Thank you for standing by. This is the conference operator. Welcome to the lululemon athletica inc. Second Quarter 2017 Conference Call. [Operator Instructions] I would now like to turn the conference over to Howard Tubin, Vice President, Investor Relations for lululemon athletica inc. Please go ahead.

Thank you, and good afternoon. Welcome to lululemon's second quarter earnings conference call. Joining me today to talk about our results are Laurent Potdevin, CEO; and Stuart Haselden, COO. 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 forecast 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 obligations to update these statements as a result of new information or future events. During this call, we'll present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our quarterly report on Form 10-Q and in today's earnings press release. The press release and accompanying quarterly report on Form 10-Q are available under the Investor section of our website, www.lululemon.com. Before we begin the call, I'd like to note to our investors that we are providing a summary of key financial and operating statistics separately on our Investor site for your reference. 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. Our strong Q2 results reflect focused delivery against our key growth initiatives. The strategic pillars, including digital, international, men's and North America drove the improvement in our business as we progress towards realizing our 2020 vision to achieve $4 billion in revenue. We've had some fantastic moments in Q2. We launched category-disrupting product innovation, such as the Enlite Bra; amplified and articulated the brand globally with This Is Yoga, reaching 50 million guests, equally split between men and women; and through powerful community activation, such as Unroll China, we connected directly with guests via live streaming our ambassador-led yoga class to over 150,000 people. As a result, we drove outperformance in Q2, delivering revenue of $581 million, a normalized gross margin of 51.6% and adjusted EPS of $0.39. Our adjusted EPS exceeded our guidance and grew modestly versus last year despite planned digital investment spending. Our comp results were strong across channels and merchandise category. Our performance in Q2 and solid momentum we're seeing in early Q3 gives me great confidence in our strategy and long-term plan. Today, I'll focus on the Q2 results and highlights of the quarter and share our plans for Q3 and the back half of the year. Stuart will review our financials and provide Q3 and full year guidance. We'll then take your questions. As an originator brand, we remain at the forefront of the market we created, powerfully owning our position as the brand that defines an active, mindful lifestyle. And in a world of increasingly commoditized guest transactions, our relentless focus on innovation, human connection and our vertical business model allows our guests to enjoy holistic experiences that transcends the 4 walls of a retail store, unlocking tremendous growth opportunity as we reach new guests around…

Thank you, Laurent. As you mentioned, we are pleased with the acceleration in our business in Q2 and the positive momentum that's now continuing as we enter fall. The strength we saw in the second quarter was broad-based across all channels and reflected in our key operating metrics. Specifically, our store business saw a nice improvement in traffic that is now extending into the early part of Q3. We also saw positive trends in conversion, AUR and UPT, which gives us confidence in our store comp trends as we're not depending on any single factor. And online, while the business did benefit from our warehouse sale, the underlying KPIs are healthy as we've seen increases in both traffic and conversion as guests are responding nicely to the enhancements we're making to the site. And as Laurent also mentioned, we are still in the early innings of our e-commerce business and continue to see outsized growth potential here. I'm also excited for the ongoing strength we're delivering in product margin. Our adjusted gross margin increased 220 basis points in Q2, well above our expectations. As we continue to elevate our game and supply chain, we expect to deliver ongoing product margin benefits as well as new strategic capabilities on which I will elaborate shortly. Before taking you through our Q2 results, I'd like to update you on the evolution of our ivivva business. As of August 20, all the ivivva stores and other locations planned to close have ceased operation. 7 locations remain operating in key markets around the country. And our Fashion Island ivivva location has been closed temporarily but will reopen in the coming months. There's been no change to our e-commerce business, which remains in full operation. We continue to estimate that total costs associated with the transition…

[Operator Instructions] The first question comes from Oliver Chen of Cowen and Company.

Laurent, the Everlux pant, how does that fit into the matrix regarding Luon and Luxtreme? And as you think about product and the big opportunity buckets longer term, could you speak to the to and from opportunity within women's? And any other thoughts you have on where your portfolio particularly has big opportunities to grow over the long term? And Stuart, I just had a question about thinking about digital in terms of where you are versus the investments and how you're feeling about the mobile experience and the integration with stores? And also, some of the earlier issues we saw, it seems like a lot of those are resolved, would love your thoughts.

Thank you, Oliver. That was a lot of questions. Well, the Everlux fabric totally fits in our Engineered Sensation, in a more high-sweat studio environment. So it's really the continuation of what we've seen be really successful with our guests, delivering the feel that they need depending on their sweaty activities from outdoor to indoor and from high sweat to low sweat. So it's the continuation of pursuing innovation in our Engineered Sensation franchise. And given the success that we've seen with Nulu and Nulux, we're actually thrilled to continue to innovate in that area. From a men's standpoint, I mean, we're going to -- we've got a great campaign coming up with the ABC franchise that you're going to be seeing expanded. And I would point that in Q2, we've seen a really, really strong inflection with tops in general, both men's and women's, short sleeve and long sleeve, with really strong comp in the low 20s. So very happy with that. And obviously, the launch of the Enlite Bra shows that when we lead with innovation, I mean, we launched our highest price point bra, which quickly became the #1 selling bra. So that really sort of validates our position as the brand that created this market that leads with innovation. And when we deliver value to our guests, we actually have a tremendous opportunity to continue to increase AUR. As far as categories in the future, I mean, we're really excited about the assortment that will -- that is landing for jackets and outerwear. I think the pilot that we're doing with footwear really speaks to how nimble our stores are in adapting to new categories, but also the strength and the elasticity of the brand in expanding our presence in multiple categories. So very, very excited about what's coming up.

And Oliver, to answer your questions on digital, we've made great progress in the second quarter. As we look at how that's reflected in our KPIs, we're seeing a really strong improvement sequentially in conversion as well as traffic. And I think as you -- most evident as you shop the site, you can see the improvements we've made in visual merchandising, the integration of the photography improvements with just how the site shops has been meaningful in how we've been able to improve the guest experience online. On your question specifically with regard to the integration with the stores. I think the majority of the focus there has been enabling and unlocking the omnichannel aspects of our business model. The -- just pooling -- how we're able to connect the pools of inventory between the different channels has been the real focus. From a mobile standpoint, I would say we have a lot of opportunity to make improvements there. That is something that, I think, is still in front of us in terms of tackling that as a major element of the broader digital strategy. I think as we look at the website upgrades, as we look forward to -- further into Q3 and the website upgrades that we're looking to accomplish with the completion of the update that we're in the work of now, I think importantly, we're going to see additional visual merchandising enhancements. We'll be able to better shop -- guests will be able to better shop. Our outfitting options -- we'll create better outfitting options. We'll have a more powerful presentation of our franchises, such as the ABC pant that Laurent mentioned. And we're also going to importantly create greater flexibility for our e-commerce team to make updates quickly. The earlier version of the site is very brittle. It's not -- we're not able to make changes quickly. The new update will enable us to have a read-and-react capability we haven't had previously. So that will be important to ensuring we've got the -- our best foot forward with what's working on the website. There'll be some checkout improvements but more substantive checkout improvements later in the year. So we're really pleased with the progress. It's showing up in our results and look forward to providing further update on the Q3 call.

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

This is Kate on for Brian. Stuart, I was just hoping you could talk a bit more about the supply chain and product margin opportunity, the work that you're doing there. Certainly understand that the product margin opportunity might moderate here into the back half as we lap some of last year's gains. But next year, how should we think about the opportunity and the timing of the supply chain work that you're doing rolling through? And also, if you could contextualize it versus the 350 basis point gain that you've seen over the last several months?

Sure, Kate. The -- first, just let me say, we're really pleased with how the teams have developed a very disciplined process across design, merchandising, planning, sourcing and logistics over the last couple of years. That effort of the team has really enabled the improvement that we've seen. As we have described, the step function improvement in the gross margin has unfolded as we have expected in the second half of '16 into the first half of '17. That being said, we are identifying ongoing opportunities to improve our product margin, not only from just the -- as we grow in scale and gain scale economies in our sourcing structure but also through a very deliberate segmentation of our supply chain. As we look at how long products live on our floor, we're able to source them more efficiently based on the lifespan they have within our assortment. And in addition to that -- and we spoke to this, I believe, a little bit on the last call, we're looking to build new capabilities in our supply chain around speed and flexibility. The opportunities we have to stage fabric, to be able to respond to demand as we see it emerging, offers really important opportunities not only to capture incremental sales as we're in a better in-stock position but also to do that in a favorable margin outcome. So those are new capabilities that we're looking to build. We're in a much stronger place to be able to play offense, if you will, with our supply chain, a place where we weren't -- we didn't have those options a couple years ago. So very excited to see those new opportunities emerging.

And Kate, this is Laurent. I would add quickly that our focus on innovation also allows us to expand on margin through AUR. I mean, like the Enlite Bra being a really good example of that. And when I think about our focus on accessories and outerwear, those are 2 categories that have a lot of growth ahead of themselves with -- there's a lot of innovation and really healthy margins. So I mean, like our innovation will drive AUR, which in return will continue to drive margin expansion.

The next question comes from Matthew McClintock of Barclays.

Yes. Laurent, I was hoping that we could talk a little bit more on the footwear pilot. Longer term, how do you see footwear as an adjacent category that you can go into? And more specifically, I was wondering, how do you think about finding what right balance in footwear between fashion and technical, especially when the technical players and the existing players in the industry are highly consolidated with substantial scale for innovation?

Thank you. Well, I mean, we look at this pilot as a great opportunity for learn -- to learn. I mean, obviously, APL sort of lives in a similar space as we do, at the intersection of function and fashion, so it was a very natural collaboration for us. And it's -- we've been able to learn how to potentially add footwear to our assortment in our stores. And in Q4, we'll continue to pilot with an online assortment. So I mean, it's definitely an adjacent category. And we're intrigued. And we don't need the category to deliver on our 2020 commitment. So I think that's really what's critical. I mean, we're looking at a number of categories. Some of it might be in the world of product that are three-dimensional, the way you know it but far too dense. Some of it might be in the world of services or content. And so we're being very curious. We don't need any of those categories to achieve our 2020 vision to get our revenues to $4 billion. And we're excited about the learning. So we're going to continue to look at the potential of the categories and how it ties to what we're doing. And we'll see more of that in the early part of 2018.

And if I could have a follow-up. Just, Stuart, on -- you mentioned one of your partners is building a facility in Haiti and getting closer to the end market. Is that something longer term that you would expect to see more of in terms of your sourcing partners? And can you maybe talk just not only about the benefits of that, but in terms of how that -- how you can establish a better relationship with those companies when there's probably a lot of competition for that local space?

Sure, Matt. Yes, it's -- the supplier that we're making reference to is one of our closest and most important partners. And the efforts that they're in, in that regard is something we've been in discussions with them around for a while. So in some level, the volumes we'd be looking to place with them have been a part of their decision, I think, to pursue that particular opportunity. And the benefits are obvious in that the speed to market as well as the cost structure advantages are strategically appealing. And we would certainly -- we're constantly looking at different options, different regions of the world and looking, at the same time, to diversify our supplier base to create the strongest combination of suppliers. So the regional appeal of having something closer to our home market is pretty compelling. And it's certainly something that we'll look to explore and amplify where we see that it makes sense.

The next question comes from Paul Lejuez from Citi.

Can you talk about your plans for physical and online warehouse sales that are built into your back half guidance? And also curious about who that customer is. Are you seeing a different customer respond to that online warehouse sale? And then just one clarification. Did you quantify how the performance of tops versus bottoms or for men's? If you could provide some color there.

Paul, let me start with the warehouse sale question. It's really -- the decisions and when we make those decisions to hold warehouse sales are really driven by our inventory position and where we see the sell-throughs and the inventory position that it makes sense for us to go ahead and pull the trigger on holding those events. We don't do it as a revenue driver. And so as we think about our revenue outlook for the second half of the year, it's not dependent on any warehouse sales. And again, we'll continue to evaluate our inventory position and make a decision on how to -- how and when and if we'll hold one in the second half. Certainly, longer lead time on the physical warehouse sales than the online. And we also -- we don't want to train our guest to wait for those. And so we want to have -- we don't want to have a predictable cadence of when we host those warehouse sales. And so we may or may not end up doing one or some combination of them in the second half. It's a lever we have to pull to stay on top of our inventory movement. The customer question around who is the customer that participates in that. It's a combination of probably some of our best customers as well as more price-sensitive customers. And we're pleased with the pretty robust interest that we see around both of those formats I think is a testament to the demand and the appetite for the brand. And also how we don't do it often. And so when we do it, we see a pretty frothy response to those sales. And then you had a question on tops versus bottoms. So we have -- we continue to see a really strong sell-through in bottoms. Strong double-digit sell-throughs really in the 20s for both women's and men's pants in the second quarter and extending into the third quarter. Tops have been strong as well, very healthy high single digit, low double-digit trends in both men's and women's tops in Q2 and into Q3. So [ other ] than stronger, but we're not unhappy with the tops trend.

Stuart, just what's not performing well?

Well, it's a good question. I mean, we're really seeing like our efforts paying off across all of our key 4 pillars across digital, men's, international and North America. I mean, I think we've got a tremendous opportunity ahead of us. Not that it's not doing well, but there's an opportunity to realize both in accessories and outerwear. And we're really increasing our focus in both categories. I mean, accessories is a really high-margin category. It's got a lot of upside, but it's also a great point of entry for people to get into the brand and become our guest. So we're excited about that. I think we've got opportunity to do -- to have a stronger and wider assortment, both in bags, socks and intimates. And I'm really passionate about the work that we can do with outerwear. When you think about what we've done with Engineered Sensation and translating that to the world of outerwear with the amount of innovation that's available in that world and it's another high-margin category. So I would point out to these 2 categories with -- not necessarily where we're not doing well because we're really pleased with the assortment that's landing for jackets and outerwear this fall, but a lot of upside and both for men's and women's, actually.

The next question comes from Mark Altschwager of Robert W. Baird.

I wanted to ask about the DTC business and the performance relative to the low to mid-teens guidance you gave for Q2. Just wondering, was the warehouse sale much larger than anticipated? Or what were the factors that drove total DTC so far ahead of your plans? And then ex the sale, I think up 16% constant currency. Is that how we should be thinking about that heading into the back half of the year? Or would you perhaps anticipate some acceleration as the site enhancements and digital marketing initiatives gain some momentum?

Yes, Mark, it's Stuart. So really pleased with the e-commerce trend that we saw in the second quarter. And as I mentioned, conversion in particular recovered nicely. I think that's a result of the work that we had talked about as part of that digital acceleration effort. And the warehouse sale did exceed our expectations. It was -- actually, it set a record for us in terms of the amount of volume that we did with an online warehouse sale. So it was well above expectations. And as we think about the guidance into Q3, we're certainly putting that aside as we look at that mid-single-digit guide and looking at the trends that we're seeing currently in the business sort of more in line with the e-commerce also in Q2, excluding the warehouse sale. But there's -- there are benefits that we see in the second half of the year, in Q3 and Q4, from a digital standpoint. As we complete the website work that we just talked about, we are expecting that to have a tailwind on our e-commerce trend. We're still realizing benefits from This Is Yoga. We have ongoing investments in digital marketing. I think our product assortment is continuing to improve. Big opportunities for us in jackets and outerwear that Laurent mentioned into the second half of the year as that part of the assortment, in particular, improves. And on the brand marketing side, you heard Laurent mention the men's campaign that you will see later in September that will coincide with the introduction of several new styles in our ABC franchise, the first of which is our ABC slim pants that's in stores and on the website now and is really exceeding expectations. So there's a number of things that we believe offer upside opportunity for us in the second half of the year, both from a product standpoint, a brand marketing standpoint and from a channel execution standpoint. So really excited for what's in front of us.

Next question comes from Matthew Boss of JPMorgan.

On your global store profile, how best to think about the pace of store openings in Asia, in Europe? Can you talk to some of the drivers of the improved productivity you've been seeing more recently? And just where do we stand on international profitability?

Yes, I mean, I think, I'm not sure that I think about it in terms of number of store is the right metric, to be honest. I mean, we're seeing what we've done during Unroll China and how we were able to live stream to 150,000 guests. That was incredibly powerful. You look at our performance on Tmall being 175% up year-over-year. That's an incredible avenue for us to put eyeballs on the brand. And our densification strategy in key cities, whether it's London, Beijing, Shanghai or Tokyo, is really paying off. Because when we look at sort of the halo that it creates in Tier 2 cities from a social media or from a brand awareness standpoint, it's actually really, really powerful. I mean, I was really very pleasantly surprised with the impact of This Is Yoga in China, where for a very low cost of acquisition, we were able to create tremendous brand awareness. So I think that we're not going to get ahead of our ourselves with stores. I mean, we want to be really sort of vibrant in the communities that we're in, mostly in those Tier 1 cities where we're densifying. And I think that we'll continue to look at footprint the same way we're looking at it in the U.S. and like you saw products like what the work -- what the team is doing in North America where, in a mature market, we're actually incredibly nimble with the number of store formats, from local, all the way to what we've done recently on Fifth Avenue. So I think it's more a question of really being strong in those Tier 1 cities and then leveraging that, the halo that it creates with a strong digital ecosystem. And I mean, in Asia, we've got a great sort of presence on Tmall, and we're partnering with WeChat in pretty powerful ways so. And as far as the growth, I mean, the growth is -- it's consistent with what we said in the past. I mean, it's -- we're really, really excited. There's such strong momentum in Asia. It's a little bit slower in Europe. But I was there this summer, and I could -- the difference in Paris and Munich in terms of excitement, the number of studios, how people sweat was very, very noticeable. So I -- and we've got 50% growth year-over-year in that market. So I mean, it's by no means left far behind. I think it will grow slower. And we're really focused on China right now, which we think by 2020 will represent probably 60% to 70% of that Asia Pacific market. And then there was a second part to the question.

Right, on profitability. And so, Matt, now we're seeing a nice acceleration in Asia. I think we've spoken to that previously. At this point, we expect Asia to be breakeven inclusive of Australia. So Asia Pacific to be breakeven from a profitability standpoint this year. And it's going to -- we're going to be a little bit longer on the -- to reach that same milestone in our European business but feel good about the progress there as well. So then as we kind of think about the international combination of those markets and when they will collectively reach profitability, that's something we can speak to, I think, subsequently.

Great. And then just one follow-up. With the competitive environment clearly amplified across the overall athletic space, you guys have definitely been an outlier. Any categories where you've found that you do need to be a little bit more promotional? And just what do you attribute your relative strength? I'm just curious on your overall take on the athletic backdrop and if you had been pulled into it in any way.

Well, I mean, I think, we're very differentiated and we've got such a strong, unique point of view. And first of all, we created this market, and then we're driven by innovation. I mean, we're certainly not focused on being competitive to gain market share. And we're so much more than a channel. I mean, we're a brand. I mean, we created this market. We're driven by innovation. We're an originator brand. I think that's a very unique positioning. I mean, we're best in the world at human connection and at product and at solving problems for the athletes. And in the process of doing that, I mean, we're engaged with our guests every step of the way. And I think that's really unique and really powerful. I mean, people are looking for -- they are a lot more intentional with their purchases and how they behave with brand. And that's such a massive asset for us. When I think about men, I mean, I think there's a really strong redefinition around the world with what masculinity means. And again, our positioning is really unique there at the intersection of athleticism and mindfulness. So I think it's probably a mistake to look at us as a channel, like a lot of the brands you're probably thinking about. I mean, we're first and foremost a brand and that creates a form of loyalty. So I mean, our positioning is unique, and we're very, very pleased. So we don't see pressure in categories where we need to be more promotional. If anything, when we deliver innovation, we continue to be incredibly pleased with how it resonates with our guests.

The next question comes from Ike Boruchow of Wells Fargo.

Stuart, just 2 margin questions for you. I think you said that in the second quarter, markdown was unfavorable, a slight offset to the product margin. Could you just give us a little more color on what the markdown pressure was in Q2? And then just based on the guide in the back half of the year, what's left in Q4. It looks like there's a pretty decent leverage opportunity that you're guiding to, 50 bps or more. Just kind of curious, Stuart, where is that coming from? Are there investments that are rolling off? Is there something in the P&L that we should keep in mind? And then how do we think about that sustainability in leverage as we get into next fiscal year?

Yes. Certainly, Ike. So on the markdown question, in the second quarter, we had -- as we talked about, we had a really successful online warehouse sale that accounted for that 14 points in e-commerce. So that was really what drove the elevated markdowns in the second quarter. And so I mean, otherwise, we had a very healthy ongoing sort of markdown comp in our normal channel. So that is really isolated to the warehouse sale. As we look at the SG&A picture into the second half, we're pleased to see that the SG&A management efforts that we've been working on, paying off. That's reflected in the SG&A outlook for the third quarter as well as sort of what we're signaling for the fourth quarter in terms of leverage in the fourth quarter. And it's really a -- it's a combination of completing some of those onetime investments that we have related to the digital acceleration in the third quarter. And then those are sort of rolling off, if you will, into the fourth quarter and then being able to recognize the full benefit of the cost management efforts into the fourth quarter. It's also the largest quarter from a sales standpoint, offers the greatest degree of opportunity to leverage our fixed cost. And we do certainly see leverage on SG&A as a priority as we look forward over the next several years. As we've talked about, our longer-term model holds that we will deliver modest SG&A leverage as part of the strategy to achieve operating profit north of 20%. We believe that the product margin recovery that we've seen and the gross margin that it supports is on track to achieve that 20% EBIT margin. And we see the -- after we begin to clear some of these onetime investments, we'll see leverage in SG&A that'll further complement that gross margin picture and connects to, in our model, achieving that 20% EBIT margin. So certainly -- certainly part of the strategy and part of the long-term outlook. So thanks for your question.

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

Thanks for joining us, everyone. We look forward to speaking with you in about 3 months when we report our third quarter results. Thanks.

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