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Lululemon Athletica (NASDAQ:LULU)

Q4 2013 Results Earnings Call

March 27, 2014, 9:00 AM ET

Executives

David Negus - Vice President and Corporate Controller

Laurent Potdevin - CEO

John Currie - CFO

Tara Poseley - Chief Product Officer

Analysts

Anna Andreeva - Oppenheimer & Company

Adrienne Tennant - Janney Capital Markets

Lindsay Drucker Mann - Goldman Sachs

Omar Saad - ISI Group

Brian Tunick - JPMorgan

Camilo Lyon - Canaccord Genuity

Kimberly Greenberger - Morgan Stanley

Jaime Katz - Morningstar

Howard Tubin - RBC Capital Markets

Jim Duffy - Stifel Nicolaus

Matthew McClintock - Barclays

Faye Landes - Cowen and Company

Oliver Chen - Citigroup

Janet Kloppenburg - JJK Research

Operator

Good day, ladies and gentlemen, and welcome to the Lululemon Athletica Q4 2013 results conference call. [Operator Instructions] I would now like to introduce your host for today’s conference, David Negus. You may begin.

David Negus

Good morning everybody, and thank you for joining us on the fourth quarter 2013 conference call. A copy of today's press release is available on the investor 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 section of the website. Hosting our call today is Laurent Potdevin, the company’s CEO, and John Currie, the company’s CFO. Tara Poseley, our chief product officer, will be available during the Q&A portion of the call.

We would like to remind everyone 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.

For today’s call, we’ve got a limit of one hour, so please limit yourself to one question at a time to give others the opportunity to have their questions addressed. And with that, I will now turn it over to Laurent.

Laurent Potdevin

Good morning, everyone. When I spoke to you back in December, at the time of my announcement as CEO, I shared my excitement and enthusiasm about joining and leading such an exceptional brand and group of people. After another couple of months under my belt, I’m even more inspired, as I have started to discover the lululemon culture, the passion, the energy, and the commitment of its people.

I have worked with exceptional individuals and fantastic brands over the past 20 years, and the connection and engagement of the team at lululemon both in the stores and here in Vancouver is clearly unique. As we move into 2014, we are reflecting on our learnings with humility and are entirely focused on our future.

2014 is an investment year, with an emphasis on strengthening our foundation, reigniting our product engine, and accelerating sustainable and controlled global expansion. Lululemon’s magic has been built by creating technical, beautiful products and sharing our distinct culture with our community.

The emotional connection that lululemon creates is at the very heart of what we stand for, and we are being relentless in our commitment to delivering a distinct and authentic experience for our guests that is unlike any other.

Lululemon is an originator brand, and we are refocusing our energy as a relevant disruptor in the space we created. It means being audacious, it means being curious, it means stretching our minds to invent the future, and deliver the exceptional product that our guests are expecting from us.

I plan to make sure all of our core values that make this business such a success remain in place and are leveraged and exemplified as we turn lululemon into a global brand for both men and women.

Looking forward, I see significant potential to grow both domestically and internationally as we leverage this company’s outstanding business model, and I intend to accelerate our global expansion. We see clear evidence of demand both in Asia and Europe, with several countries ready for stores, and we are currently onboarding in Vancouver our general manager of Asia, who is driving new store openings as well as [unintelligible] new markets, and who will be back in Hong Kong in the next couple of weeks.

Additionally, we have opportunities to develop partnerships to increase speed to market and accelerate our international expansion in regions that are either too complex or don’t have enough scale forward to have a direct presence in.

In Europe, we will be opening our first store in London next week. Our team on the ground has been celebrating with the community for several weeks now, including hosting yoga at the Royal Opera House. On Saturday, March 9, 700 people started queuing up for the event two hours before it started, and once the 350 spots were filled, the guests who didn’t get a spot were engaged in additional community activities like cheeky yoga. There are complementary yoga classes also throughout the City of London.

The enthusiasm from the community has been clearly contagious and I can’t wait to see it live next week. We have plans to open a second store in London by the end of 2014, recognizing there’s a tremendous platform to showcase lululemon not only in Europe but to the rest of the world.

As we embark on growing lululemon beyond our current footprint, we are strengthening our foundation to unlock our full potential. This means having our brand and our world-class product engine both back where they belong. Product has always been paramount to our success, and will remain at the very epicenter of all we do. Our product is [insane], innovative, technical, and beautiful.

Going forward, we are refocusing the organization on being design-led, about getting back to our roots and inventing the future, and we are doing that by fostering and promoting the healthy tension between technical innovation, style, function, and beauty. There will be no compromising, and it will bring out the best in us.

We are being relentless in building great product and are pushing technical innovation, through leveraging our vendor expertise in raw materials, development, and construction to capitalizing on our in-house capabilities with our new Whitespace workshop.

We are generating excitement at the store level with capsules and collaborations like our lab co-lab offering and most recently our &go capsule, which I’m sure you’ve read about, which enjoyed extensive [unintelligible] and premium athletic styling. The success of the &go capsule validates our guest’s appetite for progressive athletic products, beautiful [unintelligible].

Tara Poseley, our chief product officer, brings tremendous experience and an enormous amount of passion and vision to the product organization, and you will get a broader look into our product vision at the analyst and investor day in April. Her near-term focus is on the balance of our product mix, both core and seasonal, as well as our planning and allocation strategies.

As our business matures in North America, we see increased demand and success of our seasonal products that is taking a larger share of our overall product mix. Guests are responding so well to our seasonal product offerings that we’re experiencing sell through at a rate four times faster than anticipated.

Which brings me to our scarcity model. It’s always been a strength and we’ll continue to focus on it. While we don’t mind our guests being hungry for our product, we don’t want them to starve for it. Tara is working on short term solutions using our [unintelligible] to provide short term opportunity while bridging the gap with our long term product vision.

Impeccable quality is deeply rooted in our DNA. We are laser-focused on ensuring we have a world-class quality supply chain and [unintelligible] organization to support our current business and product platform for continued global growth.

As we continue to build on the great work that has been done, we are seeing a constantly increasing level of our product meeting our very high quality standards. Our ability to get this done over a short period of time is a true testament to the team’s effort, the strength of our vendors, and the partnerships we have with them.

This is further enhanced by the lululemon presence we have built on the ground, both in our mills and in our Taiwan and Hong Kong offices. There will be continued focus and investment in this area to ensure we’re building a product development platform that will allow us to unlock our full global potential.

I would now like to touch on an area that’s very close to me, and which I refer to as our treasure chest of amazing stories. In the past two months, there hasn’t been a day where I have not discovered an untold story that embodies the values of lululemon.

From our SeaWheeze half marathon race that sold over 10,000 spots in 66 minutes, with 45% of the guests registering from outside of Canada, to the unconditional support that we provide to more than 100 Olympians through yoga and goal setting, to the countless ambassadors, over 900 of them, that embody the best of who we are in communities across North America, there are so many examples of how we connect with our community, and what we stand for as a brand.

We’ve been voiceless for too long, and I’m anxious to have all of us share more broadly who we are and what we stand for, with confidence and humility. We have created a category of fantastic products, and our guests and ambassadors have been studying our methods since day one.

Up until last year, our grassroots communication strategy delivered exceptional results. Now is the time to amplify our voice [unintelligible] our grassroots approach and ensure that we claim back our share of the voice in the market we created.

Lululemon is an incredibly human brand that makes people cry, laugh, and love. Those of you who saw the “No Humbug” video that we shared at the ICR conference, or who have seen our “Made in Sri Lanka” video on the website will know what I’m talking about.

This past week alone, I attended TED, which made its debut in Vancouver, and I was so proud that we provided TED participants with a true lululemon experience daily, morning and afternoon, by creating a wellbeing program featuring many of our incredible ambassadors, including Ryan [unintelligible], Maria [unintelligible], and New York City’s very own Taryn Toomey, founder of The Class workout. Taryn certainly found a way to kick my butt and inspire me at the same time, and for those of you in New York, I dare you to attend her class.

During the five-day conference, we provided more than 25 classes, including yoga, run, and meditation, in both Vancouver and [unintelligible]. This ability to authentically connect with our communities is what makes lululemon unique, and you can expect to hear more of this in the year to come.

Another strategic focus that we are activating immediately is how we engage with our guests across all touchpoints, both in stores and online. Our guests are passionate and loyal, as [unintelligible] in many stores and [unintelligible] across our social channels.

The minute we add exciting new seasonal product to our assortment, the response from guests is astounding. However, unlike a few years ago, we are not the only game in town, and while we created this category and continue to lead it, we understand that our guests have choice, and sustaining that loyal relationship is a priority.

I believe this will come from ensuring that we really focus on creating a best in class guest experience. The strength of our vertical model is having a direct response with every guest, allowing us to be innovative, distinct, and authentic in our interaction. And we are investing in technology that will help us better understand our guests and deliver a seamless yet personalized experience.

Our 10,000 educators who are 100% committed to delivering an outstanding experience had to play defense for most of last year. We are now empowering them to drive the business in their local markets with an emphasis on listening and delighting our guests and bringing forward the passion, the caring, and the creativity that have set lululemon apart.

In closing, 2014 is an investment year. We are returning to our design-led roots, fine tuning our supply chain and sourcing, providing an exceptional and inclusive guest experience, and finally sharing the stories of who we are and what we stand for, with confidence and humility. And with that, I will turn it over to John to go through the quarter and provide guidance for 2014.

John Currie

Thank you, Laurent. I’ll begin by reviewing the details of our fourth quarter of 2013, and then I’ll update you on our outlook for the first quarter and the full year of fiscal 2014.

For the fourth quarter, total net revenue rose 7.3% to $521 million, from $485.5 million in the fourth quarter of 2012. The increase in revenue was driven by the addition of 43 net new corporate owned stores since Q4 of 2012. Out of those, 33 new stores were in the U.S., two stores in Canada, four stores in Australia and New Zealand, and four new ivivva stores.

Direct to consumer sales, which increased by 24.9%, or $19.5 million, offset by comparable store sales decline of 2% on a constant dollar basis. And on a combined basis, including both physical stores and ecommerce, our total cost increased 4% on a constant dollar basis.

A weaker Canadian and Australian dollar, which had the effect of decreasing reported revenues by $13.4 million or 2.6%. And finally, a reminder that there was an additional 53rd week, which contributed $26.2 million in total sales during the fourth quarter of 2012.

During the quarter, we opened four corporate owned lululemon stores in the U.S., one in Canada, one in New Zealand, and one ivivva store. We ended the year with 254 total stores versus 211 a year ago. There are 199 stores in our comp base, 39 of those in Canada, 129 in the United States, 23 in Australia, and 8 ivivva.

At the end of the year, we also had 69 showrooms in operation, 17 of them outside of North America, 2 in Australia, 6 in Asia, and 9 in Europe. Corporate owned stores represented 75.9% of total revenue, $395.2 million versus 77.9%, or $378 million, in the fourth quarter of last year.

Revenues from our direct-to-consumer channel totaled $97.8 million or 18.8% of total revenue versus $78.3 million or 16.1% of total revenue in the fourth quarter of last year. Other revenue, which includes wholesale, showrooms, and outlets totaled $28 million or 5.4% of revenue for the fourth quarter versus $29.2 million or 6% of revenue in the fourth quarter last year.

Gross profit for the fourth quarter was $278.8 million or 53.5% of net revenue, compared to $274.5 million or 56.5% of net revenue in Q4 2012. The factors which contributed to this 300 basis point decrease in gross margin were a product margin decline of 270 basis points attributable to a variety of factors, including a shift in product selling mix to seasonal lower margin items, increased air freight usage, higher inventory provisions, and foreign exchange due to a weaker Canadian and Australian dollar and deleverage of 30 basis points on fixed costs, including occupancy and depreciation and product and supply chain team costs.

SG&A expenses were $124.6 million or 23.9% of revenue, compared with $121.9 million or 25.1% of net revenue for the same period last year. The higher SG&A dollar spend included an increase in store compensation and operating expenses associated with new stores, showrooms and outlets; increased variable operating costs associated with our ecommerce business, consistent with the year over year revenue growth; and increases in expenses at our store support center, including salaries, administrative expenses, and professional fees.

These were offset by a $9.1 million reversal and true up of management incentive bonuses and stock based compensation, $11.1 million in foreign exchange gains in our Canadian operating entity, which was offset against overall SG&A; and a weaker Canadian and Australian dollar, which decreased SG&A by $5.1 million.

So though we’re reporting 120 basis points of leverage of SG&A expenses, this leverage resulted from the nonrecurring impact of the incentive compensation true up and the foreign exchange gain. As a result, operating income for the fourth quarter was $154.1 million, or 29.6% of net revenue, compared with $152.6 million or 31.4% of net revenue in 2012.

Tax expense for the quarter was $46 million, or a tax rate of 29.5%, compared to $44.7 million, or a tax rate of 29% from the first quarter of 2012.

Net income for the quarter was $109.7 million, or $0.75 per diluted share. This compares with net income of $109.4 million or $0.75 per diluted share for the fourth quarter of 2012.

Our weighted average diluted shares outstanding for the quarter were 146 million versus 145.8 million a year ago.

Capital expenditures were $34.5 million for the quarter, compared to $21.2 million in the fourth quarter last year. The increase is associated with new stores, renovation, and IT and head office capital.

Turning to highlights for our full fiscal year 2013 performance, net revenue rose 16.1% to $1.591 billion, from $1.37 billion in fiscal 2012. Our annual store comp was 4% on a constant dollar basis, and including ecommerce, our annual comp was 9%.

Ecommerce sales totaled $263.1 million or 16.5% of total sales. Gross profit was $840.1 million or 52.8% of net revenue, compared to $762.8 million or 55.7% of net revenue in fiscal 2012. Net income for the year was $279.6 million, or $1.91 per diluted share compared to $270.6 million, or $1.85 per diluted share for fiscal 2012.

Looking at our balance sheet highlights, we ended the year with $698.6 million in cash and cash equivalents, an increase of $108.5 million over fiscal 2012 year-end. Inventory at the end of the fourth quarter was $186.1 million, or 19.9% higher than at the end of the fourth quarter of 2012.

This is slightly higher than optimal, however the composition is weighted more toward core items, which will typically sell throughout the year at full price and balance inventory levels by reducing future orders.

This now leads me to our outlook for the first quarter and full year of 2014. As I mentioned on the last earnings call, commencing with 2014, we will begin aligning with standard industry practice and reporting total comparable sales that include both stores and ecommerce.

As Laurent discussed earlier, we have seen a demand shift from our guests toward seasonal product, which is becoming a larger proportion of our sales mix. Although this has resulted in strong and fast sell throughs in numerous styles, we will not have the depth to capture the demand in these categories in the first half of 2014 as the buys were placed six to nine months ago.

While we are actively pursuing our opportunities to chase and fast turn product which will help mitigate some of this gap, our ability to buy deeper to rebalance our assortment to this shift in guest demand is weighted towards the back half of the year.

So with that in mind, for the first quarter of 2014, we expect revenue to be in the range of $377 million to $382 million. The sales guidance assumes a flat comparable sales percentage on a constant dollar basis, which as I said earlier includes both stores and ecommerce. For comparison purposes, we included a table in the press release to show comparable sales results for 2013 including ecommerce. Our outlook assumes a Canadian dollar at $0.90 with the U.S. dollar and nine new store openings, three in the U.S., one in Australia, one in Europe, and four ivivva.

We anticipate our gross margin in the first quarter to be between 50% and 51%. While we will lap the Luon writeoff from Q1 last year, the shift in our selling mix from core to seasonal product, which has a higher cost, will negatively impact gross margin this year. In addition, the decline in the Canadian and Australian dollars by over 10% from a year ago will reduce gross margin on our sales in those regions.

We expect to be flat as a percentage of sales in occupancy and depreciation, but we expect deleverage in product and supply chain team costs as we continue to make the necessary investments to enhance these functions.

We expect SG&A deleverage as a percentage of revenue compared with the first quarter of 2013, which is driven primarily from the run rate of key investments and headcount made in 2013 and additional strategic initiatives in 2014.

Our SG&A also reflects pre-opening costs related to the nine stores planned to open in Q1 and additional stores planned to open in early Q2 2014. So assuming a tax rate of 30%, and 146.2 million diluted average shares outstanding, we expect diluted earnings per share in the first quarter to be in the range of $0.31 to $0.33 per share.

For the full fiscal year 2014, we’re targeting to open up 42 corporate owned stores, including Australia and the U.K. and up to 10 new ivivva stores. We expect our annualized combined comp to be in the low to mid-single digits and therefore project net revenue to be in the range of $1.77 billion to $1.82 billion.

For the year, we expect gross margin to be in the low 50s, due primarily to a rebalancing of our product assortment to meet guest demands, continued investment in our supply chain and product operations functions to create a product development engine for global business, and also foreign exchange impact from a weaker Canadian dollar.

We’re opening a second distribution center in Columbus, Ohio in the second half of 2014 to enhance efficiency and improve service levels to ecommerce and store guests in the eastern U.S. However, the startup period costs and increased capacity will initially delever our gross margin by 30 to 40 basis points in 2014.

We expect SG&A deleverage as a percentage of revenue compared to 2013. Keep in mind we incurred foreign exchange gains and reduced management incentive compensation in 2013 that should be considered nonrecurring, and therefore not assumed in our forward projections. While continuing to invest in our infrastructure, we will also be rebalancing our investments to focus on key priorities to drive growth in areas such as brand, product innovation, and guest experience.

As a result, we expect our overall operating margin to deleverage from 2013 and our fiscal year diluted earnings per share to be approximately $1.80 to $1.90. This is based on 146.3 million diluted weighted shares outstanding and it assumes our effective tax rate of 30%.

We expect capital expenditures to be between $110 million and $115 for fiscal 2014, reflecting new store buildouts, renovation and relocation capital for existing stores, IT systems, and other head office capital.

And with that, operator, I think we can open it up for questions.

Question-and-Answer Session

Operator

[Operator instructions.] Our first question comes from the line of Anna Andreeva of Oppenheimer.

Anna Andreeva - Oppenheimer & Company

I was hoping to understand some of the investments for ’14. Maybe if you can talk about some of the buckets between the sourcing, marketing, and international, and I guess how permanent are those in nature? In other words, could we expect SG&A to be more in line with sales in ’15? And then just a follow up on comp guidance for the first quarter, what does that imply for store comp? And is that what you guys are running currently, and do you need trends to accelerate to get there?

John Currie

Maybe I can take some of the investment bucket dollar items. International in 2013, the net negative was I think mid to high single digit millions. That will probably be up $10 million and a little bit more in 2014. Compared to a run rate, I think you’ll see brand related investments $10 million to $15 million higher than you’d otherwise see.

And then the other area, I’d say quite a significant increase in the product and supply chain team costs. We’ve built those teams significantly during 2013. So you’ve got the run rate of those new hires and investments in 2014 as well as significant ongoing additions to those teams. So I’d say those are the primary buckets.

Turning to the comp guidance, in Q1 the breakout of stores is low single digit negative percent. And I think your question was how it progresses throughout the year, we do see store comp gradually improving from where we have it in Q1.

Operator

And our next question comes from Adrienne Tennant of Janney Capital.

Adrienne Tennant - Janney Capital Markets

Laurent, my question is, on the longer term operating margin structure, historically we’ve thought about the business as a mid-20% margin business. As you’ve kind of explored and taken a look at the business, do you believe that that is still the longer term margin structure? And then what’s your philosophy on perhaps more aggressive marketing and advertising?

And then really quickly, for John, can you just talk about the inventory? Obviously at the end of the quarter a little bit higher, the composition of it. And then when we should start to see that inventory kind of come down over the course of the year?

Laurent Potdevin

To answer your question, I think that long term our target is still to hit the mid-20s. Short term, we’re going to have to build our infrastructure internationally, which really hasn’t been done, both in Europe and in Asia. And we’re going to be investing in brand, but I don’t expect us to do large marketing investments. It’s really a matter of amplifying what we do really well at the grassroots level and amplifying that through PR and through communication, but not going to expensive traditional marketing tools.

So we’re building the product engine. We’re reigniting the product engine both from a design standpoint but also from a quality and sourcing standpoint, and we’re investing to grow our international platform, which really has a lot of demand, but long term, we should be going back to that mid-20s number.

John Currie

And I think within that, I’ve always talked about sort of 55% growth, 25% operating margin. There could be some shift between gross and operating as we go forward. As we’ve been discussing, increasing our seasonal mix will probably mean product margin down a bit, but I think the efficiencies that we’re building in that we’ll gain long term will bring gross margin back. As Laurent says, there’s no reason to change our thinking about a mid-20s operating margin.

In terms of your question on inventory composition, as I said, it’s a little higher than we’d normally want to be at, but the excess is really in core. It’s the product that we order on a continual monthly basis, and it’s quite easy to just reduce future orders to bring that down to the right number of inventory turns.

In terms of any kind of stragglers or aged items, we’re actually very clean, because whatever we’d had seasonally, the guest has been buying very quickly. So we actually feel quite good about where the inventory stands.

Operator

Our next question comes from the line of Lindsay Drucker Mann of Goldman Sachs.

Lindsay Drucker Mann - Goldman Sachs

Laurent, I was hoping you could talk maybe a little bit more about the international rollout, and since you’ve already been seeding some of these markets, and you probably have a pulse on brand awareness, how you’re thinking about that strategy, and how you plan to really convey the authentic, grass roots lulu message as you roll that out.

Laurent Potdevin

Having done that with a few brands in the past, I think that’s what’s critical to the international building of a global brand, which is very different from a North American brand selling its product outside the United States. It’s to really build deep, local knowledge in those markets and having local talent understand the lululemon secret magic.

And what we’ve done in the past is that we’ve taken some of our key talent and decentralized them in the region, hoping they would learn the regions, and we’re switching this mindset to really bring great local talent in the regions. And right now, the hiring and onboarding of our general manager in Asia is a great example of hiring the guy that knows the market, that understands how to adapt lululemon, what’s very unique to lululemon, to a market and ramp it up very quickly.

So we’ve got Ken back in Asia looking at locations for us, and we’ll be going through the same process in Europe. And in areas of the world where either the market is complex or maybe doesn’t have the scale for us to have a direct presence, we’ll be looking at partners. The Middle East might be a good example for that.

Lindsay Drucker Mann - Goldman Sachs

And then just a follow up question on the investments you mentioned that you’re making to enhance the in-store experience and in-store selling and learning more about your customer to improve selling. Can you give us some specifics, technology or otherwise, where you’re planning to put money to work?

Laurent Potdevin

I think most of these investments right now are centered around CRM and really sort of creating a seamless experience between online and brick and mortar, and also sort of understanding our guests at a more micro level so that we can have a more personalized experience with them.

Operator

Our next question comes from the line of Omar Saad of ISI Group.

Omar Saad - ISI Group

Laurent, I wanted to ask you about some of the comments you made in your opening remarks. You mentioned voiceless for too long, taking back share of voice, and you also seemed to imply in one of your answers to another question sticking with the grassroots strategy rather than shifting or amplifying with more traditional brand building.

Help us understand what you meant by your comments, why you’re comfortable with the existing marketing and brand building strategies, especially given how much the brand has transformed over the last several years. Doesn’t the brand building strategy need to transform?

Laurent Potdevin

When you go back a year, lululemon has been in the headlines like every other week and has not participated in pretty much any of those discussions. And that was one of the biggest findings that I discovered spending time here, is that lululemon is an incredibly authentic brand. It’s doing very unique, distinct, meaningful work in its communities. We have a set of 900 ambassadors that we support in North America, some outside of North America, and we just haven’t given these people their voice.

And I think that our grassroots communication strategy has resonated incredibly well with people. But we need to amplify that. We know we don’t need to go to traditional marketing strategies, but we need to take control of the discussion of lululemon and really share more proudly, and with humility, who we are and what we stand for, which really differentiates us from everybody else.

Operator

Our next question comes from the line of Brian Tunick with JPMorgan.

Brian Tunick - JPMorgan

I know it changes season to season, but where should the seasonal product that you’re talking about, as a percentage of the business run optimally, and what kind of supply chain and store work do you think the organization will need to quicken the lead times and inventory turns from already some of the industry best?

And maybe for John, just on some store performance metrics, can you talk about things that you’re seeing from a regional perspective, can you talk about Canada, the newer versus the older stores? Just trying to understand what’s happening to the different classes of stores over the last year.

Laurent Potdevin

If I can talk briefly about product, it’s a movie that I’ve seen before, either in the luxury or the action sports industry. When a brand becomes really iconic and is centered around a single product, its consumer evolves and so do their needs, and there is stronger and stronger demand for seasonal product.

I think we need to really refine the language that we use around core and seasonal, but our guests are clearly looking for more freshness and more, better product in our line. And our [unintelligible] are allowing us to do that short term, and Tara is building a global organization, both from a design, but also from a [unintelligible] and planning standpoint that will allow us to address these needs and we’ve shortly done so.

Tara, do you want to add a bit to that?

Tara Poseley

No, I think you’ve articulated it well. I think that, again, roughly 50-50 for a seasonal to core product. But as Laurent was saying, our guest is really responding well to our seasonal product and we’re excited about that, and we are chasing into what we can for Q2 and making sure that in the back half of the year, we’re getting that balance of core and seasonal nicely adjusted and making sure that we are not running out so quickly in our beautiful seasonal product.

Laurent Potdevin

I think what’s been really exciting is that while we don’t have the scale to make as much of that product as we’d like to, and while our scarcity is a little too scarce, the response that we’re getting to our product really validates the fact that we know how to answer our guests’ needs.

John Currie

And then your question on store performance, the factors impacting our store performance are impacting the entire market. The product assortment mix is across the board, any impact of negative PR is across the board. And that’s generally what we’re seeing.

A much smaller impact, I think, is things like weather. And the only reference point I have there, when I look at the regions where, even in Q4, we had double digit positive comps: L.A., Hawaii, South Texas, Florida, the deep south region. So I think there’s a little bit of weather impacting some regions more than others.

In terms of new and old, and I think this is intuitive, the newer age classes of stores seem to be less impacted than the older ones. I think that makes sense, because in new regions the guest is still establishing her core wardrobe, so the lack of newness is not as much an impact as in these newer stores.

And then even more so in terms of our new stores that are not in the comp base yet. They’re performing actually well above our plan, and I think in terms of any way you want to measure new store performance, whether it’s percentage of the comp base productivity or just dollars per square foot, the new stores are actually performing quite strong. We’ve been $1,100 to $1,200 a square foot for the last couple of years, and it’s actually edging above that. So that’s a positive sign in these new regions.

Operator

Our next question comes from the line of Camilo Lyon of Canaccord.

Camilo Lyon - Canaccord Genuity

I wanted to understand a little bit more about the expected improvement, the gradual improvement in comps as we should expect them to improve in the back half. How do we gain comfort that the work that’s being done on the supply chain will yield those results? And as we look to that back half comp trajectory improving, what could go better than expected? Is it more production from these incremental mills that are being added to the mix? Is it faster shifting towards seasonal product? Help us understand how we could think about that improving incrementally as we go to the back half.

John Currie

Maybe Tara can talk about the product mix part of it, and I can add some more numbers after she finishes.

Tara Poseley

Obviously, Q1 and Q2 were purchased about eight to nine months ago. Starting in December, January timeframe, seeing the guest response in Q4 to the seasonal product, we really began looking at third and fourth quarter with the team, looking at sell throughs of current product, going back and adjusting the back half, getting the core inventories in line, shifting out receipts, taking a look at all of core for Q3 and Q4, and really understanding where we had opportunity to update.

Because quite frankly, it shouldn’t matter whether it’s core or if it’s seasonal. I want to have beauty and technical in every single product that touches our floor. So that’s why you’ll see that gradual increase as we get into the back half of the year as we get that core more in line. We’ve been even trying to chase into seasonal product in late Q2, getting more prints and textures in our bottoms, which have been trending very well.

So John, I don’t know if there’s anything else?

John Currie

In terms of the quarterly comp trends, remember it’s really starting in Q2, where there’s a significant impact of Luon shortage last year. So we’re going to be lapping that, as well as lapping delivery challenges and bad PR in the second half. So there’s a lot of opportunity for positive comps over a weak second half in 2013.

Camilo Lyon - Canaccord Genuity

And just one follow up for Laurent, if I could. Kind of following up on a question asked earlier, also mentioned a few times in your script was the world humility. And I was wondering, how do you plan to convey that to your consumers that might have been impacted by the PR issues over the last year?

Laurent Potdevin

I think it starts with the guest experience. I think it’s taking the time, and obviously we’ve reflected on last year and we’ve learned from last year and we’ve done that with humility. And I think that lululemon, you know, you go back to our mission, which is really elevating the world to greatness. And I think to do that well, we need to be inclusive.

This past year, we’ve done [unintelligible] and we had to be defensive. But I think we are very proud of what we do. We’re going to talk about that with confidence. And one of our largest assets is clearly educators on the floor in our stores, and I have visited a lot of them in the past two months. And they’re the most committed people to the lululemon brand. It’s just empowering them to get back on their feet and speak about the brand, the product, who we are and what we stand for, with confidence, humility, but really with the mindset of making our guests right, listening to them, and being inclusive.

Operator

Our next question comes from the line of Kimberly Greenberger of Morgan Stanley.

Kimberly Greenberger - Morgan Stanley

Laurent, I’m wondering if you can look out over the next one, two, three years and just help us understand what’s a realistic level of acceleration in international store openings that we should be keeping in mind. And then you talked about, in your introductory remarks, some speed or flexibility in the supply chain. Maybe you could just help us understand a little bit better exactly you have in mind there. And if two years from now you’re successful in this initiative, how will your sourcing and supply chain be different than it is today?

Laurent Potdevin

I can’t really speak beyond 2014 at this point, but what I can tell you is that building the foundational work that we are doing, both in Asia and in Europe, will allow us to accelerate that footprint. And I think we’re going to evolve from a strategy of having a sequential approach to countries and regions, and building the foundation in both Europe and Asia will allow us to actually attack different regions and different countries, especially if you think about what’s in Europe at the same time.

So I think that’s where we’re going to be able to see significant acceleration of building our footprint and really sort of leveraging our showroom strategy which has been successful in seeding and growing markets, and doing that at a faster pace, simultaneously in different countries.

Operator

Our next question comes from the line of Jaime Katz of Morningstar.

Jaime Katz - Morningstar

I’m curious about what you guys are thinking about the evolution of the ecommerce channel as it becomes a bigger part of sales. Are there changes that you’re making to make it easier and more friendly to adapt to new consumers?

Laurent Potdevin

I think our people are looking at that constantly, especially as we sort of grow our product offering, as we grow our men’s business, and as we sort of start touching different regions. Our ecommerce environment is really going to be a platform where we can engage the guest in a much broader assortment. And Tara actually has a lot of great ideas in achieving that, right?

Tara Poseley

Right. I think as we grow, our goal is to have an ecommerce site that would have the full breadth of our assortment. And then as we go into countries or regions of the United States, how we parcel that broader assortment up will be very related to the community and what is the appropriate product in that community.

And we’re very excited about that going forward and as you know, we’ve tested a lot of different capsule through the years, from tennis to golf. And as you think about going into [unintelligible] markets or into warmer climates, or even really amplifying Australia, how we can mix these different capsules within our core and our seasonal product is really quite exciting to me.

Operator

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

Howard Tubin - RBC Capital Markets

Maybe just another question, maybe for you, Tara, on kind of the capsules that you have planned for this year, for spring and then into fall, without divulging too much. Will you continue to kind of test new and smaller product categories over the next couple of seasons?

Tara Poseley

Absolutely. Obviously I don’t want to play all my cards, but definitely I am a huge believer and advocate of the capsule. I think it’s a great way to test new concepts. At the end of the day, I just want to bring extreme beauty and technical to every sport our guest does. And to me, that’s exciting. We’re going to keep experimenting with that. You can see it in our &go collection that we launched. You probably saw the press around that in the spring. Fantastic guest response, and you’ll continue to see us experiment and grow that piece of the business.

Howard Tubin - RBC Capital Markets

And Laurent, you mentioned growing the brand, both for men and women. How are you viewing the men’s business? And do you still think that in 2016 you’ll have a separate standalone men’s store?

Laurent Potdevin

Actually, we’re looking this year at three locations that are going to be fully dedicated to men’s, one in Miami, one in Vancouver…

John Currie

Sorry, I should clarify. There are going to be three locations that are going to be much bigger footprint, with an expanded men’s section within the store.

Laurent Potdevin

Right. In Vancouver, Miami, and Santa Monica. And we’ve done tremendous work on our product. Our product is resonating with the guys incredibly well. And I think we have a great opportunity to play with our brand identity and [unintelligible] our brand identity in a way that’s going to resonate better with the guys and attach more to the activities and what they want to do, and we’re working on that right now.

Operator

Our next question comes from the line of Jim Duffy of Stifel.

Jim Duffy - Stifel Nicolaus

Can I ask you to speak in more detail around where you are with the evolution of the supply chain? Are you happy with the quality control process, where it is right now? Is the product flow now normalized such that merchandise assortments are cohesive? And then in more detail, what needs to happen to make the supply chain accommodate this shift to more seasonal product?

Tara Poseley

I think throughout 2014, you’ll continue to see us really build the foundation of our supply chain and shore that up. So I really want to stress that we’re still continuing to build that muscle within the organization. From a quality standpoint, every stopgap is in place, so there will not be any , bad quality getting to our customer, our guest.

As you talk about the supply chain, one of the things that I’ve noticed coming into lululemon is that we have one go-to-market calendar, which is an eight to nine month calendar. And in past companies, and this is what I’m going to be really focusing on, what I felt is that we have three distinct calendars. We have one that is more for the core, which might be slightly longer, and you have one that’s more for the seasonal product, that is shorter, and then you have a fast calendar.

And so I think this year, as we really fine tune and get our main calendar strong, then we will begin, as we move into ’15 and ’16, to continue to shore up these two other tracks of bringing a product to the market.

Jim Duffy - Stifel Nicolaus

Tara, are you happy with the product flow that you’re seeing now? Clearly you’re light on some of the seasonal items, but are things hitting stores at the appropriate times?

Tara Poseley

Yes, definitely improvement over last year. And really right now it’s not some fallout, it’s just, again, we bought the product nine months ago, and hindsight’s 20-20. We would have invested more heavily in the product, so it wasn’t running out so quickly in the seasonal.

John Currie

Other than the last two weeks, outside of our control has been a trucker’s strike at the port of Vancouver, so all of our Canadian product flow has been somewhat disrupted. But I understand that strike ended last night.

Jim Duffy - Stifel Nicolaus

And then last question, I guess it’s for both John and Tara, on the supply chain, given that you’re still in the very early innings, here, it would seem that perhaps down the road there’s margin opportunity as you evolve the supply chain. Is that an illogical thought process?

John Currie

That’s exactly the way I think about it. As I said earlier, I think appropriately we’re adding more newness and seasonality into our line that might deliver a lower product margin. But the efficiencies that we’ll gain from the steps that Tara and Jennifer and their teams are making, we’re going to see tremendous upside, again longer term, in terms of lower air freight, lower cost of cancellations, etc., and just a lot of efficiency.

Operator

Our next question comes from the line of Matthew McClintock of Barclays.

Matthew McClintock - Barclays

I was just wondering, you acknowledged some of the enhanced competition in your prepared remarks, and I was just wondering if you could talk about that perhaps on more of a seasonal category basis, and also more of a core category basis, what you’re seeing from that perspective.

Laurent Potdevin

We’re certainly not the only game in town anymore. But as we get back to our roots, we’re really focusing on innovation. I don’t want to spend too much time worrying about our competitors. I certainly want to know what they’re doing. It’s validation of the strength of our market and its global relevance and its growth in every single global market.

But we’re going to get back to what we do best, which is inventing the future, and really focusing on the magic that is very unique to lululemon, which is combining beautiful as well as technical innovation. So certainly something that we are aware of, but something that we’re going to look forward rather than over our shoulder.

Operator

Our next question comes from the line of Faye Landes of Cowen & Company.

Faye Landes - Cowen and Company

Just hoping you can elaborate a little bit more on the international strategy. Laurent, you said you’re going to ultimately accelerate the international rollout, which is a bit of a change in the algorithm. Can you just talk to us about milestones that we should be looking for along the way as you do that? And also, could you address the issue of cost of real estate overseas, and the fact that you haven’t opened stores in some markets, like Hong Kong, where you’ve had a showroom for a very long time?

Laurent Potdevin

I think maybe I’ll let John speak to that, but before I do that, I think that to go back to the international strategy, we work in a very sequential way. So we open a showroom, then we look at stores, and then we look at building the staff.

And I think going back to what I said earlier, it really does not have to be a sequential process. The showrooms are a really good way to seed the market, but at the time that we open the showrooms, we need to get the right staff on the ground, and we need to start looking at locations.

And I have a very clear timeframe by which we will be moving forward. So just working in parallel rather than a serial fashion will allow us to accelerate that in markets where we know we’re going to have a presence.

John Currie

And in terms of international real estate, lots of regions, Hong Kong in particular, rent per square foot is extremely high. And it’s high in London as well. And we’re setting our pricing, etc. to adjust for that.

When we look at Hong Kong, I think the reason that we’ve moved more slowly than we’d like is not simply sticker shock on the rent. I think as we move into different regions, we have to be a little bit flexible in terms of what our store looks like in those regions.

And I think that’s maybe a shift in our mindset. There’s the 3,000 square foot on one level, isn’t really available in Hong Kong. We have to look at what’s the best type of store layout for lululemon in that market. And I think that openness will help us accelerate.

Laurent Potdevin

And if I might add, that value comes with having the local deep expertise that we mentioned earlier. It’s not how is Hong Kong going to adapt to lululemon, but how is lululemon going to adapt to Hong Kong. And that’s going to open a lot of doors to accelerate our international growth.

Operator

Our next question comes from the line of Oliver Chen with Citigroup.

Oliver Chen - Citigroup

Can you just give us a little more insight in terms of the in-store traffic and just decipher if it’s recovered from the negative PR, or where we are in that process? And then if you could talk a little bit about ivivva and the adjacent businesses like swim and how they’re performing.

John Currie

In terms of store traffic, our overall comp performance is basically traffic driven as it has been in the past. So the negative has come from lower traffic. I wouldn’t say that that’s really rebounded, and that’s reflected in my first quarter guidance, but we do expect some gradual improvement as the year progresses.

In terms of ivivva, it kind of gets lost, but it’s a real bright spot. Ivivva comping double digits, ended the year just under $900 a square foot. And as I think I’ve alluded to in the past, we’re really putting our foot on the gas a bit with the rollout of ivivva stores. We ended the year with 12, and we’ll add up to 10 in 2014.

Operator

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

Janet Kloppenburg - JJK Research

I had a couple of questions. First, as far as the infrastructure building for international growth, will that pressure at the SG&A line be on 2014. And overall, the investment spending that you’re talking about, will that carry into 2015? And Tara, I was wondering if you could talk about your comfort level with the fashion assortments being aligned by the third quarter, and if that would mitigate the need for the air freighting that you’re now incurring. And John, if you could just talk to us about what you’re leverage point of SG&A is, that would help.

John Currie

Your question about international investment and does that impact, I think you said does that impact SG&A going into 2015, yeah, that’s absolutely true, because in fact as we accelerate new store openings in Europe and Asia, initially that will compress our margin. But of course the faster we go, the faster we get to a point of leverage in those markets. But certainly through 2015 the international rollout will be a negative in terms of the income and margin as you’d expect.

Janet Kloppenburg - JJK Research

And overall SG&A leverage, John?

John Currie

You know, I always struggle with that question when we’re in such a growth mode, because so much of what we’re spending is discretionary. But in terms of the delta, low single digit comps would leverage us normally, but again, there’s so much going on beyond just the run rate that I just can’t really give you a clear answer on that.

Operator

And I’m showing no further questions at this time. I’d like the hand the call back to Laurent for any closing remarks.

Laurent Potdevin

I want to thank you all for your time this morning, and I really look forward to speaking and meeting with many of you over the course of this year, and next month at our analyst day, and continuing this discussion on realizing our vision for lululemon’s future growth. Thank you.

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