Earnings Call: Q1 2013

Jun 7, 2012

Good day, ladies and gentlemen, and welcome to the Lululemon Aesthetica Q1 2012 Results Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference is being recorded. I would now like to introduce your host for this conference call, Ms. Terresa Hayes. You may begin. Good morning, everybody, and thank you for joining us on the Q1 2012 conference call. A copy of today's press release is available on the Investor Relations section of Lululemon's website at www.lululemon.com or furnished on Form 8 ks with the SEC and available on the Commission's website atsec.gov. Shortly after we end this morning, a recording of today's call will be available as a replay for 30 days on the Investor Relations section of the website. Hosting our call today is Christine Day, the company's CEO and John Currier, the company's CFO Sherry Watterson, our Chief Product Officer, will also be available during the Q and A portion of the call. We would like to remind everyone, of course, that statements contained on this call, which are not historical facts, may be deemed to constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. Also for today's call, we've got a limit of 1 hour. So when we get back to the Q and A, please limit yourself to one question at a time to give others the opportunity to also have their questions addressed. And with that, I'll turn it over to Christine. Thank you, Tres. Good morning, everyone, and thank you for joining us today to discuss our Q1 results. We have started off the year with another strong quarter. While every call, John and I speak to our financial achievements, we are equally aware of our broader goals to create leaders in the world, to elevate our ambassadors and the ongoing commitment of the entire team from our factories to our stores to deliver high quality innovative product and an excellent guest experience that makes it all possible. Before I go any further, I want to recognize everyone at Lululemon for once again coming together to achieve these excellent results. Our investment in increased inventory levels led to strong growth in earnings performance in the Q1 as our guests responded well to our spring styles. You will recall that in the Q1 of last year, we were very light in inventory as a result of having oversold in the Q4 of the prior year. One of our key goals for 2011 was to balance our inventory to meet demand in order to focus our resources on innovation versus chasing product. We announced during our last call that we entered 2012 with a strong inventory position to break the cycle of chase. This translated into a 53% increase in revenue to 285,700,000 dollars We are excited about our new store openings as each of these was unique and special for the individual communities. In the Q1, this included the opening of our first store in Salt Lake City, Utah, where they celebrated with a big party, including 150 of the community's top fitness supporters, ambassadors, friends and family. The 2nd store to open in the Q1 was in the historic district of Downtown Milwaukee. The opening weekend festivities included an ambassador breakfast on Friday morning and yoga demos all week. Over the course of the weekend, guests arrived from all over Wisconsin, including a group of women that rented a bus to travel from Green Bay, 2 hours away, to join us for the opening festivities. The team Tampa held a Roaring 20 scenes Speakeasy party to celebrate our Hyde Park Village store opening and we opened Boston's Newberry Street complete with acro yogis performing from an apparatus stung from the exposed beams in the store. And we were thrilled when our ambassadors surprised the team this morning with breakfast to thank them for a very special night. We continually strive for the right balance between delivering strong growth and our market leader focus on quality, innovation and execution. An example of this innovation is in the capsules we are introducing throughout 2012. Based on the past success of our capsules, both from the guest response and our learnings, we have increased the cadence from 2 to 3 a year to 8 for 2012, which is consistent with our objective to plant seeds for our long term growth. The impact of this innovation, small production runs, new fabric and technologies, the hits and misses are already built into our gross margin model. Throughout 2012, we are seeding international markets. Our London showroom opened in April and is off to a great start, hosting weekly yoga classes with 25 to 30 participants, building relationships in the community and already performing better than the average of our U. S. Showrooms. We expect to open the 2nd Hong Kong showroom at the end of Q3. We successfully launched the Australian e commerce site on May 17, so our Australian guests will have an online assortment pricing that is specific to them and most importantly, they receive their order quicker than ever before. This new website allows our stores to be even more connected and accessible to our local community. As announced previously, we also plan to launch country specific web pages in the UK and Hong Kong this year. The behind the scenes work on our international expansion in tech and legal structures, logistics, IT systems, local labor laws, onboarding strategies and product compliance assortment and distribution planning continue. We know from our country visits that market demand is growing and we are selecting our top priority markets now. To support this growth, we need to continue to invest in people and systems. We have a number of large IT infrastructure programs underway to optimize multiple supply chains, provide cross channel visibility and ensure that we have the flexibility to make, move and sell product globally. Last quarter, we announced 2 key hires, Laura Clauberg, SVP Brand and Community, previously a top executive at Unilever and Paul Zaneagle, our new SVP of Global Digital Commerce, formerly of Columbia Sportswear and Ralph Lauren. Both of them are completing their onboarding, including visiting our showrooms, completing store shifts and participating in executive team building. And we look forward to having them here full time in Vancouver as we expand the business and the brand in new directions. On a closing note, we host our inaugural half marathon event, the seaweeds on August 11 here in beautiful Vancouver, BC, and we are now only about 200 short of our sellout capacity of 7,500 participants. This will be my first half marathon, and I would love to have you join me, so register online quickly if you want to join our party. And with that, I'm going to turn it over to John to go through the numbers. Thanks, Christine. I'll begin by reviewing the details of our Q1 2012 and then I'll update you on our outlook for the Q2 and the full year of fiscal 2012. So for the Q1 total net revenue was 285,700,000 dollars an increase of 53% over the Q1 of 2011. The increase in revenue was driven by comparable store sales growth of 25% on a constant dollar basis, the addition since Q1 of 2011 of 27 net new corporate owned stores in the U. S. Plus the 4 franchise stores that we have reacquired last year, 4 Aviva stores in Canada and 6 stores in Australia and one in New Zealand. Direct to consumer sales which increased by $24,700,000 or 179 percent and offsetting this was the impact of foreign exchange which had the effect of decreasing reported revenues by $1,800,000 or 0.9 percent. During the quarter, we opened 4 Lululemon stores in the U. S. And 2 AVEVA stores in Canada. We ended the quarter with 180 total stores versus 142 a year ago, including 19 stores in Australia and New Zealand. There are now 127 stores in our comp base, 41 of those in Canada including 2 of EVA, 75 in the United States, and 11 in Australia. Corporate owned stores represented 80.1 percent of total revenue or $228,800,000 versus 83.6 percent or $156,200,000 in the Q1 of last year. Revenues from our direct to consumer channel totaled $38,400,000 or 13.5 percent of total revenue versus $13,800,000 or 7.4 percent of total revenue in the Q1 of last year. Other revenue which includes wholesale showrooms, outlets and until last year franchised stores totaled $18,500,000 or 6.4 percent of revenue for the Q1 versus $16,800,000 dollars or 9% of revenue for the Q1 of last year. Gross profit for the Q1 was $157,300,000 or 55 percent of net revenue compared to $109,700,000 or 58.7 percent of net revenue in Q1 2011. The factors that contributed to this 370 basis point decrease in gross margin were a prior year favorable non recurring adjustment of 140 basis points which related to recognizing certain input tax credits, product margin decline of 3.40 basis points due to increases in labor and raw material costs due to product innovation, function, garment complexity, as well as inflation and a more normalized rate of markdowns as a result of more balanced inventory levels. These were partially offset by leverage on occupancy and depreciation which contributed 110 basis points of improvement. SG and A expenses were $84,200,000 or 29.4 percent of net revenue compared to $58,000,000 or 31 percent of net revenue for the same period last year. The 45.1 percent SG and A dollar increase is due to an increase in store labor and operating expenses associated with new stores, showrooms and growth at existing locations, an increase in store support center costs including salaries, professional fees, management incentive based compensation and stock based compensation. We continue to make investments in building our pipeline infrastructure and operational capabilities to drive long term growth, and as well an increase in non store occupancy and depreciation. As a percentage of revenue, our Q1 SG and A gained 160 basis points of leverage due primarily to our e commerce business as we significantly lowered operating costs as a percentage of sales by in sourcing our strategic platform. As a result, operating income for the Q1 was $73,100,000 or 25 0.6 percent of net revenue compared with $51,700,000 or 27.7 percent of net revenue in 2011. Tax expense for the quarter was 20 $7,000,000 or a tax rate of 36.5 percent compared to $19,100,000 or tax rate of 36.3 percent in the Q1 of 2011. Net income for the quarter was $46,600,000 dollars or $0.32 per diluted share. This compares with net income of $33,400,000 or $0.23 per diluted share for the Q1 of 2011. Our weighted average diluted shares outstanding for the quarter were 145,700,000 versus 144,900,000 a year ago. Capital expenditures were $12,700,000 for the quarter compared with $74,800,000 in the Q1 of 2011, which included the purchase of our store support center for $65,100,000 We ended the quarter with $424,300,000 in cash and cash equivalents. Inventory at the end of the quarter was $107,700,000 67 percent higher than at the end of the Q1 of 2011. Excluding higher product in transit, on hand inventory unit growth in transit, on hand inventory unit growth of approximately 30% is consistent with our expected forward sales and will support the growth from new stores, higher same store sales, and our e commerce channel. This leads me to our outlook for the Q2 of 2012 and the full year. For the remainder of 2012 on a net basis our guidance remains basically unchanged. So incorporating our stronger Q1 results we've increased our revenue guidance for the year to be in the range of $1,320,000,000 to 1,340,000,000 dollars This guidance assumes a lower Canadian dollar at $0.97 to the U. S. Dollar versus par in our previous guidance, with the reduction in revenue on currency translation offset by slightly higher store productivity and e commerce performance. We anticipate we'll open a total of up to 35 corporate owned stores plus 2 outlets in 2012. Revenue upside opportunity is limited until Q4 as we have focused our product team on innovation for the future in favor of chasing near term revenue dollars. We continue to expect gross margin for the year right around our stated long term goal of 55%. As discussed on the last call, we expect to be below 55% through Q3 and above in Q4 due to leverage on the higher holiday volumes. We expect to leverage SG and A slightly for the year, driven by leverage in Q1 during which we still had not cycled the transition to our ATG e commerce platform which occurred in late Q1 of 2011 and also due to leverage on higher volumes in Q4. As a result, we expect our fiscal 2012 earnings per share to be approximately $1.55 to 1 $0.60 This is based on a tax rate of 36.5 percent and 146,000,000 weighted average shares outstanding. Within this full year guidance, we anticipate Q2 revenue to be in the range of $273,000,000 to $278,000,000 This is based on a comparable store sales percentage increase in the low double digits on a constant dollar basis compared with the Q2 of 2011. Again, our outlook assumes a Canadian dollar at $0.97 to the U. S. Dollar compared to $1.03 in Q2 of 20 11. We plan to open 7 Lululemon stores in the U. S. And 1 in Australia during the Q2. As I've just mentioned, we expect gross margin to be below 55% in Q2. We expect some gross margin decline versus the Q2 of 2011 driven primarily by the same reasons experienced in Q1, higher product costs due to innovation, construction and more normalized markdowns due to balanced inventory levels. This will be partially offset by leverage on occupancy and depreciation. During the Q2, we expect to deleverage slightly on SG and A as a percentage of revenue over the Q2 of 2011. We continue to invest in initiatives that drive capability in our supply chain and infrastructure, leadership, guest experience and growth. Assuming a tax rate of 36.5 percent and 145,700,000 diluted average shares outstanding, we expect earnings per share in the Q2 to be in the range of $0.28 to $0.30 We expect capital expenditures to be between $80,000,000 $85,000,000 for fiscal 2012 reflecting new store build outs, renovation capital for existing stores, IT and other head office capital. This amount could potentially increase if we meet success in an initiative underway to acquire or build our own retail street stores to control our occupancy in key strategic locations. With that, I'll turn it back to Christine. Thanks, John. I just want to reiterate that we are exactly where we want to be, balancing our long term growth, innovation and execution and that our business fundamentals remain strong. With that, we're going to open it up for Q and A. Our first question comes from Sharon Zackfia with William Blair. Good morning, Sharon. Good morning. One moment. Thank you. You may ask your question, Sharon. Okay. Can you hear me now? We can. Yes. All right, great. So a few questions. I think, John, you said something on the order of the expectations that you have for the rest of the year essentially unchanged. Obviously, I think your Q2 guidance was a little bit below what the Street expected. Just curious if you're seeing anything so far in the Q2 that we should maybe be concerned about? And then secondarily, on the capsules, I think there has been anxiety in the market as they've seen more of the risk you've been taking on the product. And if you could help us understand how those capsules evolve over time, how you analyze them into potentially becoming permanent parts of the collection going forward? And how we on the outside can really view those and kind of analyze the hits or misses as you mentioned Christine? Okay. I mean on the guidance for the balance of the year as Christine mentioned we're basically right on plan for the year. The cadence quarter to quarter, of course, I had given guidance on quarterly revenue previously. So our Q2 guidance is really consistent with where we expect it to be. And we feel good about the way the business is running right now. The capsules? Yes. On the capsules, we feel they're doing exactly what we want them to do and we had planned for the impact of those capsules throughout the year. The 2 that are dropped, which are swim and the commuter line, on swim, we learned a lot about the technical manufacturing of swim. And while we think there were some things that were overall successes that were really great, we learned a few things about fit and function and fabric as we constructed those swimsuits. So we had great guest response to them, but we also I think learned some things technically. And the beauty of capsules and why we deploy this strategy is so that we don't make big buys in new categories and then have huge markdowns or place big bets. So these are small controlled bets, one time where we take the learnings, always looking for that anchor piece that we can take forward. On the Commuter Capsule, that was very successful. We learned a lot about some great pieces in that Commuter Capsule. But we felt like we made a little bit of an issue with the buy there, doing it a little deeper than we should have for capital and pulled that back. So the learnings that we take from one to the next, I think are great. We tried some new fabrics. So those are things that will compress our margin in the short term, but we also can translate some of those learnings into other product lines. Sherry, do you want to add anything? All done. Okay. So I think we feel that we got some great learnings about the bikes. And I also want to be clear that we don't just maybe test something once. Something like the cycling could repeat and we will come back later in the year with some additional tests. So we feel it's a very controlled way to manage our long term growth opportunities and it's the right thing as a market leader to continue to innovate. Perfect. Thank you. Our next question comes from Adrienne Tonet with Janney Capital. Good morning. And let me congratulate you on the Q1, nice start to the year. Christine, my first question is, can you talk about the macro environment, Canada versus U. S. Versus Australia? Which of those as you look into the back half of the year, are you planning for largely those to be similar, worse or better in each of those markets? And then for John, can you talk about low double digit positive? I'm assuming the debt by definition 10% to 12%. It's a deceleration from the Q1 trends. So can you give us any color on how you exited the Q1? And typically, I'm assuming that you give that guidance based on what you're currently seeing, if that's the case. Thank you. I think market by market, we feel optimistic about each one of those markets. And while we have sometimes day to day choppiness, we know it's more related at this point to our product flow and timing of deliveries. We hear a lot of noise in the macro market. I think like other retailers, we're going to control what we can control. We've always been disciplined planners looking at upside and downside, and I feel we're well poised to manage through anything. And John and I are professional warriors, so we always will look at that and have our contingency plans. But at this point, we don't see anything that, as we stated in our guidance, that's going to change our outlook for the year. Yes. Okay, great. In terms of the Q2 comp, remember the Q1 part of the our ability to hit a 25% comp in Q1 was because we were so under inventoried a year ago. So one thing to remember is Q2 and the balance of the year is getting to a tougher compare. But beyond that, again, it's really product flow. Again, in terms of comp, last year was very up and down. And so the comp month to month, week to week and quarter to quarter is a function of what we saw a year ago. But in general, the strong comp in Q1 more modest for the mid part of the year. And as I said in the prepared remarks, we deliberately chose to not have our product team dedicate a lot of time to chasing inventory to catch every last dollar of revenue. They're really much more focused on innovation this year. And so as I said, the ability to have higher opportunity in product is really back ended to Q4. Okay. Did you see any March, April Easter shift impact? I think that was harder for us to tell because our delivery cycle and what we were anniversarying, if you remember last year, our biggest chase dropped the end of Q1 beginning of Q2 and we oversold a little bit more than we planned in Q1. So I think could that have been a little bit of it? Yes, but I think separating that from our own cadence of product flow for us at this time, it's just noise. I don't think it was anything significant. Okay, great. Thank you very much and best of luck. Thanks. Our next question comes from Omar Saad with ISI Group. Good morning. I wanted to follow-up on the kind of strategy around product innovation versus inventory chase. What kind of opportunities are you seeing there on the innovation side? And in terms of resources and allocating resources, both kind of capital and human, how does that work internally where you're kind of shifting the focus in terms of replenishing and chasing the inventory as opposed to really focusing on developing innovative new products, new areas and new categories. Can you maybe dive into that question a little bit because it seems like somewhat of a shift from maybe the last couple of quarters? I think it's a shift from last year, Omar. And what we learned in last year when we were so heavily in Chase, as we stated in prior calls, what we started to get a little concerned about was when you over order what you can get versus what you know the consumer needs, there's a brand cost to that. And so chasing any dollar might produce something in the short term, but longer term making sure that we have the quality, that we have the right amount of scarcity, that we're always innovating what's needed as a market leader from a brand and long term growth story is the position we'd rather be in rather than if we chase an extra amount of pink when yellow is what's needed, we really just create, in our opinion, future markdowns and destroy the brand. So we're always looking at that. Now are we doing no chase? Absolutely not. Are we doing as much as we did the year before? No. We believe our buys are solid. We're planning for a great Q4 and Q1. And as we've always been committed to quality, because the other thing we don't want to run into is we're doing and innovation just isn't capsules and pods, it's new fabrics, it's blending fabrics on garments. And that requires more complexity and more construction. So we want to make sure that quality is always what we're doing well because those are the long term fundamentals our brand builds upon. So we're smart about it and balancing that with growth and innovation and our ability to execute the brand that we know the consumer wants us to be. Thanks, Christina. And John, does this have an impact on the balance sheet, the inventory levels? Should we see those come down as a result of this? No. I mean the inventory level we're at in terms of compared to forward sales is appropriate. So inventory levels should be in that same balance for the rest of the year or at least through to Q4. Thanks guys. Our next question comes from Janet Kloppenburg with JJK Research. Good morning everyone. Congratulations. John, I wanted to flush out this innovation comment just a bit more. It sounds like it may constrain comps on the core business, perhaps help you read the acceptance of new product or new technical fabrics or styling. Maybe you could talk a little bit about that, or Christine? Also, I'm wondering about sales metrics in the quarter, change in AUR, change in traffic, conversion levels, etcetera. Also, the e commerce business came in much higher than I expected. And I'm wondering if there's a trade off there with comps. And lastly, Sherry, can you talk to us about the capsules? I think you're adding maybe 6 this year and when we might see those flow in. Thank you. There's a lot of questions in one. It's quick. I'll answer them quick. It makes it hard to remember what the first one. I'll go. The first one was the innovation is hurting comps in the overall comps because of core product being perhaps below where it has been? Yes. I wouldn't say innovation is constraining comps. I mean we're again we're not scrambling and chasing further upside, but the buy of our core and key styles is appropriate for the level of business we expect and the innovation is just where we're dedicating those additional efforts. Okay. Conversion AUR pricing, I guess what we saw in the quarter, most of the comp came from traffic with strong higher conversion and slightly higher average basket. Which mainly was driven by more complexity in the garment not Yes, but also slight increase in units per transaction as well. Yes. Yes. E commerce as you say, I mean it's tremendous growth there at 179% over last year and that channel definitely has tremendous momentum came in at 13.5% of overall revenue which matched Q4 which was actually a pleasant upside surprise because traditionally seasonally Q1 and Q2 e commerce is a lower percent of total. So e commerce definitely outperformed. We don't include that in our comp base of course, but it is something to keep in mind when you're looking at overall sales growth. And on the capsules? And on the capsules, so commission Hi there. How are you doing? June, August October, we have cycling, commute and spin respectively. And then also for November, we have a bar capsule coming up. And for December, we are going deeper into one of our warm wear capsules, which was lightweight and mid weight puffies along with running luan separates for layering. And then in January, gym and CrossFit, so a training capsule for back to gym. Thank you. Welcome. Our next question comes from Kimberly Greenberg with Morgan Stanley. Great. Thank you. Good morning. John, I wanted to know if you could help us with the relative spread in comps between the U. S. And Canada. And secondarily, if you look out into the second half of the year, do you have any product cost, any lower product cost opportunities or are you seeing the innovation cycle just continuing to raise your cost of goods sold? Thanks. Okay. We don't specifically break out comps or performance between country, but consistent with what we've seen in recent quarters, Canada, even though you'd think it's a mature business, comped in the mid double digit and the U. S. Was comping in the mid-30s. So yes, pretty strong in both regions comparable to the maturity of the business. In terms of lower product costs later in the year, I think certainly after Q2 any inflation that is really that we started seeing a year or so ago is going to be reflected in our product costs. But I think as you mentioned, I would say continued innovation using new fabrics, new construction is likely to offset any cost relief that we might otherwise see in. Again, we're maintaining sort of a 55% gross margin target for the year and that reflects the impact of the innovation that we're doing. And I think strategically using our very strong gross margin to continue to create a long term brand success story is the right thing to do. Great. Thank you. Our next question comes from Paul Lejuez with Nomura. Hey, thanks guys. I'm just wondering if you could talk about the weather during the quarter, if you think that the warm weather helped you pull sales forward. Also wondering what sort of e comm increases you're assuming for the rest of the year because it doesn't seem like based on your guidance that you'd be assuming a similar rate of increase in 1Q as 1Q. So I'm just curious what's baked in? And then last, John, maybe you could expand a little bit about one of the last comments you made on your prepared remarks about maybe buying some stores. What do you think in there? Thanks. I'll do the weather one. We, like anybody, would be subject to extreme weather patterns like huge floods or closing or whatever. But on a day to day basis or overall seasonal basis, we don't seem to be as tied. We are much more tied to our product flow. Now could there have been a little pull forward? As we started hearing other people talk about that, we kind of looked at it. We feel our business is still run far more by our product flow and the guest demand we create than weather patterns or other factors. Yoga is done indoors. Yes. Yoga is done indoors this year. We're pretty lucky. John? In terms of e commerce, the increase in Q1 was in part boosted by the fact that last year we were going through our transition to the ATG platform, which meant we really gradually diminished the inventory that was dedicated to that 3rd party site until the transition. So even though the increase was still pretty impressive, it will be somewhat more muted for the rest of the year. As I said, it was 13.5% of overall revenue, which is a surprise to the upside. We'd expect it to be a little bit lower than that as a percentage of total through the middle quarters of the year and then traditionally tends to bump up in Q4 for holiday gift giving. The comment about buying stores, I just wanted to flag that because it would impact our capital expenditures. As you know, we have a very healthy balance sheet and a good cash position and it's available to use strategically. And one of the areas that we're looking at is in certain key strategic locations where we know we're going to want to have a store for the long term, it's certainly open to us to acquire those locations as opposed to simply leasing, especially if it's a situation where we may find ourselves in a weak negotiating position down the road on renewal with either the landlord in that location or in malls in the immediate vicinity. So for example, we do have under contract to purchase the store that we recently opened in Newberry. And you may see some more of that, not a significant amount of capital overall, but I just want to flag that that's an initiative that we're pursuing. Got you. Thanks, John. Good luck, guys. Thanks. Our next question comes from Liz Dunn with Macquarie. Hi, good morning. Let me add my congratulations. Just a couple of questions. I guess, first, how much inventory should we see dedicated to these sort of innovation, the capsules? And also for John, I am listening to everything you said on gross margin. It seems as though the normalized markdowns was sort of around 100 basis points. Is that did that have to do with some of these with some of the hit you took on the commuter line or can you help us understand that a bit better? And then just on product, I kind of want to get a better sense of for like CrossFit or Bar, how is your current assortment not meeting the needs for those activities? Because when I see people doing those classes, it's certainly they're wearing a lot of Lulu as it currently stands. Thanks. Okay. On the inventory for capsules, it's pretty insignificant quite frankly. Think of capsules are to product what showrooms are to our store base. They're not really a profit driver, they are testing. So the sales for any one capsule might be expected to be mid single digit millions or less. And therefore, the inventory related to those capsules is fairly minor. And you're right about the impact of markdowns being about 100 basis points, which is about what we would have expected. And the impact of the commuter line or any other capsule is fairly minor within that. What I think is important to understand when we talk about innovation, capsules is one small part of it. There's also innovation in our run garments in terms of new fabric, new trim, new technology, men's in jacket. So it's also innovating in our core line that we're constantly investing in. Okay. And then as we look at the Q4 potentially a little bit more opportunity for acceleration in the comp, is that just strategically you think it's important just to focus on driving as many sales high quality as you can in the Q4 and so the innovation will perhaps take a little bit of a back seat during that important sales quarter. Is that the right way to think about it? I think the right way to think about it is that that's always our biggest opportunity for a buy and consumer demand. There's less risk with taking bigger buys for that quarter. So that's always just part of the psychology of that, but there's a lot of different factors. Where we didn't want to be where we were last year was whenever you chase and you innovate a new line while you chase, you have a choice, right? You're going to chase what you already have and will that sell again and is that the right answer or are you going to chase something new? And if you chase something new and you have to go all the way back to fabrics like we do, then that takes a lot of your time and you're not then also planning for great success later in the year. So we're always balancing future success with immediate success. And as our garments get a little more complex and which is a cost of creating the market and being a market leader, We always want to make sure we're maintaining quality with all of these new fabrics and innovations that everything from the dyes work on the cross fabrics that we get all the right trims and then that meet our quality standard. And we don't want to chase a short term sale and sacrifice a reputation for quality or execution. That's a slippery slope and we really just don't want to be there. Great. Thank you. Our next question comes from John Morris with Bank of Montreal. Thanks. Good morning, Mike. Congratulations on a great quarter too. John, we've talked a little bit about it. I'm wondering on the product costs, understanding a lot of that's coming from some of the innovation that you're pursuing as well. But on the other side of it, are you able to do anything to control some of the increases that you're seeing in labor and raw materials and what would those be? And then maybe, Christine, if you can talk a little bit about the performance of AVEVA and what your learnings are there so far and what your insights are there for AVEVA, both Canada and U. S? Thanks. In terms of product cost pressure coming from inflation, that's really already baked in and we're just anniversarying some of those increases that happened up through the first half of last year. So it's not that there's further inflation that's significantly impacting our costs going forward. And is it more labor or raw material? What's kind of the breakdown there, John? Yes. I think it's primarily raw material. Okay. And Christine? Yes. On AVEVA, it continues on track. We're pleased with the performance of it. But it's not at this point, we're not ready to blow it out. You'll see a couple more stores opening. The business continues to do well because we don't have stores open in the U. S. We did do a flash sale recently with zulily to exit some aged product within the U. S. Market. We didn't do it in Canada where we have the stores. And you won't see us do that very often, but we don't want to open we're not ready to open stores in the market and we don't want to discount too much on our website sales. So on track, pleased with the story, feel like we've got a great concept there. But right now, we want to let it mature, grow at the right pace and we feel it's doing well. Got it. Thanks. Our next question comes from Jamie Kath with Morningstar. Good morning. Thanks for taking my call. My first question is, if e commerce kind of stays where it is or grows slightly as a proportion of sales, have you guys thought about what how that can effectively impact the gross margin and SG and A and maybe what sort of potential you guys can reach on that front? And then also with entry into the UK market, is there any estimate on what the potential store base is if you guys decide to move forward with that marketplace? I don't think we haven't released going forward what we think the store count is internationally, but obviously it's a healthy market for us as we believe a couple of other of the bigger markets in Europe are. But honestly, we're equally excited by Asia and the demand that we're seeing there. The yoga market is very strong and growing in Asia as well. So we actually see both markets as attractive, but I really feel in a lot of ways that Asia is even more compelling than Europe. And in terms of e commerce and its impact on margins, I think in the Q, you can see the segmented information. And it's true the margins coming from the e commerce channel are at a point where they're stronger than our already pretty high store margins. And so as e commerce and we do expect that over time it will continue to grow as a percentage of the total and so that will have a positive impact on both gross and operating margins in the future. Thank you. Our next question comes from Lorraine Hutchinson with Bank of America. Thank you. Good morning. Just wanted to dig a little bit into the businesses in Australia and New Zealand. Where's the productivity gap between those stores in the U. S? And what opportunities do you have to drive in those markets? The way we are kind of looking at it, I'd say the brand recognition in Australia and I guess now New Zealand now that we've opened our first store is running about 3 years behind the U. S. And it's comping well. We just opened the e commerce site down there and I'm optimistic that that will also help drive brand recognition. There's a lot going on back in 2,009 when we opened our e commerce site in North America that certainly coincided with a real turning point in terms of brand recognition in the U. S. And I'm sure part of that was attributable to e commerce. So we're optimistic that we'll see the same sort of momentum gained in Australia. So I mean Australia and New Zealand are great markets for us. As I said they're a little bit less mature, but pretty exciting and on track. And Sherry just recently got back from a trip to visit the markets last week. And after she looked at how we're handling counter seasonal products, she said, we have a lot of opportunity. And I think that we do feel we've constrained ourselves a little bit as we've been learning to deal with that situation because they've had to buy and hold and our product changes so rapidly. Mixing those together, after Sherry saw that, she said, Wow, I can do a lot better. So I think we always have opportunities and that I think it's been a great growth story and to have profitable markets where your labor costs and store costs are higher gives us great confidence in our ability to grow the mall internationally and the learnings we've had from supporting that market has been key to our planning for international strategy. So I think there's been a lot of wins and a lot of potential in that market and a lot of learnings for us. Thank you. Our next question comes from Topesh Bary with Jefferies. Hi. Congratulations on the next quarter. I wanted to ask you, I guess, Christine, a question going back to the whole point about prioritizing innovation versus chasing product throughout the rest of the year. I mean, aren't those 2 separate functions, design versus planning? Just trying to get a better sense of why chasing products would distract the designing process. Well, if you think about our model, there's core and replenishment, right? So let's break out the 2 conversations. On the core product, which is replenished, of course, that flowed and that is a planning and buy function. But then when we color seasonal items or we do our new kind of innovative or wow items or colors, where it's more difficult. So if you put like Paris Pink for instance, that has to go all the way back because we're yarn dyed, we're not a grayish dip, which is what gives us the quality that lasts 5 years. So if I want to hold grayish fabric to chase and dip, I'm going to have a different quality level than I currently see today. And then if I over order Paris Pink and all of a sudden it becomes ordinary, I haven't created something special. So then I would have to take a designer to design something new, change either the garment or change and create a new fabric. So what we are doing is investing in our development function, which allows us to do more of and have a faster response to our lab dips and dyes, I'm getting quite technical here, but you asked, so that we can speed up our ability to have incremental colors and products. What we really don't want to be is just buying in bulk to meet demand because then we'll lose what makes us special. So we have to balance that with the demand. And then as it gets more complex as you start to add garments with more functionality and 2 fabrics together, die voles on 1, not on another. So it's complex. And I think as a growth company, what we always want to make sure we're doing is also balancing quality. We had a couple of dies that didn't work and we pulled those qualities, those items because we won't put bad product on the floor. So we're committed to that. We leave room for that. That's already all forecasted in everything we do. They weren't big mistakes, but we don't want to make those kind of mistakes and put that out in our guests' hands. Got it. That's helpful. So is there a and I guess the question then is, is this a change in philosophy versus the past couple of years because we're coming off of this multi year period of 20% plus comps for your company and which in retrospect was greater than where you initially planned most of the time. So obviously, there is a degree of catch up with some of the early some of the stores that opened up during the recession. But just trying to get a better sense of what's why that philosophy is changing now versus maybe a year ago. And I guess along the lines of that question, like what's a normalized kind of healthy type of comp run rate for this company going forward? Thank you. I don't I think it's some of the learnings that we had last year when we heavily invested in Chase and then we stopped and which you saw kind of in Q3 and then really just focused on a forward Q4, Q1 execution, which obviously you saw play out really well. So what we take a look at is current sales trends. We're trying not to overreact in the short term because look in this environment, at the size we are, strong double digit comp growth, we think is a great story with a healthy margin. So I really don't feel the need to apologize for that level of performance and growth track record that we have. And then looking at the forward opportunity and making those right investments to create that continued success. And that's what we're always after, strong and steady, excellence in execution, being better than everyone else in the marketplace is what creates a winning strategy for the long term and balancing short and long term and the impact it has on an organization that's still growing infrastructure. That's our job and we think we do it pretty well. Thank you very much. Our next question comes from John Kernan with Cowen and Company. Hey, guys. Good morning. Thanks for taking my question. You've talked a lot about higher product cost due to innovation. Are you realizing higher prices on some of the new innovation? And could you what's the balance between units and AUR in the comp right now? Thanks. We do see some, but in the beginning when we first like when we introduced Run, for example, we had a lot of new fabrics and we chose to price it with the right price was for the garment in the marketplace and in the beginning take a little bit of a reduced margin. And then we built that up over time as we extended the line, got into our minimum runs, etcetera. So that's part of the cadence. We always plan a garment for a future that it will live within our product line at the high margins. But in the beginning, when we innovate and we're testing fabric, that's built into the way that we build the model and extend the line. So we always are looking for high value, high margin garments. That's the business we're in, not quick turn, high volume T shirts. And the comp is very largely units, probably 85%, 90%, just a slight contribution from AUR. Okay. Thanks. And then I guess as we look into Q2, I mean obviously you're cycling that bringing the direct to consumer business back in house. There's going to be some SG and A deleverage associated with that. But if your comp trend I guess comes ahead of plan, do you feel like there's some room to re leverage SG and A or are there a lot of fixed SG and A expenses in the quarter? Thanks. In terms of the SG and A cadence for the year, at the start of the year we budget, we plan, We set what initiatives we can handle for the year and the headcount associated with it. If anything, it tends to take a little bit of time to hire those people and to get those initiatives started. So as we look at Q2, Q3, what you'll see is those initiatives kicking in and our headcount will add and that's what compresses the SG and A in the middle of the year. And then at the end of the year with higher volumes, we'll get leverage again. Okay. Thanks a lot. Our next question comes from Roxanne Mair with UBS. Great. Thanks. Let me add my congratulations on a great first quarter. A couple of questions, just wondering if you can share with us how you're thinking about inventory growth as we move throughout the year? 2nd, just wanted an update on the men's business, just wondering what the penetration looks like as a percent of sales. I know from our checks, we've seen a lot of product sellouts. And just last, was the magnitude of the markdowns in light of your increase in inventory greater or less than you expected in the quarter? Thanks. Okay. Inventory growth throughout the year, again, coming into the year and at the end of Q1, I think our inventory levels are pretty balanced with the way we plan the business. And since we're not doing a lot of chase that's true for the balance of the year. Men's was about 12% in Q1 which again it's typically highest in Q4 during the holiday gift season it was over 14% in Q4. So 12% in Q1 is about in line with the way it goes season to season. I'm sorry, what was your last question? Just on the magnitude of the basis point hit from markdowns, was that in line with your expectations, a little more or a little less? It was pretty much bang on our expectations. Okay, great. Thanks and good luck in 2Q. Yes. And I just say we feel really great about our inventory position, how clean it is. So we don't feel like there's any risk on the table either. Yes. Our next question comes from Dana Telsey with the Telsey Group. Hi, everyone. Good morning. Can you talk a little bit about the online business and cadence of online versus stores? What did you see there this quarter compared to the stores? And then just as you've expanded into other categories with the men's, any update on men's, how is it doing online and in the stores and margin opportunity? Thank you. I think online and stores, we see them March very in sync with each other. Our guest is very attuned. It's all about product flow. It's all about product flow. The guest is looking for that new product wherever it's going to land. They shop both, run to the store quickly. So we don't see a huge difference between the 2. We aren't in the business of really doing a lot of exclusives online. We found that the cadence of the long the life of the product is pretty similar in both stores and online. So we've seen them pretty March pretty lockstep with each other. So there's no real difference there. In terms of men's, we definitely see demand for men's growing. And yes. But online it's actually, I guess men don't like shopping online as much as women because the men's penetration online is much lower than stores. Yeah. So that's an opportunity. Yeah. Thank you. Our next question comes from Blair Menck with Robert W. Baird. Hi. Thanks for squeezing me in at the end. I just wanted to confirm on AVEVA, you said waiting to open stores while the market's maturing in the U. S. Does that mean that you're no longer planning on opening those 5 stores in July August timeframe? No, we didn't have 5 stores. Maybe those are showrooms. But we're still on plan for showroom for stores for AVEVA this year, which is a modest increase. We opened 2 in Q1. And within our overall store count guidance, there might be 1 or 2 more in the back part of the year. Okay. So you're not you talk about California, Washington, Illinois and Massachusetts and New York. Those were showrooms? Showrooms. Okay. Yes. Great. Thank you. That's all I had. Our next question comes from Tal Woolley with RBC Capital Markets. Hi, good morning everybody. Good morning, Tal. Hi. Just wanted to talk a bit about CapEx. If I back out the building purchase last year, your CapEx sort of $50,000,000 growing $80,000,000 this year. Can you just talk about what are the bigger projects in there? Yes. Of course, new store build out is always there. As our store base grows and matures and we're getting up to lease renewals, we have a growing number of renovations. And when we come up to a lease renewal, we'll typically do a full renovation which is pretty much the same cost as a new store. In addition, there's a lot more IT system spend and that becomes a much longer conversation. But as we've been talking about IT systems to support the whole supply chain, we're moving forward with the new financial system this year. So that's where a lot of the CapEx is. And if you look at sort of the next 3 to 5 or sort of 3 years, are there any other big ticket items that have to come online? Like I don't know whether you'd have to look at revamping distribution or sourcing, anything along those lines? Or you expect that CapEx in order to scale with sales? I think there's an ongoing need to implement and upgrade systems especially. But I think as we look forward there I don't see any shockingly large lumps in our CapEx and we a lot of it is discretionary in terms of timing to some extent. So we'll balance our CapEx. So yes, I don't think you'll see any big surprises. Just lastly, you had made a comment at the end of your commentary about outlet stores and was that a discussion of net new openings of outlet stores? I did mention that we're opening 2 new outlets this year. When you look at I mean we've been operating with 3 outlet stores in the U. S. For a couple of years now. And when you look at the volume of our business in the U. S. And now that we're back in inventory, it's pretty simple arithmetic to see that that requires a couple more outlets just to keep the inventory clean. So that's part of the plan for the year. Great. Thank you very much. Our next question comes from Jim Duffy with Stifel Nicolaus. Hi. Thanks for taking my call. This is Molly on for Jim. Congrats on the quarter. Real quick, you had talked about the Hong Kong showroom now opening at the end of 3Q or as before. I think it was supposed to open in June. Just wondering if there's anything going on there. And then lastly, hoping that you could maybe give more specific rollout dates for the U. K. And Hong Kong e commerce sites? Thanks. I think we're just we've already done the U. K. And dates, which we said will be later in the year. We're not ready to be a little more specific about that at this time. In terms of Hong Kong, it was really just negotiating the lease and holding out. Yes. As we got into some of the details negotiating with a landlord in Hong Kong, took a little bit longer than the plan, but we're now moving ahead. Okay, great. Thank you. Operator, I think we have time for just one more question. Our next question comes from Christian Buss with Credit Suisse. Thanks for squeezing me in with the last. Congratulations as well on a great quarter. I was wondering if you could talk about the level of full price selling. Do you think that's now at normalized levels? And then I was also wondering if you could give just a quick update on your systems investments, what kind of progress you've made there? Okay. In terms of full price selling versus discounts, I think it is more of a normal balance now, still very low relative to retail in general. It's still maybe high single digits, but that's more of a normal run rate. And sorry, your question on IT investments? How they're doing? Oh, boy. There's a whole bunch of questions in that. We feel good. We're really focused on our supply chain and the flow, building more visibility into our factories, factory capacity, really advanced allocations, so that we have more ability to get the right product to right stores. We've had some real wins and the Catherine and her team have delivered in terms of getting data analysis and our business intelligence is in a whole new place, which has really freed up our merchant planning and allocation teams to have more simple answers on the buy. So we've made some really short term quick wins and feel really great about the progress that the team is making on the longer term investments. Do you want to add anything, Sherry? We laid out a go to market roadmap about a year ago and we're making good progress on it. So we're about way through our PLM implementation right now and looking at additional planning tools and so on. Great. Thank you very much. Good luck. Thank you and I apologize that we've had to leave some people in the queue, which we normally don't like to do. But hopefully, we'll be able to catch you in follow-up calls. So thank you everyone for joining us for the quarter. Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have