Lululemon Athletica Inc. (LULU) Q4 2016 Earnings Report, Transcript and Summary

Welcome to the lululemon athletica inc. Q4 and Year-End Conference Call. [Operator Instructions] And the conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Howard Tubin, Vice President of Investor Relations. Please go ahead.

Thank you, and good afternoon. Welcome to lululemon's fourth quarter and fiscal 2016 earnings conference call. Joining me today to talk about our results are Laurent Potdevin, CEO; Stuart Haselden, CFO. Celeste Burgoyne, EVP, Retail Americas, will also be available during the Q&A portion of the call. Before we get started, I'd like to take this opportunity to remind you that our remarks today will include forward-looking statements reflecting management's current forecasts of certain aspects of the company's future. These statements are based on current information, which we have assessed, but which by its nature is dynamic and subject to rapid and even abrupt changes. Actual results may differ materially from those contained in or implied by these forward-looking statements due to risks and uncertainties associated with the company's business. Factors that could cause these results to differ materially are set forth in the company's filings with the SEC, including our annual report on Form 10-K and our quarterly reports on Form 10-Q. Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our annual report on Form 10-K and in today's earnings press release. The press release and accompanying annual report on Form 10-K are available under the Investors section of our website, www.lululemon.com. Today's call is scheduled for 1 hour. [Operator Instructions] And now I'd like to turn the call over to Laurent.

Thank you, Howard, and good afternoon, everyone. Today, I am pleased to share with you our strong fourth quarter and 2016 full year results. I will discuss current business trends and the initiatives in place to build momentum in the quarters ahead. Stuart will review our financials, provide 2017 guidance, and we'll then take your questions. Let me start with our fourth quarter highlights. We delivered a very strong holiday season in the quarter, with operating income growth of 18%, driven by a healthy 7% constant dollar comp and gross margin improvement, up 390 basis points, which exceeded our expectations. I am proud and very grateful for the performance our teams delivered against the challenging macro environment. Our relentless focus on product and exceptional guest experiences allowed us to outperform during peak weeks, with strong full-price sell-through and merchandise margin. Taking a closer look at product. We continue to own our position as the leading brand for women's bottoms, comping 14% on top of a very strong Q4 last year. This was driven by the depth of our assortment in key franchises such as Align and wunder under and complemented by special editions such as tech mesh. In our bra category, the breadth of assortment drove a 10 comp, reflecting lululemon's strengthening position as the destination for active bras. We are excited to see continuing strong momentum in our men's business, delivering a 20 comp this past quarter. From athletes, and as some of you may have seen, their coaches, to our growing male collective, our guest loyalty is driven by the core styles we're known for, with new editions such as Metal Vent Tech Wool and the License to Train capsule both performing very well. Q4 also marked some significant milestones as we strengthened and amplified our global brand position. When we last spoke, I was on my way to China, where we opened our first 3 stores. Building on the energy of our Unroll China event last summer, I experienced firsthand the energy of our fantastic locations across Shanghai and Beijing. These openings have been a catalyst in boosting our already strong performance across Asia. In addition, our presence on Tmall has shown tremendous growth, led by our performance on a Single's Day last quarter. Collectively, this reflects the strong brand affinity and the magnitude of opportunity ahead of us, and I'll speak to that later. In January, we opened our European flagship under London's Regent Street, one of the world's top shopping destinations. Reflecting our commitment and vision for the brand in the U.K. and Europe, this flagship features bespoke designs, concierge services and digital art installations. I am excited to build on the increased brand awareness since the Regent Street opening and the halo impact it will have across our European business. 2016 was a critical year and marks an exciting milestone for us. Just 3 years ago, we set on an ambitious agenda to reaccelerate our top line growth, regain our guests' trust and loyalty, build a digital culture, own our opportunity in men's and ignite our international potential, all while building a scalable supply chain infrastructure and focusing on operational efficiencies. The result of our work returned the company to positive operating earnings growth for the first time since 2013. Some significant highlights reflecting the strength of our strategy include: being design-led, blending fashion and function and building a solid innovation pipeline for both our men's and women's categories; evolving how we come to life in stores, from new formats, to connecting with new communities; our curiosity, relentless focus on innovation and discipline fuel our highly profitable physical presence in North America; setting the vision and building our digital ecosystem and culture; igniting international growth through expansion in key cities; rapidly building brand awareness outside of North America; maintaining strong industry-leading gross margin through completing the buildout of our supply chain infrastructure and focusing on operational efficiencies; and last but not least, building a world-class management team, filling key leadership roles across merchandising, digital, store design and leading our European expansion. Our performance reflects the strength of lululemon and our unique position as the leading brand for an active, mindful lifestyle. Despite a slower start in Q1, 2017 is set up to be one of our most compelling years, with unprecedented product innovation and our sales global brand activations to drive growth towards our long-term vision. Looking specifically at Q1, let me articulate the immediate changes we have made to positively impact momentum this quarter and then share our plans for the future. The slowing sales trend in early Q1 has most acutely impacted e-commerce. We have clearly identified the issues: an assortment lacking depth in color for spring compounded with visual merchandising that did not powerfully translate our design vision. With focused urgency, our teams have been course-correcting the issues, with early indications reflecting an immediate and positive impact on performance. We will see more color in selected styles as early as next week. And from a visual merchandising standpoint, our Loud & Clear Jacket is the perfect example of what happens when we capture both design and function, infused with energy and movement into our e-com images. Since delivering these results, the performance of that jacket has significantly increased. Stuart will provide additional details on the first quarter. As we write our next chapter of growth, I'd like to take a few minutes framing our 2017 priorities in the context of our 2020 plan to double revenues to $4 billion and more than double our earnings. Starting with brand, we have an untapped opportunity to tell the world who we are and what lululemon stands for. Beginning in early Q2, we'll launch our first global brand campaign, in partnership with a dynamic creative agency that is also the leading amplifier and distributor of content to millennials across the world. Through this disruptive and innovative campaign, we will strengthen our guest loyalty while also inspiring millions of new guests to join our growing collective. Turning to product. The performance of our core business will be powerfully augmented, with an unprecedented current of innovation between now and the end of the year. In women's, we are on track to build a $3 billion business through our continued leadership in acclimatizing and innovating the fabrics and styles that define our standout performance in bottoms and bras. Leveraging the success of our #1 performing bottom, the Align Pants, we are thrilled to globally launch our new Fast And Free collection, designed with our top-performing Nulux fabric. For the first time, our innovative high-performance Naked Sensation, Nulux, will include a tights, crop and bra. Validated by Nulux' recent ascension as one of our guests' favorite technical fabrics, we know this launch will deliver substantial revenue for 2017 and beyond. Following extensive R&D, and in partnership with our athletes, in early May, we will reveal our newest whitespace innovation with a bold new concept that will disrupt the bra category and redefine women's expectations of active bras. This launch anchors our continued commitment to innovation that make lululemon the leading destination across our core women's categories. And last but not least, we have focused plans and resources in place to realize our substantial opportunities across outerwear and accessories in the second half of the year. Now turning to men's. This remains one of our largest growth opportunities and is on track to become a $1 billion-plus business by 2020. Our focus and talented cross-functional teams are bringing our men's vision to life. And with a clear design and direction and increasing brand awareness, we expect to see accelerated results beginning to take shape in the second half of the year. I'm excited by our men's performance, particularly within our co-located formats, where, for example, in our Mall Of America store, by doubling our dedicated men's square footage, we saw a 70% lift in the business with no increase in inventory. In 2017, we will open further co-located and local stores while optimizing our men's [ presence ] online to capture the significant runway ahead of us. Shifting to digital. With the potential to grow in excess of $1 billion by 2020, we will continue to build our digital ecosystem this year and beyond. We are laser-focused on realizing the power of our CRM platform at scale and continuing the seamless expansion and integration of our omnichannel strategy to empower our guest-centric model for the future. In Asia, to capitalize on the tremendous opportunity and unique digital landscape, we are building the infrastructure and a talented team in Shanghai to increase our reach, engagement and performance on a localized platform. As shared earlier, we will continue executing the immediate and longer-term strategies in place to accelerate our e-commerce growth, including inspiring our guests through more engaging visual merchandising, optimizing and expanding the online product assortment, improving guest experience to drive conversion and launching our new mobile app. Turning to North America. We have substantial upside as we continued to ramp up our most established business. Our disciplined store expansion has produced a store fleet among the most productive and profitable in the industry. Our store teams are second to none, and we're continually inspired by their innovations, from new store formats to market optimization strategies. This year, we will target square footage growth of approximately 10%, with up to 28 new stores and 12 optimizations. This will also include additional locals, a strategic evolution of our showroom models, which has been successful in curating unique experiences and building brand awareness in smaller markets. Looking towards our international potential. We are on track to build this into a $1 billion business by 2020. While pleased with our performance across our 3 major regions outside North America, our focus in 2017 will be on China. We will use a market densification strategy centered in Tier 1 cities, including Shanghai, Beijing and Guangzhou and Chengdu, with digital amplification to reach our guests across the entire region. With China's activewear market valued at $28 billion and growing, the world's largest middle class and over 450 million millennials living an increasingly active lifestyle, the magnitude of our opportunity in China is unparalleled. And the strong performance we've seen out of our store openings thus far gives us confidence in the market readiness as we accelerate our expansion. Before I pass the call over to Stuart, I want to recognize the passion, commitment and creativity from our global teams who have all contributed to our success last year. With the goal of our ambitious 2020 plan to double revenue to $4 billion and more than double earnings in sight, we are on track to realize our vision through a constant flow of high-impact initiatives that will fuel our growth this year and beyond. At a time when experiences matter more than ever to consumers around the world, our vertical model puts us firmly in control of our destiny, and that destiny is one I wouldn't trade for any brand in the world. Stuart?

Thanks, Laurent. I'll begin today by reviewing the details of our fourth quarter 2016 and highlights on the year. I'll then introduce our outlook for the first quarter and full year 2017 and spend some time offering additional color on the initiatives we have in place to deliver on our 2017 guidance and how this connects to our long-term growth plans. The fourth quarter capped an important year for us that marked several milestones, including our successful efforts to recover our product margins as well as [ supporting ] progress against our strategic growth initiatives. In the quarter, we drove positive comps in both our store and direct channels, continued to extend significant gross margin improvements and ended the year in a healthy inventory position. This resulted in 18% operating profit growth versus last year and 130 basis points of operating margin expansion for the quarter. Turning to the details for Q4. Total net revenue rose 12.2% to $789.9 million, with the increase in revenue driven by a total constant dollar comparable sales growth of 7%, comprised of a bricks-and-mortar comp store sales increase of 6% and an e-commerce comp of 12%, and also an increase in square footage of 11% versus last year driven by the addition of 43 net new company-operated stores since Q4 of 2015: 16 net new stores in the United States; 3 stores in Canada; 1 in Australia and New Zealand; 7 in Asia; 4 in Europe; and 12 ivivva stores. Foreign exchange had an effect of increasing reported revenue in Q4 by $2.8 million or 0.4%. During the fourth quarter, we opened 17 net new company-operated stores: 9 in North America; 4 in Asia; 2 in Australia and New Zealand; 1 in Europe; and 1 ivivva. We ended the quarter with 406 total stores versus 363 a year ago. There are now 346 stores in our comp base, 45 of those in Canada, 221 in the United States, 26 in Australia and New Zealand, 4 in Asia, 7 in Europe and 43 ivivva. At the end of Q4, we also had a total of 51 showrooms in operation, 16 lululemon showrooms in North America, 18 internationally and 17 ivivva. Company-operated stores represented 72.3% of total revenue. Revenues from our digital channel totaled $164.3 million or 20.8% of total revenue, a consistent rate with the fourth quarter of last year. Other revenue, which includes strategic sales, showrooms, pop-up stores, warehouse sales and outlets, totaled $54.9 million versus $48.9 million in the fourth quarter of last year. Gross profit for the quarter was $427.9 million or 54.2% of net revenue compared to $354.5 million or 50.3% of net revenue in Q4 2015. The factors which contributed to this 390 basis point increase in gross margin were 410 basis points of overall product margin increase primarily due to lower average unit costs and improved AUR, a continuation of the factors you saw driving the margin improvement in the third quarter. Markdowns continued to be well managed, with only 20 basis points year-over-year impact to product margin for the quarter. We also saw 10 basis points of leverage in product and supply chain overhead costs. These were offset by 20 basis points of deleverage from occupancy and depreciation and 10 basis points of decline due to the foreign exchange impact of a stronger U.S. dollar. SG&A expenses were $231.3 million or 29.3% of net revenue compared with $188.2 million or 26.7% of net revenue for the same period last year. This is 110 basis points above prior guidance of approximately 150 basis points of deleverage in the quarter and was the result of the following. Nearly half of this increase versus guidance is due to FX-related revaluation of U.S. dollar cash balances as we have seen the Canadian dollar strengthen significantly in the final weeks of the quarter. The balance of the increase was opportunistic investments to fuel long-term growth. As we have mentioned previously, when we see outperformance in sales and margin as we did in Q4, we will invest to continue to fuel our long-term growth. As a result, operating income for the quarter was $196.6 million or 24.9% of net revenue compared with $166.3 million or 23.6% of net revenue in Q4 2015 or an increase of 130 basis points in operating margin. The effective tax rate was 31.1% compared to 29.8% a year ago, which includes certain tax and related interest adjustments associated with the finalization of the company's transfer pricing arrangements and associated repatriation of foreign earnings. Excluding these adjustments, the effective tax rate would have been 30.6% compared to 29.6% in the fourth quarter of 2015. Net income for the quarter was $136.1 million or $0.99 per diluted share compared to net income of $117.4 million or $0.85 per diluted share for the fourth quarter of 2015. Excluding the tax and related interest adjustments I just mentioned, EPS for the quarter was $1 per share. In addition, the negative net impact to earnings from foreign currency this quarter was $0.09 per share, $0.02 higher than what we previously estimated for Q4. Our weighted average diluted shares outstanding for the quarter were 137.2 million versus 138.2 million a year ago. There were a minimal amount of shares repurchased during the quarter under our recently approved $100 million authorization. Capital expenditures were $43.3 million for the quarter compared to $35.4 million in the fourth quarter last year. Turning to the highlights for our full fiscal year 2016 performance. Net revenue was $2.344 billion, up 14% on both a reported and constant currency basis, which reflects a 7% constant currency comparable sales growth. E-commerce sales totaled $453.3 million or 19.3% of total sales. Gross profit was $1.2 billion or 51.2% of net revenue compared to $997 million or 48.4% of net revenue in fiscal 2015, reflecting an increase of 280 basis points. Net income for the year was $303.4 million or $2.21 per diluted share compared to $266 million or $1.89 per diluted share for fiscal 2015. This is based on an effective tax rate of 28.2% in 2016 versus 27.8% effective tax rate in 2015. Normalized for transfer pricing and repatriation tax adjustments, our adjusted EPS was $2.14 for fiscal year 2016 compared to $1.86 in 2015. Turning to our balance sheet highlights. We ended the year with $734.8 million in cash and cash equivalents. Inventory at the end of the fourth quarter was $298.4 million or 5.1% higher than at the end of the fourth quarter of 2015, reflecting a 5.7% decrease in inventory per square foot. This was slightly lower than expected due to the timing of in-transit inventory. As we head into 2017, we expect our inventory growth going forward to normalize and be more in line with our forward sales trend. Turning now to the details of our Q1 and fiscal year 2017 outlook. As Laurent mentioned, we've seen a slow start to the first quarter. Soft traffic in stores combined with lower conversion on our e-commerce site have weighed on our trend so far this quarter. Within our stores, we've seen conversion. AUR and UPT all remained solid, with traffic as the primary headwind. Despite this difficult trend, we are excited to launch a number of guest acquisitions and retention programs beginning this week and ramping into Q2. These programs leverage all parts of our business model and include the following: the launch of our Fast And Free Nulux collection, as Laurent mentioned, this week, leveraging our fast-turn capabilities to deliver color in selected styles to land in our stores next week and the expansion of our successful omnichannel strategies such as the ramping of our ship-from-store program from 85 to 145 stores by the end of Q2; the addition of our outlet stores to the ship-from-store program beginning in the first quarter; the introduction of a pilot of our buy online, pick up in-store capability beginning in Q2. Within e-commerce, the online conversion trend has also been a particular focus, and we've taken aggressive actions to improve site performance, which I'm sure many of you have noticed. Our initial reads indicate that these efforts are gaining traction. That said, we expect revenues in Q1 to be in the range of $510 million to $515 million. This is based on a comparable sales percentage decrease in the low single digits on a constant dollar basis compared to the first quarter of 2016 and assumes a Canadian dollar at $0.76 to the U.S. dollar and 10% more square footage versus Q1 last year. We are seeing the product margin improvements we achieved in the second half of 2016 extend now into the first quarter of 2017 in a similar order of magnitude. However, these improvements are being offset significantly by deleverage on product and supply chain overhead and occupancy and depreciation expense due to the sales trend in Q1 sitting below our expectations. As a result, we now anticipate gross margin in the first quarter to increase by approximately 50 basis points versus Q1 2016. We expect SG&A in the first quarter to delever approximately 100 to 150 basis points, a function of our negative low single-digit comp assumption for the quarter. Assuming a tax rate of 31.2% and 137.3 million diluted weighted average shares outstanding, we expect diluted earnings per share in the first quarter to be in the range of $0.25 to $0.27 per share versus $0.30 per share a year ago. For the full year 2017, we expect revenue to be in the range of $2.55 billion to $2.60 billion. This is based on a comparable sales percentage increase of low single digits. This full year guidance reflects our view of strengthening trends in both e-commerce and stores as a result of the strategies we've mentioned around product assortment improvements, website enhancements and acceleration of our omnichannel model, and we are starting to see evidence of these strategies now materializing. We expect to open up to 50 company-operated stores, which includes an acceleration in our international store openings to 15. This represents a square footage increase of approximately 12% for the year. We expect gross margin for the year to be flat versus 2016. The benefits from the product margin improvements that we have been seeing will have the most meaningful impact in the first half of the year and then moderate into the second half of 2017. Offsetting this is a modest level of deleverage in product and supply chain SG&A and in occupancy and depreciation, primarily due to the accelerated international store openings which carry a higher occupancy rate. We also expect full year SG&A rate to be flat versus 2016. We expect deleverage in the first half of the year, with an improved SG&A picture in the second half. As a result, we expect operating margin to be relatively flat with last year at 18%. We expect our fiscal year 2017 diluted earnings per share to be in the range of $2.26 to $2.36 per share. This is based on 137.5 million diluted weighted average shares outstanding, which does not reflect an estimate of shares repurchased after Q4 2016 and also assumes an effective tax rate of 31.2%. We expect capital expenditures to range between $170 million and $175 million for the fiscal year 2017, reflecting new store openings, renovations, relocation capital and also strategic IT and supply chain capital investments. As we've mentioned on prior calls, operational excellence has been a priority to enable our growth strategies and recover our profitability. As we look forward to 2017, our agenda for operational excellence focuses on 3 areas. First, we will continue to develop our supply chain capabilities, building on the success we have seen over the last 2 years. This focus will not only enable us to maintain and extend our product margin recovery, but also help us strengthen our chase capabilities and provide shortened lead times in responding to market trends. An example of this currently includes our ability to accelerate color in key styles into our assortment to impact the first half of this year. Our second operational priority focuses on SG&A and our current plan to deliver leverage on sales growth for 2017 and beyond. Earlier in Q4, we retained BCG to support us in a strategic effort to evaluate our cost structure and identify opportunities for cost efficiencies. We are now on the final stages of this work, which will help us become a leaner business and deliver operating results with less resource requirements. This work will enable us to reinvest a portion of these savings to support our growth strategies and also deliver the leverage in expenses for the balance of the year that our guidance contemplates. And lastly, our third operational priority is our IT infrastructure. We are deep into a number of projects that will support key operational capabilities for this year and beyond, in areas including: planning and allocation to build new abilities to flow inventory to better meet demand; e-commerce through enhancements to our website and mobile guest interfaces; and CRM to support our new loyalty programs as well as various elements of our guest engagement strategies. In closing, I'd like to reiterate our confidence in the tenets of our long-range plan as we previously articulated them: revenues of $4 billion by 2020; gross margins in the low 50s; earnings growing faster than sales; EBIT margins in the low 20s. We see the results of 2016 as evidence of our progress against these goals. And we remain bullish for 2017 despite the slow start we've seen early in Q1, especially given that our most important growth drivers for the year are still in front of us and reflect exciting new elements of our business model, including the new product introductions we mentioned with Nulux in Q1; bra innovation in Q2; and jackets and outerwear as well as accessories into the second half; the e-commerce enhancements noted earlier such as the mobile app in Q2, visual merchandising improvements both on our websites and in stores; new guest acquisition strategies with our brand campaign launch in Q2; and our expanded CRM programs in the third quarter; the acceleration of our expansion in China; and finally, our men's initiatives ramping throughout the year. And we will accomplish all of this while building important new cost efficiencies through the strategic SG&A project that I mentioned. We look forward to updating you on our progress on these programs and more over the course of the year. With that, I will open up the call for questions.

[Operator Instructions] The first question comes from Matthew Boss of JPMorgan.

So on same-store sales, I guess what have you seen from traffic and AUR so far in the first quarter versus what you saw in the fourth quarter? And I guess just how best should we think about comps you're expecting in the second quarter versus the second half? I'm just trying to gauge the improvement that you are embedding as we move out of the first quarter and your confidence level in that taking place.

Matt, it's Stuart. So on the comps in the first quarter, basically, as we were into the second -- into the final stages of the fourth quarter, we began to see conversion on our website soften. That trend has extended into the first quarter. We also saw store traffic soften in the early part of February. The other KPIs, particularly in the stores, remain solid. And in particular, AURs in stores remain strong. And so the headwinds that we're seeing in traffic really account for the softness in the store comp trends, and online, it's really related to conversion. So as Laurent mentioned, we're focused on addressing, in particular, the e-commerce softness through the assortment, through the color gaps that we saw on the assortment as well as how the visual merchandising on the site had opportunities for improvement. So we've been in aggressive actions on those points, and we're pleased to see positive results in the early days since we've made those changes. Beyond that, I think as we think about the Q1 comp, the guidance reflects just the quarter-to-date results and a measured outlook for April. We see more upside as we think about the balance of the year. And really, the guidance that we issued for the full year contemplates a degree of improvement across stores and e-commerce. That said, the improvement is more weighted to e-commerce. Many of the initiatives that we mentioned will benefit e-commerce disproportionately, specifically the site merchandising that I mentioned, also the mobile app launch in the second quarter, the omnichannel strategy as well, specifically ship-from-store, which has been a very successful initiative for us in 2016. We're expanding that, as I mentioned, significantly. And we'll have that expansion ramping through Q2 and benefit from that for the balance of the year. And also, there's just the broader macro trends that I think we're seeing across the industry, with consumers and our guests, in particular, shifting their shopping preferences to digital versus brick-and-mortar. So in terms of the store side of the equation, we've taken a sober view on our store outlook given the traffic trends. It's safe to say that our guidance does not reflect the same store comp performance that we saw in 2016. That said, we have a number of strategic sales-driving investments that will ramp over the course of the year that will benefit our stores and our website business in Q1. And in particular, February and March really did not benefit from all the initiatives that we've been talking about. And what we're -- and specifically, and we enumerated most of these on the -- in the prepared remarks, the product introductions are very important. The Nulux styles that landed this week have now risen to be our top sellers in both women's pants and crops. So we're excited to see the traction with Nulux. The bra innovation that we'll introduce in the second quarter, we believe, is also incredibly exciting and will -- can move our business. Jackets and outerwear, big businesses for us in the second half. We've had teams working to develop exciting new styles for that part of the business for the second half. And then also, as Laurent described, the brand campaign in the second quarter, we've never done -- had a strategy like that, so we're really excited to see how that can move our business as well. CRM in the third quarter and the expansion of our co-located strategies, which has proven exceptionally successful, we're ramping that into the second quarter. We see upside potentially for those -- for that strategy into the second half of the year as well. And the acceleration of China, so exciting comp trends in China. We've -- we're excited to see the number of stores opening there, increasing with more potential beyond that. So let me pause and see if Laurent would add anything.

Well, Matt, I think that -- thanks, Stuart. Matt, I think what the performance that we've seen in Q4 was driven by the neutral and the jewel tones that were perfect for the gift-giving season and especially Q3, Q4. I mean, in Q1, we should have been bolder with the color assortment. And from a visual merchandising, we didn't bring that powerfully to life. Now with that said, we added a lot of talent on the merchant side later in 2016, with a real focus on visual merchandising. So we actually saw this trend happening very early on in the quarter, and with the much stronger supply chain, we've been able to react very quickly. So you're going to see more color showing up this next week actually. And we've actually added a lot of creative resources, both in Vancouver and in L.A., our ability to bring visual merchandising to life in a much more powerful way. So if you look at some of our products, which I'm sure some of you guys may have seen, whether it's the Loud & Clear Jacket or whether it's the Cool Racerback in hydrangea blue. When we've actually brought that to life in a way that we're proud of, showing fluidity and movement, the performance in sales has drastically increased. So disappointed with the beginning of Q1, and with that said, we own it. And by owning it, we also mean that we know how to fix it. And we've have seen very quick results in how we've been fixing it. So we know what to do. We're doing it. It's actually paying off. It's being validated in both traffic and conversion. And as Stuart said, I mean, I am more excited about 2017 than I've been since being around in 2014. I mean, we've got an unprecedented amount of product innovation and global brand activation that's ahead of us for '17 that will definitely drive traffic and conversion. So we're going to continue -- 2017 will be our best year ever, with earnings continuing to grow in line with sales.

Great. And there's just one follow-up on the margin front. On gross margin, what's -- Stuart, what's the embedded product merchandise margin for -- in the first quarter and for the year? I'm just curious, what comp do you need to leverage the rod?

Yes, Matt, as I had indicated on the -- in the prepared remarks, we're seeing product margins recovering as expected in the first quarter. And to put a number to it, we're seeing product margins improving over 300 basis points in the first quarter, and we'd expect a similar trend into the second quarter. Unfortunately, the deleverage on our fixed cost components of gross margin is offsetting that to a greater degree than we expected as a result of the sales trend. And notably, we have 39 net new stores in Q1, which we didn't have last year, and the occupancy costs related to that is also weighing on that leverage point. So what we've said is that we will leverage our cost in the mid-teens total revenue growth rate. We're obviously falling short of that in the first quarter. We're happy with the product margin results overall. And I think the strategic cost reduction improvements that we've mentioned will benefit not only the SG&A line, but also the -- there's certain elements within the buying cost in gross margin that it will also benefit. So from a long-term basis, I still see us leveraging the cost structure at the mid-teens total revenue level. We'll probably do a little better than that in 2017 as a result of the expense initiatives we have underway.

The next question comes from Adrienne Yih of Wolfe Research.

My question is -- Stuart, you mentioned something about the brand campaign. So I was wondering if you could talk more about that, the investment in that. Is that global? And then can you also talk about the investment as you build in multiple continents? What's the infrastructure investment? And what can it support outside of North America?

Adrienne, this is Laurent. From a brand campaign standpoint, you've heard us, I mean, I think we're best in the world at grassroot initiatives, building communities and being [ pulled ] in those communities. And that's why we've been so successful with our physical footprint. Where we haven't always been as strong is really amplifying our voice, who we are as a brand, what lululemon stands for in the world. And as we grow the global brand, I mean, it's becoming increasingly important. So we've actually partnered with an amazing creative agency that's one of the world's leaders in editing and building content for millennials, and I'm not going to share today who it is, but we're very excited about the partnership to actually add the level of amplification that we need to really sort of share our voice. So it is a global launch. It will be focused on a number of key cities. It will be more focused on a couple of key cities around the world, and it will come to life mid-May. But it will be a very important moment in not only increasing our guest retention, but when you think about 2017 really being a year of bringing more eyeballs on the brand, guest acquisitions, I'm getting really excited about our ability in a really relevant, nimble way to put millions of eyeballs on the brand and therefore increase our collective. So it is a really exciting project, and I can't wait for -- I can't wait to share it with all of you.

Laurent, is it traditional media? And can you give a -- is it marketing dollars that are being reallocated? Or is it new investment in marketing dollars?

It is. There is some element of incremental, and I wouldn't want you to think about it in terms of traditional. I mean, think about distributing that content in a really powerful way, but in a way that millennials are best at absorbing that content.

Fantastic. We'll be looking forward. And then the infrastructure?

Sure, Adrienne. It's Stuart. So the infrastructure priorities that we have globally are certainly to enable the expansion in Europe and Asia. We're seeing the fastest growth right now in Asia, and particularly in China. There is a lot of energy right now in building out the team and the infrastructure in China to enable the store opening pace that we'd like to see. I was in Hong Kong a few weeks ago with the team, evaluating how we can accelerate our market entry plans from a -- on a cross-functional basis. So we're aggressively recruiting the team to lead those efforts in the region, and we're excited with the momentum that we're seeing in China specifically. The team in Europe is being built out as well. We have a new GM, Gareth Pope, in Europe, who's helping us set the vision. So I'm sure there will be more to talk about in the future as Gareth develops that's strategy. But yes, it's definitely a big part of the -- of our long-term vision and that infrastructure is important to enabling it.

Adrienne, maybe one more point on the brand campaign and the incremental investment. I mean, given the nature of how we're going to be distributing that content, we're going to have the ability to be very flexible in how we invest. So we'll see the reach of what we're doing by region, by segment, by channel, and so it's not -- we'll be very nimble in how we invest based on the region that we're seeing.

So will you give us a heads-up on when that's being launched?

Yes, we will. We're going to talk to you soon.

The next question comes from Brian Tunick of RBC Capital Markets.

I guess on the 2017 comp guidance, maybe first, can you maybe give us some sense of how much an increase in ticket or AUR you're assuming in the business? Particularly on the bottoms side, are you assuming that bottoms have a similar year to 2016? And then maybe, Stuart, on the supply chain and calendar work, what inning are you in now relative to making some of these product changes. That sounds like Laurent's unhappy with what's in the stores right now on the color side and Lee's work as well?

Sure, Brian. On the guidance, as we think about the KPIs, we're seeing strong results in AUR. And our expectations were that AURs would moderate into 2017 as we begin to lap some of the really strong I&Es that we saw in 2016. I think we see more opportunity on the conversion side. As the product strategies and the product innovation lands, we'd be able to convert at an improved level both in stores and online. And I would say there's important traffic drivers as well between the brand campaign that Laurent just mentioned, improvements in our digital marketing strategies, the various CRM engagement enhancements that we have planned for the year, those will all drive traffic across both channels. But we're not relying on at least in how we've modeled the year, improvements in AUR to drive the comp. In fact, we expect to see AURs moderate. So I think that's how we're thinking about the comp from a KPI standpoint. And the -- on the supply chain work, we're really pleased with how that's proceeding. Ted Dagnese, our head of supply chain, has done a nice job of building out the team and continuing to take that agenda forward. And the partnership that we have with our suppliers is critical to that. We are continuing to now build on the success, as we mentioned, on -- in '16. The margin architecture that we landed is certainly a part of how we will manage the business and take it forward. We're turning our attention now to how to extend our supply chain capabilities to shorten lead times, to make us more agile, to identify how we can expedite product to market more quickly in response to market trends. And a number of our suppliers have had success with a number of other companies as well with that model that we're looking to learn from. So excited on the developments, see even more potential, even to gain efficiencies as our segmentation strategy within our supply chain continues to ramp. So a lot of upside as we think about supply chain and how it supports the business going forward.

And Brian, to be clear, I mean, I'm not disappointed with product by any means. I think that our stores look better than they ever have, and I think that our vision for product is right on point where it should be. I mean, what we should have done in Q1 is be bolder with our color assortments, which would have been driving traffic and conversion and which would have lifted actually the entire range of product, including the more neutral tones. So I just wanted to clarify that. I'm really, really proud about where we are, where we're headed, especially when you think about innovation in categories. And that's actually being translated really strongly in our anchor categories for both men's and women's, with bottoms and bras, and with our technical products on the men's side.

The next question comes from Ike Boruchow of Wells Fargo.

Stuart, I was wondering if you could maybe give us a little bit more detail. So you mentioned the quarter-to-date soft traffic in stores as well as softer conversion online. Can you maybe just help us out in terms of what's embedded in your down low single-digit comp guide for Q1 from both the stores channel and the e-comm channel? I'm just trying to understand where -- is pressure coming on both channels equally, or is it more one side of the other?

Ike, so I think versus our expectations, the e-comm channel has been softer than stores. The -- and I think as the guidance -- I know the guidance that we have given reflects a stronger recovery in trend in e-commerce versus stores, and it's related to all of the things that we described earlier that are sort of disproportionately expected to benefit our e-commerce business. The store business has been tougher, but not to the same degree as we've seen e-commerce. And maybe I'll invite Celeste to offer some commentary there.

Yes, thanks, Stuart. Yes, I mean, we've definitely seen a bit of traffic deceleration in Q1 from Q4, but overall, I'm definitely still happy with where we are. Regionally, we're seeing more impact in Canada versus the U.S. And in Canada, more impact in Alberta due to the resource sector. Overall, AUR, UPT and conversion are all holding strong in the store opportunity. And really, what we're focused on from a store perspective and really an omnichannel perspective is focusing on acquisition and retention and really being able to be agile and move to where the traffic is versus sitting still and waiting for traffic to come to us. So as we've spoken about with our real estate strategy, co-located and local both continue to be something that we see as really exciting opportunities from 2016 and into 2017 in areas we're focusing really hard on. And they both allow us to really capture traffic in the most relevant ways for those communities, co-located, expanding our square footage, for example, Mall Of America and Somerset, 2 key West co-located stores in 2016. We've driven more traffic in those locations and have grown the men's business, in particular, from 50% to 70% through more dedicated square footage. And then locals has also allowed us to go into smaller communities in a really locally relevant way. And the results have been something we're really proud of. Bend, Oregon and Fort Collins also, for example, have been 2 of the 4 that we're really excited about, and we'll continue to really push into that strategy into 2017.

Just as a follow-up, I was just trying to find out, are you guiding both channels to be down? Or is one channel up versus the other? That's the specific question I'm trying to get at.

Yes, we didn't break it out. But I think it's safe to say the e-commerce channel is still up, just not to the degree that we expect it would be. And we're seeing more pressure on the comp in stores in terms of an absolute number.

The next question comes from Paul Lejuez of Citigroup.

Just to dig a little bit deeper on the 1Q. Stuart, can you maybe talk about February specifically versus March? I'm not sure if you could get into that detail, but it might help understand just the progression of what you've seen so far. Also, is the issue just as much in the men's assortment as women's? And then just separately, any way to quantify the level of newness you expect in F'17 versus '16? Not sure if you can break out what percentage of sales was driven by new product introductions in '16. What do you expect that to be in '17?

Okay, Paul. I'll try to cover as much of that as I can. I think to offer some of color on how Q1 has been shaping up, as I've mentioned, we saw a deceleration in e-commerce related to conversion that began in the last couple of weeks of January that's persisted into the early part of Q1, February and March. We saw it on the store side. Traffic headwinds become tougher early in February. So I wouldn't draw a distinction between February and the early weeks of March. I think what we're -- as we think about the guidance that we gave, the distinction we are drawing is we're expecting some measured improvements into April related to some of the things we've talked about. The Nulux program that's landed in stores this week, it's having a very strong guest response as well as the -- some of the chase activities that we mentioned that will begin to land next week. So February and March have not had the benefit of those particular activities or efforts. And then beyond April, into the balance of the year, there's just a number of things that we're focused on with major investments behind them that will help drive the different parts of the business that we've already talked about. From a product category standpoint, we've seen strength in bottoms across men's and women's. We've seen jackets and outerwear that had been a challenging category for us in the fourth quarter, and we've seen that continue into Q1. I don't know if Laurent or Celeste would add anything from a product standpoint.

Yes, Paul, it's difficult to quantify newness. What I can say is that in '17, you'll see more newness both from a design standpoint and from a function standpoint. So when you think about launching a new fabric like Nulux, I mean, like the response has been tremendous. I mean, I think our tights' already #1 selling tights since the launch. So I mean, it really speaks for how well our new fabrics resonant with our guests. But also from a design standpoint, we've caught on in print. I mean, we've got a lot coming up. And when you think about the bra category that's already been performing strongly, we're going to have this really bold launch after a field of R&D and product testing with our athletes. So 2017 is -- the pipeline, and we've been talking about for the past years about sort of filling up the pipeline of innovation, and 2017 is really the year where both from a design and from a functional standpoint, we're going to see this pipeline really delivering the values to our guests that we have been waiting for.

This concludes the time allocated for questions on today's call. I'd now like to turn the conference back over to management for any closing remarks.

Okay. Thanks so much, everyone, for dialing in. We'll speak to you next quarter.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.