Lululemon Q2 Earnings Call

Opening Statement:
Laurent Potdevin - Lululemon Athletica Inc - CEO 

Good morning, everyone. The results we are sharing with you today are beginning to reflect the ongoing work that is being done across our entire organization, and our sales and bottom line for the quarter finished slightly ahead of plan. We are early in the process of getting back to consistently delivering amazing and innovative product to our guests, along with unmatched guest experiences. We obviously don't aspire to flat same-store sales and earnings that are down year-over-year, and yet are confident that work and investments we are making is building the foundation that will fully unlock Lululemon's long-term global potential. 

On our last call, I let out four key priorities, product, brand, guest experience, and international expansion, and our second quarter results indicate consistent progress against those priorities. On the product front, product flows were (inaudible) forth in our sales trend in the second quarter. his was particularly evident in July, as we changed into additional trends in bottoms, and leveraged our fast turn team to create mesh product, which brought newness and excitement in stores and online. 

Additionally, our transitional collection which was a new strategy to bridge summer and fall was incredibly well-received by our guests, and created the upside we saw in July by selling through faster than anticipated. While our assortment are not optimal this year, we have started to shift our mix with further improvement expected in 2015. 

We have also emphasized our commitment to building our foundation over the next 18 months, in order to set ourselves up for global growth.One of these foundational areas to strengthen is our go-to-market process, and although it's still early, we are hitting each milestone in the implementation of the calendar that we have set to achieve. At this time, we have completed the [cadence] of the calendar, resulting in four additional weeks of creative space for our designers, as they start the design of fall 2015.

This past quarter, our Whitespace workshop has started partnering with our ambassadors on three different fronts. First, co-creating innovative technical and beautiful product with a small group of early ambassadors. 

Second, gaining a deep insight into the athlete/product relationship, and third, testing and validating product development in upcoming launches.The information we derive from our workshop projects, combined with the world-class product engine will drive the innovation that our guests love. 

Moving on to brand and guest experience. On our last call, I spoke about one of our most unique yet under leveraged asset, our 1,500 strong army of ambassadors. These athletes are leader in their communities, they embody our lifestyle, and reflect our amazing culture in everything that they do. They are the authentic voices in our communities, whose local stories and insights are shifting our global brand, and we are committed to building and nurturing this group of inspirational athletes.

One of the ways, we are harnessing the collective power of this group is through the online ambassador forum we recently launched. Through this forum, more than a thousand of our ambassadors are collecting and sharing feedback with each other, the Lululemon store, and the product and Whitespace teams here in Vancouver.

Our SeaWheeze half marathon event in Vancouver, which brings together running, yoga and community, was once again a tremendous and inspiring success, and we are thrilled to see our annual event become such a sought after destination. We hosted more than 10,000 runners, 70% of whom were from outside of Vancouver, and 50% are from outside of Canada. In fact, registration for 2015 took place yesterday, and sold out in 36 minutes. This event truly embodies the spirit of Lululemon, and we are rollingout locally relevant experiences in San Francisco, Los Angeles, New York and Toronto from October through December that will reflect that same spirit.

This year, the SeaWheeze event took place on the heels of the opening our flagship Robson store in Vancouver, a beautiful 4,500 square foot space featuring in-store digital storytelling, dedicated space for mens and women, and onsite product personalization. This new space serves as an example of the directions we are taking, with similar openings scheduled to take place in Miami and Santa Monica in the next quarter.

The store opening was supported with community events that truly showcase the engagement that currently exists among our guests. The store performance in its opening week performed at 141% to plan, which was the highest volume store globally, reaching a18% penetration in mens sales, the highest in North America.

To further elevate our guest experience and global brand awareness, we are relocating our Soho store in New York and opening both mens and women's standalone locations kitty-corner to each other on [Prince] and [Wooster], with the mens location opening by late fall 2014. This will provide unique experiences for both men and women in spaces that are designed uniquely for their needs. I look forward to seeing how these two stores build a steady partnership, while still making sure to one-up each other every now and then.

Once again, the Ivivva business performed very well, with a positive comp of 36% this quarter. We recently launched a dreams and goals program for all our stores and showrooms to connect with our young guests, and we are incredibly excited about the potential of this growing brand. And we continue to invest in our infrastructure to support our goals. 

We made significant headwinds in improving our online guest experience by opening another distribution center to improve the service level to our guests by delivering product faster. The distribution center is located in Columbus, Ohio. Our new guest order management system went live on July 11. This is a major pillar in our one guest omni-channel strategy, enabling efficient routing of orders among all distribution centers. And this quarter, our back backroom app which allows us to process sales in-store from our onlineinventory created incremental opportunities, and enhanced the experience for our guests by giving them access to a broader product selection.

Moving on to our international expansion. We are seeing continued demand in brand strength globally, with our London store continuing to perform strongly, and we look forward to opening our second store in Chelsea by December 2014. We are on track to build a network of showrooms in both Europe and Asia through 2014 and 2015, and by the end of 2017 to have 20 stores in both regions. And we are very happy to announce that we have secured a fantastic location in Singapore in the Ion Mall, and are on track for a Q4 opening.

We are also in the final stages of securing our first location in Hong Kong scheduled to open early 2015. On the heels of the successful opening in London in the spring, and a continuation of strong demand and performance, we continue to look to opportunities to accelerate market entry into other regions, including being in discussions with a potential partner in the Middle East to enter the regions by Q4 2015.

Before I turn the call over to John, I want to mention that we are all looking forward to having Advent back as a shareholder. Advent was an early investor in Lululemon, and David Mussafer and Steve Collins were both instrumental in helping to guide our growth in the early years. We look

forward to having their guidance once again, as we write the next Lululemon chapter.

Q&A (I've not included all questions, just the ones that are interesting or relevant to us as customers)

Adrienne Tennant - Janney Capital Markets - Analyst

Okay, great. Well, congratulations on the improvement in the product. Laurent, can you talk about what percentage of the July flows and are -- go forward are in the seasonal versus the core category? And then, John, if you can talk about the inventory, you had to pull some of it forward because demand was good. So where does that put you in terms of inventory flows going into the early part of fall season. So if you can talk a little bit about that? And then really quickly, the Canadian comps versus US, if you can talk to that? Thank you so much.

Laurent Potdevin - Lululemon Athletica Inc - CEO

As far as the breakdown, I mean, we had this strategy of launching the transitional line that was a bridge between summer and fall that was receivedreally well, and the sell-through was higher than anticipated. And so, we had a plan of selling about three weeks of those in July, as well as the first few weeks of August, and we pretty much moved all of that product in July. So that probably created a void in the first two weeks of August. What is the break down exactly?

Omar Saad - ISI Group - Analyst

Thanks. Good morning. Two questions. First one is, on the success you are seeing in the [transitional merchandise assortment], what is really goingon there? What are you learning? What is so good about the assortment really driving that business, and how can you carry forward that momentum,

and build upon it going forward? Any insights especially around product and stylings that is driving it?

And the second question, I have is on Ivivva. You mentioned a really good number there, a comp number there. I know it is really small. Maybe youcould talk about the long-term vision for that concept and brand, and how it's going to fit versus the Lululemon brand and complement it, and

where you see that going long-term? Thanks.

Tara Poseley - Lululemon Athletica Inc - Chief Product Officer

So I will answer the success of the transition lines. I think it really underscores what I have been talking about over the last two quarters, about our opportunity to be really consistent in bringing beauty and technical back to our product. And I think that line definitely illustrated that. I also think the work that the team did with print, and also some of the print that we chased into in the quarter, also we saw great response there. So again, it is just that newness and beauty, but always underscored by great technical products. Do you want to talk about Ivivva?

Faye Landes - Cowen and Company - Analyst

Hello. I am just hoping that you can elaborate a little bit more on inventory. The -- pretty consistently, your -- the products that sell really well, sellout ahead of -- earlier than you have expected. Which is in some ways, is a high class problem obviously, but you are also leaving money on the table. I don't remember the last quarter where that didn't happen. So can you talk about how you plan to adjust things, so that you can fully capitalize on the opportunities that you have?

Tara Poseley - Lululemon Athletica Inc - Chief Product Officer

Yes. So what we talked about in Q1, where we had seen the high comp [weaken] with the seasonal goods, and we had overplanned our expectation for us. So what we did for Q3, obviously, we weren't able to effect Q2. But what we did for Q3, was really shift that core investment and open tobuy into the seasonal product.We went back and looked at sell-throughs on all of our seasonal product in Q1, made sure we are planning our APSs appropriately in Q3. And really did that diligence, in making sure we were investing appropriately. But we will -- I mean, we also do really value the scarcity model. We have a very low markdown rate in the brand, which I love. So it has always got that fine balance. That is what we are looking and perfecting towards. And then, as part of -- what we had talked about -- I think we had mentioned this earlier, we are in the process of implementing a new planning and allocation tool. That will be fully live for the planning of winter 2015, and we are on time and on budget with the execution and implementation of that tool.

Dorothy Lakner - Topeka Capital Markets - Analyst

Thanks. Good morning, everyone, and congratulations on the progress. Just a question for, I guess, either Laurent or Tara. In terms of the milestones that we should be looking at into the back half of the year, as to where you are in the calendar, and getting to where you want to be from a product standpoint, what should we be looking for as that product comes into the stores in the second half of the year? You were obviously able to chase more in second quarter. What should we be looking for in the third and into holiday?

Tara Poseley - Lululemon Athletica Inc - Chief Product Officer

So for the back half, obviously, the go-to-market calendar and all the work that we are doing with that, we commenced that in Q1 of this year. So obviously, that did not affect Q3 and Q4 of this year, since that was already bought and commercialized at that time. So in relation to the back half of the year, it was rebalancing the core versus the seasonal, which I just talked about a few minutes ago, and just making sure we are investing appropriately in the seasonal. We have continue to really focus with the design team, on making sure we are getting all of that beauty and technical, always technical, back into our product. Because we are very proud that we are the originators of that, and that in this space and a lot of focus there. So that is really, that is a focus this year. And then just using our [fast turn] where we can, and continue to chase them into product. A good example of that, is using the fast turn team to create a special capsule, a little capsule product to arrive right before Black Friday for some (inaudible) price selling during that weekend.

Janet Kloppenburg - JJK Research - Analyst

Hello, everybody. Congratulations on the progress being made. Tara, just a question on the product mix. I think you have introduced a lot of new bottoms, to try and reinvigorate that core category. I was wondering if you could talk about the performance there in your outlook, as we go forward for that category?

And Laurent, I think you had defined $10 million in incremental SG&A spending on traffic-driving initiatives for the stores, and for the entire business. And I am wondering if that -- there was impact in the SG&A line from that in the second quarter, or if most of that will be incurred in the back half? Or if we potentially could see more investment there? Thanks so much.

Tara Poseley - Lululemon Athletica Inc - Chief Product Officer

Yes, Janet, and you are right. We had talked about that Q3 was going to be a focus on really reinvigorating our core products, starting with the bottom. And early signs are, that (inaudible) there are some emerging core that is in store now that we are excited about. And as we move into --I am not going to call it out with (inaudible), because that is proprietary information, but we are seeing good signs there. And then as we move into Q4, the other area that we have -- or we are very clear that we needed to continue to evolve, and create newness within tops and the tanks. And we are also will be testing some new emerging core among those areas as well. And then the fast turn team will continue to also be testing and learning, and getting that insight and information that we can chase into the future quarters.

Laurent Potdevin - Lululemon Athletica Inc - CEO

And then to the second part of your question, we had allocated $7 million to drive traffic through increased page search, online campaigns, e-mail segmentation and redesigning our product notifications, that are so relevant to our guests. And most of that spend will happen in the back half of the year. In Q2 I think we spent less than $1 million on it, and we looked at sell-through and inventory, and saved that investment for the second part of the year.

Dana Telsey - Telsey Advisory Group - Analyst

Good morning, everyone. Can you talk a little bit on where do you stand on some of the improvements in -- from the third-party consultants, what you are learning as they look at the organization and the processes? And then just lastly, Tara, what -- on the new line where you have seen the big improvement, on the style, price, how are the learnings able to influence the other product flows in short-term? And is the margin on this product, do you see that developing early and the ability to have improved margin? Thank you.

Tara Poseley - Lululemon Athletica Inc - Chief Product Officer

Okay. So the third-party consultants that we brought into help us with reengineering our go-to-market calendar, we have had really good insights. I think on the whole, it is a lot around how we were sequencing events within the calendar, and we are going through a process of resequencing how we bring product to market. Some things were happening too late in the process that need to be moved forward. I am not going to get into all that detail, but we really, really honed in on what those pieces are, and are going through the process of a redesign of every single quarter for each season. And we are on track by Q1 of 2016, to have a fully operational go-to-market calendar. And then, I think -- Dana, what was your second question, it was about style and price, and what we can do in the short-term? We -- this is a very scrappy and entrepreneurial culture which I deeply value, and we literally are learning minute by minute about our assortments, as we see that getting in, and using our fast turn team when we can, to react quickly to get those learnings in, And then also, in fusing that into -- any of the learnings into the future seasons that are in process and being worked on.