Call Excerpts, Part 2

Finanacial Guy: "With late deliveries during the first part of Q1 and no opportunity to accelerate product deliveries until April, our sales in Q1 will be limited to a level of growth below the demand that we have seen and, when in-stock, continue to see from our guests...

We plan to open five lululemon stores in the U.S., one lululemon store in Australia and one ivivva store in Canada during the first quarter...

...we are transitioning away from our third-party model for E-commerce. To facilitate a smooth transition, we're gradually reducing inventory allocated to the third-party fulfillment provider so that inventory to be transferred is minimized at the mid-April go-live date. We will then gradually increase assortment on our new platform as it is stabilized. Therefore, although E-commerce has been running at approximately 10% of overall revenue, we expect for Q1 that it will be closer to 8% of revenue."

 [Day, again]: "I'd also like to thank everyone for joining us today, and in closing, I want to state how devastated we are, as a leadership team and a company, over the events that happened in our Bethesda store over the weekend. And the senior team flew to the market and took care of our people, the families, and we made sure that we did everything that we could to ensure that the police could cooperate with them to have effective investigation. And I'm very proud of the way our company responded to the event though horrified [indiscernible] had to. So with that, we'll turn it over to Q&A."


Q&A Section:

 Q: I was wondering if you could touch a little bit more on the inventory constraints that you're experiencing. Is there any way to quantify how much that's holding back sales? And then also help us understand, in the second half, how you're adjusting your inventory plan? And is there an opportunity to take a much bigger position in safety stock for basic items?

A: ... we're coming into this year only 15% higher in inventory than we were two years ago. ...we're still significantly under-inventoried on a historical basis. ... we'll continue to be inventory-constrained through the first half of the year. We've placed deeper buys into Q3, and we still have an opportunity to place a deeper buy again into Q4, which we will.

Q: Last time I saw you, Christine, you talked a little bit about needing to build the infrastructure to support the growth, which has been, I think, stronger than expected. I'm wondering if you could talk about some of those investments, and if any of those were made in the fourth quarter? And, Sheree, on the yoga and run investment for fiscal '11, I wondered if you could embellish on that a bit? Perhaps tell us about newness there or exactly how the investment will be characterized, whether that will be novelty or basic, et cetera.

A:  So, on the architecture, you did see some costs come through in the fourth quarter for the new E-commerce launch, as we're getting to the final stages of that project. We had people running around the office yesterday wearing the product, they had received from all the test shipping. So we are in the soft launch stage. We feel really good about where we are for that launch...And we are heavily focused on our supply chain systems...But our main focus is on the whole supply chain end-to-end and allocations to the stores, and really getting those systems to be best-of-class. So those are the primary areas that you'll continue to see us make our investments.

[RE: New Products] We're going to continue to focus on diversifying yoga. So you will see our focus on hot yoga as well as other forms of flow and so forth. We also have a little capsule of yoga surf [yoga surf?] coming up, and we will continue to explore capsules, to look at different technologies and different technical design features and garments. In terms of our run line, we are introducing a new run short, which we are really excited about, as well as, again, focusing on UV as we did last year. And those are our big ones.

Q: Just one last question on inventory. It's just -- when do you all think that inventory will be back to the level that you'll be able to fully exploit demand levels?

A: We're rebuilding, starting Q2, as the really more significant deliveries come in, and then we'll keep building. I mean, Janet, I'm ready to sell my personal closet. I mean, you can't get enough.

 Q: ...I was wondering if you had a goal for the year or for the next couple of years in terms of how much your E-commerce can be as a percentage of sales? And then on product, I was wondering if there's an opportunity to take some of the technology in sort of running tees into tanks? It's a very personal question. [huh?]

A: ...I think you will really like the line that we were just previewing yesterday. So, yes, we do see us actually introduce a lot more fabrics in the tanks that come from our other technology lines. And there's a beautiful collection of yoga tanks that Sheree and her team have designed, which were based off of the running tanks. ...And E-Commerce percentages, I mentioned in my script, we see a midterm target of 15% as being very achievable. I will call out that we did purchase a significant amount more for the E-Commerce channel starting in Q2. And we're trying to transition the product down in a very lululemon way, so there's a very fun campaign around that. [Fun? It's fun sitting at the computer for two hours waiting for something to be uploaded?] And then we'll bring it back up a little bit slowly just to make sure we don't overwhelm the site. But we have purchased more significantly for that channel starting a little earlier in the year.

Q: You guys ended the year with over $1,700 of square foot in sales. Can you talk a little bit about the performance of your older stores? Are you starting to see some level of maturation? And kind of your most productive stores, how productive are they?

A:  As you would expect, the older stores aren't comping at that average, but they're still comping in the teens or high teens. And the newer stores, especially in some of the newer markets in the U.S., are comping well above that average...The half dozen most productive stores are well over $4,000 a foot.

A: So one of the strategies that we're working on as a company with the new E-commerce launch, and that will be the first half of the year is really just getting the platform up, making sure it's stable, introducing international, just some additional features on that, and then working on some integration and -- some, basically, just so you can keep it on the site. And then in the back half of the year, you'll see us do a lot more with an integrated digital strategy. So we'll be working on things like mobile apps and a lot more integrated guest experience. And I don't want to say anymore than that, because it's kind of fun at this time, and we want to have a little confidentiality about what we're doing. But you'll see us take a lot more of our -- community strategy online will be the basic premise of our mobile and digital strategy. And let's see, what else are we doing? The other things that we are doing, we are starting to heat up our international ad placement strategy. It's the only thing, as you know, we do is in the back of Runner's World and Yoga Journal. You will see us expand that to a more global footprint to drive those E-commerce sales as well. [This is kind of interesting but I'd rather have accurate product information that includes inseam lengths and fabric content than a "fun" experience. An iPhone app would be much appreicated, too.]

Q:  From an ivivva standpoint, is there any plans for E-commerce, or is it just too young in the cycle for review?

A: No. We feel very good about where ivivva is. ...We've really refined it into a dance, ice skating and gymnastics line, plus active wear for young women. And the response has just been incredible. So we do see, in the back half of the year, introducing E-commerce potentially for that site. Our timing will really depend on the progress we make on our main lululemon site, and we don't want to disrupt that. And if we can't make it by the back-to-school on ivivva, we would push that to the next year.


Q: Can you just talk a little bit about the Men's business and kind of big picture, as you view the lululemon brand as the number one leading athletic apparel brand for women, where does Men's fit into the picture, long term?

A: Our Men's business was introduced to lululemon to create an amazing atmosphere for our guests. And currently, Men's hovers around 12% to 15% of the business. We are nurturing the Men's business and fine-tuning the assortments. And as we're doing that, we can see the demand increasing. The future of Men's is -- since we always are thinking in the possibility there, there are things that we could do. But currently, Men's is part of who we are at lululemon.... And so I think it's just a continued focus on the basics and getting the profiles of the basics right. And we've seen a really strong response already to the men's short line that we dropped for spring. And so we'll just continue to focus on basics.

Q: where do you think longer-term operating margin potential is?

A: I think it's a pretty unsettled sourcing climate, so I think that's one thing that keeps us cautious from saying that. But as we go back to what our growth strategy is, it's very high volume, fewer stores and then reach with E-commerce, both of which giving you high-margin businesses. I think competition is the other thing that could potentially disrupt that model if we go a little bit deeper maybe in stores to make sure that we protect our reach to guests. And then as you expand into international, typically you have a little bit lower margin profile because of higher occupancy costs than labor costs. So I think overtime, as we utilize different growth strategies, you might see some different operating margin pressures from those. But we do believe that this can be a best-of-class operating margin business.

Q: I wondered, as your web business grows, what are your learnings, especially with international? Are you seeing a more diverse group of international buyers? And are there any new countries that you would call out?

 A: We definitely see our product beginning to penetrate. We just recently had somebody from the team who was in Paris and was absolutely surprised at the amount of lululemon they saw on the street. So we know that our reach is expanding internationally and the demand is really growing, which is why it's one of our first priorities on the website to convert, to have the ease of shipping internationally, including the duty tax, et cetera. So that'll be the first priority that we do, as well as in beginning local pages, in strategically following the markets that we've planned out. So right now, I can't remember the exact total off of E-commerce as a percentage of sales, but it is growing international shipments.


Q: And then I wondered also, can you quantify how much you need to increase your web inventory? And I know it sounds like you won't do this until you make the changeover to meet the current demand while keeping that customer hungry. And then my last question was as you gain information about your guests, are you doing anything to reward your special guests besides what you've already been doing? [I think this analyst wears Lululemon, herself.]

A: Our strategy is much more -- is kind of an in-the-know strategy as opposed to anything that's discounting. So our really loyal guests, whether it's on the social media -- that we will give them heads up for -- and since we had a special edition hoodie online, that we invited certain guests to know. We thought that product would last, what, a couple of weeks, Sheree? And it lasted a day and a half. So things are selling out very quickly online, and we know that, that's our job to bring the products in. We're a little bit short-term constrained because of the transition. We made the decision not to ship in the summer product line and bring that down so that we had it ready to go here, and with the new DC, as opposed to trying to transition all of that product. So we've learned a lot about what the guest wants online. And we've really fine-tuned the product assortment. You'll actually see us doing some broader and special online-only categories. And we see it as a real tool in the future to bring back things like classics that the guests have been asking for that we maybe don't have room in our stores. Something like the Deep V [!]or the athletic tanks that we had. We have a lot of demand for that, but we would bring something like that back online.


 Q: ... as you look at some of your newer stores and the sales increases there, do you have a sense if that's driven more by new customers or repeat customers, or is it pretty equal? And then, secondly, I think you said in your K that 12 to 15 of your openings this year will be in markets seeded by showrooms. And I was just wondering how you locate the other stores that aren't seeded by showrooms? Are those just fill-in stores in markets you're already in?

A: Well, mainly, the new stores, the base of new customers, particularly if it's a market that we've just had a showroom that you're really tracking. Now they might be familiar with the brand from shopping in either online or in other cities in close proximity when they travel. So that's mainly a new guest that we would be attracting in those locations. And for the stores that we don't do a showroom, it's typically part of an expanded market strategy. So it could be the opening, the fourth or fifth store, maybe, in a city. So we wouldn't do a one-for-one with the showrooms, because those guests are already familiar. And it's through the design meetings we do and our E-commerce sales. It's rather an -- we have an integrated market strategy that we look at, that we then know that we have a lot of guest demand in a certain trade area, and so then we'll open a store as soon as we have the management team ready. So we have a very deep working list of locations for the build out that we've stated of the over 300 stores. So it's always just, for us, a proofing-out that those are the right locations. And that's the process that we follow.





 Q: Do you have any sense of what the repeat customer is looking like at some of your newer stores? I mean do you track that data?


A: We don't really track that data. We only have overall transactions. But just anecdotally, we know that we have a very loyal guest following that stops into the store two or three days a week. They know exactly when a product notification goes out. They know exactly when the key shipments of new products come in. It's a very interactive guest. And then we have another guest that shops in the stores but looks online and checks everything out. So we actually have put together a Facebook catalog where people can click in, that will go, as part of our digital strategy during the launch transition, to make it really easy for that guest to identify what she wants and get it at the location that she wants. [Unfortunately, that doesn't sound like buy on line and hold at the store like Best Buy does. Would love that.]

A: We don't have enough product for a warehouse sale, so we won't be doing one of those in the near future.

A: [Re: Inventory shortages]The other critical part is forecasting your fabric. On the luon, we're fine, and we actually now have brought on a second manufacturer of the luon. [I wonder if the second factory is making the thicker luon found in the Pure Balance jacket. So far, mine looks great] It's more the specialty fabrics like the Silverescent. We now have -- what is it, Sheree, 47 key fabrics instead of the original seven. So making sure we have enough fabric to bring it in. And then it's more, honestly, a short-term issue of the number of factories that shut down for what used to be a two-week -- and now, between the ramp-down and the ramp back up, you're seeing -- it almost would be a four-week impact. So it's a little bit of timing. We had a lot of product on the water and not in the air for the spring launch post-holiday. So even though we're air freighting some of the product in, it just takes a little bit longer to catch up. So we see this as a pretty short-term issue, not a longer-term, and not a manufacturing past issue. We've been on boarding new factories. They're just starting to come into play and increasing theirs.

Q: Can you give us, as a follow-up, an update on some of the systems investments you have underway?


 A: Obviously, the biggest one in the short term is this E-commerce transition, which -- the first phase of cold launch will happen on April 15. And then there's a phase of stabilization, and then we'll be adding new capability and technology, including our digital strategy, to that platform. Our next biggest focus is the end-to-end supply chain. We've been undergoing a business process project with KSA, which is not only identified current state but future state of our supply chain, and the end-to-end systems that we need to really manage and be best-in-class in supply chain. And so that will be a significant portion of our investment and time. We've been working on a PLM, which is a product life cycle management system. And so that will be one of the first priorities that go in, as well as the planning and forecasting and the allocation down to the stores. Systems are things that we're continually refining. When the original systems were put in place almost three years ago now, the vision of the company, prior to my arrival, was that it would be a North American-only retail company. We're obviously now multi-channel, multi-concept, multi-geography. So there will be increased investment in just even our core and basic financial systems to go into multi-currency. So that would be probably the next set, as well as things like business intelligence, data warehouse management, just the things that you need as you get to be a bigger company. And I forgot, we have our new HRS system going live in April. So our new HR system, which gives us complete online management. Up to now, we've basically had a payroll system, and now we will have a complete people management system effective April.

Q: Christine, you mentioned, I believe, at the ICR conference that you weren't going to try to increase prices. And we've all listened to a lot of conference calls over the last couple of months where, basically, every company says they're increasing prices. So I'm just curious, philosophically, how do I reconcile that?

A: I think we're obviously going to be smart about the decisions that we make. And if cotton continues to have poor crops, then it's a constant demand issue, we're obviously, in a longer-term situation, going to have to address what we think that is. Right now, what I want to be really careful of is that we don't build a culture of relying on pricing to solve issues. And obviously, when you have tremendous raw materials and labor costs, we're going to have to do something at some point. But right now, we still have a lot of room for efficiency, effectiveness. We have a lot small inefficiencies across the company. So keeping a discipline of working on those issues first, and then being smart in pricing, as Sheree said, to the value of the garment. And we also -- we do look at what happens in our competitors, and what are they pricing garments at, what qualities that they're pricing at, and we have a lot of people trying to come into this space. And the one thing that I'm very, very confident of is the quality of garment and construction design and value to the guest at the price we offer is exceptional. And by just continuing to take price increases, we leave a lot of room for competition. So we look at it from a very holistic perspective. And we also can distort the line, as I said earlier, by doing special edition hoodies, and, as Sheree said, increasing the value and construction of some garments. We will higher-price those, but keep our basic quality goods at a price that's very attractive.