Lululemon Athletica Inc (LULU) 2016 Q3 法說會逐字稿

Thank you for standing by.

This is the conference operator.

Welcome to the lululemon athletica inc.

third quarter 2016 conference call.

(Operator Instructions)

I would now like to turn the conference over to Chris Tham, Senior Vice President, Finance for lululemon athletica inc.

Please go ahead.

Thank you and good afternoon.

Welcome to lululemon's third quarter 2016 earnings conference call.

Joining me today to talk about our results are Laurent Potdevin, CEO; and Stuart Haselden, CFO.

Lee Holman, EVP Creative Director, will also be available during the Q&A portion of the call.

Before we get started, I'd like to take this opportunity to remind you that our remarks today will include forward-looking statements reflecting management's current forecasts of certain aspects of the Company's future.

These statements are based on current information which we have assessed, though which, by its nature, is dynamic and subject to rapid and even abrupt changes.

Actual results may differ materially from those contained in or implied by these forward-looking statements due to risks and uncertainties associated with the Company's business.

Factors that could cause these results to differ materially are set forth in the Company's filings with the SEC, including our annual report on Form 10-K and our quarterly reports on Form 10-Q.

Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events.

During this call, we will present both GAAP and non-GAAP financial measures.

A reconciliation of GAAP to non-GAAP measures is included in our quarterly report on Form 10-Q and in today's earnings press release.

The press release and accompanying quarterly report on Form 10-Q are available under the Investors section of our website, at www.lululemon.com.

Today's call is scheduled for one hour, so please limit yourself to one question at a time to give others the opportunity to have their questions addressed.

And now I would like to turn the call over to Laurent.

Thank you, Chris, and good afternoon, everyone.

I'm pleased to report another strong quarter, with revenues of $544 million and normalized diluted EPS of $0.47, representing earnings growth of 34% versus last year, a substantial inflection point for lululemon.

Similarly to last year, as we entered Q4, sales results have been mixed, with a more recent strengthening in the trend, and Stuart will offer more details later on our outlook.

That said, we continue to be on track with our five-year plan of doubling our revenue and more than doubling our earnings, as we continue to execute against our long-term growth strategies: ranging from product innovation, expanding our international footprint, building a $1 billion men's category, and connecting our global collective through our digital ecosystem.

In the most recent quarter, we saw the top line momentum from the first half of the year continue, as we delivered a plus 7% combined comp.

A critical component of our success in Q3 was our gross margin performance.

The ongoing focus on our supply chain, upgrading our sourcing, and our logistics structure drove a 420 basis point gross margin improvement over the past year.

This gross margin expansion is a key element in the earnings recovery that we see today and expect going forward.

Taking a closer look at our results this quarter.

We delivered a mid single-digit comp in both tops and bottoms within the women's category, with our bra revenue growing more than 20%.

Our performance in tops and tanks was perfectly illustrated by the success of layer combination, such as our Sculpt tank, a lightweight shelf [lift] top which paired beautifully with our Free To Be Zen and Energy bras.

As you will remember, we completely redesigned our pant wall a year ago.

The 11% comp we experienced in this category in Q3 validates the strength of our assortment, as this anchor category continues to resonate with our guests.

The Align pant, which uses our exclusive Nulu fabric, has become our number one pant style in less than a year.

Continuing to build on the Naked Sensation family, we just introduced a new lux fabric designed for high sweat and high intensity training.

The Like Nothing pants, made with new lux, landed in the top new five styles introduction, demonstrating that our focus and innovation results in fantastic guest demand.

In our men's category, we delivered another mid-teens comp in Q3, consistent with the momentum from the first half of the year.

We continued to see strong performance with our key franchises, ABC Construction, Metal Vent, and shorts; and as we focus on innovation and expanding our product offering, we showcased the collaborative creation process with our athletes through the voice of our Advanced Concepts team.

The story highlighted our technical outerwear focused on thermal regulation, breathability and active layering systems, along with the design and craftsmanship of the garments.

The outerwear collection was designed for cold weather workouts, as well as urban commuting and travel.

At the pinnacle of our innovation, we were excited to introduce the Einn Shell, engineered from a single pattern piece to reduce weight without sacrificing function.

Our white space R&D team worked out the critical attributes, minimizing weight and construction in the garment while achieving the highest level of performance in an outdoor environment.

Turning to the key strategies that will drive the success of our five-year plan.

I will now highlight our progress within product innovation, international expansion, building our digital ecosystem, and last but not least, maximizing our North American potential.

Starting with product innovation.

Our design vision continues to cut through with the application of more intentional and beautiful craft details grounded in function.

These details are what sets us apart and what our guest continues to expect from us.

We introduced new outerwear and texture in our Restless series, which is an expansion of our women's seamless assortment.

And we continue to stand for our critical fabric innovation for sweat across both women's and men's.

While I cannot completely share the floor plan with you, what I can tell you is that we'll be coming up with fantastic innovation in the bra category in 2017.

Earlier this year, we opened our second lab concept on Bond Street in New York.

Bringing our lab innovation to a broader audience for the first time, we launched a splatter reflective run collection both in our lab and online in October.

The collection featured raw materials and prints that created a unique texturized reflectivity.

We also launched a capsule of mens' products in our lab store online, which offered a variety of new silhouettes including the Vector jacket, a hybrid design that combines a button down shirt and jacket.

Our labs, both in Vancouver and New York, are incubators for design, innovation and style exploration, and our lab strategy is gaining momentum, stretching beyond just two locations.

You can expect to see the presence of lab-inspired product and design offered online and in selected locations in the future.

This winter, we are introducing specific innovation for men, with abrasion resistance yarns and thermal regulating benefits.

Expanding on the Metal Vent Tech franchise, we're excited to introduce Metal Vent Tech Wool, which is a wool yarn technology to keep our guests warmer and dryer during their athletic pursuits.

Turning to international.

We are accelerating our expansion in China by densifying our presence in Shanghai and Beijing.

This month, we will be opening our first three stores in China.

We are putting two stores in Shanghai, the first at the financial hub ISC Center with an outstanding 2,150 square foot location.

Our second store in Shanghai will be located at Kerry Center, a 2,250 square foot location on Nanjing West Road.

This premium area for shopping and business hosts a blend of local and western culture, and both locations will benefit from a high volume of qualified traffic.

Building on these first two locations, we're planning to open two to three additional stores in Shanghai next year.

In Beijing, we will open our first store in Sanlitun in the next few weeks.

And to further accelerate our presence in China, we are also launching our local [Doxien] site later this quarter.

I'm flying off to Shanghai tonight to be with our team and I'm proud of what they've accomplished in a short amount of time, growing this important and strategic market.

These openings are happening on the heels of our performance on Alibaba's Singles Day on November 11, the world's largest online shopping day.

Our [TIMO] site greatly exceeded our expectations, generating over 10,000 orders in one day.

In Europe, we are opening our international flagship store on Regent Street in London mid-January 2017.

This iconic 8,200 square foot location is one of the best shopping streets in the world.

To build momentum and celebrate the opening, we will be releasing a limited collection of product designed in collaboration with Central Saint Martins, where students and our in-house concept team partnered to create a print and textile capsule collection that draws inspiration from the great outdoors and nature's perfect imperfections.

These fantastic locations in both China and London will be key in continuing to build international brand awareness.

Moving to our digital strategy.

Our focus has been on bringing to life our design vision sold through a combination of engaging storytelling, personalization, and product assortment, while making the commerce experience scalable, easy, and frictionless.

We continue to leverage our CRM engine to drive digital marketing campaigns, local store activities and events with deeper segmentation and knowledge of our guests, further enhancing our guest loyalty and experience.

By using a channel agnostic model, digital continues to boost the success of all of our channels.

In Q3, we launched store inventory look-up on our mobile app and website, allowing our guests to see what inventory is in our stores, as well as the ability to ship from stores.

We've also extended our platform globally, having completed our website redesign with the launch in EMEA and Asia Pacific, giving our guests a seamless experience.

Finally, with our North American business, we continue to optimize and grow our store portfolio through a combination of standard store, expanded co-located stores, and locals that are uniquely tailored to their market and community.

I'm particularly thrilled with the continued success of our expanded co-located stores.

This approximately 5,000 square foot location allow us to showcase a broader assortment of the men's lines.

In Q3, we reopened our Yorkdale store in Toronto, situated in one of Canada's leading luxury malls.

In addition to an expanded men's area, the stores include a personal shop service where guests can receive one-on-one personalized consultations and fit session.

Since the store opened, sales are up 35%, while the men's business has increased over 60%.

In the US, we just reopened Scottsdale Quarter, the Wednesday before Black Friday.

The store is now 60% larger and so far, we've seen similar performance.

We also opened our first three locals, which are locations under 2,000 square feet that allow us to enter intimate communities, create unique and curated experiences, and build our brand.

These locations are in Fort Collins, Colorado; Bend, Oregon; and Sun Valley, Idaho.

We've seen tremendous is success from our locals concept and have plans for additional locals next year.

We believe that this is a strategy that can apply anywhere in the world and is an exciting evolution of our showroom model.

As is evident with our locals, engaging with our community and our guests in a unique and relevant way remains a powerful tool and differentiator for us in the marketplace.

We are staying connected with our guests in unique ways.

Our Sweatbox in New York City, which is a mobile pop-up complete with a treadmill, provided new guests with an opportunity to test our new, run-specific technical gear.

And as many of you have seen on various social channels, we kicked up the holiday with the Air Out There campaign.

Building on this campaign, we also launched lululemon's first-ever winter guest lookbook, which showcases our cold weather technical gear with breathtaking images shot in Norway.

With all of our strategic initiatives gaining momentum, we are on track to deliver on our long-term goals, and this would not be possible without an amazing team of leaders who inspire me every day with their passion for lululemon and what our collective stands for.

With people in mind, I'm excited to announce some important organizational updates.

I'm thrilled to share Celeste Burgoyne's promotion to EVP Americas Retail.

With over a decade at lululemon, Celeste is a powerful leader who embodies our culture, values and consistently delivers exceptional results as she leads our largest team and operations.

The Americas remains a critical part of our future and I could not envision a more inspiring leader to continue unlocking this potential.

Sun Choe has joined lululemon as our Senior Vice President of Global Merchandising.

Sun has an extraordinary background leading global merchant teams, coming to us most recently from Mark Jacobs, where she held the role of Chief Global Product Merchant.

Sun will be instrumental in partnering with our design and innovation teams to continue to refine our merchandising capabilities and bring our design vision to life globally.

Gregg Hurley joins us in Vancouver in the newly created role, SVP Global Store Design and Development.

Gregg will lead all of our real estate functions and setting the overall vision for store openings, relocations, and remodels.

Gregg joins us most recently from Tesla Motors, and prior to that, Apple, with over 20 years experience in international real estate, design and construction, to infuse innovation and push the boundaries to create one-of-a-kind experiences for our guests.

And joining us at the end of January is our new GM for EMEA, Garrett Pope, who will be based in our London office.

Garrett has built his career expanding the global footprint of well-known brands, having most recently served as Converse GM for EMEA.

Garrett's deep understanding of the European market will be invaluable in our international expansion.

In summary, I'm really happy with our continued progress and excited for the future.

The holiday season is what we gear up for all year, and I'm grateful for our thousands of educators who bring their passion, energy and commitment to build our collective around the world.

With that, I will now turn the call over to Stuart, who will review our financial results for the third quarter and provide guidance for the full year.

Stuart?

Thank you, Laurent.

I will start by offering some additional color and details on the third-quarter results, before discussing our current outlook for the fourth quarter and the resulting full year 2016.

The third quarter was an important period that marked the achievement of several milestones toward which we have been working for the last couple of years.

As Laurent mentioned, the gross margin results in the third quarter exceeded expectations, as our supply chain efforts to recover our product margins are now in full swing.

This recovery is continuing into Q4 and will extend into 2017 and become our new margin architecture.

We also posted a moderating SG&A rate increase, as expected, which enabled us to deliver strong flow-through on the continued top line momentum across all channels and regions.

The resulting 36% increase in operating profit and nearly 300 basis points of EBIT margin expansion speaks for itself; and we are pleased to see the story continuing into the current quarter, on which I'll offer details momentarily.

But first, I'd like to review the details of Q3.

Total net revenue rose 13.5%, to $544.4 million.

The increase in revenue was driven by several factors.

First, a total constant dollar comparable sales growth of 7%, comprised of a bricks and mortar comp store sales increase of 4% and an e-commerce comp of 16%.

We also increased total square footage by 11% versus last year, driven by the addition of 35 net new Company-operated stores since Q3 of 2015, 14 net new stores in the United States, 2 stores in Canada, 4 in Europe, 3 in Asia, 13 Aviva stores and offset with 1 store closure in Australia.

We continue to be pleased with the strength of our store portfolio, where we've seen positive comps consistently across all age classes since last year.

Foreign exchange had a minimal impact on reported revenues in Q3, increasing revenues by $700,000.

At the end of Q3, we also had a total of 56 showrooms in operation, 20 in international markets and 36 in North America.

Revenues from Company-operated stores totaled $393.5 million, or 72.3% of total revenue, compared to 73.7% of total revenue a year ago.

Revenues from our digital channel totaled $104 million, or 19.1% of total revenue, compared to 18.6% of total revenue in the third quarter of last year.

Other revenue, which includes outlets, showrooms, strategic sales, franchises, pop-up stores, and warehouse sales, totaled $46.9 million, versus $37 million in the third quarter of last year.

Gross profit for the third quarter was $278.4 million, or 51.1% of net revenue, compared to $224.8 million, or 46.9% of net revenue in Q3 2015, an increase of 420 basis points.

The factors that contributed to this outcome include a 450 basis point increase in product margin, driven primarily by higher merchandise margins from lower average unit costs and improved AURs.

Markdowns for the quarter had a nominal impact to product margin on a year-over-year basis.

We maintained a measured level of clearance activity across our channels in Q3, as we lapped the physical warehouse sale in Boston last year.

This ensured a healthy inventory position as we entered Q4.

We also saw continued success in expanding our ship-from-store program that reflects the evolution of our omnichannel model.

Specifically, we were able to leverage the clearance section of our website to move slower selling styles in over 80 of our stores at a superior margin than we would have otherwise.

This is a new capability introduced this year that we continue to scale.

We also saw 20 basis points of gross margin improvement due to foreign exchange.

Offsetting these improvements in product margin was 50 basis points of deleverage from investments in our design, merchandising, and supply chain functions that are included in our cost of goods sold.

Store occupancy and depreciation expense growth had a slight benefit to gross margin for the quarter.

SG&A expenses were $185.5 million, or 34.1% of net revenue, compared to $156.6 million, or 32.7% of net revenue for the same period last year.

The 140 basis point increase in SG&A rate was driven by increases in store and overall employee costs, including annual incentive and stock-based compensation expenses, continued investments in areas such as digital, brand and IT functions, and investments to drive top line, such as digital, marketing, product campaigns, and related brand marketing costs.

These were offset with an increase in net foreign exchange gains compared to Q3 2015.

As a result, operating income for the quarter was $93 million, or 17.1% of net revenue, compared with $68.2 million, or 14.2% of net revenue in Q3 2015, an increase of 290 basis points.

Tax expense for the quarter was $25.3 million, or 27% of pretax earnings, compared to 18.6% a year ago.

In the third quarter this year, we recorded a $4 million recovery that is connected to the Company's transfer pricing arrangements and an associated repatriation of foreign earnings.

This compares to a tax recovery adjustment in Q3 2015 of $7.7 million.

The effective tax rate for the third-quarter 2016, excluding the above tax adjustments and associated interest costs, would have been 31.3%.

Net income for the quarter was $68.3 million, or $0.50 per diluted share.

This is compared to net income of $53.2 million, or $0.38 per diluted share for the third-quarter of 2015.

Excluding the tax and related interest adjustments, diluted earnings per share in Q3 would have been $0.47 compared to $0.35 last year, or an increase of 34%.

Our weighted average diluted shares outstanding for the quarter were 137.2 million, versus 140.5 million a year ago.

This reduction is due to our recent stock repurchase program that was completed in Q2.

At our recent Board meeting, we received approval to repurchase an additional $100 million of our common shares in the open market at prevailing market prices.

The program is intended to create shareholder value by making opportunistic repurchases during periods of favorable market conditions.

The timing and actual number of shares repurchased will be dependent on market conditions and other factors.

And finally, capital expenditures were $34.9 million for the quarter, compared to $42.9 million in the third-quarter last year.

Turning to our balance sheet highlights.

We ended the quarter with $480.4 million in cash and cash equivalents.

Inventory at the end of the third quarter was $364.5 million, or 2% higher than at the end of the third-quarter of 2015, reflecting an 8% decrease in inventory per square foot.

We expect our inventory growth at the end of the fourth quarter to now be more in line with our forward sales trend, which also takes into account in-transit inventory movement to manage around the product flows during Chinese New Year.

Now turning to our outlook for Q4 and the resulting full year 2016.

Like many others, we experienced a slow start to Q4 in the first three weeks of November.

Since then, we've seen a strengthening trend into week four, with the Black Friday weekend and Cyber Monday being particularly strong and continuing into December.

While we are encouraged by the recent trend and believe we will deliver a mid-single digit constant dollar comp for the fourth quarter, we are updating our guidance to reflect a Q4 revenue range of $765 million to $785 million.

This revenue range also reflects the opening of 15 net new stores in the quarter and a Canadian dollar at $0.74 to the US dollar, which is $0.03 lower than the $0.77 assumed in our prior guidance and an approximate impact of $5 million to our prior revenue guidance.

The gross margin inflection that began in Q2 and Q3 is now extending into Q4.

For the fourth quarter, we anticipate gross margin to increase by approximately 300 to 350 basis points over Q4 of last year.

The improvements in our supply chain efficiencies and product costing that accounted for the Q3 gross margin expansion are the same factors now driving these improvements in Q4, again offset by slight deleverage in occupancy and depreciation and also in product and supply chain costs.

We expect SG&A in the fourth quarter to delever by approximately 150 basis points.

This SG&A outlook reflects investments associated with brand marketing, digital and IT areas of the business.

Assuming a tax rate of 31.2% and 137.3 million diluted weighted average shares outstanding, we expect diluted earnings per share in the fourth quarter to be in the range of $0.96 to $1.01 per share, versus normalized diluted earnings per share of $0.85 a year ago.

For the full year 2016, we expect revenue to be in the range of $2.32 billion to $2.34 billion.

This is based on comparable sales percentage increase in the mid-single digits on a constant dollar basis.

We expect to have open 42 Company-operated stores by year end, which represents a square footage increase of approximately 11.5%.

We expect gross margin for the year to increase from 2015, driven by the significant improvements in our sourcing and supply chain structure.

We expect deleverage in full-year SG&A versus 2015, driven by the strategic investments that were mentioned earlier, principally in supply chain, brand, digital, CRM, and IT systems, along with the net FX revaluation losses incurred so far this year.

Importantly, as our infrastructure investments moderate into next year, we expect to see a modest level of SG&A leverage in 2017, while still continuing to invest in our critical growth strategies.

We will provide more specific guidance for 2017 as part of our Q4 call.

We now expect our FY16 diluted earnings per share to be in the range of $2.18 to $2.23, or $2.11 to $2.16 normalized for the tax and related interest adjustments incurred this year.

This is based off of 137.3 million diluted weighted average shares outstanding and also assumes an effective tax rate of 28.2%, or 30.9% on a normalized basis.

We expect capital expenditures to range between $165 million to $170 million for FY16, reflecting new store openings, renovations, relocation capital, IT, supply chain and head office capital investments.

With that, I will open up the call for questions.

Operator?

(Operator Instructions)

The question comes from Brian Tunick of RBC.

Thanks.

Good afternoon and congrats, everyone.

First question for Stuart.

I think you talked about 300 basis points of gross margin opportunity to recover from the 2014, I think, year-end level.

So just wondering, given what we've seen here, given what you're commenting on from Q4 guidance, any thoughts on a timing perspective of recapturing the 300 basis points, or are there other levers to pull?

And similarly on the pricing side, now that you're going to be lapping some of the price increases from Q4 last year, are there any elasticity or category learnings you can share with us on what you're seeing on your increased pricing?

Thanks very much.

Brian, it's Stuart.

So absolutely.

On the first question you have there on the gross margin recovery, first we're really pleased with what we've seen in the quarter.

The most recent quarter exceeded our expectations.

As we look at the original goal that we had of recovering the 300 basis points of product margin from 2014, and I'll remind you that was excluding the impact of FX, we are in the third quarter now in that range of recovery.

And we expect to see that extend certainly into the fourth quarter and into, I would say the greatest degree of inflection will occur in the second half of this year and into the first half of next year.

And I think that's consistent with how we have framed it previously for folks.

So we're pleased to be on track for that level of gross margin recovery.

We believe that beyond the middle of next year, it becomes a structural element of our business model.

We will see more modest improvements from that point forward, and it connects to our broader five-year goal we had outlined back in March of achieving a $4 billion business by 2020, with our gross margin starting with a 5 and our EBIT margin starting with a 2. So I think this is an important milestone for the Company and an important step in achieving that level of profitability and affirming very positively the progress against those goals.

And then on to your other question regarding pricing.

We have really over the last, I would say, 12 to18 months built a new muscle within the Company within our merchandising team around pricing.

And it started with a very important project that BCG led for us and actually helped us step from that project, away from not just understanding where our pricing architecture fits within the industry, but also helping us build the internal processes so that we can have a more sophisticated approach to how we price our goods.

I would say we certainly benefited from that over the last, call it, 12 months.

But as we look forward, the AUR improvements that we will see are not simply just raising prices.

It becomes a more robust process where we look for opportunities from a mix standpoint that will improve AURs, not just this year but going forward.

So where we see opportunities to evolve the mix of our business, those can and often will bring with them AUR upside, and it doesn't necessarily mean a price increase.

So I think that's an important part of the business model that we need to help folks understand.

From an elasticity standpoint, we're very pleased with what we saw from some of the more meaningful price moves that we made end of last year into this year.

We've made more measured moves in other regions, including Canada, and we're still collecting and evaluating those additional pricing moves.

So overall, very pleased with the results of those specific moves, but even more importantly, pleased with the new capabilities regarding pricing that we've developed within the Company.

And Brian, I would remind everybody that a lot of our pricing strategy and the expansion that we've made have been driven by innovation.

So when you look at us launching the Nulu fabric and the [alignment] last year or the Nulu fabric, when we deliver innovation to our guests and when they see the value, we actually see very little resistance.

So those pricing, the pricing strategy has been driven, for the vast majority of the product, by innovation.

All right.

That sounds super.

Thanks again.

The next question comes from Matthew Boss of JPMorgan.

Thanks, guys.

Nice quarter.

Thank you.

So as we think multi year, what's the best way to break down your mid-single digit total company same-store sales target; meaning what kind of growth are you embedding between tops, bottoms and men's to hit that mid-single digits on a multi-year going forward?

Hi, Matt.

It's Stuart.

So we certainly feel like that level of comp is sustainable, and that's how we think about our top line picture over the next five years.

And as we had shared, we see our men's business growing in penetration somewhere in the ballpark of 25% of the total by 2020.

That implies a faster growth pace for men's.

The double digit comps that we've seen in men's, we feel like we're just getting started.

And we're thrilled with the momentum that we have in men's, but we see a tremendous amount of opportunity in front of us in that business.

We've also been really pleased with the momentum that we've seen in women's pants.

We had a very successful pant wall launch last Q3.

I think Laurent mentioned in his prepared remarks, we posted a double digit comp in women's pants in the third-quarter of this year.

We're seeing really strong momentum in women's pants into Q4, which really speaks to our ability to comp that business and drive innovation into our products consistently.

And Laurent mentioned some of the new fabrics and new designs that we have in women's pants.

Maybe I'll pause there and give the floor to Lee to maybe speak a little bit more about some of the innovation in our product strategy that will drive that mid-single digit comp.

Yes, I think it's just really exciting, as you see Q3 come to fruition, just seeing a pipeline of fabric innovation that's coming to our guests.

And I think this is just the start of the journey.

You can see how we're bringing it to our women's pant business from 12 months ago, with Nulu and new lux come in and you're going to see that being achieve scale and maximizing in 2017.

But then just getting into the men's business, you'll see releveraging our franchises around ABC, the Metal Vent and also our technical shorts, and adding innovation as we go through the year.

So I'm really excited about the team's work and how we're bringing that together.

And I think on the men's point, just recently, recruiting Ben Stubbington into the Men's Senior Vice President job really actually elevates our talent across the leadership in design and merchandising.

And so I'm really excited about the future and this is just a starting point of how we land innovation to our guest.

Great.

And then just a follow-up.

As we move forward, what's the best way to think about square footage growth into next year versus the low double digit pace this year, and just the profitability of international today and the opportunity as you see it?

So Matt, on the square footage question, I think what you're seeing in 2016 is the pace of square footage growth we would expect to see going forward over the next few years.

The mix of how we will deliver that will evolve, obviously.

We're really pleased with the progress in China, in particular.

And that will become a growing and more important part of the square footage growth story.

Maybe I'll let Laurent speak to the international strategy.

As far as international, we talked in the remarks about the acceleration in China and the densification in Shanghai and Beijing.

So I'm really, really excited about that and really excited about the location that the team has been able to secure.

And I'll see that, I'm flying there tonight.

And so we had said that by 2017, we'd have about 20 stores, both in Europe and in Asia, and we'd be breaking even by the end of 2017.

I think that statement is totally irrelevant.

We're going to see an acceleration in Asia, where we've had a lot of momentum and greater level of profitability.

In Europe, we're going to be a little bit more patient.

But the overall international picture really remains the same.

Great.

Best of luck, guys.

Thank you.

The next question comes from Oliver Chen of Cowen and Company.

Hi.

Congrats on really solid results.

We had a question.

Your omnichannel experience has really gotten much better and more exciting and more of a lifestyle picture.

What do you think about the long-term prospects of how you will strategically utilize the we made too much, in terms of just making sure that you stay brand appropriate as you engage in using that as an efficient way?

And Stuart, on the markdowns for Q4, what are you incorporating in terms of markdowns versus last year for Q4?

It has been a tough industry environment for traffic volatility, so curious about your thoughts there.

It sounds like your inventories are really under control.

And Laurent, I had a question on tops.

We were in the stores today and we've seen a lot of nice moves towards the flowy, away from built in, but built in also having a strong offering.

Is that a permanent shift that you're seeing or is it seasonal or cyclical?

Would love your thoughts.

Thanks.

So thanks, Oliver.

I'd love to answer the question on tops.

I think Lee is going to do that much better than I will, so I'll let him speak to that.

But quickly on your question, on the we made too much.

Our strategy is really clear.

We're not making product for that section.

We're not planning with that section in mind.

And I think actually what we've seen recently, with being able to leverage the store and the ship-from-store actually allowing us to use that section to really clean up our inventory at higher margins.

So I'm really, really pleased with that.

So it's a matter of being really agile and using it as a really efficient tool and certainly building not that as a category, or as a section, that we rely on.

So on the why we made too much.

Maybe Stuart can chime in on the second part of your question, and then Lee can talk about tops.

Sure.

Yes, and Oliver, on the we made too much, so we're going to continue to leverage the various levers that we have to clear inventory that you're aware of.

And we're just really pleased to have this new capability with ship-from-store that enables us to move this inventory, these slower moving styles more efficiently at a higher margin with a great guest experience.

So this is, I think in the quarter and what's been written, I think this is one of the most misunderstood parts of our business model right now.

And so you simply, you can't simply look at the style count on the clearance page of the website.

It's not an apples-to-apples comparison to last year, or even last week, as we are continuing to add new stores into the program.

We're up to over 80 stores that participate in that today.

And we'll obviously continue to evaluate what the most effective presentation of that page is and balance that with the overall experience for the guests on the website.

But again, really pleased with the results and I think it is reflected in the margin results and certainly the markdown results that we just reported.

And on the tops, thank you for recognizing the shift that we've made.

And it's really had a focused team cross-functionally to work on our tops business.

And it really came down to leading with sweat, with innovation and having a balanced assortment, from shelf to shelfless tanks.

We're leading with, obviously, our Skull tank.

But as you can see on the comps in our bras, really going back to some of our key franchises from Free To Be, the Free To Be Zen that we introduced and the Tranquil, and then how then are our guests wearing our tops together.

So having a really diverse portfolio of fabrics from Pima cottons to some of our silver innovation platforms, but really getting close to our guests, understanding how people are sweating in transition for their day, as people are leading more of a, moving more in their lifestyle.

So really tapping into that, but really around a balanced assortment.

So really happy about where we are and also the future opportunity around tops.

Great.

Happy Holidays.

Best regards.

Thank you.

The next question comes from Paul Lejuez of Citigroup.

Thanks, guys.

As of last quarter, I think you had a few regions in Canada that were underperforming.

I'm curious if you've seen any improvement in those regions.

And maybe also more broadly, can you talk about US versus Canada performance and particularly on the traffic side?

Thanks.

Hi, Paul.

It's Stuart.

So yes, I think we had mentioned the underperformance in certain parts of Canada, the oil producing regions have been challenged just from a broad macro economy standpoint.

That generally continues to be the case.

Canada overall in the third quarter performed well, even with the soft trend in Alberta, in particular.

And so as a result, there wasn't really a headline to call out in terms of Canada outperforming or underperforming the US in the third quarter.

And so as we look forward into the fourth quarter, we've seen the choppy trends that we have described in the prepared remarks and we're looking to lean in and drive the business where we see opportunities geographically.

And we've seen some important store optimizations in Canada.

I think we had three in the third quarter, two in the US.

The Toronto optimization, in particular, was a very successful one.

So we're pleased with how we're being able to find opportunities to evolve in the square footage strategy in Canada, where we probably didn't see as much opportunity previously.

And there's obviously more opportunity yet remaining in the US, from a square footage standpoint.

So I think those are the headlines I'd call out.

Laurent, I don't know if there's anything else you'd add?

Well, the only thing I would say from a Q4 standpoint in Canada, that I just recently visited a number of stores.

And I think we've done, first of all, our people are incredibly energized.

The store looked great.

And we've had a real focus on continuing to really engage with the communities and a real focus on visual merchandising in some of the windows.

So I think that as I said earlier, like the holiday season is what we gear up and the energy that I've seen in the store and how good the stores look really give me a lot of confidence in our people's ability to really maximize that season that we love the most.

And any color on the traffic trends, Stuart?

Yes.

On traffic, first, as we've said, we've been pleased with our comps and how we drove them over the course of the full year, not just Q3.

And this has really also supported our margin outcome.

And our focus with regard to traffic is in driving quality traffic to support a premium full price business.

We're not simply going after every last bit of traffic possible.

We're driving comps with higher AURs in a very healthy way for our brand.

That said, while our store traffic is slightly negative, it is consistent with the trend we've seen throughout the year and is substantially better than most of what we see reported in the industry broadly.

And the traffic that is out there today tends to be more serious about making purchases and not just window shopping.

So we are still seeing healthy traffic from these guests.

And as we look into Q4, there's really no reason that the Q4 traffic or the composition of our comps should be should really be that much different than it has been all year.

So I think those are the headlines on traffic and why we remain confident in our comp trends.

And when you think about traffic, obviously you have the macro environment is what it is and we think it will stabilize.

It's interesting to see the balance of online and brick and mortar and how it's happening.

Think about Amazon Go just launching their grocery store, right?

So we think it will stabilize.

And we're not waiting for it to stabilize.

I think that's what we are really thrilled to continue to really push the co-located expanded format officially, as we grow the men's business and we see the acceleration, and as we grow the assortment.

So those co-located stores, we know we've got highly qualified traffic.

They are very vibrant communities, so that's really, really powerful.

And then on the flip side, the locals, where we can be very nimble and very agile in entering some communities and leveraging our digital ecosystem to continue to drive traffic.

So we're not waiting for the macro environment to gel.

We think it will stabilize and we're taking steps.

And then I would add that on game days and during the holiday season, we know how to drive traffic and our people are the best at that.

On Black Friday, we had a plus 16 comp in the US, and on Cyber Monday, a plus 29 comp.

And I think what's most exciting in those comps is that the full price comps who are very similar to the overall comps, so that really speaks to not only our ability to drive traffic, but also our ability to continue to be the leading brand that sells its merchandise at full price.

Thanks a lot, guys.

Best of luck to you.

Thanks, Paul.

The next question comes from Betty Chen of Mizuho Securities.

Thank you.

Good afternoon.

Congrats on a great quarter.

Thank you, Betty.

I was wondering if we can talk a little bit about ivivva.

The stores that we've seen, they look terrific, seems like there's growing brand awareness, certainly that seems to be another big opportunity for the company as a whole.

Can you talk about what you're seeing there, any comp trends and any latest thoughts around productivity and openings?

Thanks.

Yes, we're actually really excited about ivivva.

One thing that I did not mention on the call is Kristy Maynes, who was running Europe and who's been with us for quite a few years and is a very strong operator who was running Europe, recently relocated back in Vancouver and is leading the charge at ivivva.

So for the first time, ivivva, if you looked at a standalone brand with a general manager.

And we're thrilled to have her run this brand reporting into Celeste.

And that's why we have Garrett coming in Europe.

And so I think that the goal in 2017 is really to accelerate both the growth, but also the profitability of ivivva by being a separate brand and being a guest that we've got between the ages of 8 and 12, is how do we maximize the [foyer] that we've got with this young guest and really looking at disrupting the model a little bit; so continuing to have this amazing experience, but how do we do that differently and more profitably?

So really continuing to push what we do best with ivivva, which is engaging with that demographic, but really, also having permission to disrupt the model and potentially look at different distributions and different categories.

So you'll see accelerated profitability in FY17 and probably some evolution of the business model.

The next question comes from Ike Boruchow of Wells Fargo.

Hi, everyone.

Congrats.

Great quarter.

Thanks for taking my question.

Thank you.

Stuart, I guess you talked about being able to leverage the clearance section on the website, move slower selling styles in 80 of the stores.

I'm curious, is there a plan to move that technology into the remaining 300 stores?

And if so, is there timing behind that?

And then just a quick follow-up.

You talked about brand marketing as a driver of the higher SG&A in Q4.

Just curious, more color on that, is that overseas marketing, is that domestic and then how do you think about your marketing spend as we go into 2017?

Thanks a lot.

Yes, Ike, so on your first question, the number of stores that will participate in the ship-from-store is still a moving target.

I would not necessarily expect that every store would necessarily participate in it.

As we look at the size of the stores, the density of inventory, and we set the parameters for what makes sense in terms of how we will be able to tap that inventory reliably to support web sales, we're still landing the exact algorithm for which stores are going to be good candidates to participate.

So certainly, suffice it to say, we'd like it to be as many as possible.

There's not a set timing, other than I would expect it will likely unfold probably over the next 18 months, we'll land what the full penetration of store participation could look like.

But that's something we can certainly continue to keep you abreast of.

On your second question, with regard to brand marketing, we have, as Laurent mentioned, we have a powerful and disruptive community marketing model.

And that's something we're continuing to invest in aggressively.

And so it's the elements of the model that you're familiar with, in terms of how we get our educators into our communities to make those connections with our guests and ambassadors, just continuing to evolve that model.

But then there's also investments that we're making from a brand standpoint to continue to explore are there new ways that we can maybe be louder in how we communicate the brand outside of those well time tested community model strategies, are there other ways we can leverage a brand marketing voice.

So we've invested into that into the second half of the year, with the team here led by Duke Stump.

And so that's something that we'll be looking to expand and test in different ways into next year.

So more to follow on that, likely on the Q4 call.

But that's something that's really coming together, as we speak.

Got it.

Operator, we have time for one last question.

Thank you.

The next question comes from Jessica Schmidt of KeyBanc.

Hi.

Thanks for taking my question.

Can you talk about the competitive environment and the higher end yoga athletic category, and with some of the new products you launched with the new fashion and technical components, do you think that these innovations are helping you maybe regain share?

So Jessica, yes, the competitive environment is, it's crowded.

It's a crowded space.

And certainly on one hand, we believe that it's growing the overall size of the pie, if you will.

And I think as Laurent had mentioned on previous calls, we view athleisure as a trend, and like all trends, it will come to an end at some point.

And those competitors who are not in the business in a high quality manner, they're going to go away.

So we view ourselves as, in many ways, a technology company that is investing in innovation to drive our business.

And the pant wall launch last year and the continued investments in innovation that we have this year to continue to drive the business in that regard exemplifies when we invest in innovation, we win.

I think it's really important to differentiate from the athleisure trend and how people want to live their life.

And I think that lululemon is the only brand out there that is truly a metaphor for how people want to live their life and how they want to move.

And that's true across gender, that's true globally, and we really actually don't see that lifestyle changing any time soon.

So you could argue that either the space is really crowded and we have a lot of competitors, or we have very few.

And as long as we focus on function and innovation and delivering value to our guests, we really don't see any risk to the market that we've created and the market that we continue to lead.

So I get really excited when I look at the runway of innovations, the categories that we can get into and the global footprint that we're building.

And also I think, just at the moment, and you'll see it as you go through the upcoming season, just really heightened focus on building a pipeline in innovation.

And at lululemon, it's very unique in the sense of we have an innovation team from the white space, but also Advanced Concept, and also we have different avenues of how we're building innovation, from our lab strategy, also how we're gathering information from our ambassadors constantly and just really building out our pipeline.

And I think you're going to see it come to fruition and really around seeing scale maximize.

And I think the Nulu fabric is a good example of that, 12 months ago being a launch and now being our number one pant product.

And I see that for new lux, as well, and really building around that sensation of naked and how you can build out in different areas of our business going forward.

So I'm really excited about leading with innovation that really separates ourself from the market.

Great.

I'll pass it along.

Okay.

Thank you.

Thank you.

This concludes time allocated for questions on today's call.

I'll now turn the conference back over to the presenters for any closing remarks.

It was good.

Thanks again, everyone, for joining us today.

Have a wonderful holiday and look forward to speaking again next quarter.

Thank you.

Thank you.

This concludes today's conference call.

You may now disconnect your lines.

Thank you for participating.

Have a pleasant day.