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Lululemon Athletica (NASDAQ:LULU)

Q3 2012 Earnings Call

December 01, 2011 9:00 am ET

Executives

Joseph Teklits - Senior Managing Director

Sheree Waterson - Executive Vice President of General Merchandise Management, Supply Chain and Logistics

John E. Currie - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Christine M. Day - Chief Executive Officer, President and Director

Analysts

Paul Lejuez - Nomura Securities Co. Ltd., Research Division

Dana Lauren Telsey - Telsey Advisory Group LLC

Stacy W. Pak - Barclays Capital, Research Division

John D. Morris - BMO Capital Markets U.S.

Erika K. Maschmeyer - Robert W. Baird & Co. Incorporated, Research Division

Jennifer Black

Claire Armstrong Gallacher - Auriga USA LLC, Research Division

Michelle Tan - Goldman Sachs Group Inc., Research Division

Janet Kloppenburg

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Howard Tubin - RBC Capital Markets, LLC, Research Division

Omar Saad - ISI Group Inc., Research Division

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Lorraine Maikis Hutchinson - BofA Merrill Lynch, Research Division

John Zolidis - Buckingham Research Group, Inc.

Andrew Burns - D.A. Davidson & Co., Research Division

Taposh Bari - Jefferies & Company, Inc., Research Division

Christian Buss - Crédit Suisse AG, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the lululemon athletica Quarter 3 2011 Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn your conference over to your host for today, Mr. Joe Teklits. Sir, you may begin.

Joseph Teklits

Okay, thanks. And good morning, everybody, and thanks for joining us for the third quarter conference call. A copy of today's press release is available in the Investor Relations section of lululemon's website at www.lululemon.com or furnished on Form 8-K with the SEC and available on the Commission's website at www.sec.gov. Also available in the Investor Relations section of the company's website will be a recording of today's call, which is available for 30 days as a replay shortly after we end today. Hosting our call today is Christine Day, the company's CEO; and John Currie, the company's CFO.

We would like to remind everyone, of course, that statements contained 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 might differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. [Operator Instructions]

With that, I'll turn it over to Christine Day.

Christine M. Day

Thank you, Joe. Good morning, everyone, and thank you for joining us to discuss our third quarter results. Today, we are doing our call from New York City. And with me is John Currie, our CFO; and Sheree Waterson, our Chief Product officer. Following my opening remarks, I will turn the call over to John Currie to review the financial details for the quarter and our outlook for the fourth quarter.

In the third quarter, we achieved 31% revenue growth with 50% year-over-year EPS growth, and we set a new record in comparable sales per square foot of $1,880. These strong revenue results were at the top end of our guidance. And as anticipated, we also had unmet sales demand throughout the quarter. Our new stores continued their strong performance, and we also bought back our last remaining franchises in Colorado and Santa Barbara.

Our goal for Q4 was to break the inventory cycle we ran all year, and we have achieved it. As you will remember, in Q4 of 2010, we were well positioned in inventory to meet demand, which drove the 28% comp. This was a great result for 2010, but it left us under-inventoried and began the cycle of chase. In Q4 2011, we have the right mix of new styles and color and a healthy and clean inventory. New product highlights for Q4 include new running luon, polar fleece, featherweight down layering pieces, a dance capsule and bright colors.

To set Q4 and Q1 up for success, our Q3 in-transit inventory includes 2 modules. We brought forward a portion of the spring deliveries built around a back-to-studio marathon training, cycling commuter themes, along with our black-and-white capsules. This will create inventory flexibility as it is appropriate for either quarter. We expect the inventory turns and markdowns to appropriately normalize due to our in-stock position. Given our confidence in our inventory levels, we have increased our revenue guidance for Q4.

One of the highlights of the quarter was the launch of our ivivva Canada and then subsequent November launch of ivivva in the U.S. Even without an ivivva U.S. store presence, our U.S. sales are exceeding Canadian e-Commerce sales, with strong demand coming from Chicago, L.A. and New York. As we do with our lululemon site, ivivva e-Commerce gives us insight into guest demand and potential future store locations.

We also completed the seamless migration of our e-Commerce servers from a shared to dedicated environment to meet growing demand. In addition, we were excited to see our guests’ reaction to our new lululemon site redesign, which launched in early November with new features, such as video education, and a new front page every day with new feature campaigns. We encourage you to check it out if you have not already.

Activities to support international growth in the quarter included third-party logistic agreements to support international e-Commerce for Europe and Asia and the expansion of our Australian DC to accommodate local e-Commerce shipping. In Q1 2012, we will launch our first localized website in Australia, with the U.K., Hong Kong and potentially one other market to follow later in the year, supported by our planned opening of 2 new showrooms in both Hong Kong and London in early 2012.

We also launched a new business intelligence tool, upgrade our POS and store network system to speed up our POS transactions and increase reliability. We have selected our design and development system software, known as PLM, and have commenced implementation. We have made substantial investments in our IT, digital, e-Commerce and product organization to increase our capacity and depth to prepare for the increased complexity and growth. In December, we will begin our initial round of interviews for an SVP of Brand and Community and replacing Chris Ladd, our former Head of e-Commerce, who left for personal reasons.

So as we finish 2011, we are positioned where we want to be. We continue to perform at the top of our sector and remain focused on our 4 strategic growth priorities: driving comp store sales, e-Commerce, new stores and preparing for international expansion. As we've said before, growth alone is not a strategy. Elevating the brand through innovative technical product and guest experience, excellence in execution, investing in our people and communities and producing a strong return on our assets are equally important.

I will now turn the call over to John to go through the financial results.

John E. Currie

Thanks, Christine. I'll begin by reviewing the details of our third quarter of 2011. And then I'll update you on our outlook for the fourth quarter, and therefore the full year fiscal 2011.

Our shareholders approved the 2-for-1 stock split, which took effect in early July. Please keep in mind that all comments with regards to share count and per-share amounts in our results and outlook are now on a post stock-split basis.

For the third quarter, our total net revenue rose 31% to $230.2 million from $175.8 million in the third quarter of 2010. Increase in revenue was driven by: comparable store sales growth of 16% on a constant-dollar basis; the addition of 28 net new corporate-owned stores in North America and 3 net new corporate-owned stores in Australia since the Q3 of 2010; direct-to-consumer sales, which increased by 71% or $9.9 million; and stronger Canadian and U.S. dollars, which had the effect of increasing reported revenues by $3.7 million or 1.6%.

During the quarter, we opened 13 corporate-owned lululemon stores in the U.S. and 1 in Australia. We also reacquired our 4 remaining franchise locations, which brings to an end our franchise program. We ended the quarter with 165 total stores versus 134 a year ago. There are 118 stores in our comp base, 40 of those in Canada, 68 in the United States and 10 in Australia. During the quarter, we had 5 high-volume stores under renovation operating in temporary premises. Corporate-owned stores represented 82.6% of total revenue or $190 million versus 81.5% or $143.2 million in the third quarter of last year.

Revenues from our direct-to-consumer channel totaled $23.9 million or 10.4% of total revenue versus $14 million or 7.9% of total revenue in the third quarter of last year. Other revenue, which includes franchise, wholesale, showrooms and outlets totaled $16.3 million or 7% of revenue for the third quarter versus $18.6 million or 10.6% of revenue in the third quarter of last year. This decrease resulted from: reduced markdown product available for sale at our outlets and a warehouse sale held in Q3 of the prior year; fewer showrooms, as several have transitioned to new stores; and the transition of our franchise stores to the corporate-owned store category.

Gross profit for the third quarter was $128.5 million or 55.8% of net revenue compared to $96.8 million or 55.1% of net revenue in Q3 of 2010. The factors which contributed to the 70-basis-point increase in gross margin were: a product margin decline of 20 basis points; higher product costs due to inflationary pressures on raw materials and labor were partially offset by fewer markdowns and discounts, associated with strong product sell-through; as well as improvements due to mix shift, lower duty rates and other input cost efficiencies and improvements; leverage on occupancy and depreciation of 70 basis points was offset by increased product and supply chain team costs of 60 basis points; and foreign exchange improvement of 80 basis points due to stronger Canadian and Australian dollars.

SG&A expenses were $68.8 million or 29.9% of net revenue compared with $54.5 million or 31% of net revenue in the same period last year. The 26.3% SG&A dollar increase is due to: an increase in store compensation and operating expenses associated with new stores, as well as increases at existing locations; an increase in head office employee costs, including management incentive-based compensation, stock-based compensation and other head office costs as a result of the investment in people and systems needed for long-term growth; and finally, the higher Canadian and Australian dollars, which increased SG&A by $1.2 million or 1.7%.

As a percentage of revenue, our third quarter SG&A decreased by 110 basis points due mainly to lower e-Commerce operating costs, following the transition of our e-Commerce platform to an in-house platform, as well as some smaller factors, partially offset by 80 basis points of deleverage from the increased head office costs. As a result, operating income for the third quarter was $59.7 million or 25.9% of net revenue compared with $42.4 million or 24.1% of net revenue in 2010.

Other income, including net interest expense, totaled $0.6 million compared to $0.1 million in the third quarter of 2010. Tax expense for the quarter was $21.4 million at a rate of 35.5% compared to $16.5 million at a rate of 38.9% in the third quarter of 2010. So net income for the quarter was $38.8 million or $0.27 per diluted share. This compares with net income of $25.7 million or $0.18 per diluted share for the second quarter of 2010.

The weighted average diluted shares outstanding for the quarter were 145.3 million versus 143.7 million a year ago, which, again, has been adjusted for the 2-for-1 stock split. Capital expenditures were $13.6 million in the third quarter, relating to new store buildouts, existing store renovations, IT capital expenditures, and net assets from reacquired franchises. We ended the quarter with $276.9 million in cash and cash equivalents.

Inventory at the end of the third quarter was $129.2 million or 77% higher than at the end of the third quarter of 2010. Within this total is a significant increase in in-transit inventory of $33 million versus $11 million last year, which, as Christine discussed, was largely spring product pulled forward. Excluding the in-transit inventory, our units of inventory on hand was up approximately 45%, which sets us up well to meet guest demand for Q4 and early 2012.

This leads me to our outlook for the fourth quarter of 2011. This outlook assumes a Canadian dollar at CAD $0.95 to the USD $1 compared to an average exchange rate at par in Q4 of 2010. We anticipate revenue in the range of $327 million to $332 million. This is based on comparable store sales percentage increase in the low- to mid-teens on a constant-dollar basis compared with the fourth quarter of 2010. We plan to open 2 lululemon stores in the U.S., 5 in Australia and 2 ivivva stores in Canada during the fourth quarter.

We, again, expect our gross margin to be in the 55% range. Similar to the third quarter, we expect higher product cost from both labor and raw materials that we have not passed on to the guests through higher pricing, combined with more normalized markdown levels associated with more sufficient inventory levels, to compress our gross margin from year ago.

We expect SG&A as a percentage of revenue to be roughly 300 basis points below the third-quarter level, which is consistent with our normal historical seasonality. During the fourth quarter, we expect to continue to see cost efficiencies as a result of the transition of our e-Commerce platform to an in-house model, but at the same time, we'll be increasing our reinvestment back into the e-Commerce business to develop the necessary foundation to achieve the potential growth trajectory in this channel. Our SG&A will also reflect higher store-level compensation designed to attract and retain the best of staff; preopening costs related to the 9 stores planned to open in Q4 and additional stores planned to open in early Q1 2012; as well as additional resources at our head office to continue to drive long-term scalability and growth.

Assuming a tax rate of 36% and 145.3 million diluted average shares outstanding, we expect earnings per share in the fourth quarter to be in the range of $0.40 to $0.42 per share. This brings our full year sales to a range of $956 million to $961 million. For the full fiscal year 2011, we anticipate we'll open a total of 37 corporate-owned stores, including Australia and ivivva locations. Since our last update, this includes one additional U.S. store and one additional Australia store.

We also now expect 2011 fiscal year earnings per share to be approximately $1.16 to $1.18. This is based on 145.2 million diluted weighted average shares outstanding, and it assumes an effective tax rate of 36%. We expect capital expenditures to be between $116 million and $108 million for fiscal 2011, reflecting the purchase of our store support center of $65.1 million plus closing costs in the first quarter, as well as new store buildouts, renovation capital for existing stores, IT and other head office capital.

And with that, I'll turn it back to Christine.

Christine M. Day

Okay. Thank you, John. We'll go ahead and go to Q&A. [Operator Instructions]

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes -- today comes from the line of Lorraine Hutchinson from Bank of America.

Lorraine Maikis Hutchinson - BofA Merrill Lynch, Research Division

Just wanted to talk about the fourth quarter gross margin guidance for a minute. It seems like quite a bit more of a drop versus what you had in the third quarter. And I guess, are you seeing product cost escalate further? Or do you just expect the fully in-stock inventory position to lead to more markdowns?

John E. Currie

It's more of the second. The inflationary pressure, as we guided previously, in Q3 was give or take 250 basis points. We expect the same in Q4. It's really we're reflecting and assuming that with our inventory position, as you'd expect, to more normalized markdown level.

Christine M. Day

And maybe I'll just add a little bit of color to that. We did not clear in Q3 -- we didn't have a warehouse sale, which we had, had the year before. So we didn't have enough product to do it, frankly. And then we -- because inventory receipts were a little later than we would have liked, we didn't do the rack markdowns until October. So we've already cleared any product that we would have wanted to clear at the beginning of this quarter. And then looking at January year-over-year, last year, we didn't have any product to do the holiday sales. We sold through full-priced merchandise. This year, we anticipate we'll be in a more normal markdown post-holiday mode. So year-over-year, I think it's important to recognize that both October and January will be a little different for the fourth quarter.

Operator

Our next question comes from the line of Edward Yruma from KeyBanc Capital Markets.

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Could you give us some color to the performance of the Canadian stores? And have you seen the weakness that some other retailers have exhibited?

John E. Currie

I guess this is, what, the third quarter we've had the same kind of discussion about the weakness in Canada that we're reading about. And when I look at statistics on mall traffic, et cetera, it does say that Canada's weakening, although Canadian economy, to me, seems pretty strong. We're -- throughout the year, we've been give-or-take 5% comping Canada, rounding up to 6% or down to 4%. It's been pretty consistent. Given our high level of productivity -- and that comp really exceeds what other retailers in Canada are seeing. I think that we're not really concerned about the Canadian market. I suppose if there is weakness there, that means that we'd normally be doing better than the comp that we're doing. But it's a very healthy business and continues to be.

Christine M. Day

And the other thing I'd add is that we've seen really strong growth in our e-Commerce business there year-over-year, as well. So that's in addition to what we're producing in that comp.

Operator

Our next question comes from the line of Michelle Tan from Goldman Sachs.

Michelle Tan - Goldman Sachs Group Inc., Research Division

I was wondering if you could give us any sense of what kind of trends you've seen so far in November, and then maybe talk a little bit about the timing of when out-of-stocks last year really started to materially impact your sales trend, if we look at Q4 and Q1. And then if I could sneak one extra one in. John, any color you can give us on the productivity of the Australian franchises that you bought in?

Christine M. Day

I think sales -- obviously, we did really well in all of Q4 last year, which we sold through everything that we brought in early. And we really eroded our base going into Q1. If I look at our -- Sheree and I were doing an analysis. And we looked at our year-over-year Q1 base of inventory, and it was down 40%. So -- and then we sold through strongly in that January, finishing off Q4. So going into Q1, starting in that February, we were 40% lower than we really should have been to support the sales from the Chinese New Year. That's really when you saw it. And March, if you recall, was probably our worst out-of-stock period. So -- and that definitely affected our sales ramp and began that chase cycle. And where we really want to be is set up for a strong Q1, and most importantly for us is the energy we spent on chase, I'd really rather be spending on innovation. So the cost is more than just sales. It's about creating the future. So our goal for 2012 is to set ourselves up to have a strong inventory flow throughout the year, and that's we've been working on. We feel we're in a great position to accomplish that. So just in summary, very little impact to really Q4 last year, most of the impact into Q1. And this year, we'll be really carefully watching and, frankly, capping sales so we don't impact Q1.

John E. Currie

Michelle, your question on Australia, again, the Australia brand recognition is maybe 1 to 2 years behind the U.S. The productivity is strong, comping low 20s, and the productivity is just over $1,000 a square foot and rising.

Michelle Tan - Goldman Sachs Group Inc., Research Division

Great. That's helpful. And any color on November?

John E. Currie

Well, again, we came into November in a great in-stock position, strong Black Friday, even without markdowns, and strong Cyber Monday. That supports our guidance.

Operator

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

Omar Saad - ISI Group Inc., Research Division

Christine, you mentioned something in your prepared remarks about elevating the brand, the work to elevate the brand. We've been hearing a lot of the luxury brands that we cover are seeing price points move higher. The consumer's looking for higher quality, more premium, more interesting, unique product. Are you guys incorporating that theme into your strategy? Are you seeing a mix shift in terms of price points that your consumer is being attracted to? And how does the ivivva brand fit into that kind of, if you think about the price point scheme?

Christine M. Day

We definitely are. We see that there's not a lot of price pushback, and as we've been innovating in the garments, adding more details -- and we haven't taken pricing on the basics, but we are pricing the premium above the basics. So like the special edition hoodie, for instance, that's in the stores right now, is just getting snapped up. So we definitely see we have opportunity, and that's that part of the reason why, strategically, I'd rather be spending my time chasing that market, which we really consider differentiates ourselves. So Sheree and her team have done a great job. I think when you see the spring product that hits, I think it's some of our best stuff we've ever done. So I'm really excited about the work that we've done there.

Sheree Waterson

Yes, just to add onto what Christine said. This is Sheree. As we continue to innovate more and more for our technical products, both in our fabrics, our trends and in our make and functionality, the value equation is so much higher. And the guest is, as Christine said, really snatching it up. So yes, they like it.

Christine M. Day

And I think -- yes. For instance, like one of the pieces that's in the store right now is a new featherweight running piece that has almost like a down vest built into it, but it's featherweight light. And it's just incredible, and it's exactly that type of technical jacket that you'll see us focus more on.

Omar Saad - ISI Group Inc., Research Division

And then on the ivivva piece, like how does that fit in there?

Christine M. Day

Well, what we're seeing is there's a market for premium girl’s athletic wear, especially in that dance-gymnastics space and then carrying over into casual wear. So it works very much the same way that lululemon does, with active wear, casual wear built off of those core sports. And both in Canada, and as we said when we opened, the U.S. e-Commerce site was very, very little marketing. The draw has been really incredible, and we don't even actually start a lot of our marketing on that until after the holidays. So we've done a few things, like we have put flyers in our -- all the holiday shipping bags that go out, so that the guest knows we have the ivivva U.S. website. But most of the on-ground work doesn't start till after the year. So we're really encouraged by the reception for that brand in the U.S.

Operator

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

Howard Tubin - RBC Capital Markets, LLC, Research Division

Maybe just a question on inventory. Where do you think it'll be at the end of the fourth quarter, kind of on an increase versus last year basis?

John E. Currie

I guess the way to look at it, if you ignore the large increase in the in-transit that we had at that point in time at the end of Q3 and look at where we are, inventory versus forward sales, we would expect to be in a similar position at the end of Q4. Of course, that depends on how Q4 goes, et cetera. But like I said, we're comfortable with the inventory level that we've achieved coming into this quarter. So hopefully, we'll be similar.

Christine M. Day

I would love to be above last year, because we know last year wasn't enough to support Q1, right? So our main goal was starting 2012 off in a really great position, so we can put our energies towards design and take some pressure off our manufacturers and the supply chain and just do healthy chase, which is a little bit more on-demand based rather than the catch-up. And for us, I think that the critical issue is also when we're chasing, it depends on what fabrics are readily available and what manufacturing space is available. So then we're not as in such a planned mode. And I think really in Q3, that's what we struggled with the most, as we were still living with what we could get versus what we ideally wanted. And then timing of that and managing the flow of that without bumping into our next season takes a lot of energy. So that's the cycle we're committed to really ending. And I'd rather be sitting here telling you we're in a great inventory position that's up than be sitting here quarter-after-quarter talking about being down, because -- and the cost is big to our guest and it's big to our brand, long-term. So we really are excited about where we are for inventory, because it's with relief we can turn our energies to other things, and we know what we have in the mix for Q4 and into Q1 is what the guest wants.

Operator

Our next question comes from the line of Erika Maschmeyer from Robert W. Baird.

Erika K. Maschmeyer - Robert W. Baird & Co. Incorporated, Research Division

Could you talk a little bit about your e-Commerce penetration? It's a strong number. I know it helps by having some better inventory in the back part of the quarter in ivivva. Could you talk a little bit about where your penetration was running at the end of the quarter, or how it's trending in November?

Christine M. Day

I think the #1 thing is that U.S. is accelerating, so our penetration in the U.S. and broadly across the U.S. Because I think in the initial build, as you'd expect, primarily the big cities and where we have the big stores, we're starting to see the brand penetrate more generally across the U.S. And so we're excited that we are growing that customer base, which then, also then helps us to grow our store base. So I think that's the, really the big story. And Canada is healthy growth, as well. So I think you are going to see a little less coming in store comps maybe in the future, because we're penetrating more through the convenience of e-Commerce. So I think that's really the big story there. And then with ivivva, as we said, the big penetration spots are really built around those dance studios, where we've seen -- and markets where there's a lot of children in dance, or young girls. For instance, New York, Chicago, L.A. have been the initial hot spots for ivivva. And then internationally, we're seeing a lot of business coming in lululemon continues to be from, really, the Germany, U.K., France. And then shifting over into Asia, it's really Hong Kong and Japan.

Erika K. Maschmeyer - Robert W. Baird & Co. Incorporated, Research Division

And then I know you've talked about a 15% sort of midpoint goal for e-Commerce penetration. I guess, kind of where do you think you could be in Q4?

John E. Currie

Yes. It'll -- I mean, we were 10.4% in Q3. We expect to be higher than that. But the 15% target is still a ways out there.

Christine M. Day

Yes. [indiscernible] I don't think we'll get there by year-end, though we had a very strong Black Friday and Cyber Monday online. So we have some record days that we're very excited about.

Operator

Our next question comes from the line of Adrienne Tennant from Janney Capital Markets.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

My question is, John, can you talk a little bit about sort of the inventory shortage in the first half of the year, and how we should think about a more normalized gross margin in the first half of 2012? It still seems like expectations are for maybe a high-50% gross margin. And after having guided to sort of the more normalized level of markdowns, plus ongoing but better cost inflation impact, should we be thinking about the first half as more normalized in that mid-50% range?

John E. Currie

Okay. So again, I mean, inventory levels, as we've been talking about all year, in the first half, were constrained. You’ll recall, I guess 3 earnings calls ago, we -- in the first quarter, especially in March, comps really dropped because we were so out of stock, and similar shortages in the second quarter. So again, I'm not giving guidance for next year. But it is reasonable to assume that being in a better in-stock position should give us a tailwind in the first half of next year. I'm not at a point where I want to be giving guidance on gross margin next year but, again, the same themes. The inflationary cost pressures are likely still to be there, and we will be seeing a more normalized level of markdowns. And so just those factors alone bring gross margin down from where it had been, but still on a very healthy level.

Christine M. Day

Right. And the other thing I'd add is in addition to not doing any warehouse sales this year at all, then we also had very low outlet store sales because we don't manufacture separately for our outlet. And we've really starved those all year. And so this -- just this last month was the first time we were able to really give the outlet product, the outlet stores any product at all. And we had weeks we were down like negative 50 in our outlet stores.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Will you be doing a warehouse sale in the fourth quarter, or none at all in 2011 and then bringing them back in 2012 with a better in-stock position?

Christine M. Day

We will be doing one in 2012, yes.

John E. Currie

Actually, we are looking at January or February for one. So there may be one in Q4.

Operator

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

Janet Kloppenburg

I wanted to just talk a little bit about the top line in the quarter. It seems that the differential, John, between your comps and your total sales has narrowed, and I'm wondering if that has to do with maybe new store openings. Some people are worried about productivity per store. And I'm also wondering if there was -- if you could highlight the lost sales from the warehouse sales, or perhaps timing differences, either with showroom closings or new store openings that may have affected that. And hello to Sheree. I was wondering if you could talk a little bit about what I'm seeing in the stores, which is, I think, a higher focus on new fashion, not only in color but in treatment and detail. And I'm wondering if that is a focus of the brand going forward.

Christine M. Day

Sure.

John E. Currie

Okay. Yes, the other categories, especially, is coming down, as I said in the script. There are a number of things going on in the revenue line that aren't visible. As you said, the warehouse sale that we had last year, we didn't have one in Q3 this year. I can't remember exactly what the revenue was from that, might have been a couple of million. I mentioned this in the script, because it isn't insignificant. There were 5 of our -- pretty much all high-productivity stores that were under renovation during a good portion of Q3.

Janet Kloppenburg

And are they complete now, John?

John E. Currie

They are now. They -- I think a couple just opened this past weekend, so…

Christine M. Day

Three.

Janet Kloppenburg

So there's some -- there was some lost revenue there?

John E. Currie

Yes. They were operating out of smaller temporary locations. So there's -- I don't know the exact number, but it's probably around $1 million, at least, of lost revenue there. Then the other -- I mean, it'd be very difficult, if you're outside the company, to model new store timing. We opened a lot of stores in the quarter, a total of 14, and they were really very much weighted towards the end of the quarter.

Christine M. Day

Yes, only 3 opened earlier.

John E. Currie

Yes. So if you had assumed that they opened, on average, at the middle of the quarter, you would've expected more store weeks, and therefore more revenue. And then the other piece that I'm more aware of than most, shortly after the last earnings call, the Canadian and Australian dollars took a dip. And so the translation of Canadian and Australian revenue, at least for a period, was a little bit lower than it would have been expected.

Christine M. Day

That was another couple of million, yes, and then the lower outlet store sales, as well.

John E. Currie

And then, again, this is the last quarter where we have any franchises, so that was -- that revenue has moved into corporate stores.

Christine M. Day

And we did close a few storerooms – showrooms, as those then translated into business stores.

Sheree Waterson

Okay. And now on to the product. So very observant, Janet, thank you very much. We -- the color that we're introducing for Q4 is phenomenal, and the guest is responding. So for Q3, we had some more subtle color palettes, and we know that she really responds to some of the brighter colors. And so those are being very well received right now. And in terms of detailing, this is one place where we really know that counts for lululemon. So we've looked at fit, function and finishing. And in terms of the fit, continuing to focus on body-flattering styling, as well as for running, as an example, fits that feel like nothing's on your body, which is exactly what a runner wants to feel like. The functionality of the fabric, again, being light as air and in terms of running -- or seamless and so on and so forth, and in terms of yoga, just being extremely functional. And then our finishing is, I'd say, one of the things that we're best in the world at. So whether or not it's the perfect functioning pocket or zipper or ventilation system or it's a gorgeous ruffle or treatment, it's something that the design team now is really putting their attention to, so…

Christine M. Day

But I think in terms of -- maybe hidden in your question, are we shifting to more fashion? No. It's always fit, function and technical product first, adding elements that come from the fashion world to that. And that's our magic formula. So we will always still be athletic, technical, functional wear.

Operator

Our next question comes from the line of Claire Gallacher from Auriga Investments.

Claire Armstrong Gallacher - Auriga USA LLC, Research Division

So I was curious about the trend for your traffic and sell-through rate throughout the quarter, if you saw any manner major fluctuations maybe early in the quarter versus what you saw late in the quarter.

John E. Currie

No, not any discernible trend. Again, as has been the case earlier in the year, the ups and downs tended to follow more the product drops as opposed to any kind of trend based on general traffic or economy.

Operator

Our next question comes from the line of John Morris from BMO Capital.

John D. Morris - BMO Capital Markets U.S.

Wanted to know maybe, Christine, a little bit more about the performance of the new dance category, how that's going. Is it very meaningful? And are you contemplating other interesting new classifications that are in the works, that you've talked about before? And then in addition to that, I'm also kind of separately -- maybe John can address this. I'm thinking with the inventory up as much as it is and the better positioning you've got on the spring product, would you anticipate that maybe some of the offset, from a cost perspective, would be that freight costs could come down? And would that be helpful as we move into next year?

Christine M. Day

Yes. So starting with the new dance category, that -- we did for the -- in the stores right now -- you'll just see finishing, actually, because it’s almost all gone, a dance capsule that we did, which was kind of just a kickoff to holiday and kind of just something interesting and new for the guests, as then we eased into our more traditional holiday set. So it went very quickly. It was very well received. There were some really great winning pieces in that. And we use those capsules to kind of test our product edge, see what we can incorporate into the core line, what needs to be repeated for maybe a quarter, what's seasonal, and then how we build that into the longer line plan going forward. But we're also very conscious of the fact that we have under 3,000 square feet in the majority of our stores. So we use the capsules as a way of creating excitement, testing new lines, but at the same time, really maximizing the space. So you will see an emphasis on that as part of our comp-driving strategy and a way of offering newness to the guest, but without cluttering our stores.

John D. Morris - BMO Capital Markets U.S.

And it sounds like it's a bit of a keeper. Are there other classifications that you're looking at? I know it's such a new way to create excitement. Anything else to anticipate in the coming months?

Christine M. Day

You'll see us, and I discussed it in there, that we're doing a bike commuter line for spring. So you'll see us do that. The real power comes from not just what we do in the stores but then how we translate that into online. And we can use that to extend shoulder seasons. We can use that to sell longer online with a quick hit in the store. So it's really an integrated strategy that we're looking at developing, which drives that overall business, which is really where we think the retail world is trending.

John E. Currie

And John, your question on -- with inventory up at the end of the year, would that imply maybe lower freight costs early next year, yes, that is valid. The in-transit that you saw in the balance sheet at the end of October, a lot it for spring, was on the water as opposed to in the air. So I can't quantify it yet, but that will be a possible benefit in Q1.

Christine M. Day

And our airfreight really didn't start till late. It was really in Q2 -- sorry, into Q1, Q2 of next year because of where Chinese New Year and when we could get product. So the airfreight catch-up happened after March, April, so -- just for timing perspective.

Operator

Our next question comes from the line of Christian Buss from Credit Suisse.

Christian Buss - Crédit Suisse AG, Research Division

Okay. I was wondering if you could provide some color on the margin rate decline in the corporate-owned stores. Just kind of running through the numbers from the Q.

John E. Currie

Are you talking gross margin or what?

Christian Buss - Crédit Suisse AG, Research Division

The income from corporate-owned stores line. I guess my math suggests that margins there were down 60 basis points.

John E. Currie

Okay. You’ve got more detail on that than I have in front of me. Again, as we've talked about higher product cost due to inflation and in raw materials and labor, that's about 250 basis points. Lower markdowns year-over-year is 70, 75 basis points to the good. And then just a variety of smaller items that gave us about 160 basis points of improvement and the product margin offsetting those amounts. That gave us the net. I'm just looking at overall as opposed to just corporate stores. But that's what came to the net 20-basis-point decline in product margins. So yes, and then beyond that, it was the leverage and FX that I talked…

Christian Buss - Crédit Suisse AG, Research Division

Okay. And then as you're comping Oprah week this week, and I'm wondering how things are going as the favorite things episode is being lapped.

Christine M. Day

I do understand that we're -- it does mention that again. So we got some notice, I think, from Oprah on that. So I don't think that there's -- it wasn't a really -- I think it was a great visibility. Did it cause a run on fitness pants? I mean, we didn't know enough in time last year to have ordered enough pants to have met the demand that was created. And it's kind of a dangerous thing to buy a whole bunch of those again this year, because is it really what the guests wants. So we always design to what we know she wants versus what historically has sold, so that we don't ever get into a place we're buying a bunch of stuff we have to mark down.

Operator

Our next question comes from the line of Stacy Pak from Barclays Capital.

Stacy W. Pak - Barclays Capital, Research Division

A few follow-ups and then a couple of questions. So I guess, first, did you -- or would you repeat what you said about the comp or -- and/or sales in Canada? I missed that. Second of all, when you add up pretty much everything you said on the list of why total sales were light, does that get new store productivity sort of back to the 90%, 100% range? Or was there still a decline -- because I don't have every single number. What should we look at for SG&A dollar growth in 2012? Should it be similar to '11? And I guess the other big question is if inventories are so high and you're guiding to more markdowns, right, more normalized markdowns, shouldn't you also be driving a higher comp with those higher inventories? And if not, why not?

Christine M. Day

Which question do you really want answered?

John E. Currie

That's a whole lot of one question, so I'll go quickly through them. To repeat, comps or sales in Canada, again, the whole year and Q3 was similar, where mid single-digit comps, which is better than the overall Canadian retail market, seems to be performing. Our productivity in Canada is huge, and we're comping at that level. So we're not feeling weakness in Canada. If the Canadian economy is suffering, then I suppose we would be doing better. Total sales productivity, I think your question was when you do the puts and takes about, [ph] I went through, responding to Janet's question, what does that mean for new store productivity. New store productivity is not down from what it's been, at all. Our new stores are still opening at a projected annual rate in excess of $1,100 a square foot, and that's been the case throughout the year. And it is not declining. SG&A dollar growth, 2012, I'm not guiding to that yet. And with higher inventory, higher markdowns, why not a higher comp? I mean, last year, Q4, we were in a pretty good inventory position coming in. And we did a 28 comp, lapping a 28 -- a 29 comp a year before. So we're just being realistic in terms of what's a good level of comp in addition to the last year.

Christine M. Day

Well, the dollar value of a comp is huge. I mean, if you just do the math, I mean, what it takes to drive a dollar comp in Canada, what it takes to drive a dollar comp now in the U.S., it's a huge number, right? So it takes a lot more units to drive that comp -- so just realistically, if you do that math alone. The other point, which I said earlier, which is, this year, we're going to cap our overall growth so that we set ourselves up for next year. And I think it's really important that we do that, so that we don't have another year of trying to chase the product. So there's, I think, an upper range that we're comfortable with, and I think we've provided -- we feel like if the consumer isn't there, we're in great shape. We haven't taken on any more risks than we can manage. That protects the overall business, and that's always our objective, is to manage a well-run business and set ourselves up for success next year so our resources go to our strategic objectives versus catch-up.

Operator

Our next question comes from the line of John Zolidis from Buckingham Research.

John Zolidis - Buckingham Research Group, Inc.

Question on the SG&A. I believe the guidance was for SG&A to slightly delever in the quarter, and it came in with 110 basis points of leverage. I'm looking at the SG&A dollar growth rate on a per-square-foot basis in Q3. It would decelerate it sharply from the first half of the year. So can you just talk about what was different in SG&A in Q3 relative to the guidance?

John E. Currie

Right. There are a lot of small things. I'd say the biggest one was we anticipated a quicker ramp-up in our spend on our own e-Commerce team and digital marketing around the e-Commerce channel, having brought it in-house. And that spend did not happen as early as I anticipated in the guidance.

Christine M. Day

But it has happened now.

John E. Currie

Yes. We're now catching up.

Christine M. Day

So I mean, I think this is one of the points where -- I mean, we have substantially hired, and I said it in my script about -- in the product organization, in the IT organization to support a lot of the new systems and business process work we're doing for the increased complexity in the business. And the capital projects we have slated for -- really, they're in process this year, that will go in next year, and the digital strategy and the Web teams. And so it took us a little longer to do the sourcing, but those hires have been made. There was a substantial increase in the back half of the year in our headcount and hiring, and that run rate then will continue. So it's more of a step change than a small run-rate increase.

Operator

Our next question comes from the line of Taposh Bari from Jefferies & Company.

Taposh Bari - Jefferies & Company, Inc., Research Division

And then I guess the question that I had was -- I just wanted to dive back into the third quarter performance, specifically around your comp. So 16%, obviously at the high end of your range, a great number by any kind of standard. But I think the market has kind of come to expect you guys to, for better or for worse, beat even the high end of your range. So looking back at the third quarter, has anything changed? Or is it all kind of inventory constraint-related? Or like, has there been any kind of U.S. macro choppiness, or is it simply an inventory issue that you should be able to work through into 2012?

John E. Currie

I think I'd want to answer that by saying we really don't intend to blow away our guidance. We've had pleasant surprises in the past, where -- I like where we came in, relative to guidance. I'd say the only significant change was, as I said earlier, the Canadian and Australian dollars dropped after I gave guidance, and that might have knocked a little bit out. But otherwise, this is where we expected and hoped to come in.

Christine M. Day

Yes. And I think we do feel like we had unmet demand in Q3, but that was reflected in our guidance. We knew we couldn't maybe step up because we -- our mix was still, in my mind, not optimal. And where we don't want to be is buying either poor quality product, because we're rushing it just to fill a number, and we don't want to buy 10 more pink when it's 10 more yellow that will sell, because that creates markdowns. And it creates what the guest doesn't want, which hurts the brand. So as we're chasing, we have to be really careful to create the right balance of what the product is the guest wants and have the discipline not to just put anything in the store. And that's really what we were still managing through in Q3, which limits potential upside in that quarter. And then flow of goods was probably a little more challenging in Q3. We got some product later than we wanted. So there were, I think, some small execution pieces in there that affected that. But as John said, in going into Q4, we really want to make sure we manage Q4, to not blow it away, so that we're set up for Q1 of next year. And so that's -- and without placing stupid bets that place the company at risk. So managing well thought-out growth and a well-executed business to deliver great bottom line results consistently is where we come from.

Operator

Our next question comes from the line of Dana Telsey.

Dana Lauren Telsey - Telsey Advisory Group LLC

As you're thinking about the growth for next year, Christine, how are you thinking about the team? Is there any new people that you need to hire? And as you think about online, how are online operating margins this quarter versus what you had, and how does that normalize going forward?

Christine M. Day

So kind of going back in hire, as I mentioned, we are bringing in -- it's time to bring in a new SVP of brand and marketing that has that global experience. So we're looking to add that to the team. We're backfilling Chris Ladd's position. So at the executive level, there's there. We're still building out some our supply chain and sourcing leadership, as well. We think that's really the next important area that we invest in. So not at the senior, senior level, but some significant executive hires there. And so I think that's really the areas that we're building out. We are starting to bring in people who have more international and global experience in every position as part of that strategy, so that we're building a team that's capable of running a global operation. So that's one of the qualities we look for in every hire that we do. So I think we're getting ourselves ready for the things that are critical and important to us. And then the IT organization, Kathryn Henry has done a fantastic job of attracting top, top, top talent. So there's a new person that's brought in to run our store operating POS systems, which will help us integrate our online and store systems, which is one of our objectives for next year. And she's brought on a great person who has supply chain experience. So 2 critical hires in that area that we were very excited about, to drive those initiatives. And so -- I'm sorry, Dana, your second question?

John E. Currie

The online operating margin. And it's laid out in the Q. It's in the high 30s, which is down a little bit from Q2, because we were starting to spend some of the dollars with the new sites launching, et cetera. Q4, again, there's additional SG&A spend, but it's a higher revenue quarter. So it'll probably be similar or maybe slightly lower. And we'll see for next year, there's lots of room for leverage on the upside.

Operator

Our next question comes from the line of Andrew Burns from D.A. Davidson.

Andrew Burns - D.A. Davidson & Co., Research Division

With all the categories that are and will be in stores for the expanded run lines, cycling, small dance capsule, new spring lines, how do you think about the proper store size to adequately merchandise the depth of product that you now have? And do you think a larger box could be in the future for new stores, or opportunity to expand stores in stronger markets here?

Christine M. Day

One of the strategies we have been deploying, and that's why we had 5 of our top stores under renovation, was we do look at the older store base, particularly in Canada, where we've added so many more product lines since they were first originated. And a lot of those stores were in the low 2,000, 2,200, 2,300 square feet. So at the point of renewal, which is your optimal kind of business model time to do it, we are taking additional square footage and renovating those stores, if we could take it next to us. And if not, in some, we've relocated in the mall to a new location to do that. Or if it's more of a street-front location, making sure that we renovate to add room for the capacity by deploying new fixtures. So we have a whole strategy that's around upgrading some of those older, smaller stores that's timed around their lease renewal rates. And so that strategy is being deployed. And we have in -- we've looked at our stores. And if it's a neighborhood store, we stay pretty close to the 2,800-square-foot model that we've traditionally been doing. But if it's a store we believe will be that future anchor store, we will take it up a little closer to the 3,000 square feet. But we don't have any intention of building 5,000-square-foot stores or flagships. Our strategy is much more around the flow of goods and about integration with online.

Operator

Our next question comes from the line of Paul Lejuez from Nomura.

Paul Lejuez - Nomura Securities Co. Ltd., Research Division

I was just wondering if you could talk a little bit about third quarter performance, maybe East Coast versus West Coast in the U.S. And then also on the comp breakdown, if you can talk traffic versus ticket and what your AURs were. Also just an update on Men's, how did they do during the quarter?

Christine M. Day

Let's see, we love the Midwest. I mean, that's really -- our business is just phenomenally blowing out there, strong performance across all markets. We don't have any soft markets that we've really seen. So I think that is definitely the good news. The brand is going everywhere. Men's, we wish we had more. We -- Men's has really done well. We've been a little light on product on Men's. As Chip and our new designer were revamping the line, we stuck with pretty much basics. And you'll just really start to see the new Men's stuff in, really, summer of next year, really the kind of the big popping stuff. So it'll pretty much be a basic story, but high quality, great colors, great lines between now and then. And then in terms of traffic, it's still primarily traffic. John?

John E. Currie

Yes, the overall comps, a little over half just came from traffic. 25%, give or take, from conversion. There was a little bit that came from AUR, about 2% increase in our average transaction value, and that just reflects a little bit of a mix shift as opposed to any take in pricing.

Christine M. Day

More of a top per year.

Paul Lejuez - Nomura Securities Co. Ltd., Research Division

Got you. And what percent does Men's represent now?

John E. Currie

We were still around 12.

Christine M. Day

About 12. And…

John E. Currie

The comp on Men's was just slightly ahead of the overall average.

Operator

And due to time constraints, our final question today will come from the line of Jennifer Black from Jennifer Black & Associates.

Jennifer Black

I have a follow-up to Men's. I was curious to know if you were going to broaden the assortment. And do you -- are you still thinking that it could represent 15% to 20% of your business? And then I also wondered about limited -- the limited edition collection. Are you carrying more inventory in this category, corresponding with your inventory increase?

Christine M. Day

Yes. That's kind of seasonal. Like right now, we have a limited edition hoodie that's in the store. So…

Sheree Waterson

And some pants.

Christine M. Day

And some pants, which we do every holiday season. I think what you are seeing is kind of the premium running jackets and the premium yoga jackets. I mean, there are a few more in that premium category, but not yet what I'd call special edition.

Sheree Waterson

We did expand the special edition hoodie categories, and we also have some special edition leggings. And so yes, you are seeing that. And the guest is responding, which is fantastic. And then in terms of Men's, you asked are we still bullish on expanding the Men's business. And the answer is absolutely yes. And with what I just saw that is coming through for next year, just post the first half of 2012 looks really good. So the -- I think there's a tremendous amount of potential there, both in-store and then, of course, Christine has continued to mention leveraging our online sales as well. And who knows what's next, so…

Christine M. Day

I really think the work that we've done in the last 6 months about finding our voice in Men's and what's our spot that we're going to go after, that's what I'm most excited about, is because I think we've really defined that. And that's what you'll start to see up and -- show up in the second half of 2012.

Operator

I would now like to turn your conference back over to Ms. Christine Day for any closing remarks.

Christine M. Day

Thank you, everyone, for joining us today. And as usual, I would just love to thank everybody from our e-Commerce team, who worked so hard to get really 3 new websites up and running for us, between the 2 ivivva sites and the new lululemon skin, in a very short period of time, and everybody out there in our stores who delivers a great guest experience. So thank you, everyone.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect. Have a great rest of the day.

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