones for our Company in sales productivity and operating margin while growing pretax income by more than 60%.

Importantly, our success continues to be based on running a healthy, brand-focused business that consistently delivers product quality and innovation along with a great guest experience -- attributes that we are passionate about, that have enabled us to build a brand recognition and win the loyalty of our existing customers.

So not only are we growing nicely, including revenue growth of almost 40% in the second quarter, we also continue to invest in a strong foundation for building long-term success.

And we believe that we are well positioned to continue our growth initiatives despite any potential recessionary retail environment and product inflation headwinds.

Adding to a major initiative earlier this year, which was transitioning our e-commerce platform in-house, we also continued to advance on a number of fronts.

First, we took the next step with ivivva, with the launch of our new ivivva e-commerce site in Canada, with the US to follow late fall.

ivivva is all about dance, movement, and fun; and we are excited to bring this to life for Canadian girls nationwide with our new online store that captures the vibrant colors and technical features of the product assortment as well as other cool features on the new site.

Also for ivivva, we are developing a new line in partnership with Disney Consumer Products for Spring 2012, providing girls with dance-inspired athletic wear that fits their active lifestyles and ties back to the Disney Channel dance comedy series Shake It Up.

Next, we are rolling out Australian stores at a more rapid pace this year than originally planned -- now, seven stores versus an original plan of two.

We are very confident in our ability to continue to grow the Australian business given the strong guest response to the brand and business results and the great team that we have in place there.

We also continue to make new hires and investments and to spend on building our infrastructure for e-commerce, international, and other expansion plans in order to prepare for the future.

Beginning next year you will see us add additional country sites to our e-commerce, along with other grassroots strategies to seed the markets, while remaining focused on the large opportunity we continue to have in the US.

Another major initiative for us has been improving our inventory flow.

We have achieved one of our objectives, which is to be inventoried in our core and key items.

Our inventory position on new and seasonal items is still a little lighter than we would like it to be for Q3, and we will continue to build levels in those categories throughout the quarter.

Our focus going forward will be on-time deliveries and the flow of new styles for the optimal mix of color, seasonal items, and innovation.

This matches our new product initiatives, which are focused on technical product, new fabrications, as well as new features within our basics such as a new seaming technology.

Better flow of this merchandise is an opportunity for us in the remainder of 2011 and 2012, especially in Canada where our customer gravitates towards anything new that we introduce.

Looking at the second half of the year, we believe we can grow pretax income by close to 30% on top of strong growth a year ago, despite product cost pressures.

We have worked hard to develop a winning formula.

We are going to stick with it and continue to make it even more potent as we develop new areas for growth.

As we said on our last call, we are confident that we are strategically positioned to manage through the current economic environment.

We see many opportunities ahead, and we are in a position to pursue them in a sensible way.

We strive to balance the expansion of our brand with the integrity of our brand, with the end result being long-term shareholder value creation.

Now over to John.

Thanks, Christine.

I will begin by reviewing the details of our second-quarter 2011 and then I will update you on our outlook for the third quarter and the full-year fiscal 2011.

On June 8 our shareholders approved our proposed 2-for-1 stock split, which took effect in early July.

So please keep in mind that all comments with regard to share count and per-share amounts in our results and outlook are now on a post-stock split basis.

The second-quarter total net revenue rose 39.5% to $212.3 million from $152.2 million in the second quarter of 2010.

The increase in revenue was driven by comparable store sales growth of 20% on a constant dollar basis; the addition of 18 net new corporate-owned stores in North America and three stores in Australia since Q2 of 2010; direct-to-consumer sales, which increased by $8.9 million, driven by increased traffic and conversion; and a stronger Canadian and Australian dollar, which had the effect of increasing reported revenues by $8.3 million or 4.1%.

During the quarter we opened eight corporate-owned lululemon stores in the US and one in Australia.

We ended the quarter with 151 total stores versus 130 a year ago, 147 of which are corporate-owned and four franchise stores, all in the US.

There are now 117 stores in our comp base -- 40 of those in Canada, 68 in the United States, and nine in Australia.

Corporate-owned stores represented 83.9% of total revenue or $178.2 million, versus 85.1% or $129.4 million in the second quarter of last year.

Revenues from our direct-to-consumer channel totaled $18.6 million or 8.8% of total revenue, versus $9.6 million or 6.3% of total revenue in the second quarter of last year.

Other revenue, which includes franchise, wholesale, showrooms, and outlets, totaled $15.5 million or 7.3% of revenue for the second quarter, versus $13.1 million or 8.6% of revenue in the second quarter last year.

Gross profit for the second quarter was $122.1 million or 57.5% of net revenue, compared to $80.3 million or 52.8% of net revenue in Q2 2010.

The factors which contributed to this 470 basis point increase in gross margin were as follows.

Product margin improvement of 210 basis points.

Higher product cost due to inflationary pressures from raw material and labor, along with higher airfreight to accelerate product deliveries, were more than offset by fewer markdowns and discounts associated with strong product sellthrough and improvements in duty rates and other input costs.

Leverage on non-merchandise costs such as occupancy, depreciation, and product and supply chain team costs, including efficiencies from our new US distribution center, contributed 160 basis points of improvement.

And foreign exchange improvement of 100 basis points due to stronger Canadian and Australian dollars.

SG&A expenses were $62.6 million or 29.5% of net revenue, compared with $46.1 million or 30.3% of net revenue for the same period last year.

The 35.9% SG&A dollar increase is due to an increase in store compensation and operating expenses associated with new stores and showrooms and growth at existing locations; an increase in head office employee costs, including management incentive-based compensation, stock-based compensation, and other head office costs as a result of the investment in people and systems needed for long-term growth; and finally the higher Canadian and Australian dollars, which increased SG&A by $2.5 million or 4.1%.

These increases were partially offset by cost efficiencies gained as a result of transitioning our e-commerce platform to our in-house model.

As a percent of revenue, our second-quarter SG&A decreased by 80 basis points, due mainly to the e-commerce operating cost improvement following this transition.

As a result, operating income for the second quarter was $59.5 million or 28% of net revenue, compared with $34.2 million or 22.5% of net revenue in 2010.

Other income including net interest expense totaled $0.6 million compared to $2.1 million in the second quarter of 2010.

The decrease was primarily a result of an accounting gain recorded in fiscal 2010 relating to our acquisition of a controlling interest in the Australia business during the 2010 quarter.

Tax expense for the quarter was $21.5 million or a tax rate of 35.7% compared to $14.6 million or a tax rate of 40.3% in the second quarter of 2010.

Net income for the quarter was $38.4 million or $0.26 per diluted share.

This compares with net income of $21.8 million or $0.15 per diluted share for the second quarter of 2010.

Our weighted average diluted shares outstanding for the quarter were 145.2 million versus 143.5 million a year ago, which has been adjusted for the 2-for-1 stock split.

Capital expenditures were $12.5 million in the second quarter, relating to new store buildouts, existing store renovations, and IT capital expenditures.

We ended the quarter with $264.7 million in cash and cash equivalents.

With respect to our inventory position, as Christine mentioned throughout the second quarter we continued to improve our product flow and in-stock position.

Inventory at the end of the second quarter was $88.9 million or 34% higher than at the end of the second quarter of 2010.

Having said that, a portion of this inventory increase comes from higher product costs as opposed to higher quantities on hand; so the actual units available for sale coming into the third quarter are up by a lesser amount over the prior year.

Our inventory quantities have and will continue to improve with stronger inventory inflow as the third quarter progresses.

This now leads me to our outlook for the third quarter of 2011.

This assumes a Canadian dollar at par with the US dollar, compared with an average exchange rate of $0.97 in Q3 of 2010.

We anticipate revenue in the range of $225 million to $230 million.

This is based on comparable store sales percentage increase in the low to mid teens on a constant dollar basis compared to the third quarter of 2010.

We plan to open 11 lululemon stores in the US and three in Australia during the third quarter.

On September 2 we closed on the acquisition of the three Colorado franchise stores; so going forward these stores will be accounted for as corporate stores.

We expect slight gross margin compression versus the third quarter of 2010, driven by higher product costs from sourcing pressures in both labor and raw materials as we have previously discussed.

We made the strategic decision not to pass on higher product costs to the guests through higher pricing.

Sequentially from Q2 2011 we expect gross margin to decline as we seasonally move towards our Fall merchandise, which carries a lower merchandise margin, along with the return to more normalized markdown levels associated with more sufficient inventory levels.

During the third quarter we expect to continue to see cost efficiencies as a result of the transition of our e-commerce platform to an in-house model; but at the same time we will be increasing our reinvestment back into the e-commerce business to develop the necessary foundation to achieve the potential growth trajectory of this channel.

Our SG&A will also reflect higher store-level compensation designed to attract and retain the best staff; preopening costs related to the 14 stores planned to open in Q3 and additional stores planned to open in early Q4; and additional resources at our head office to continue to drive longer-term scalability and growth.

As a result, we expect SG&A as a percentage of revenue to slightly deleverage against the third quarter 2010.

Assuming a tax rate of 36% and 145.5 million diluted average shares outstanding, we expect earnings per share in the third quarter to be in the range of $0.22 to $0.24.

For the full fiscal-year 2011 we anticipate we will open a total of up to 35 corporate-owned stores, including Australia and ivivva locations.

As Christine mentioned, the increase over our previous target of 30 stores for this year comes from five additional openings planned for Australia as a result of the strong momentum of the business there.

We expect net revenue to be in the range of $930 million to $950 million for the fiscal year, representing revenue growth of approximately 30% over 2010.

For the year we expect gross margin to increase slightly from fiscal-year 2010, due mainly to leverage gained in the first half of 2011.

As we have discussed on previous earnings calls, sourcing pressures are expected to be greater in the second half compared to the first half of 2011 and we expect will account for approximately 225 to 250 basis points of gross margin compression relative to the back half of 2010.

We also expect to see more normalized markdowns with inventory levels at more appropriate levels.

This will be offset by leverage on fixed costs such as occupancy and depreciation, more so in Q4 than in Q3 due to seasonality of sales volumes.

Keep in mind also, when we transition into Fall and Winter there is a seasonal mix shift in our product assortment that will result in lower merchandise margins compared to the first half of 2011.

Adding this all up, we expect our second-half gross margin to be in line with our historical targets in the low to mid 50%s range.

We do expect, however, to enjoy leverage on overall SG&A as we gain cost efficiencies from the transition of our e-commerce platform to our in-house model and leverage on our SSC costs in place, offset by higher store compensation designed to attract and retain the best staff and investments to continue to drive longer-term scalability and growth.

So as a result, overall we expect our operating margin to leverage slightly over 2010.

We expect 2011 fiscal-year earnings per share to be approximately $1.10 to $1.14, up from our previous guidance of $1.05 to $1.08 on a split-adjusted basis.

This reflects the beat of $0.04 in Q2 and an additional $0.02 from improved operate -- expectations for the second half of the year.

This is based on 145.4 million diluted weighted average shares outstanding, and it assumes an effective tax rate of 36%.

We expect capital expenditures to be between $113 million and $108 million for fiscal 2011, reflecting the purchase of our Store Support Centre of $65.1 million plus closing costs in the first quarter, as well as new store buildouts, renovation capital for existing stores, IT, and other head office CapEx.

With that, I will turn it back to Christine.

Thank you, John.

As always I would like to thank all of our educators and managers for making these results possible, as well as a big shout-out to our e-commerce team for all of the work they did with the transition.

And how happy we are with the transition with the e-commerce launch and excited about some of the initiatives that we have happening for Q3.

So with that we will open it up for questions.

(Operator Instructions) Michelle Tan, Goldman Sachs.

Can you guys hear me?

So Christine, I was wondering.

You mentioned some of the new innovations that you have rolled out, some of the lighter weight seaming and things like that.

I was wondering if you could just give us a little more color on the kind of things you have added in over the last couple of months and what the response has been.

And then just an update on what you are seeing out of some of the newer markets that you have opened up in the US over the last six months.

Thanks.

Great.

Maybe I will start with the third one.

In the US the business has just been phenomenal.

The new markets that we are opening in, including and particularly the Midwest area, the guest has just been phenomenally responsive.

So we are very happy with the productivity of our new stores and just in general very happy coast-to-coast with where the US business is and the growth that we are seeing there.

In terms of new product innovation, first, we are just happy to have really great product in the stores.

I think us and our guests are very relieved to see the level of product that we have.

In the men's business right now particularly we have got some great product in, in the outerwear, that we are very excited about.

It is the best men's presentation we have had all year.

With that, I may turn it over to Sheree to talk about some of the other new products such as we had the bike pod and some other things in the quarter.

Great.

As Christine just mentioned we had a cycling capsule that did very well, and we continue to leverage our learnings from these capsules and put those into both our yoga and our run technologies.

On the technical front we have more no-sew technology than we have ever had before, which is laser cutting and gluing, laser cut venting, and mesh technology, along with more seamless technology and something that we are calling Light As Air, which is ultralight jackets, ultralight run skirts, and ultralight run tops.

So those have all been really very well received.

The only issue is more of those items.

That's right.

Great.

Thanks.

Then John, can you put any color around the comment on the Midwest?

just in terms of level of initial volumes relative to the US, or some kind of metric so we can understand the performance there.

As I said last quarter we are opening new stores.

It is hard to extrapolate when a store has only been open for a few weeks.

But we are opening stores in the US in the Midwest in the $1,000 to $1,100 or higher per square foot trajectory.

The US average is now up well over $1,300 a foot, so it is as you would expect; it is 75%, 80% of the more mature US store base, which is a great place to start and will contribute to high comps going forward.

Great, thanks so much.

Good luck, guys.

Janet Kloppenburg, JJK Research.

Good morning, everyone; congratulations.

I did have a couple of questions.

It seemed to me that the merchandise margin improvement in the second quarter was higher or greater than it was in the first quarter.

I was wondering if you could talk a little bit about what drove that even though you had airfreight and I think your product cost pressure was greater in the second quarter than it was in the first quarter.

So I would like to learn a little bit more about that.

Also on the new product that is coming in, I am wondering about the cycling category and if that will be developed into a full-scale business category as we move forward for both men and women.

I was also wondering, Christine, if you could talk about the success of the Hong Kong showroom and if that could lead to some other international showroom development this year.

Thank you.

Okay, so maybe I will start on the gross margin question.

Actually the inflationary pressure on our gross margin was similar in Q2 to what it was in Q1.

Q2 I think the pleasant result -- better than what we had expected -- was we continued to see very little if any markdowns.

And that made a huge contribution to the product margin in Q2.

In addition -- I mean there's a number of smaller items.

We have been working on the efficiency of our duties.

There is efficiencies through shifting to other countries; and the way we characterize our buys from our suppliers we can reduce duties.

And that is starting to benefit our gross margin.

That is something that could continue to benefit the gross margin, John, and help to offset some cost pressures?

Yes, for the most part that should continue.

Okay, thank you.

Sheree, on the cycling?

I have to say we love cycling.

We absolutely do.

There is -- because of the fact that it is a multipronged type of business.

It is commuting; it is road biking; it is spin.

It is all of that, and the capsules have been successful.

We have a strategy to leverage e-commerce for this as well so that we can show our cycling capsules for a longer period of time.

Right now, for the next couple of quarters we are just going to be leveraging the capsule strategy that we have, which is infusing our current assortment with drops quarterly or twice quarterly.

And stay tuned.

Okay.

Thanks.

And Christine, on Hong Kong?

On Hong Kong, we did move the showroom because we moved our office to a bigger location.

So we are no longer on the 14th floor of a dental building.

We are in a main office area, which did take it a little bit out of the retail traffic area; so we are looking at that from -- to put a second one in that is maybe closer back to the business trade area.

That said, we want to make sure that we are really ready from a systems and an operating perspective to support the volume that we know that would do.

So our constraint isn't market opportunity; it is just making sure we don't do things that distract from building the operating capability.

Kathryn Henry, our new CIO, is working very hard to deliver a tremendous amount of capability in our supply chain and operating systems.

And we don't want to distract from that effort by adding too early things that would not allow us to be as successful.

So this will be it for international showrooms this year?

This year.

Okay.

What about product costing?

Sheree, we are hearing that cotton has come down quite substantially for the first half of next year.

I am wondering what you are seeing and how much that could benefit your sourcing cost next year.

Thanks.

Sure.

Cotton is coming down; but as I mentioned in the last call, we are not a cotton house.

We are a technical house.

So the benefits of that might be seen more elsewhere than at lululemon.

But we are obviously seeing those benefits.

But additionally we continue to invest in technology.

So one thing that you will see is more innovation in terms of our run line, our cycling line, and so on and so forth.

So you will see some of that gain offset by additional investment in technical product.

Well, has there been any relief on the technical fabric costs that you have been investing in?

Some.

Some.

Okay, great.

Thanks a lot and lots of luck.

You bet.

Lorraine Hutchinson, Bank of America, Merrill Lynch.

Hey guys this is Paul Alexander for Lorraine.

Could you guys give us a little bit more color around the third-quarter comp guidance?

It is a deceleration from the first half, and I think that makes sense given the difficult comparisons.

But what else goes into that?

What else are you contemplating?

Are you seeing anything in the macro environment or in the competitive environment?

And then can you remind us what the inventory position was like last third quarter, fourth quarter?

Were you overly lean back then as well?

Okay.

Going into the comp guidance, a number of things.

First of all, the stronger performance last Q3 that we are lapping, and that is the same for Q4.

In terms of our inventory position, as we mentioned maybe a little bit lighter than we would like to have been at the start of the quarter; but it's definitely improving through this quarter and through the rest of the year.

As always our guidance, our outlook, is influenced by what is going on in the macro economy.

We all read the headlines.

Having said that, we are not saying that we are seeing that in our business; but we are just being cautious of what is going on in the world.

From a competitive point of view, as always we are watching the competition.

We are aware of them.

We are not seeing any measurable impact from new competition.

Great.

Did you see anything in your business in early August with the heightened market volatility?

No, what we saw in early August was light inventory coming into the quarter.

And when inventory came in, our sales reflected that fact.

Great, thanks guys.

Dana Telsey, Telsey Advisory Group.

Good morning, everyone, and congratulations.

Can you talk a little bit about speed to market, what you are seeing there, what further opportunities there are, and how it may help gross margin and inventory?

And you mentioned ivivva.

Any update there, whether it is cost and what you're seeing.

And just lastly soft -- the operating margins by stores and direct showing terrific improvement.

Where do you see the opportunity go-forward?

Thank you.

Maybe I will start with the ivivva question.

Where we have reached some scale in that business has really helped the operating margin of the business.

And we have built out a team to successfully drive that business.

So especially with going online we are now exceeding the minimum.

So our general manager of that business, Bree, has done a fantastic job building just a brand strategy that has really resonated with the guests; really firmed up the product line.

So we are very excited about where we are with that concept and the opportunities.

So feel very positive about the business model, the brand model, and how the guest is responding to that.

So we are looking forward to expanding that concept.

So your next question, Dana, was on --?

Speed to market.

Initiatives.

Speed to market.

Yes; it is definitely out -- if you look at our strategic plan it is probably opportunity number one and number two and number three and number four.

Working on flow and being really good at flowing our business.

As you know we have less inventory risk in carrying product because we are not a fashion house.

That said, it still has some long lead time, especially with the new technologies that we are developing.

So what we are focused on is putting teams together that are planning and developing that much farther in advance, so that is smoothes out our ability to deliver that on time and have technical innovation.

So when we say more seasonal items, for us they are really technical innovations and designs.

It is not about fashion.

It is about the ability to deliver those complex items on time and quickly.

We are very excited about not only the systems that we have been putting in place, the teams that we have been putting in place to do this, and I think you will see us really make great strides in that in the balance of this year and into next year, being able to deliver a constant flow of new technical items to the market very quickly.

Your question on operating margins, as you say we are showing improvement both in stores and direct.

With the comp store sales increases, and even new stores with pretty good leases we are signing, we are getting good leverage on occupancy and depreciation.

So that is what is driving that.

In particular we have worked hard over the past couple of years to put caps in on our percentage rents.

So there is a lot of stores now that we are hitting that cap, and therefore the leverage on higher volumes drops to the operating margin.

On the direct side, I think what you saw this quarter with being the first quarter on our own platform, you are seeing the kind of flow-through that we can achieve in that business, which of course excites me -- until Chris Ladd says that he actually has to spend some money to achieve the tremendous growth I think we can see in revenue in that channel.

So you will probably see over the next few quarters, as I mentioned, some investment to continue to improve the website.

And then even into next year as we add country-specific sites for other countries there will be an investment that will moderate the operating margin in that channel.

But as you can see, it is very strong.

Thank you and congratulations.

Taposh Bari, Jefferies & Co.

Hey guys, good morning.

I had a question.

I guess I just wanted to follow up on inventories.

Can you just I guess clarify for us what the difference is between, I guess, some of the constraints that you are seeing or you saw in the second quarter of this year versus the first quarter?

I guess the basis of my question, just going back to I guess it was April in your fourth-quarter call, my sense is that your inventory issues would have been resolved by the third quarter.

So has anything changed between then and now?

I guess just finalizing the question, at what point do you expect your inventories to be fully balanced with the strong level of demand that you guys are seeing?

I think where we were in Q2 was getting back in-stock to meet a sales plan level that basically in our core and what we would call key items, which are like mainly your colored tanks and your colored core; and then we were still chasing a little bit into Q3 some of the more seasonal and some of the technical new -- getting that in enough volume to support the growth opportunity.

So that is probably where the timing in the beginning of Q3, we were still a little lighter than we wanted to be.

We feel very good by the end of Q3, which we are hitting right now, that we are there.

So we feel for Q4 we will be in a very good inventory position not only in volume but in mix.

And then you will see that really be in a good position for Q1.

We don't want a repeat of last year; so we feel very good that we are in a good position for Q4 and Q1.

Okay, that's helpful.

So is there a way to quantify?

I know it is tough.

Is there a way to help us quantify what the impact was from the inventory issues in the second quarter versus what you saw in the first quarter?

Were they comparable, or was the magnitude lower in the second quarter versus the first?

I think it was a little -- it was lower than Q1.

It was lower.

In Q1 as you recall it was very distinct, because it was -- as I said back then, we started Q1 at a 20% comp; when we ran low it dropped to low double digits.

It wasn't so defined in Q2.

So we were better.

It was a bit lumpy though.

Do you have some kind of outlook you can provide us with where you expect inventories to be either at the end of 3Q or at the end of 4Q?

I would rather not because it is a point in time, and that means we have to be precise on the timing of the flow.

We have got lots of inventory coming in, adequate to meet our targets for Q3 and Q4.

But I don't want to pin to a number.

That's fair.

I just wanted to follow up with a second question on just geographic performance.

So I think it is interesting that you guys are seeing Australia outperform, considering that the retail environment there has been really challenging.

A lot of other companies, US-based, that are operating there are seeing weakness in Australia.

So can you just maybe talk about Canada, Australia, and the US and how those geographies are performing for you?

Sure.

Canada as you know, we have been here for 11 years now.

Tremendous productivity.

A lot of other retailers are calling out Canada as being a problem in the first half of the year.

We are continuing to see positive comps in Canada in spite of some level of maturity here.

And our business here gets even stronger when we have that new product, that innovative product come in.

So we are solid single-digit comps in Canada.

In the US and Australia you are seeing similar levels of comp store increases each year.

It is somewhat masked by the overall; but both the US and Australia are comping well into the 30%s.

So if you just isolate those two countries, that is tremendous growth in a tough environment, as you say.

And yes, we continue to see that in spite of the macro environment.

Okay, thanks a lot.

Best of luck.

Paul Lejuez, Nomura Securities.

Hey, thanks guys.

Two questions.

One, just wondering -- and sorry if these were asked and I missed it.

But if there has been any impact from the Athleta stores opening nearby to your stores?

Then second, John, I am just wondering at what point you would actually pass through higher costs to customers -- higher sourcing costs, that is.

Thanks.

Well, on the Athleta question I keep asking the same question, whether it is Athleta or other competitors.

And the answer is consistently there is no measurable impact.

So yes, that is what we are seeing there.

Sorry, what was your second question?

At what point would you pass through some of the higher costs that you are seeing to customers?

How high would it have to get?

I think we are comfortable with the current level of anticipated costs.

We have enough efficiency in the system and leverage that we feel that the best value for the long-term brand is to stay kind of put.

That said, what we look at is, as we design a more technical garment, that we do take the pricing on those.

So I think you will see the pricing expand in the new garments with where we have that technical value that's demonstrated for the guests.

And then keeping some of the core and basic at the current level of pricing, unless we do a specialty item for the season.

So for instance a specialty hoodie or defined jacket or something that has something unique in it.

But keeping the basics priced well, and then taking pricing in the new technical garments, and probably ending up with a more blended approach.

Got you.

Thanks guys.

Best of luck.

Sharon Zackfia, William Blair.

Hi, good morning.

Just a quick question on direct-to-consumer.

I think on the last conference call you had indicated you were hoping that would be about 10% of sales for the full year.

I just wanted to see how you were tracking towards that goal, if that's something you think is beatable when all is said and done this year?

Because of the transition, as you recall, it was something lower; I think it was about 7.4% in Q1, 8.8% in Q2, which was lower at the start of the quarter and ended the quarter at something close to that 10% level.

So with us being a little bit behind that 10% target, we still feel that we will be very close to that for the year; but not likely to be above that for this fiscal year.

Then on the ivivva-Disney partnership, could you explain that a little bit more?

Is that product only going to be sold at ivivva?

Is it going to be sold through any Disney channels?

Any kind of color on that would be good.

We won't sell it through any of the Disney channels, but we are working with them on some unique opportunities which would be either more pop-up or trunk show type things in the US to increase our presence there.

It will be sold.

So it is a select number of items that it will have a tag that will indicate them as Shake It Up items, and those will be available online and in our stores.

Okay, thank you.

Jennifer Black, Jennifer Black & Associates.

Let me add my congratulations.

You have done a great job with your jackets as far as the diversity.

It looks like there is a lot more detail in your outerwear, which I just noticed you raised your price point on the new raincoat.

I wondered if you could give a little bit more color on these categories as far as -- will you do more outerwear?

I know it has been a small percent.

And then I have a follow-up question.

Outerwear is a category that is on fire for us right now.

I guess the question that you had asked is -- are we going to be doing more outerwear?

I think we are going to be doing more variety in outerwear.

Our guest is really, really responding to not only the function but the beauty and the novelty I think of some of the offerings.

So we are looking at that.

There is also other types of outerwear that are coming up on our radar like lightweight puffies and so on and so forth that are excellent as part of the layering system for either run or apres yoga.

So, yes.

What I will say Jennifer is -- get to the store early for the Spring collection.

Well you know I am always in there anyway.

Yes we do.

Sales spike in your area.

Well, in my follow-up I actually have two follow-up questions.

You have done a great job as far as the improvements on your website.

I wondered if there were additional improvements coming.

Will you have the ability at some point -- I don't know if you have the systems -- to pull inventory from the Web or from other stores?

Will the sales associates be able to do that?

And then I have one more question.

Hey, Jennifer, it's Chris.

I think what you saw in Q2 was us really settling into the platform and really understanding how the team works with it.

I think where you are seeing us focus now -- and to give you a preview of what is coming -- yes, look for some expanded improvements heading into Holiday for the site itself.

Then I think longer-term we are looking at what are those right cross-channel opportunities specifically around inventory availability to allow our guests to find the products that they are looking for; and how can we help them?

So I think that is more of a broader-term strategy for us, but I think you will see us focus in the short term on improving the overall experience on lululemon.com; and we would be really excited to do that in the short term.

Chris, maybe you want to speak to our mobile app.

Yes.

Jennifer, I don't know if you saw.

We did launch our mobile site in the quarter, and that product is already exceeding our expectations.

We know that our guest is a pretty active mobile user.

She has her particular iPhone with her during the day, and she is actually transacting pretty regularly on it.

So we are really pleased with the progress we have made to date so far there.

Great.

And as far as being able to pull inventory?

I think that is a longer-term strategy for us than one that we are looking at right now.

I think initially just getting the right level of product availability and inventory in our DCs to serve our current e-commerce business has been our primary focus.

Then once we sharpen the pencil there and get better at that, I think you'll see us expand our strategies beyond that.

Okay, great.

Well, my last question has to do with what your strategies are for Holiday and accessories.

Will we see (technical difficulty) accessories?

Any comments about Holiday would be great.

Thank you.

This is Sheree.

We continue to add newness in our bags and we also -- our guest loves it when we have technical run accessories that go with the run technical clothes that we have.

So we are looking forward to doing more of that.

One thing that I think that we are going to capitalize on this year in addition to more variety in some of the bags and as I said the technical, is just more better outfitting than we have.

Which is a huge gift item -- is our luon outfits, tops and so on and so forth, have been great giftgiving items.

And just being really in-stock in bags, in socks, in those items is just key to the Holiday season for us.

Yes.

Great.

Okay, thanks and good luck.

Erika Maschmeyer, Robert W.

Baird.

Great, thanks so much.

Could you share your thoughts on how the UK is doing with your current distribution and thoughts around how you might expand that next year?

We have only had one strategic sales partner in the market that has gone back probably over four or five years now.

It is in the King's Road area, and has done very, very well, and continues to have, as the brand grows, tremendous demand.

We have expanded now to several other strategic wholesale accounts similar to what we do in the US, so that we have a presence there primarily for the Summer Olympics in 2012.

You will see us do some activity around that, but we are not ready to commit to opening that market until we really get our supply chain systems in place so that we can handle the complexity that we know that that takes to execute.

We are really trying not to do a lot of ancillary things that detract from our ability to really get the infrastructure right, right now.

So even though we see tremendous opportunity in those markets and great demand coming through on e-commerce, we are trying to stay disciplined and not add any more complexity to the work that the team is doing right now.

Then just to follow up on your international e-commerce, have you seen the penetration there jump now that you don't have to call customers back to confirm their credit card information?

Yes.

And happier customers.

That's definitely better.

Then in terms of -- you mentioned additional resources at the head office.

Could you just talk about where you are prioritizing the growth now and adding the most of the team, and where you just feel like you have the most pressing hires?

We are definitely working in that digital space and building out Chris's team.

We have just a tremendous opportunity on things like content and our editorial voice in the brand area, and sharing our story, which we think is really critical for us.

So a lot of the Web infrastructure; everything from that content side; certainly the e-commerce platform.

And that breaks us into Kathryn's team, the IT team, building our depth so we are able to be self-sufficient on our systems, not as dependent on outside contractors and consultants.

So Kathryn has done a very nice job of building a team since she has got here.

Then still in the design group we see so many opportunities to be innovative.

We have so many product ideas, bringing in the talent to develop those and continue to deepen our bench in the designers, which we view as a critical area.

Then as we are growing as a Company, making sure that we have enough in our plan for succession planning and that we are -- at the executive and developing the next layers is what we are really working on.

So you just see some general staffing increases at the mid-management level.

But primary areas are the digital, IT, brand, and product.

And supply chain and product.

So everywhere.

Thanks so much and best of luck.

I will tell you, we have been a little thin around here.

So I will look forward to the day that I am not actually a working member of the management team on a daily basis.

Edward Yruma, KeyBanc Capital Markets.

Hi, thanks very much for taking my question and congrats on a nice quarter.

Can you talk a little bit about sustainability of your markdowns?

I know that you benefited clearly from having some really strong demand.

But as inventory picks up and comes more aligned with your existing sales trend, do you expect markdowns to increase and pressure gross margins?

Thank you.

Yes, absolutely.

That has been the last two quarters and the end of last year, I think I have said every call that our gross margins comes through higher than even we anticipated because of the real lack of markdowns.

But the balance is, if we want a better inventory position to meet demand, by definition there will be more cleanup, more markdowns.

So that can be a couple hundred basis points of difference in the gross margin, and we do expect that.

Got you.

Thank you.

Howard Tubin, RBC Capital Markets.

Thanks.

Hey, guys, can you talk a little bit about your thoughts on new store openings?

You kind of back up to that 35 number, and as you look forward is that a number you're comfortable with?

Or could it go even higher over the next couple of years per year?

Of course we are not guiding on next year's store count yet.

But as you know with all the showrooms and all of the work we are doing to seed markets and make sure that we are prepared in every way to open new stores, we do have the ability to open more stores in this year.

To go out on a limb, I would say likely next year it will be more stores than this year.

But we are not at a point to be more specific yet.

But the capability is there to open at or above this level.

I think the only thing I would add, John, is the one thing that I think is very different for us from like 2009, when the recession hit and we cut back to preserve capital, to kind of retrench and build on solid growth.

We feel like we are not in that position at all anymore.

So one thing we want to be really clear on is we would not see ourselves slowing down the growth of new stores in a moderate recession.

It would have to be something pretty catastrophic before we would make a decision to pull new stores.

Great, thanks.

John Zolidis, Buckingham Research.

Hey, good morning.

A couple of questions.

First one, just housekeeping.

What do you estimate the foreign currency benefited the bottom line in the second quarter?

Then second small question is just on the men's.

Can you give us an update on how that is performing relative to the women's product?

Then lastly a more strategic question.

I was in one of your stores yesterday, and the product looks great and the store looks fantastic.

And clearly the US opportunity is very robust.

So I am a little bit confused as to why you are opening up a second concept, this ivivva, and pursuing growth in countries like Australia at what one could argue is a fairly early point in the growth curve for the US.

So just if you could comment on the strategic approach from the timing of those initiatives.

Thanks.

Let me just quickly deal with the currency one.

I think last year Q2 the Canadian dollar was about $0.97; it was about $1.04 this year.

It translated to somewhere in the neighborhood of $0.01 a share.

Okay.

I think just addressing Australia, maybe you are not familiar with the story there.

But Chip, prior to going public, had opened a franchise there with a partner.

Then he sold it to David Lawn at the time we went public and who is the former CEO of Rip Curl.

So David Lawn and some partners started to expand the concept there.

We bought into that last year to the 80% mark.

So David has developed a very profitable business model in Australia, and for us there is tremendous learnings there about supporting an international market.

And the learnings we also get from a high labor cost and a high occupancy cost, how the model will translate globally, has definitely been a benefit to us for future growth.

As we said in the call, our focus is North America.

But in Canada you have got a business that is 11 years old.

It is very high productivity.

We believe in a more scarcity model with stores, with very high volume per store.

We have also seen with this guest in Canada we own a tremendous amount of her active wear wardrobe.

There has been tremendous demand to create that for a younger group of girls.

What we saw happening for the brand in Canada was, as the customer got younger and younger, our target avatar is that 32-year-old and she doesn't want to wear what 11-year-olds are wearing.

So we felt strategically if we did not address product for that younger girl there would be brand erosion in the Canadian market for our core lululemon.

So we have got a very successful concept in ivivva that we believe has great legs.

But we are not in any way distracted from the North American opportunity for lululemon, which is why we are not -- even though we see tremendous global opportunity right now -- pursuing that and staying focused on building the infrastructure to support the North American, particularly the US expansion.

Thanks for that answer.

Could you comment on the sales productivity and returns in the ivivva stores in Australia relative to the US?

Australia I would say is running sort of a year or two behind the US in terms of the brand recognition.

So we are seeing about $1,000 a square foot at Australia and a very high comp in the 30%s.

Ivivva is still pretty young and it's $700 to $800 a square foot at this point, but again comping very well.

Thanks very much.

Good luck.

Stacy Pak, Barclays Capital.

Hi, a couple things.

I guess, one, can you specifically comment on the comp in Canada?

I just want to confirm you did not see a slowdown from -- I heard what you said.

But you didn't see any slowdown sequentially?

Second of all, can you comment specifically on yoga pants, where I have seen an explosion in competition, albeit not what you guys do.

Then third, on the men's business I guess I am in California and I am seeing a lot more of it just being worn around.

I am wondering; can you comment on the growth in that business and what you are seeing there?

And your confidence in your ability to take share in that market rather than people taking share from you in women's?

Okay.

Really quickly on Canada, as I said, the Canadian business is comping somewhere in the single digits.

Q2 was actually slightly stronger comp than we saw in Q1.

So it is not trending down; it is slightly the opposite.

Okay.

On the yoga pant competition, we certainly see a proliferation in the marketplace of copycat product that comes from sometimes the technical players, meaning the athletic wear players.

But a lot from more what I would call the other soft line, casual wear, active wear type players, which the performance and quality level is not really comparable.

I think that is our huge competitive advantage, is the technical detailing of the pant; the longevity of it; the fit of the garment.

So we are not really seeing anybody come up with something that is as directly comparable.

The different channels that they are sold through, I think our guest experience in the store is also what brings that guest back.

So even though there is a lot of proliferation it is really coming at that lower -- it is on price in general, and there are quality issues at that price for the guest.

So we are not currently seeing any erosion or substitution from our core guest who seems to be very loyal.

In men's we have been very light on product as we have reshifted the line.

We really felt in the past we weren't -- we had a lot of casual wear pieces and we weren't technical.

So we stripped those out, stripped the inventory down, and have worked on building a lot more technical line for men's.

And the response has been terrific.

We have some items that the men are just incredibly loyal to, such as the technical shirts and the shorts.

We are just now building on that targeted line.

We have a fantastic new men's designer.

We are very excited about the product that he is putting out.

And we think the men's product we have in the store right now is some of the best that we have had.

I think you will continue to see that grow at a pace faster than women's, but still staying still below that 15% in the store in the short term.

Great.

Thank you very much.

Omar Saad, ISI Group.

ISI Group.

Thank you very much.

Christine and John, I guess you guys deserve a shout-out too for the great execution this quarter.

Christine, could you talk about the way the brand has transformed?

I know you haven't been there from the beginning; but I know you also have a great feel for what's -- how the Company has transformed over time.

Can you talk about the brand and the perceptions of the brand and perceptions of the product and how that has changed as the Company has grown and moved into new markets?

Whether it is the Midwest or the growth you are seeing in Australia and maybe some of the stuff you have in Hong Kong or new categories, men's, how are people -- how are consumers --?

Have you done research around how consumers are viewing this brand, and how it has changed?

We don't believe in a lot of formal research, but we believe in being present and being out there a lot.

So what I am seeing and the team is seeing is a deep, deep affection and love of the brand for everything that we stand for.

Not only that product quality, but the guest experience inside the stores; the education; how we participate in the community.

That authentic giving, a relationship with ambassadors and the work that we do to support their businesses in a very genuine way.

I think what we are seeing is a very deep brand loyalty which we are very proud of.

I think importantly, the people know that the product stands for something more than just the quality of the product.

Really the brand association is with living a great and healthy life that you love.

That is really what we are focused on.

And people know that the brand is more than just a product and that they come to us for -- whether it is the goalsetting sessions that we do at our stores, as well as the free yoga classes that we do, people come in to feel good.

And they feel good about association with the brand; and that is critical.

Part of our strategy is to continue in that.

Would you say you are seeing the same thing on the men's side too?

That same sort of relationship and that emotional connection?

I think most men would deny that.

But we see -- I think there are a lot of technical products and I think certainly we see more men coming into yoga.

And we are that technical product for them.

I think we are seeing -- we are seeing from like the underwear, the run shorts, the technical tops.

Once we see the guys put on a piece of those -- and I was just at a trail race with my husband and we saw a lot more men in the product.

We were really pleased with the penetration that we are seeing there, and talking to some of the men that are in the garments.

Like, those are their favorite shorts; that is it.

So they want 12 of them.

And they come in and they buy 12 at once.

We are really seeing great response from that.

Great, thank you.

John Morris, Bank of Montreal

Hi guys.

Can you hear me?

Congrats also on another great quarter.

Well, a lot of the questions have been asked.

But John, as you look out a little bit ahead on the product cost pressures, I hear you on -- and you guys have done a very good job in making everybody aware and communicating some of the product cost pressures out there into the back half as far as gross margin is concerned.

The Spring season is way out there; but would you expect to continue to see philosophically some of those product cost pressures continue into the Spring season?

Or would we begin to see some of that abate by then?

I am asking really from I guess a philosophical structural basis.

And then I have got one or two small follow-ups.

Well, some of the inflation that we have already seen will continue.

As Sheree mentioned, cotton prices are down; and so to the extent that we have cotton in our mix there is some improvement going back to product costs that we saw more like a year ago.

But the other elements of inflation in our cost structure haven't reversed.

For example labor rates in a lot of countries where our manufacturing is taking place, you know that is not reversing.

They continue.

It is hard to have much of a crystal ball.

So I don't think you will see much of a reversal, but I don't think the increase will be as significant as what we saw this year.

I think there is more opportunity for leverage in that.

If you think about the fact that we have been basically rushing product to market for about six months or seven months, there are certain inefficiencies in that process that as we get our flow and control of next year that will also offset and give us some room.

Christine, I would also imagine, as you pointed out earlier in the call, that part of the potential offset would be some of the pricing that you might be able to get in the product that warrants that, with respect to higher specifications -- you know, more technical aspects to it.

That piece, which I think is intriguing and obviously well received by your customer, can you give us some rough feel in terms of what piece of the mix that might be now and what it could grow to?

It is definitely our focus and where we believe we have the opportunity to differentiate.

What we have seen happen in past recessions is people strip quality and details out of product to lower price points.

Yet the guest that we serve really wants those, and that has given us tremendous opportunity to take market share.

Our guest responds to that, and that is what differentiates continuing her to make that purchase.

So technical is our emphasis.

We add beauty to garments, but we want to make sure that people recognize this isn't about adding fashion.

This is about adding technical function and the detailing that is functional that she is looking for, but we do it in a beautiful way.

So that you will continue to see us penetrate more and more of the line.

But yet keep a very strong basic key and core, so that we have -- which is highly technical and called new product -- but differentiating ourselves even more with that technical product at the upper end.

So right now the key and core is close to about 65% of the business, plus or minus, on a regular basis.

That might lower a few percentage points as we penetrate with even more technical product.

Very helpful.

Then just finally, on the e-commerce expansion into new international arenas next year that you referred to, what regions would we see or countries, if you can be as specific?

Well, the first one up will be Australia because we want to make sure that we address market pricing, because of the strong Australian dollar and the duty situation there, where you can bring a package in under $1,000 without duty.

So we want to make sure that we set that market up for long-term success and have pricing parity in the market and great product available for the guest.

So that will be our first.

And then we do have a strategic list of markets that follow that, which I am not ready to disclose yet.

Okay, great.

Thanks.

Good luck for the back half.

Thanks.

Pamela Quintiliano, Oppenheimer.

Great, thanks so much for taking my question and congratulations as well.

So just a few things.

With Australia, is there any change to your longer-term outlook now in terms of how many stores you think you can open there?

We have been pretty consistent in the 20 to 30 range.

Each one has been very successful.

We are expanding or seeding the New Zealand market now, which we also see as part of that.

Okay.

Then in terms of the emphasis on the technical garments, that has obviously proven to be very successful thus far.

The manufacturing facilities that you have been relying on, will there be any change or any new facilities that you're going to look into as the technical component increases?

Also on the flip side, with labor rates being so high, would you potentially look at other countries to go into, obviously if they have the quality controls in place that you would need?

I think for us the most important is a relationship with a quality manufacturer that meets all of our sustainability guidelines and the labor guidance.

We operate at the high end of the manufacturing spectrum, so we need the quality sewers.

So we are not as concerned about the labor, which is built into our model, as we are about expanding in a way that gives us the best duty rates into the US and then other future markets that we want to expand into.

We have few manufacturers that we work with, that we work with in a very deep relationship.

They have been building factories for us over the last two years that have been coming online.

I just got back from a recent trip visiting five new factories and really, really pleased with the partnerships that we have and the capacity that we have been able to develop for the product levels.

So near term you think you have the capacity in place to support the growth?

I would say long term.

Excellent.

Thank you and congratulations again.

Laura Champine, Cowen and Company.

Good morning, guys.

Just wanted to clarify the SG&A expense guidance.

If I run through the numbers that you mentioned, John, it looks like after a little bit of deleveraging rate in Q3 you would see significant SG&A expense rate improvement in Q4.

Am I reading that right?

And what is driving that?

Well, that is pretty typical if you are talking about sequential quarters.

Because of the high volume in Q4 we do get leverage on SG&A and that is what you would be seeing.

Okay.

But on a year-over-year basis, it looks like you go from a little bit of deleverage to significant leverage.

I just wanted to make sure that that is correct.

I also wanted to just follow up by asking for a little more information about -- you mentioned in the Q and in your comments that you guys raised wages at the store level.

If you could maybe quantify that or talk about what the thinking is behind that.

We believe we have the best educators in the world, and it is critical to our guest strategy.

What we are very conscious of is, with a lot of knockoffs coming into the marketplace, if you hire a few lululemon people you have got really a trained program.

So we haven't seen that, but we want to make sure that our educators know that they are valued for the work that they do.

With having fewer stores with really great flow-through, part of our key strategy is making sure that our store manager and our educators are paid very well comparatively in the marketplace.

Because that is what gives us that community constancy which is critical to the brand.

Christine, was there a change in the way that they are paid?

Meaning did the commission structure change or their incentive structure change in any way?

Or was it just a general increase?

We gave an hourly increase; and we have changed some of the upside in terms of their daily and other commission structures so that as they deliver the upside there is more that goes in for them.

Great, thank you.

Christian Buss, Credit Suisse.

Hi, thank you for taking my call.

I was wondering if you could provide some perspective on new stores and their productivity, and how we should think about store productivity as you open in some secondary markets.

Okay.

We'd say -- what secondary markets?

Yes (multiple speakers) proven to be primary markets.

As I have said, our new store productivity -- stores that we opened really since we went deep in the showroom strategy year, year and a half ago, so the stores we opened in 2010 and early days with the stores we're opening in 2011 are opening -- I mean there is a range.

But on average some are on that $1,100 per square foot level, which again is much higher than what we had seen previously.

Lower than the more mature market average, but that is to be expected.

So we continue to be very pleased with the way (technical difficulty) stores are opening.

That's helpful.

Could I also ask about your gross margins?

About how much of your cost of goods is relatively speaking fixed?

Well, maybe a little under a quarter.

Okay.

Thank you very much and best of luck.

I have no further questions.

I would like to turn the conference back to lululemon for any final remarks.

I'd like to thank everybody for joining us today, and we look forward to continuing great momentum through the back half of the year.

Thank you, everyone.

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

This does conclude the program and you may now disconnect.

Everyone have a good day.