Lululemon Athletica Inc

NASDAQ:LULU

Earnings Call Transcript 2019-Q2

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the Lululemon Second Quarter 2019 Conference Call. [Operator Instructions]

I would now like to turn the conference over to Howard Tubin, Vice President of Investor Relations for Lululemon. Please go ahead, sir.

[Howard Tubin, VP, IR]

Thank you and good afternoon. Welcome to Lululemon's Second Quarter Earnings Conference Call. Joining me today to talk about our results are Calvin McDonald, CEO. Celeste Burgoyne, EVP Americas and Global Guest Innovation and PJ Guido, CFO.

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 Lululemon's future. These statements are based on current information, which we have assessed, by which 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 our business, including those we have disclosed in our most recent 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 expressly disclaim any obligation or undertaking to update or revise any of 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 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 Investors section of our website at www.lululemon.com.

Before we begin the call, I'd like to remind our investors to visit our Investor site where you'll find a summary of our key financial and operating statistics for the second quarter as well as our quarterly infographic. Today's call is scheduled for one hour. So please limit yourself to one question at a time to give others the opportunity to have their questions addressed.

And now I'd like to turn the call over to Calvin.

[Calvin McDonald, CEO]

Thanks, Howard. I'd like to welcome everyone to our second quarter earnings call.

I'm pleased to take you through our results, which reflect continued strength across all areas of the business. Lululemon had another successful quarter as our teams across the world continue to build upon the momentum in our business and execute on our Power of Three vision for growth. On today's call, I'll provide an overview of our Quarter 2 results, including further details on some key initiatives within product innovation, and our international business.

Next, Celeste Burgoyne, our EVP of the Americas and Global Guest Innovation will join us to discuss the success within the North American region, early learnings from our Lincoln Park experiential store and the progress of our membership pilot. Then PJ will provide a detailed financial review as well as our guidance outlook. To wrap up our call, I'll provide a few closing comments and then we'll be happy to take your questions.

Looking at our second quarter results. Momentum in the business remains strong across product categories channels and regions. We're now two quarters into our 5-year vision, and I'm pleased with the strong execution and passion across the business to continue to deliver on our growth priorities.

In Quarter 2, total revenue grew 22%, constant dollar comps increased 17% on top of a 19% increase last year and earnings per share increased 35%. I'm also proud to share how we are living into our vision to be the experiential brand that ignites a community of people living the sweat life through sweat, grow and connect.

In July, we opened our first experiential store in Chicago's Lincoln Park neighborhood and just a few weeks ago we hosted our Eighth Annual SeaWheeze Half Marathon in Sunset Festival in Vancouver. These are both fantastic examples of how we are bringing innovation to guest engagement and connecting with our community both inside and outside the four walls of our store. You will hear more specific details from Celeste shortly on these exciting initiatives.

I will now update you on our Power of Three growth pillars product innovation, omni-guest experience and market expansion. I'll speak to product and international and then Celeste will take you through the North America and omni-guest experience.

As you will recall our 5-year vision details our path to grow our core business in the low double-digits annually, while doubling our men's, doubling our digital and quadrupling our international businesses between now and the end of 2023.

Within our product innovation pillar guest response to our merchandise offering was particularly strong across the board, as we continue to leverage our key core franchises, while always delivering new innovation through the Science of Feel. In women's comps grew 13% as bottoms remained strong, driven by both pants and short.

Within the men's business comps grew 27% with ongoing strength in both tops and bottoms. Like women's, the men's side also saw strength in shorts. Across both men's and women's, we continue to innovate to serve our guests across key activities Yoga Run, OTC and Train.

Within Train this quarter, we launched our latest collaboration Stronger as One with Barry's. This dual gender collection was designed specifically for the type of work-outs that are popular Barry's bootcamp sweat classes, with fabrics that offer abrasion resistance, breathability and moisture wicking. The strong response to the collection provides a compelling proof point of the opportunities as we push further into the Train category in future seasons.

Now, I'll provide a quick update on self-care. We're thrilled with the initial guest response, as performance has exceeded our expectations.

Look for several new additions to the line between now in the end of the fiscal year. We're in the early phases of this pilot and see many opportunities to create product with our unique positioning of solving sweaty problems for athletes.

Looking ahead across all categories I'm happy with our near-term product pipeline and the many innovations that our teams have in longer-term development. Through our unique approach to innovation, the Science of Feel we've recently relaunched our Metal Vent collection. This builds upon our successful franchise by offering improved performance attributes and we're supporting the launch with compelling storytelling to attract new and existing guests to this product line.

Our outerwear continues to represent a meaningful opportunity for us and we're excited to launch waterproof wool in the fall. This fabric innovation will offer guests the warmth and texture they expect from wool while keeping them dry as they spend time outdoors.

We'll also be expanding our lab product to 45 stores and online for fall. As we showcased for you at our Analyst Day, our lab product reflects our Pinnacle aesthetic and appeals to a younger, more urban guests relative to our core.

Turning now to international. Let me share an update on the progress and success we're seeing in Europe. I spend several days with the team in London a few weeks ago and we're continuing to see strong trends in this market now that we are more established in the region. In quarter 2 total revenue in Europe grew 35%.

We're also pleased with the continued success of our global event strategy and in June, we hosted our Annual Sweatlife Festival in London. This amazing event brings together guest, educators, ambassadors and other members of the local community for a weekend of sweat classes, yoga, personal development and meditation.

In August, we hosted Sweatlife Berlin for the second time, and I'm excited that we are bringing this event to Paris for the first time in early October. We're also pleased with the recent opening of our first mainline store in the St. Germain area of Paris and with the rollout of our local market, e-commerce sites in France and Germany. Both sites went live during Quarter 2 and we're happy with the performance to-date.

In our APAC region, the momentum continues to be driven by strength in both our store and online channels. Total revenue and APAC grew 33% in Quarter 2 with particular strength in China where we saw market growth of 68%. We opened two new locations in China and our fourth store in Singapore, with our Marina Bay location.

We're in the early stages of our growth potential and remain on-track to open approximately 15 stores in China this year, almost doubling our store count when compared to the end of 2018. And we continue to see strength in our e-commerce business as guests engage with our brand across channels. In China, our e-commerce comps were over 70% and our new local market sites in Korea and Japan are exceeding initial expectations.

I will now turn it over to Celeste to share an update on North America and omni-guest experience. Celeste?

[Celeste Burgoyne, EVP, Americas and Global Guest Innovation]

Thanks Calvin.

I'm thrilled to speak with you about the growth we're seeing across our stores and online channels, which reflects a strong connection we have with our guests. In Q2 revenue in North America increased 21% as our guests continue to respond well to our merchandise assortment, engaging store environments and unique brand activations.

Traffic remains a key driver in North America, as our strategies and investments continue to drive guests in the stores and to our e-commerce sites. During the quarter we opened one new store in the U.S. and will remain on-track to open 15 to 20 stores this year in North America. In addition, we remain particularly excited with the results we're seeing from our co-located remodel strategy and we completed 8 projects in Q2.

Within our digital business guest engagement continues to be strong and we are focused on pushing forward with improvements to our sites and mobile apps. We are currently in the process of rolling out new search and browse functionality, which will further enhance and personalize experience for guest visiting our e-commerce site, We are also enhancing our product detailed page across our digital ecosystem which will improve product storytelling and product education and further support conversion.

And finally, we now have buy online pickup in store capabilities in nearly all of our stores across North America, up from 150 stores at the end of Q1. So far the favorable response from guests shows how much they appreciate the flexibility and efficiency of this service.

As Calvin mentioned we are living into our vision and engaging with guests in compelling new ways both inside and outside of the store. Our Lincoln Park store is truly the physical manifestation of the heart and soul of Lululemon which is reflected and be an active, cultivating mindfulness and developing meaningful connections.

At Lululemon we refer to these three tenants as the Sweatlife. We're really excited with Lincoln Park's performance since its opening in July as it provides our guests, educators and ambassadors a space to sweat, grow and connect together all under one roof.

The store offers dedicated studio space for sweat classes and meditation, locker rooms and showers, healthy food at our fuel bar, a community space created simply to foster connection, and of course, an elevated shopping experience. 45 of our local ambassadors call the store home and they lead the 6 to 10 classes we offer every day. Currently the store is a one of a kind for us as we learn from the initial results.

Looking forward, we're excited to share that we have two key store openings planned for November, one in Minneapolis and one in New York City. In Minneapolis we will be opening our second full experiential store in the Mall of America. This location will offer several of the features found in Lincoln Park and we are excited about what the store can teach as a high volume mall-based locations.

In New York City we will complete the relocation of our large format 5th Avenue store near Rockefeller Center, while this store is only moving across the street. The new 23,000 square foot location will offer an enhanced shopping experience for our guests with a better representation of the product assortment for both men and women. These two openings illustrate the agility of our store formats as we meet the wants and needs of guests in each community where we open.

Let me shift gears now and update you on membership. Our program remains very much attached. However, we are happy with engagement we're seeing from our members in the first three cities of Edmonton, Denver and Austin. As we expected our loyal guests make up the majority of members so far, but we have a number of members who are signing up for the program with their first purchase with our brands.

In addition, we are seeing men connect with us via the program with over 20% of our members being male in Austin. While we continue to test and learn, we won't get into the specific economics of the program yet but we recently launched in our fourth test market of Chicago. With the opening of Lincoln Park, we're excited to see the potential synergies that our membership program and experiential store can create together.

Looking at our community activations in Q2, I'd like to highlight several for you that help us further engage with our guests who choose running as a preferred way to sweat. We hosted our 10K Runs in Toronto and Edmonton with positive response from the local community and had 10,000 and 7,000 participants, respectively.

In addition, we announced our first large-scale run event in the U.S., a 10K in San Diego that will happen in November and sold out in three days. Our brand momentum continued into the third quarter with our SeaWheeze Half Marathon. In addition to the race, which had 10,000 participants including three of our global Run ambassadors, we also had 6500 guests join us for yoga.

We offered Vision and Goals sessions and we held a celebration in the evening with world-class musical acts. SeaWheeze is a powerful example of how we create lasting ways to sweat, grow and connect with our community beyond what happens within our stores.

Before turning it over to PJ, I'd like to express my sincere gratitude to our educators and store teams as they continue to bring the Lululemon brand to life every day for our guests. I'd also like to specifically thank the cross-functional teams that work to open Lincoln Park. This was a considerable undertaking and I really don't have the words to express my gratitude for everyone involved.

And now I'll pass it to PJ.

[PJ Guido, CFO]

Thanks Celeste.

Before I provide highlights on Q2 and our guidance outlook. I will refer you to the financial supplement posted on our Investor site for additional details. For Q2 total net revenue rose 22% to $883 million driven by continued strong execution across all parts of the business.

In our store channel, we delivered in the 11% constant dollar comp store sales increase on top of a 10% increase in Q2 of last year. Square footage increased 17% versus last year, driven by the addition of 45 net new Lululemon stores since Q2 of 2018. During the quarter, we opened five new stores and completed eight optimizations, including the opening of our experiential store in Lincoln Park.

In our digital channel, we posted a 31% constant dollar comp increase on top of a very strong 47% increase last year. For the quarter e-com contributed approximately $218 million of top-line or nearly 25% of total revenue. Increased traffic in Q2 continues to drive comps, both in-store and online with increases in the high single-digits and over 30% respectively. And I'd add that the impact of foreign exchange decreased revenues by $8.4 million in the quarter.

Gross profit for the second quarter was $485.8 million or 55% of net revenue, compared to 54.8% of net revenue in Q2, 2018. The gross profit rate in Q2 increased 20 basis points versus gross margin last year and was driven primarily by the following. A 90 basis point increase in overall product margin resulting from lower product costs, favorability in product mix and lower markdowns. This comes despite the additional air freight expense we incurred as a hedge against potential port congestion related to China tariffs.

We remain pleased with the product margin strength we continue to realize on top of the strong gains over the last several years. Product margin expansion was partially offset by a 30 basis point increase in product and supply chain costs driven by ongoing investment in product development and supply chain, including our new Toronto DC and an increase in occupancy and depreciation expense of 20 basis points. We also saw 20 basis points of unfavorable impact from foreign exchange.

Moving down to P&L, SG&A expenses were approximately $318 million or 36% of net revenue, compared to 36.2% of net revenue for the same period last year. We're happy to have achieved leverage in-line with our guidance in Q2, while at the same time continuing to use the strength in the business to build brand awareness and invest in initiatives that fuel current and long-term growth, including data and analytics, loyalty, self-care and men's. These ongoing investments contributed to deleverage a 70 basis points, which is more than offset by 90 basis points of leverage in store costs and foreign exchange.

Operating income for the quarter was approximately $168 million or 19% of net revenue, compared to 18.5% of net revenue in Q2, 2018. Tax expense for the quarter was $45 million or 26.4% of pre-tax earnings compared to an effective tax rate of 29.5% a year ago. The decrease in our effective tax rate relative to our guidance reflects the release of new regulations, which resulted in additional foreign tax credits for prior years.

These deductions benefited EPS in Q2 by approximately $0.02. We now expect our full-year 2019 tax rate to be approximately 27.5%. Net income for the quarter was $125 million or $0.96 per diluted share compared to earnings per diluted share, $0.71 for the second quarter of 2018.

Capital expenditures were approximately $67 million for the quarter compared to approximately $50 million in the second quarter of last year. The increase relates primarily to store capital for new locations, relocations and renovations and IT and supply chain investment.

Turning to our balance sheet highlights, we ended the quarter with $624 million in cash and cash equivalents. Inventory grew 26% and was $494 million at the end of Q2. We repurchased approximately 9,600 shares this quarter at a cost of $1.6 million. Coming into 2019 our Board authorized a new $500 million share repurchase plan of which approximately $336 million of authorization remains at the end of Q2. We believe that repurchasing our shares is an efficient and effective way to return cash to shareholders and we'll continue to be opportunistic with our share repurchase activity.

Turning now to our outlook. For Q3, we expect revenues to be in the range of $880 million to $890 million. This is based on a comparable sales percentage increase in the low-teens on a constant dollar basis, compared to the third quarter of 2018. This also assumes 22 new store openings in the quarter. We expect gross margin to be flat to up modestly versus Q3 of last year. Our guidance reflects the impact from new tariffs imposed on imports from China, as well as additional air freight expense.

For the full-year, we continue to expect a $0.04 to $0.05 negative impact within gross margin related to the new tariffs and to the new tariffs and incremental airfreight cost used as a hedge against possible port congestion. We incurred approximately $0.01 of this $0.04 to $0.05 in Q2 and expect the remaining $0.03 to $0.04 to impact Q3 and Q4 more evenly. We remain excited with the opportunities we see to drive further increases in product margin.

As we laid out for you at our Analyst Day, we're continuing to execute on our strategies to further segment our supply chain and increase efficiencies within our distribution network. These initiatives coupled with ongoing scale benefits as we continue to grow, give us confidence that our gross margin will continue to expand modestly on an annual basis through 2023. We expect SG&A rate in Q3 to leverage modestly as we balance investments for future growth with efficient management of our cost structure. We continue to expect modest leverage on the year.

Assuming a tax rate of 28% and approximately 131 million diluted weighted average shares outstanding, we expect diluted earnings per share in the third quarter to be in the range of $0.90 to $0.92 versus EPS of $0.71 a year-ago. For the full-year 2019, we now expect revenue to be in the range of $3.8 billion to $3.84 billion. This is based on a comparable sales percentage increase in the low-teens on a constant dollar basis.

We expect to open approximately 45 to 50 company-operated stores in 2019. This includes approximately 30 stores in our international markets and represents a square footage percentage increase in the mid- to high-teens range.

We expect gross margin for the year to expand modestly primarily driven by continued product margin improvement. We expect SG&A for the full-year to leverage modestly. We expect our fiscal year 2019 diluted earnings per share to be in the range of $4.63 to $4.70. Our EPS guidance is based on 131 million diluted weighted average shares outstanding for the year. This range takes into account, approximately $0.04 to $0.05 of additional cost within gross margin related to the tariffs and airfreight that I mentioned earlier.

We expect our effective tax rate to be approximately 27.5% in 2019. We have assumed the Canadian dollar at CAD0.75 to the U.S. dollar for 2019, as well as Q3. We now expect capital expenditures to be approximately $275 million to $285 million for the fiscal year 2019.

The increase versus 2018 reflects a ramp up of our store renovation and relocation program, new store openings, technology investments and other general corporate infrastructure projects. In closing, we're excited with the continued strength we're seeing in the business and we remain optimistic about the fall season and beyond.

And now back to Calvin for some closing remarks.

[Calvin McDonald, CEO]

I would like to thank, PJ and Celeste for providing these insights in our business and performance. All of us within the company are proud of what we've achieved. As I travel around the world, I see guests responding to our products, our innovations and living the Sweatlife. Finally, I'd like to thank everyone at Lululemon for their commitment and dedication in achieving these results.

And with that, we'll be happy to take your questions. Operator?

[Operator]

[Operator Instructions] The first question comes from Paul Trussell with Deutsche Bank. Please go ahead, sir.

[Paul Trussell, Deutsche Bank]

My first question is just related to the margin outlook for the third quarter and second half overall. Maybe just talk a little bit more about the puts and takes to the flat to up modest gross margin outlook, as well as help us think a little bit more about why just modest leverage when low-teen comps in the second half as you leverage some of those strategic investments that you started making last year?

[PJ Guido, CFO]

So similar to Q2 going forward in back half for gross margin, it's a similar story. We expect continued gains in product margin driven by lower product costs. We don't forecast into a mix benefit but mix has been a benefit for the first part of the year given the strength in our women's pants business.

But product cost remains the big opportunity and it comes through scale, through segmenting our supply chain, a better cost visibility and certainly greater efficiency across our distribution network, so we expect that to continue.

The takes as you alluded to, we will see some occupancy and depreciation pressure as we continue to open stores internationally, which carry higher rents as you know, but we also have some product development costs for newer categories such as bras, outerwear and accessories, so those are - those are the puts and takes we see in the back half, but net-net we still expect modest gross margin expansion for the year and going forward.

[Paul Trussell, Deutsche Bank]

And on SG&A?

[PJ Guido, CFO]

And on SG&A - so we are committed to modest SG&A leverage. Last year we delivered. We're committing to the same for this year and going forward. We continue to use strong performance to invest in current and long-term growth. We are seeing the results from that.

During Q2, we invested specifically we've expanded testing in new growth vehicles, loyalty, we continued our investment in our North American online guest experience, we continue to expand our omni capabilities both in North America and globally and that will continue to roll forward in the second half of the year. If we don't do these investments we can see higher SG&A leverage for the quarter and beyond, but we continue to believe this is the right strategy for the business.

[Paul Trussell, Deutsche Bank]

And lastly from me is, one of the more impressive parts of this quarter was the brick-and-mortar comp growth. Maybe just speak a little bit more about what is leading to the traffic increases and improvement in conversion that you're seeing in store?

[Calvin McDonald, CEO]

On the momentum that we're seeing in the business. I really break it down into three key categories. The first is the athletic space in general is very healthy relative to other sectors in both apparel in retail in general.

Second, our business has fewer highs and lows relative to other apparel brands and we're less dependent on seasonal fluctuations. And we have a very healthy core business that is driving our success.

And then finally in it to me is what the team is doing such a wonderful job at and that's engineering that growth. And that's coming from one, compelling product, two, brand activations and three our continued improvement in our data analytics and digital marketing where we're testing and learning and developing those strengths within the business.

So it's a combination of the health of the space and the success and momentum the team is doing in terms of engineering that growth and we're seeing that across all international businesses and we're seeing it within not just in traffic, but as you alluded to, very healthy conversion numbers, which normally you don't see those to run together and that's the work that our store teams are doing on guest engagement, investing in the educator and I also think it's a reflection of the data analytics as I alluded to, guests coming in prepped with what their intent is and we have educators engaged and ready to assist them and all that work is paying off.

[Operator]

The next question comes from Matthew Boss, who is with JPMorgan. Please go ahead, sir.

[Matthew Boss, JPMorgan]

So Calvin maybe on the gross margin, what do you see as the multiyear opportunity here, or maybe a different way to put it, any structural feeling as we think about gross margin, considering digital is outpacing store revenues and just the overall control that you have over distribution?

[Calvin McDonald, CEO]

I mean I think I would, in our 5-year guidance and our long-term plan that we shared on Analyst Day is the best guidance that you should use to model and it's what we're building into, it's a combination of fine-tuning opportunities to improve cost-to-goods as we grow in scale and as we build those relationships with our vendor base. Second, obviously we're mixing in new categories and making sure that we get that balance correctly.

Third, we're mixing in new markets, and PJ alluded to different markets around the globe have a different cost structure, as well as we're expanding our North American business and building stores that are driving wonderful sales numbers and engaging and guest and offering them the full product.

So that full balance across our 5-year plan, we're committed to we're seeing great success in it. A lot of that innovation is what's driving our top-line and I think the result is we are going to see leverage in gross margin, but it will be more in-line with how we've provided guidance over the next coming years.

[Matthew Boss, JPMorgan]

And then maybe just a follow-up on the expense front. So I guess really the question is, best way to speak to the balance between in-store cost leverage versus ongoing brand investments. I'm trying to figure out is 2Q a microcosm for the go forward modest SG&A algorithm? And then just one follow-up would be on the comps. Have you seen any moderation as you speak to the momentum, any moderation whatsoever in August or fair to say that the momentum has continued through strong?

[PJ Guido, CFO]

Well, to your second question. We're pleased with them a momentum, can't give too much color on comp, but we're pleased with where we are and we continue to see strong traffic. So good news there. On your question about SG&A, I would not say it's a microcosm of the future, but I would say, given our store performance we did leverage channel SG&A to a higher degree this quarter. But we also did have higher investment and again we use the upside of good performance to set us up for growth in the coming years.

So, I would also say, we'll start to see benefit and we are already are seeing benefit from our prior investments that we've made in prior quarters, specifically digital marketing investment has driven guest acquisition, the enhancements to our website, search-browse, checkout out are driving conversion and our investments in data analytics are allowing for greater personalization and closer relationship with our guests. So our prior investment is leveraging and again, that is a model that - that's been working for us and we'll continue to deploy that.

[Operator]

The next question comes from Mark Altschwager who is with Baird. Please go ahead, sir.

[Mark Altschwager, Baird]

Good afternoon and congrats on the continued momentum. It was nice to see the trend of lower markdowns continuing in the quarter. I was wondering if you could provide some color on the percent of your total sales that are coming from markdowns today. I think you most recently commented on some numbers for the holiday period, just curious how that's trending year-to-date? I was also wondering if you could touch on what's been happening with some of the ship from store capabilities and how that's may be affecting the merch margin trends on the markdown front? Thanks.

[PJ Guido, CFO]

Yes, we don't really give out the specific markdown number as you said so - our markdown activity was lower in this quarter and it did contribute to gross margin expansion.

[Mark Altschwager, Baird]

And then maybe as a quick follow-up, I was hoping you could comment on some of the trends you're seeing in the Bra category. It's been a tremendous amount of innovation there in a bigger marketing focus, so curious what your key learnings are from the spring season?

[Calvin McDonald, CEO]

Yes. We remain very excited about the opportunity within the Bra category. The product team continues to launch and develop product that we'll launch in the coming quarters and years as we see opportunity to innovate into whitespace within the category and add to our assortment. One of the new areas for this quarter that we activated was a bit of that brand activation and storytelling and we saw the guest respond well to it.

In Q1, we really started to invest and set up the stores, how we merchandize. Q2, as we continue to roll out a couple of incremental SKUs. We got into some of the storytelling, Lincoln Park is a test, but an expression of how we want to lean into the category and tell our unique innovative story behind Science of Feel as well as present the athletic Bra category to our guests in the different segments that we see as opportunities.

So it is very early for us in Bra this will be a multi-quarter multi-year investment. We are testing and learning and moving along, but the good news is that we're very happy with the results and we're equally excited about how we're learning as an organization and what's to come as we continue to make investments in this category.

[Operator]

The next question comes from Kate Fitzsimons who is with RBC Capital Markets. Please go ahead.

[Kate Fitzsimons, RBC Capital Markets]

You've seen amazing strength in the bottoms business in recent quarters. Did you say how much women's bottoms, were up in the second quarter and I guess when you parse out that strength between more athletic offerings maybe versus more lifestyle offerings like office, travel, commute, how do you think about the strength there? Is it more broad based? We're just trying to get a sense as to what aspects of the customers' lifestyle you guys are really appealing to and just how to think about the trajectory of that business into the back half? Thank you.

[Calvin McDonald, CEO]

On the bottoms business, as you know, it's a core category for us in both women's and men's and in Q2 we saw both of those continue to perform very strong with double-digit comp performance. In fact, men's outperform women's as we continued to see success in our men's initiative as one of the key Power of Three growth initiatives.

Strength in women's was really driven by both long styles and shorts. We're fueling the strength in short by leveraging our core line in Fast and Free franchises into a shorter in-seam bike short, which is resonating very well with the guests. And in men's the ABC franchise continued to see great success with existing guests and as a very strong new guest acquisition item and equally seeing success in shorts with the short and the Paced Breaker and Surge.

So, a very good healthy balanced bottoms business across both pant, shorts men's and women's and we continue to have innovative plans that we'll be launching to continue to drive that momentum forward.

And as I alluded before, the team is doing a wonderful job in leveraging the relationships and then broadening if you like to share of wardrobe outside of just the bottom business and we're seeing a lot of success in that and that's helping to drive success across many of the other categories, and we anticipate to continue to see success in doing that.

[Operator]

The next question comes from Paul Lejuez who is with Citigroup. Please go ahead.

[Paul Lejuez, Citigroup]

Can you talk a little bit about your average ticket size in North America in-store versus online, curious how different the average ticket is there? And how does that compare to what you're seeing in both Europe and Asia, when you look at the stores versus online business?

[PJ Guido, CFO]

It's PJ. So average ticket has remained relatively stable and is pretty consistent across channel and there are subtle differences regionally but by and large average ticket is fairly similar.

[Paul Lejuez, Citigroup]

And then, can you maybe talk about the tops to bottoms ratio, where you are in the men's business, where are you in the women's business? And then where do you hope to be longer-term in each of the genders? Thanks.

[PJ Guido, CFO]

Yes. So the men's business, penetration has picked up given the higher growth rate. It's in the low - it was in the low-20s approaching the mid-20s. So that trend will continue. But - while the men's business is growing at a high rate, the women's business is growing pretty steadily as well. So I'm hard pressed to put specific penetration numbers on it, given both businesses are growing together, so - but men's has picked up.

[Paul Lejuez, Citigroup]

PJ I was talking more about the tops to bottoms ratio within men's and the same within women's. If you can speak to where you are today versus where you're going?

[PJ Guido, CFO]

Sorry, Paul, we don't really share - we don't share that, but bottoms is predominantly - the ratio of bottoms to the tops is obviously much higher.

[Operator]

The next question comes from Kimberly Greenberger who is with Morgan Stanley. Please go ahead.

[Kimberly Greenberger, Morgan Stanley]

I was hoping Calvin you could just talk about your business in Asia. It sounds like even with the slight deceleration in some of the economies over there, your numbers have been absolutely fantastic. Is that - I heard you talk about the strength in digital, but it sounds like the stores are equally, good. So I'm just wondering if you can talk to us about if you've seen any sort of change in trend there? And perhaps you're just so early growth stage that you can sort of - you're outgrowing what appears to be a very slight slow down there?

And then PJ, can you just remind us what your current exposure to China sourcing is and how we should think about the leverage or not to tariffs, given the risk that we could see them move higher, any quantification you can give us on that side would be helpful? Thanks.

[Calvin McDonald, CEO]

In terms of our APAC business in particular, I'll start off with our International business overall remained very, very strong in Q2 after a very strong quarter-one and remains that leading into Q3. As you know Stuart was put in to the role working with both the existing leadership of Ken and Gareth to really continue to put the focus on that business and early, but we're seeing great success of the strength of that leadership team coming together, shared learnings and working with Celeste and her team to really bring key learnings across the globe and driving the business.

Within APAC, it's a balance across both stores as well as e-commerce and that's what's so exciting. We opened up 8 stores in APAC in Q1 and other one in Q2 and plan to continue a very aggressive back half. We opened the year with 15 in China and we plan to end the year 25 to 30 stores.

So we're excited about the balance. Guests are responding to both the vision of the Sweatlife and the product, and yes it's early for us in the - in our growth journey, but I think it's the strength of the product and the community model that is resonating in that market, that's also helping to fuel our business through this quarter. So it's exciting to see.

[PJ Guido, CFO]

And Kimberly, this is PJ. To answer your question on China tariffs. So just as a reminder, our direct exposure to China is relatively small with approximately 6% of our finished goods in scope for U.S. tariffs. That percentage is down considerably, given how we have diversified our vendor base. We've never had more flexibility than we do today in our supply chain. So going forward, we do not expect it to be a big impact to the business.

In terms of quantifying it, I'll just reiterate that we guided on the last call, we expected a $0.04 to $0.05 impact in the back half of the year, weighted towards Q3. We did incur a $0.01 of that in Q2. We do see an additional $0.04 in the back half but more equally weighted given the delay in the tariffs, but it's a situation, we constantly monitor it. We had airfreight in as a hedge to ensure that we deliver for our guests. But again, this is an issue that we feel is highly manageable for us.

[Operator]

Our next question comes from Ike Boruchow who is with Wells Fargo. Please go ahead.

[Ike Boruchow, Wells Fargo]

Calvin one for you on loyalty, so you expanding out to Chicago. I know you can't give us too much detail but I guess my two quick questions would be, could you name maybe the most interesting or exciting thing that you've learned thus far in the small test? And then if things continue to progress in the right direction do you - when is the reasonable timeline that this could actually go across the U.S. or across North America?

And then a quick one for PJ, just on the supply chain deleverage on the gross margin, I know you have the new DC in Toronto, I think that recently opened, how should we think about de-leverage on supply chain in the back half and when does that headwind maybe start to flatten out? Thanks, guys.

[Calvin McDonald, CEO]

Two great questions. On the first what's been - quite honestly, a lot of fun in the learnings from the test markets are, there are number of aspects of how the guest is interacting with the program that we're really excited to see. The two that come to mind that probably we didn't anticipate to be a strong in the test markets and that are - that is one, the percentage of new guests to Lululemon that we're foreseeing through the membership program.

And the second is, the penetration of men's in the program. So we kind of went in expecting in a pilot you know in these contained markets that it would definitely appeal to our high value guest which it has, but to see it be another acquisition to acquire new as well as an acquisition for men's was not something we initially had anticipated, and has been really encouraging among many other aspects.

As you mentioned we launched in Chicago, we're excited to be in that market and we're going to continue to test and learn and rollout. We're going to expand more in 2020 and then really hit a stride probably in '21. We'll share more as we confirm our rollout plans. But it's early but very positive and we are continuing and will continue to expand to more markets and '20 will be bigger than '19 as well as '21.

[PJ Guido, CFO]

Ike, it's PJ. To answer your question about the supply chain and the gross margin impact. So yeah, the start-up in the Toronto DC has had an impact and has caused some modest deleverage that's due to the fact that, yes, it's ramping up and we're incurring some costs and some growing pains, there. We expect again a modest impact associated with that as the facility scales. But it should - we expect it to leverage thereafter.

[Operator]

The next question comes from John Kernan who is with Cowen. Please go ahead.

[John Kernan, Cowen]

You provided some very helpful commentary and guidance on international profitability at the Investor Day. I was just wondering, given the top-line strength how international profitability is trended relative to your expectations so far this year? And I just have one quick follow-up on Europe.

[PJ Guido, CFO]

So with regards to international profitability. Yeah, we're pleased with the progress we're making in all of our regions. We are profitable, from an international standpoint. So last year we did generate profit and our China business is profitable. Our Asia business is profitable and our Europe business which is still generating a modest loss is quickly marching towards profitability, so we are on plan there and we do expect to continue to scale and achieve profitability improvement, in-line with how we guided at Analyst Day.

[John Kernan, Cowen]

And then just on Europe I think up 30% in the quarter, you talked about brand activations like the Sweatlife Festival, just any more comments on how Europe is scaling. It seems like you're more - it seems like you're a little bit more excited about the region right now and certainly some of the growth backs that up. Thank you.

[Calvin McDonald, CEO]

I was just with Gareth and team, a few weeks ago and I would say across the management team, we're quite excited about the success of our business in Europe and what the team is executing and how the guest is responding there.

We've been longest in London. And we're seeing a real healthy business driven out of that, but at the same point, the other countries we've expanded to are resonating.

In Q2, we launched sites in Germany and France in local language and the guests are responding well to that, continue to open doors. We opened our first full-line in Paris in August, and as PJ indicated, we are very close to the profitability mark and the team is doing a wonderful job in recruiting guests and building that business. And it's going to be a region that plays a big part in our international expansion and the commitment. And the goal around the Power of Three of how we're going to quadruple it and we're seeing some of that success today.

[Operator]

Our next question comes from Michael Binetti who's with Credit Suisse. Please go ahead.

[Michael Binetti, Credit Suisse]

So let me add my congrats on a great quarter. I mean, I guess, some fairly specific question on the margin with the brick-and-mortar comp up 10%, obviously very strong by any compare. I guess I'm curious about the de-leverage on the occupancy line. I know there's some lease accounting noise in there and then you mentioned the international mix and probably some double rent during relocations. But I'm curious if you could help us just look ahead, a little bit on the underlying dynamics there, what is the underlying leverage point on that line as we think ahead to things like accounting rolling off next year? And then I have a follow-up.

[PJ Guido, CFO]

I think, what we pointed out in the past, is that occupancy is going to be a headwind going forward as we open new stores, particularly internationally, but we've also incurred costs associated with building out our distribution network. So going forward, there is a headwind there, but we expect to scale and leverage that over time as stores ramp up as DCs ramp up. The real story in the gross margin is that product margins remains strong and will continue to be the driving force behind gross margin but we do see occupancy and depreciation in the gross margin line as [indiscernible].

[Michael Binetti, Credit Suisse]

And then I guess what's the comments on international and some of the color you gave around profitability but in the different markets. I think the longer-term plan along with quadrupling the revenues there was to go from, I think pretty close to breakeven margins in total last year, slightly positive to I think 10% to 15% over five years. A big move obviously but I'm - I guess - would you help us think ahead a little bit on how you see the inflection in the overall margin for international maybe, where it's coming - where you see the profitability contributing the most first? And then is the overarching strategy there, similar to the corporate strategy where, look we're going to spend back any upside on the top-line to smooth it out or is it back half weighted within the 5 -year window, front-half weighted for any reason, any kind of color you could help us think about as that it seems like a big contributor here for the next few years?

[Calvin McDonald, CEO]

Yes. So the big driver will be the APAC region and specifically China, so as that business continues to ramp up that will drive a lot of the profitability. Europe will be also a contributor, so I do think we're on-track to achieve that profitability that you talked about.

And as far as, the business model - given the fact that our international businesses are fast-growing businesses that need fuel, we will continue to be investing in those businesses as we have upside, similar to what we've done in North America given we've seen the results - we've seen the results for that year. So hopefully that answers your question.

[Michael Binetti, Credit Suisse]

Okay, thanks a lot and great job on the Lincoln Park store guys.

[Calvin McDonald, CEO]

Thank you.

[Howard Tubin, VP, IR]

Operator, we'll take one more question.

[Operator]

The next question comes from Dana Telsey with Telsey Advisory Group. Please go ahead.

[Dana Telsey, Telsey Advisory Group]

As you think about inventory and inventory growth for the balance of the year, how are you thinking about inventory and airfreight given those expenses that are wrapped in there and how do you expect airfreight expenses to be moving forward? And then Calvin given the loyalty program and given the events that you're having in the stores, are you seeing the translation of the events leading to loyalty members, new loyalty members and how is new guest conversion compared to what it had been? Thank you.

[PJ Guido, CFO]

So to answer your inventory question. So we feel really good about the inventory position given our momentum. We did expedite some fall merchandise using air freight and we'll continue to use airfreight as a tool or a hedge, if we start to see issues in the Southeast Asia region associated with the volatility around tariffs. But from a pure inventory standpoint, we are a low seasonal business and our aged inventory is really low. So we feel really good about how our inventory is positioned, both at the end of the quarter and going forward.

[Calvin McDonald, CEO]

Again, I'll just add a few points to your second question. We continue to see very healthy metrics with our loyal or our high-value guest, in terms of retention and engagement in the brand. Equally, our new guest acquisition remains very strong quarter-to-quarter and they are a big part of the conversion number that you're seeing and we're celebrating across both store and on e-commerce. And one of the areas of success is in the migration of this new guest into becoming a high-value, where a healthy portion of our growth is coming from that migration.

So we're seeing very good, very healthy new guest acquisition numbers. The teams are doing a wonderful job in migrating them up through the percentage of their spend and then our retention of our high-value guest is very high and very solid and remaining in a very strong stable growing position.

So in general, when I look at the metrics of our guests, they are healthy across all of those three very important levers and we have many initiatives through both our digital and CRM to continue to improve and strengthen.

And the notion of events and our vision of the Sweatlife just reinforces those. It's either how we acquire new guests, as I shared, through membership events is how we equally share and acquire guests through our 10K events in London - sorry in Toronto and in Edmonton and in San Diego, these are great acquisitions and then they are migrating up, so very healthy across the board.

[Operator]

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

[Howard Tubin, VP, IR]

Thanks everyone for joining us. We appreciate the time and we look forward to speaking with you in a few months when we report our third quarter results. Thanks.

[Operator]

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