Lululemon Athletica Inc (LULU) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the lululemon athletica Q1 2012 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 is being recorded.

I would now like to introduce your host for today's conference call, Ms. Therese Hayes.

You may begin.

Good morning, everybody, and thank you for joining us on the first-quarter 2012 conference call.

A copy of today's press release is available on the Investor Relations section of lululemon's website at www.lululemon.com or furnished on Form 8-K with the SEC and available on the Commission's website at SEC.gov.

Shortly after we end this morning, a recording of today's call will be available as a replay for 30 days on the Investor Relations section of the website.

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

Sheree Waterson, our Chief Product Officer, will also be available during the Q&A portion of the call.

We would like to remind everyone of course that statements contained on this 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 may 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.

Also for today's call, we've got a limit of one hour, so when we get back to the Q&A, please limit yourself to one question at a time to give others the opportunity to also have their questions addressed.

And with that, I will turn it over to Christine.

Thank you, Therese.

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

We have started off the year with another strong quarter.

While every call, John and I speak to our financial achievements, we are equally aware of our broader goals to create leaders in the world, to elevate our ambassadors and the ongoing commitment of the entire team, from our factories to our stores, to deliver high-quality, innovative product and an excellent guest experience that makes it all possible.

Before I go any further, I want to recognize everyone at lululemon for once again coming together to achieve these excellent results.

Our investment in increased inventory levels led to strong growth in earnings performance in the first quarter, as our guests responded well to our spring styles.

You will recall that in the first quarter of last year, we were very light in the inventory as a result of having oversold in the fourth quarter of the prior year.

One of our key goals for 2011 was to balance our inventory to meet demand in order to focus our resources on innovation versus chasing product.

We announced during our last call that we entered 2012 with a strong inventory position to break the cycle of chase.

This translated into a 53% increase in revenue to $285.7 million.

We are excited about our new store openings, as each of these was unique and special for the individual communities.

In the first quarter, this included the opening of our first store in Salt Lake City, Utah, where they celebrated with a big party, including 150 of the community's top fitness supporters, ambassadors, friends and family.

The second store to open in the first quarter was in the historic district of downtown Milwaukee.

The opening weekend festivities included an Ambassador breakfast on Friday morning and yoga demos all week.

Over the course of the weekend, guests arrived from all over Wisconsin, including a group of women that rented a bus to travel from Green Bay, two hours away, to join us for the opening festivities.

The team in Tampa held a Roaring '20s theme speakeasy party to celebrate our Hyde Park Village store opening.

And we opened Boston's Newbury Street, complete with Acro Yogis performing from an apparatus strung from the exposed beams in the store.

And we were thrilled when our Ambassadors surprised the teams in the morning with breakfast to thank them for a very special night.

We continually strive for the right balance between delivering strong growth and our market leader focus on quality, innovation and execution.

An example of this innovation is in the capsules we are introducing throughout 2012.

Based on the past success of our capsules, both from the guest response and our learnings, we have increased the cadence from two to three a year to eight for 2012, which is consistent with our objective to plant seeds for our long-term growth.

The impact of this innovation, small production runs, new fabric and technologies, the hits and misses are already built into our gross margin model.

Throughout 2012, we are seeding international markets.

Our London showroom opened in April and is off to a great start, hosting weekly yoga classes with 25 to 30 participants, building relationships in the community and already performing better than the average of our US showrooms.

We expect to open the second Hong Kong show room at the end of the third quarter.

We successfully launched the Australian eCommerce site on May 17, so our Australian guests will have an online assortment and pricing that is specific to them, and most importantly, they receive their order quicker than ever before.

This new website allows our stores to be even more connected and accessible to our local communities.

As announced previously, we also plan to launch country-specific web pages in the UK and Hong Kong this year.

The behind-the-scenes work on our international expansion and legal structures, logistics, IT systems, local labor laws, on-boarding strategies and product compliance assortment and distribution planning continue.

We know from our country visits that market demand is growing, and we are selecting our top priority markets now.

To support this growth, we need to continue to invest in people and systems.

We have a number of large IT infrastructure programs underway to optimize multiple supply chains, provide cross-channel visibility and ensure that we have the flexibility to make, move and sell product globally.

Last quarter, we announced two key hires, Laura Klauberg, SVP Brand and Community, previously a top executive at Unilever; and Paul Zaengle, our new SVP of Global Digital Commerce, formerly of Columbia Sportswear and Ralph Lauren.

Both of them are completing their on-boarding, including visiting our showrooms, completing store shifts and participating in executive team building, and we look forward to having them here full-time in Vancouver as we expand the business and the brand in new directions.

On a closing note we host our inaugural half-marathon event, the Sea Wheeze, on August 11 here in beautiful Vancouver B.C., and we are now only about 200 short of our sellout capacity of 7500 participants.

This will be my first half-marathon and I would love to have you join me, so register online quickly if you want to join our party.

With that, I'm going to turn it over to John to go through the numbers.

Thanks, Christine.

I will begin by reviewing the details of our first quarter of 2012, and then I will update you on our outlook for the second quarter and the full year of fiscal 2012.

So for the first quarter, total net revenue was $285.7 million, an increase of 53% over the first quarter of 2011.

The increase in revenue was driven by comparable store sales growth of 25% on a constant dollar basis; the addition since Q1 of 2011 of 27 net new corporate-owned stores in the US, plus the four franchised stores that we reacquired last year; four ivivva stores in Canada and six stores in Australia and one in New Zealand; direct-to-consumer sales, which increased by $24.7 million or 179%.

And offsetting this was the impact of foreign exchange, which had the effect of decreasing reported revenues by $1.8 million or 0.9%.

During the quarter, we opened four lululemon stores in the US and to ivivva stores in Canada.

We ended the quarter with 180 total stores versus 142 a year ago, including 19 stores in Australia and New Zealand.

There are now 127 stores in our comp base, 41 of those in Canada, including two ivivva, 75 in the United States and 11 in Australia.

Corporate-owned stores represented 80.1% of total revenue or $228.8 million versus 83.6% or $156.2 million in the first quarter of last year.

Revenues from our direct-to-consumer channel totaled $38.4 million or 13.5% of total revenue versus $13.8 million or 7.4% of total revenue in the first quarter of last year.

Other revenue, which includes wholesale, show rooms, outlets and, until last year, franchised stores, totaled $18.5 million or 6.4% of revenue for the first quarter versus $16.8 million or 9% of revenue for the first quarter of last year.

Gross profit for the first quarter was $157.3 million or 55% of net revenue compared to $109.7 million or 58.7% of net revenue in Q1 2011.

The factors that contributed to this 370 basis point decrease in gross margin were a prior-year favorable nonrecurring adjustment of 140 basis points, which related to recognizing certain input tax credits; product margin decline of 340 basis points due to increases in labor and raw material costs due to product innovation, function, garment complexity, as well as inflation; and a more normalized rate of markdowns as a result of more balanced inventory levels.

These were partially offset by leverage on occupancy and depreciation, which contributed 110 basis points of improvement.

SG&A expenses were $84.2 million or 29.4% of net revenue compared to $58 million or 31% of net revenue for the same period last year.

The 45.1% SG&A dollar increase is due to an increase in store labor and operating expenses associated with new stores, show rooms and growth at existing locations; an increase in store support center costs, including salaries, professional fees, management incentive-based compensation and stock-based compensation.

We continue to make investments in building our pipeline infrastructure and operational capabilities to drive long-term growth.

As well, an increase in non-store occupancy and depreciation.

As a percentage of revenue, our first-quarter SG&A gained 160 basis points of leverage, due primarily to our eCommerce business, as we significantly lowered operating costs as a percentage of sales by insourcing our strategic platform.

As a result, operating income for the first quarter was $73.1 million or 25.6% of net revenue compared with $51.7 million or 27.7% of net revenue in 2011.

Tax expense for the quarter was $27 million, or a tax rate of 36.5%, compared to $19.1 million or a tax rate of 36.3% in the first quarter of 2011.

Net income for the quarter was $46.6 million, or $0.32 per diluted share.

This compares with net income of $33.4 million or $0.23 per diluted share for the first quarter of 2011.

Our weighted average diluted shares outstanding for the quarter were 145.7 million versus 144.9 million a year ago.

Capital expenditures were $12.7 million for the quarter compared with $74.8 million in the first quarter of 2011, which included the purchase of our store support center for $65.1 million.

We ended the quarter with $424.3 million in cash and cash equivalents.

Inventory at the end of the quarter was $107.7 million, 67% higher than at the end of the first quarter of 2011.

Excluding higher product in transit, on-hand inventory unit growth of approximately 30% is consistent with our expected forward sales and will support the new growth from new stores, higher same-store sales and our eCommerce channel.

This leads me to our outlook for the second quarter of 2012 and the full year.

For the remainder of 2012, on a net basis, our guidance remains basically unchanged.

So incorporating our stronger Q1 results, we've increased our revenue guidance for the year to be in the range of $1.32 billion to $1.34 billion.

This guidance assumes a lower Canadian dollar, at $0.97 to the US dollar, versus par in our previous guidance, with the reduction in revenue on currency translation offset by slightly higher store productivity and eCommerce performance.

We anticipate we will open a total of up to 35 corporate-owned stores plus two outlets in 2012.

Revenue upside opportunity is limited until Q4, as we have focused our product team on innovation for the future in favor of chasing near-term revenue dollars.

We continue to expect gross margin for the year right around our stated long-term goal of 55%.

As discussed on the last call, we expect to be below 55% through Q3 and above in Q4 due to leverage on the higher holiday volumes.

We expect to leverage SG&A slightly for the year, driven by leverage in Q1, during which we still had not cycled the transition to our ATG eCommerce platform, which occurred in late Q1 of 2011, and also due to leverage on higher volumes in Q4.

As a result, we expect our fiscal 2012 earnings per share to be approximately $1.55 to $1.60.

This is based on a tax rate of 36.5% and 146 million weighted average shares outstanding.

Within this full year guidance, we anticipate Q2 revenue to be in the range of $273 million to $278 million.

This is based on a comparable store sales percentage increase in the low double digits on a constant dollar basis compared with the second quarter of 2011.

Again, our outlook assumes a Canadian dollar at $0.97 to the US dollar, compared to $1.03 in Q2 of 2011.

We plan to open seven lululemon stores in the US and one in Australia during the second quarter.

As I've just mentioned, we expect gross margin to be below 55% in Q2.

We expect some gross margin decline versus the second quarter of 2011, driven primarily by the same reasons experienced in Q1, higher product costs due to innovation, construction and more normalized markdowns due to balanced inventory levels.

This will be partially offset by leverage on occupancy and depreciation.

During the second quarter, we expect to deleverage slightly on SG&A as a percentage of revenue over the second quarter of 2011.

We continue to invest in initiatives that drive capability in our supply chain and infrastructure, leadership, guest experience and growth.

Assuming a tax rate of 36.5% and 145.7 million diluted average shares outstanding, we expect earnings per share in the second quarter to be in the range of $0.28 to $0.30.

We expect capital expenditures to be between $80 million and $85 million for fiscal 2012, reflecting new store buildouts, renovation capital for existing stores, IT and other head office capital.

This amount could potentially increase if we meet success in an initiative underway to acquire or build our own retail street stores to control our occupancy in key strategic locations.

With that, I will turn it back to Christine.

Thanks, John.

I just want to reiterate that we are exactly where we want to be, balancing our long-term growth, innovation and execution, and that our business fundamentals remain strong.

With that, we are going to open it up to Q&A.

(Operator Instructions) Sharon Zackfia, William Blair.

Good morning.

One moment.

You may ask your question, Sharon.

Okay, can you hear me now?

We can.

All right, great.

So a few questions.

I think, John, you said something on the order of the expectations that you have for the rest of the year are essentially unchanged.

Obviously, I think your second-quarter guidance was a little bit below what the Street expected.

Just curious if you are seeing anything so far in the second quarter that we should maybe be concerned about.

And then secondarily, on the capsules, I think there has been anxiety in the market as they've seen more of the risk you've been taking on the product.

If you could help us understand how those capsules evolve over time, how you analyze them into potentially become permanent parts of the collection going forward, and how we on the outside can really view those and kind of analyze the hits or misses, as you mentioned, Christine.

Okay.

On the guidance for the balance of the year, as Christine mentioned, we are basically right on plan for the year.

The cadence quarter to quarter -- of course, I hadn't given guidance on quarterly revenue previously -- so our Q2 guidance is really consistent with where we expect it to be.

And we feel good about the way the business is running right now.

Capsules?

On the capsules, we feel they are doing exactly what we want them to do, and we had planned for the impact of those capsules throughout the year.

The two that have dropped, which are swim and the commuter line; on swim, we learned a lot about the technical manufacturing of swim.

And while we think there were some things that were overall successes that were really great, we learned a few things about fit and function and fabric as we constructed those swimsuits.

So we had great guest response to them, but we also I think learned some things technically.

And the beauty of capsules and why we've deployed this strategy is so that we don't make big buys in new categories and then have huge markdowns or place big bets.

So these are small, controlled bets, one time, where we take the learnings, always looking for that anchor piece that we can take forward.

On the commuter capsule, that was very successful.

We learned a lot about some great pieces in that commuter capsule.

But we felt like we made a little bit of an issue with the buy there, doing it a little deeper than we should have for capsules and pulled that back.

So the learnings that we take from one to the next I think are great.

We tried some new fabrics.

So those are things that will compress our margin in the short-term, but we also can translate some of those learnings to other product lines.

Sheree, do you want to add anything?

Well done.

Okay, so I think we feel that we got some great learnings about the bikes.

And also want to be clear that we don't just maybe test something once; something like the cycling could repeat, and we will come back later in the year with some additional tests.

So we feel it is a very controlled way to manage our long-term growth opportunities, and it is the right thing as a market leader to continue to innovate.

Perfect.

Thank you.

Adrienne Tennant, Janney Capital.

Good morning, and let me congratulate you on the first quarter.

Nice start to the year.

Christine, my first question is, can you talk about the macro environment Canada versus US versus Australia?

Which of those -- as you look into the back half of the year, are you planning for largely those to be similar, worse or better in each of those markets?

And then for John, can you talk about low-double-digit positive -- I'm assuming the debt by definition 10% to 12%.

It's a deceleration from the first quarter trends, so can you give us any color on how you exited the first quarter?

And typically, I'm assuming that you get that guidance based on what you are currently seeing, that's the case.

Thank you.

I think market by market, we feel optimistic about each one of those markets.

And while we have sometimes day-to-day choppiness, we know it is more related at this point to our product flow and timing of deliveries.

We hear a lot of noise in the macro market.

I think, like other retailers, we are going to control what we can control.

We've always been disciplined planners, looking at upside and downside.

And I feel we are well poised to manage through anything.

John and I are professional worriers, so we always will look at that and have our contingency plans.

But at this point, we don't see anything that -- as we stated in our guidance that is going to change our outlook for the year.

Okay, great.

In terms of the Q2 comp, remember, Q1, part of our ability to hit a 25 comp in Q1 was because we were so underinventoried a year ago.

So one thing to remember is Q2 and the balance of the year is getting to a tougher compare.

But beyond that, again, it is really product flow.

We will -- again, in terms of comp, last year was very up and down.

And so the comp month to month, week to week and quarter to quarter is a function of what we saw a year ago.

But in general, the strong comp in Q1, more modest for the mid-part of the year.

And as I said in the prepared remarks, we deliberately chose to not have our product team dedicate a lot of time to chasing inventory to catch every last dollar of revenue.

They are really much more focused on innovation this year.

And so, as I said, the ability to have higher opportunity in product is really backended to Q4.

Okay.

Did you see any March/April Easter shift impact?

(multiple speakers) it was harder for us to tell because our delivery cycle and what we were anniversarying.

If you remember last year, our biggest chase dropped the end of Q1, beginning of Q2, and we oversold a little bit more than we planned in Q1.

So I think -- could that have been a little bit of it?

Yes.

But I think separating that from our (inaudible) cases of product flow for us at this time is just noise.

I don't think it was anything significant.

Okay, great.

Thank you very much and best of luck.

Omar Saad, ISI Group.

Good morning.

I wanted to follow up on kind of the strategy around product innovation versus inventory chase.

What kind of opportunities are you seeing there on the innovation side?

And in terms of our resources and allocating resources, both kind of capital and human, how does that work internally, where you are kind of shifting the focus in terms of replenishing and chasing the inventory as opposed to really focusing on developing innovative new products, new areas and new categories?

Can you maybe dive into that question a little bit?

Because it seems like somewhat of a shift from maybe the last couple quarters.

I think it is a shift from last year, Omar.

And what we learned in last year, when we were so heavily in chase, as we stated in prior calls, what we started to get a little concerned about was when you over-order what you can get versus what you know the consumer needs, there is a brand cost to that.

And so chasing any dollar might produce something in the short-term, but longer-term, making sure that we have the quality, that we have the right amount of scarcity, that we are always innovating what is needed as a market leader, from a brand and long-term growth story, it is the position we would rather be in.

Rather than if we chased an extra amount of pink when yellow is what is needed, we really just create, in our opinion, future markdowns and destroy the brand.

So we are always looking at that.

Now are we doing no chase?

Absolutely not.

Are we doing as much as we did the year before?

No, we believe our buys are solid.

We are planning for a great Q4 and Q1.

And we've always been committed to quality.

Because the other thing we don't want to run into is we are doing -- and innovation just isn't just capsules and pods.

It is new fabrics, it is blending fabrics on garments.

And that requires more complexity and more construction.

So we want to make sure that quality is always what we are doing well, because those are the long-term fundamentals our brands are built upon.

So we are smart about chase, and balancing that with growth and innovation, and our ability to execute the brand that we know the consumer wants us to be.

Thanks, Christine.

And John, does this have an impact on the balance sheet, the inventory levels?

Should we see those come down as a result of this?

No, the inventory level we are at in terms of compared to forward sales is appropriate.

So inventory levels should be in that same balance the rest of the year, or at least through to Q4.

Thanks, guys.

Janet Kloppenburg, JJK Research.

Good morning, everyone.

Congratulations.

John, I wanted to flesh out this innovation cost comment just a bit more.

It sounds like it may constrain comps on the core business, perhaps help you lead the acceptance of new product or new technical fabrics or styling.

Maybe you could talk a little bit about that, or Christine.

Also, I'm wondering about sales metrics in the quarter.

Change in AUR, change in traffic, conversion levels, et cetera.

Also, the eCommerce business came in much higher than I expected, and I'm wondering if there is a trade-off there with comps.

And lastly, Sheree, can you talk to us above the capsules?

I think you are adding maybe six this year, and when we might see those flow in.

Thank you.

There is a lot of questions in one.

I'll answer them quick.

It makes it hard to remember what the first one was.

The first one was if the innovation is hurting comps and -- overall comps because of core product being perhaps below where it has been.

Yes, I wouldn't say innovation is constraining comps.

We are -- again, we are not scrambling and chasing further upside.

But the buy of our core in key styles is appropriate for the level of business we expect, and the innovation is just where we are dedicating those additional efforts.

Okay.

Conversion, AUR, pricing, just what we saw in the quarter, most of the comp came from traffic, with strong, higher conversion and slightly higher average basket.

Which mainly was driven by more complexity in the garment, not (multiple speakers).

Also a slight increase in units per transaction as well.

ECommerce, as you say, it is tremendous growth there at 179% over last year.

And that channel definitely has tremendous momentum.

Came in at 13.5% of overall revenue, which matched Q4, which was actually a pleasant upside surprise, because traditionally, seasonally Q1 and Q2 eCommerce is a lower percent of total.

So eCommerce definitely outperformed.

We don't include that in our comp days, of course.

But it is something to keep in mind when you are looking at overall sales growth.

And on the capsules?

And on the capsules -- so.

Hi, Sheree.

Hi there.

How are you doing?

Good.

June, August and October, we have cycling, commute and spin, respectively.

And then also for November we have a bar capsule coming up.

And for December, we are going deeper into one of our warmwear capsules, which was lightweight and midweight puffys along with running luon separates for layering.

And then in January, gym and cross-fit, so a training capsule for back to gym.

Thank you.

Kimberly Greenberger, Morgan Stanley.

Thank you.

Good morning.

John, I wanted to know if you could help us with the relative spread in comps between the US and Canada.

And secondarily, as you look out into the second half of the year, do you have any product costs, any lower product cost opportunities, or are you seeing the innovation cycle just continuing to raise your cost of goods sold?

Thanks.

We don't specifically break out comps or performance between country.

But consistent with what we've seen in recent quarters, Canada, even though you would think it is a mature business, comped in the mid-double digits.

And the US was comping in the mid-30s.

So yes, pretty strong in both regions comparable to the maturity of the business.

In terms of lower product costs later in the year, I think certainly after Q2, any inflation that is really what we started seeing a year or so ago is going to be reflected in our product costs.

But I think, as you mentioned, I would say continued innovation, using new fabrics, new construction, is likely to offset any cost relief that we might otherwise see.

And again, we are maintaining sort of a 55% gross margin target for the year, and that reflects the impact of the innovation that we are doing.

And I think strategically using our very strong gross margin to continue to create a long-term brand success story is the right thing to do.

Great.

Thank you.

Paul Lejuez, Nomura.

Thanks, guys.

I'm just wondering if you could talk about the weather during the quarter, if you think that the warm weather helped you pull sales forward.

Also, wondering what sort of eComm increases you are assuming for the rest of the year.

Because it doesn't seem like, based on your guidance, that you would be assuming a similar rate of increase in as 1Q.

So I'm just curious what is baked in.

And last, John, maybe you could expand a little bit about one of the last comments you made on your prepared remarks, about maybe buying some stores.

What are you thinking there?

Thanks.

I'll do weather one.

We, like anybody, would be subject to extreme weather patterns, like huge floods or closing or whatever.

But on a day-to-day basis or overall seasonal basis, we don't seem to be as tied -- we are much more tied to our product flow.

Now, could there have been a little pull-forward as we started hearing other people talk about that?

We kind of looked at it.

We feel our business is still run far more by our product flow and the guest demand we create than weather patterns or other factors.

Yoga is done indoors.

Yoga is done indoors, as Sheree said.

We are pretty lucky.

In terms of eCommerce, the increase in Q1 was in part boosted by the fact that last year we were going through our transition to the ATG platform which meant we really gradually diminished the inventory that was dedicated to that third-party site until the transition.

So even though the increase was still pretty impressive, it will be somewhat more muted for the rest of the year.

As I said, it was 13.5% of overall revenue, which is a surprise to the upside.

We would expect it to be a little bit lower than that as a percentage of total through the middle quarters of the year, and then traditionally tends to bump up in Q4 for holiday gift-giving.

The comment about buying stores, I just wanted to flag that because it would impact our capital expenditures.

As you know, we have a very healthy balance sheet and a good cash position, and it is available to use strategically.

One of the areas that we looking at is in certain key strategic locations, where we know we are going to want to have a store for the long term, it is certainly open to us to acquire those locations as opposed to simply leasing, especially if it is a situation where we may find ourselves in a weak negotiating position down the road on renewal with either the landlord in that location or in malls in the immediate vicinity.

So for example, we do have under contract to purchase the store that we recently opened in Newbury.

And you may see some more of that -- not a significant amount of capital overall, but I just want to flag that that is an initiative that we are pursuing.

Got you.

Thanks, John.

Good luck, guys.

Liz Dunn, Macquarie.

Good morning.

Let me add my congratulations.

Just a couple of questions.

I guess first, how much inventory should we see dedicated to this sort of innovation in the capsules?

And also, for John, in listening to everything you said on gross margin, it seems as though the normalized markdowns were sort of around 100 basis points.

Is that -- did that have to do with some of the hit you took on the commuter line, or can you help us understand that a bit better?

And then just on product, I kind of want to get a better sense for like crossfit or bar, how is your current assortment not meeting the needs for those activities?

Because when I see people doing those classes, certainly they are wearing a lot of lulu as it currently stands.

Thanks.

On the inventory for capsules, it is pretty insignificant, quite frankly.

Think of capsules are to product what show rooms are to our store base.

They are not really a profit driver; they are our testing.

So the sales for any one capsule might be expected to be mid-single-digit millions or less, and therefore the inventory related to those capsules is fairly minor.

And you are right about the impact of markdowns being about 100 basis points, which was about what we would have expected.

And the impact of the commuter line or any other capsule is fairly minor within that.

What I think is important to understand, when we talk about innovation, capsules is one small part of it.

There is also innovation in our run garments in terms of new fabrics, new trim, new technology; men's, in jackets.

So it is also innovating in our core lines that we are constantly investing in.

Okay.

And then as we look at the fourth quarter, potentially a little bit more opportunity for acceleration in the comp.

Is that just strategically you think it is important just to focus on driving as many sales high quality as you can in the fourth quarter, and so the innovation will perhaps take a little bit of a back seat during that important sales quarter?

Is that the right way to think about it?

I think the right way to think about it is that's always our biggest opportunity for a buy; in consumer demand, there is less risk with taking bigger buys for that quarter.

So that is always part of the psychology of that, but there is a lot of different factors.

Where we didn't want to be, where we were last year, was whenever you chase and you innovate a new line while you chase, you have a choice.

You are going to chase what you already have, and will that sell again, and is that the right answer.

Or are you going to chase something new.

And if chase something new and you have to go all the way back to fabrics, like we do, then that takes a lot of your time and you're not then also planning for great success later in the year.

So we are always balancing future success with immediate success.

And as our garments get a little more complex then, which is a cost of creating the market and being a market leader, we always went to make sure we are maintaining quality with all of these new fabrics and innovations, that everything from the dyes work on the cross fabrics, that we get all the right trims in them that meet our quality standard.

And we don't want to chase a short-term sale and sacrifice a reputation for quality or execution.

That is a slippery slope, and we really just don't want to be there.

Great.

Thank you.

John Morris, Bank of Montreal.

Good morning.

My congratulations on a great quarter, too.

John, we've talked a little bit about it.

I'm wondering on the product costs, understanding a lot of that is coming from some of the innovation that you are pursuing as well.

But on the other side of it, are you able to do anything to control some of the increases that you are seeing in labor and raw materials and what would those be?

And then maybe, Christina, if you can talk a little bit about the performance of ivivva and what your learnings are there so far, and what your insights are there for ivivva both Canada and US.

Thanks.

In terms of product cost pressure coming from inflation, that is really already baked in, and we are just anniversarying some of those increases that happened up through the first half of last year.

So it is not that there is further inflation that it is significantly impacting our cost going forward.

And is it more labor or raw material?

What is kind of the breakdown there, John?

It is primarily raw material.

Okay.

And Christine?

Yes, on ivivva, it continues on track.

We are pleased with the performance of it.

You know, it is not -- at this point, we are not ready to blow it out.

You will see a couple more stores opening.

The business continues to do well.

Because we don't have stores open in the US, we did do a flash sale recently with Zulily to exit some aged products within the US market.

We didn't do it in Canada, where we have the stores, and you won't see us do that very often.

But we don't want to open -- we are not ready to open stores in the market, and we don't want to discount too much on our website sales.

So on track, pleased with the story.

Feel like we've got a great concept there.

But right now, we want to let it mature, grow at the right pace and we feel it is doing well.

Got it.

Thanks.

Jaime Katz, Morningstar.

Good morning.

Thanks for taking my call.

My first question is if eCommerce kind of stays where it is or it grows slightly as a proportion of sales, have you guys thought about how that can effectively impact the gross margin and SG&A, and maybe what sort of potential you guys can reach on that front.

And then also, with entry into the UK market, is there any estimate on what the potential store base is if you guys decide to move forward with that marketplace?

We haven't released going forward what we think the store count is internationally.

But obviously, it is a healthy market for us, as we believe a couple of other -- of the bigger markets in Europe are.

But honestly, we are equally excited by Asia and the demand that we're seeing there.

The yoga market is very strong and growing in Asia as well.

So we actually see both markets as attractive.

But I really feel in a lot of ways that Asia is even more compelling than Europe.

And in terms of eCommerce and its impact on margins, I think in the Q you can see the segmented information.

And [it's] true -- the margins coming from the eCommerce channel are at a point where they are stronger than our already pretty high store margins.

And so as eCommerce -- and we do expect that over time, it will continue to grow as a percentage of the total, and so that will have a positive impact on both gross and operating margins in the future.

Thank you.

Lorraine Hutchinson, Bank of America.

Thank you, good morning.

Just wanted to dig a little bit into the businesses in Australia and New Zealand.

Where is the productivity gap between those stores and the US?

And what opportunities do you have to drive comps in those markets?

The way we are kind of looking at it, I would say the brand recognition in Australia -- and I guess now New Zealand, now that we've opened our first store -- is running about three years behind the US.

And it is comping well.

We just opened the eCommerce site down there, and I am optimistic that that will also help drive brand recognition.

There was a lot going on back in 2009 when we opened our eCommerce site in North America.

That certainly coincided with the real turning point in terms of brand recognition in the US, and I'm sure part of that was attributable to eCommerce.

So we are optimistic that we will see the same sort of momentum gained in Australia.

So I mean Australia and New Zealand are great markets for us.

As I said, they are a little bit less mature, but pretty exciting and on track.

And Sheree just recently got back from a trip to visit the markets last week.

And after she looked at how we are handling counter-seasonal product, she said we have a lot of opportunities.

And I think that -- we do feel we've constrained ourselves a little bit as we've been learning to deal with that situation, because they've had to buy and hold, and our product changes so rapidly, mixing those together, after Sheree saw that, she said, wow, I do a lot better.

And we think we always have opportunities, and I think it has been a great growth story.

And to have profitable markets where your labor costs and store costs are higher gives us great confidence in our ability to grow them all internationally.

And the learnings we've had from supporting that market have been key to our planning for our international strategy.

So I think there's been a lot of wins and a lot of potential in that market, and a lot of learnings for us.

Thank you.

Taposh Bari, Jefferies.

Congratulations on a nice quarter.

I wanted to ask you I guess, Christine, a question going back to the whole point about prioritizing innovation versus chasing product throughout the rest of the year.

Aren't those two separate functions, design versus planning?

I'm just trying to get a better sense of why chasing product would distract the designing process.

If you think about our model, there is core and replenishment, right?

So let's break out the two conversations.

On the core product, which is replenished, of course that slowed and that is a planning and buy function.

But then when we color seasonal items or we do our new kind of innovative or wow items or colors, that is where it is more difficult.

So if you put like Paris pink, for instance, that has to go all the way back because we are yarn-dyed.

We are not a greige dip, which is what gives us the quality that lasts five years.

So if I want to hold greige fabric to chase and dip, I'm going to have a different quality level than I currently do today.

And then if I over-order Paris Pink, and all of a sudden it becomes ordinary, I haven't created something special.

So then I would have to take a designer to design something new, change either the garment or change and create a new fabric.

So what we are doing is investing in our development function, which allows us to do more of -- and have a faster response to our lab dips and dyes -- and I'm getting quite technical here, but you asked -- so that we can speed up our ability to have incremental colors and products.

What we really don't want to be is just buying in bulk to meet demand, because then we will lose what makes us special.

So we have to balance that with the demand.

And then it gets more complex as you start to add garments with more functionality and two fabrics together, dye-holds on one, not on another.

So it is complex.

And I think as a growth company what we always want to make sure we are doing is also balancing quality.

We had a couple of dyes that didn't work, and we pulled those items because we won't put bad product on the floor.

So we are committed to that.

We leave room for that.

That is already all forecasted in everything we do.

They weren't big mistakes.

But we don't want to make those kind of mistakes and put that out in our guest's hands.

Got it.

That's helpful.

So I guess the question then is this a change in philosophy versus the past couple of years?

Because we are coming off of this multiyear period of 20% plus comps for your Company, which, in retrospect, was greater than where you initially planned most of the time.

So obviously, there is a degree of catch-up of some of the early -- some of the stores that opened up during the recession.

I'm just trying to get a better sense of why that philosophy is changing now versus maybe a year ago.

And I guess along the lines of that question, what is a normalized, healthy type of comp run rate for this Company going forward?

Thank you.

I think it is some of the learnings that we had last year, when we heavily invested in chase, and then we stopped.

And -- which you saw kind of in Q3.

And then really just focused on a forward Q4/Q1 execution, which obviously you saw play out really well.

So what we take a look at is current sales trends.

We are trying not to over react in the short term.

Because, look, in this environment at the size we are, strong double-digit comp growth we think is a great story, with a healthy margin.

So I really don't feel the need to apologize for that level of performance and growth track record that we have.

And then looking at the forward opportunity and making those right investments to create that continued success.

And that is what we are always after, strong and steady, excellence in execution, being better than everyone else in the marketplace, is what creates a winning strategy for the long-term.

And balancing short and long-term and the impact it has on an organization that is still growing infrastructure.

That is our job and we think we do it pretty well.

Thank you very much.

John Kernan, Cowen and Company.

Good morning.

Thanks for taking my question.

You talked a lot about higher product costs due to innovation.

Are you realizing higher prices on some of the new innovation, and could you -- what is the balance between units and AUR in the comp right now?

Thanks.

We do see some, but in the beginning when we first -- like when we introduced Run, for example, we had a lot of new fabrics.

And we chose to price at what the right price was for the garment in the marketplace, and in the beginning, take a little bit of a reduced margin.

And then we built that up over time as we extended the line, got into our minimum runs, et cetera.

So that is part of the cadence.

We always plan a garment for a future, that it will live within our product line at the high margins.

But in the beginning when we innovate and we are testing fabric, that is built into the way that we build the model and extend the line.

So we always are looking for high-value, high-margin garments.

That is the business we are in, not quick turn, high-volume T-shirts.

And the comp is very largely units, probably 85%, 90%, just a slight contribution from AUR.

Okay, thanks.

And then I guess as we look into Q2, obviously, you are cycling that bringing the direct-to-consumer business back in-house, there is going to be some SG&A deleverage associated with that.

But if your comp trend, I guess, comes ahead of plan, do you feel like there is some room to releverage SG&A or are there a lot of SG&A expenses in the quarter?

Thanks.

In terms of the SG&A cadence for the year, at the start of the year, we budget, we plan, we set what initiatives we can handle for the year and the headcount associated with it.

If anything, it tends to take a little bit of time to hire those people and to get those initiatives started.

So as we look at Q2/Q3, what you will see is those initiatives kicking in and our headcount will add, and that is what compresses SG&A in the middle of the year.

And then at the end of the year, with higher volumes, we will get leverage again.

Okay, thanks.

Good luck.

Roxanne Meyer, UBS.

Thanks.

Let me add my congratulations on a great first quarter.

A couple of questions.

Just wondering if you can share with us how you are thinking about inventory growth as we move throughout the year.

Second, just wanted an update on the men's business, just wondering what the penetration looks like as a percent of sales.

I know from our checks, we have seen a lot of product sellouts.

And just last, was the magnitude of the markdowns in light of your increase in inventory greater or less than you expected in the quarter?

Thanks.

Okay, inventory growth throughout the year, again, coming into the year and at the end of Q1, I think our inventory level is pretty balanced with the way we planned the business.

And since we're not doing a lot of chase, that's true for the balance of the year.

Men's was about 12% in Q1, which, again, it's typically highest in Q4, during the holiday gift season; it was over 14% in Q4.

So 12% in Q1 is about in line with the way it goes season to season.

And sorry -- what was your last question?

Just on the magnitude of the basis point hit from markdowns, was that in line with your expectations, a little more or a little less?

It was pretty much bang on our expectations.

Okay, great.

Thanks, and good luck in Q2.

I'd just say we feel really great about our inventory position, how clean it is.

So we don't feel like there is any risk on the table either.

Dana Telsey, the Telsey Group.

Hi, everyone.

Good morning.

Can you talk a little bit about the online business and cadence of online versus stores, what did you see there this quarter compared to the stores?

And then just as you have expanded into other categories with the men's, any update on men's?

How is it doing online and in the stores and margin opportunity?

Thank you.

I think online and stores, we see them march very in sync with each other.

Our guest is very attuned.

It is all about the product flow.

It is all about product flow.

The guest is looking for that new product wherever it is going to land.

They shop both.

Run to the store quickly.

So we don't see a huge difference between the two.

We aren't in the business of really doing a lot of exclusives online.

We've found that the cadence of the life of the product is pretty similar in both stores and online.

So we've seen them march pretty in lockstep with each other.

So there is no real difference there.

In terms of men's, we definitely see demand for men's growing and -- yes.

But online, it is actually -- I guess men don't like shopping online as much as women, because the men's penetration online is much lower than stores, so that is an opportunity.

Yes.

Thank you.

(inaudible), Robert W. Baird.

Thanks for squeezing me at the end.

I just wanted to confirm, on ivivva, you said you're waiting to open stores while the market is maturing in the US.

Does that mean that you're no longer planning on opening those five stores in July/August timeframe?

We didn't have five stores.

Maybe those are showrooms.

But we are still on plans for stores for ivivva this year, which was a modest increase.

We opened two in Q1.

And within our overall store count guidance, there might be one or two more in the back part of the year.

Okay, so you are not -- you used to talk about California, Washington, Illinois, Massachusetts and New York (multiple speakers).

Those were showrooms.

Showrooms, not stores.

Great.

Thank you.

That's all I had.

(inaudible), RBC Capital Markets.

Good morning, everybody.

Just wanted to talk a bit about CapEx.

If I back out the building purchase last year, your CapEx sort of about $50 million, growing to $80 million this year.

Can you just talk about what are the bigger projects in there?

Yes, of course, our new store buildout is always there.

As our store base grows and matures and we are getting up to lease renewals, we have a growing number of renovations.

And when we come up to a lease renewal, we will typically do a full renovation, which is pretty much the same cost as a new store.

In addition, there is a lot more IT system spend, and that becomes a much longer conversation.

But as we've been talking about, IT systems to support the whole supply chain.

We are moving forward with the new financial system this year.

So that is where a lot of the CapEx is.

If you look out sort of the next three years, are there any other big-ticket items that have to come online?

Like I don't know whether you would have to look revamping distribution or sourcing, anything along those lines?

Or you expect that CapEx (inaudible) to scale with sales?

I think there is an ongoing need to implement and upgrade systems, especially.

But I think as we look forward, I don't see any shockingly large lumps in our CapEx.

A lot of it is discretionary in terms of timing to some extent.

So we will balance our CapEx.

So yes, I don't think you'll see any big surprises.

Lastly, you had made a comment at the end of your commentary about outlet stores.

And was that a discussion of net new openings of outlet stores?

I did mention that we are opening two new outlets this year.

When you look at -- I mean, we've been operating with three outlet stores in the US for a couple of years now.

And when you look at the volume of our business in the US, and now that we are back in inventory, it is pretty simple arithmetic to see that that requires a couple more outlets just to keep the inventory clean.

So that is part of the plan for the year.

Great.

Thank you very much.

Jim Duffy, Stifel Nicolaus.

Thanks for taking my call.

This is Molly on for Jim.

Congrats on the quarter.

Real quick, you had talked about the Hong Kong showroom now opening at the end of 3Q, whereas before I think it was supposed to open in June.

Just wondering if there is anything going on there.

And then lastly, hoping that you could maybe give more specific rollout dates for the UK and Hong Kong eCommerce sites.

Thanks.

I think we are just -- we've already done the UK and dates, which we've said would be later in the year.

We are not ready to be a little more specific about that at this time.

In terms of Hong Kong, it was really just negotiating the lease and holding out (multiple speakers).

Yes, as we got into some of the details negotiating with the landlord in Hong Kong, it took a little bit longer than the plan, but we are now moving ahead.

Okay, great.

Thank you.

Operator, I think we have time for just one more question.

Christian Buss, Credit Suisse.

Thanks for squeezing me in at the last.

Congratulations as well on a great quarter.

I was wondering if you good talk about the level of full-price selling.

Do you think that is now at normalized levels?

And then I was also wondering if you could give just a quick update on your systems investments, what kind of progress you've made there.

In terms of full-price selling versus discounts, I think it is more of a normal balance now.

Still very low relative to retail in general, so maybe high single digits.

But that is more of a normal run rate.

And sorry, your question on IT investments?

How they are doing.

Oh, boy.

There is a whole bunch of questions in that.

We feel good.

We are really focused on our supply chain and the flow.

Building more visibility into our factories, factory capacity.

Really advanced allocations so that we have more ability to get the right product to right stores.

We've had some real wins that [Katherine] and her team have delivered in terms of getting data analysis.

And our business intelligence is in a whole new place, which has really freed up our merchant planning and allocation teams to have more simple answers on the buy.

So we've made some really short-term quick wins, and feel really great about the progress that the team is making on the longer-term investments.

Do you want to add anything, Sheree?

We laid out a go-to-market road map about a year ago, and we are making good progress on it.

So we are about halfway through our PLM implementation right now, and looking at additional planning tools and so on.

Great.

Thank you very much.

Good luck.

Thank you, and I apologize that we've had to leave some people in the queue, which we normally don't like to do.

But hopefully, we will be able to catch you in follow-up calls.

So thank you, everyone, for joining us for the quarter.

Ladies and gentlemen, this does conclude today's presentation.

You may now disconnect, and have a wonderful day.