Lululemon Athletica Inc

NASDAQ:LULU

Earnings Call Transcript 2017-Q4

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the Lululemon Athletica Inc. Fourth Quarter and Year End 2017 Conference Call. As a reminder all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]

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

[Howard Tubin, Vice President of Investor Relations]

Thank you and good afternoon. Welcome to Lululemon's fourth quarter earnings conference call. Joining me today to talk about our results are Glenn Murphy, Executive Chairman; Stuart Haselden, COO; Celeste Burgoyne, EVP Americas and Sun Choe, SVP in Merchandising.

Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements reflecting management's current forecasts of certain aspects of the company's future. These statements are based on current information, which we have assessed, but which by its nature is dynamic and subject to rapid and even abrupt changes. Actual results may differ materially from those contained in or implied by these forward-looking statements due to risks and uncertainties associated with the company's business 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 expressively disclaim any obligations 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 annual report on Form 10-Q and in today's earnings press release. The press release and accompanying annual report on Form 10-Q are available under the Investors section of our website, at www.lululemon.com.

Before we begin the call, I would like to remind our investors to visit our investor site where you will find the summary of our key financial and operating statistics for the fourth quarter as well as our quarterly info graphic. 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 would like to turn the call over to Glenn.

[Glenn Murphy, Executive Chairman]

Thank you, Howard and good afternoon, everybody. So, it's been a while since I've been on an analytical call but I plan on being brief today because we have a full slate of speakers. So, I can say there is overall board was very pleased with our performance in 2017. Clearly was a market share gains in year across categories, across channels, across all geographies. What was really gratifying for, I know the management team, but also for the board is how we actually recovered after a tough Q1, we diagnosed them [ph] wrong and we took precaution.

And when we look at the year, we actually improved sequentially, you have been through the P&L this is not the first call in 2017 its actually the Q4 call, when you look at it sequentially the business improved from Q2 to Q3 and Q4 across pretty much every KPI which Stuart will take you through the second. What that tells us a board and I am sure the management team, I'm not just sure, I know the management team feels that this was a real testament to the character of the people of the SSC, are people who work in our stores, all are educators, the business was able to recover very quickly from a disappointing Q1 to produce the overall 2017 results that we’re showing to you today. I was actually in Vancouver last week, I was kind joking with the management team that this is the kind of quarter that you take, you laminate, you frame and ultimately you replicate it.

Now last week we had a board meeting in Vancouver and the management team presented to us, in actually pretty good specific detail, the 2018 strategic initiatives, where we’re going to focus their time, and where we’re going to invest our capital.

So, you’re going to hear not just on today’s call in the Q&A but in subsequent calls in 2018, like you have for the last couple of years, you are going to hear today from Celeste and Stuart [ph] about how we’re going to continue to focus on product innovation, category extensions, our digital business, our international expansion and much more.

So, our top strategic priorities that you’ve been hearing about for a while, obviously are intended to drive long term shareholder value. What I can tell you from last week’s meeting while we spent a lot of time on those strategic initiatives and the levers to create value, what I would say is that the board really was engaged and the management team took us through not only those strategic levers, but they took us through how they planned to actually build on our competitive advantages of people, community, and guest experiences.

Every company -- they don’t change every year but when you have a five-year vision, like we do for 2020 everybody has key strategic initiatives, they work on, they refine them, and they tight them up, and make them better every single year and that's what Lululemon is doing in 2018.

But foundationally this business, which will celebrate by the way it’s 20th anniversary in 2018, sits on a very clear set of competitive advantages, our people, our focus on community and our guest experiences.

One thing I will add, from the board meeting last week is that we acknowledge as a management team, Stuart, Celeste and [Sean] [ph] and everybody who came and presented to the board, we acknowledge we’re little behind on data analytics and embracing the power of data. So, we have a number of company veterans as well as some new execs we met last week in Vancouver, who joined the business from outside LULU, who are already working hard to turn this into a strength of the company. You add data to the competitive advantages I took you through and the strategic initiatives in 2018 and beyond and that’s going to be really something that’s going to ignite the performance of the business.

Lastly, I am pretty sure there’s going to be a number of questions on the CEO search, so I want to get ahead of that. It’s been less than two months. We’ve met a number of actually great candidates and people who put their hand up to be considered for this incredible role amidst a very unique brand in retail and look at our performance in Q4 and our intent to maintain that kind of performance as we go forward. So, Board’s very confident in our ability to attract a top, proven, global consumer executive.

So, right now, with the time that’s going to take, as we’re going to take our time, we’re going to meet as many people as we can, we’re going to make the right decision, we’re very fortunate as the company, to have the three leaders you’re going to hear from today. They’re working well together, and they’re not waiting around, they’re pushing ahead aggressively to take Lululemon to new heights.

With all that said, let me pass the call over to Stuart to take you through the financial results for 2017 and to talk about 2018. Stuart?

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

Thanks, Glenn. Let me start by offering some highlights on the quarter, Q4 was an important period for us, with several key moments of truth. First, we began to see powerful benefits from our new website. Second, we lapped tough comparisons in both cost and product margins. Third, we clearly expensed pressure from the digital recovery earlier in the year. And finally, we accomplished all of this while scaling product innovation, expanding internationally and introducing new store formats.

I'm pleased to report that the results our teams delivered exceeded expectations across the board. Our website re-launch enabled important new capabilities and helped us achieve a 42% constant dollar increase in ecommerce in Q4. Our combined constant dollar cost for the quarter was 11% on top of strong business in 2016. We saw normalized gross margin expand 200 basis points and we leveraged SG&A by 90 basis points. This produced adjusted operating margin expansion of 290 basis points for Q4 and 100 basis points for the year, moving us toward our 2020 goal of EBIT margins above 20%.

All of this connected to normalized EPS growth of 33% for the quarter which comes on top of the 18% growth we delivered in the same quarter last year. Reflecting on 2017 while we continue to see exciting innovation in our product assortments and store channels the more remarkable part of the story has been our digital business transformation maybe two kind of the words that we certainly now have new capabilities in this area that are accelerating our growth. Celeste will share additional details that we are thrilled by only with the numbers we are seeing but also with how well the teams across technology, merchandizing and marketing and ecommerce operations are collaborating. Looking ahead we are excited for 2018 with steady improvements in our product assortments and key innovation launches setting us up well for this year.

As we are now in the early days of 2018 we are seeing the hard work over the last year continuing to pay-off. Store traffic is accelerating into Q1 and seeing sequential increases in store cost.

Product innovation launches in Everlux, Enlight and ABC in men's are providing powerful tailwinds in our assortments. Online conversion benefitting from the new website continues to exceed expectations. Our digital business continues to have much lower hanging fruit with additional opportunities in the near-term to feel further conversion increases with website improvements planned this year and check-out search and personalization. And finally, international continues to be an exciting part of the story, with accelerating store growth in Asia and Europe.

Looking beyond this year to 2020 and thereafter we see a truly global business, dual gender digitally enabled with store and online communities driving authentic guest connections in new and innovative ways. We continue to shape the industry through our product innovation strategies and new category expansions that solve problems for our guests. This vision supports the financial and operational goals we have previously offered for 2020. $4 billion in total revenue and $1 billion men's business, 25% ecommerce penetration and a $1 billion international business. We are on track-to achieve our goals and we're excited by the momentum we are currently seeing across the business.

Let me now hand it over to Celeste to provide additional details.

[Celeste Burgoyne, EVP, Retail, Americas]

Thanks Stuart. I'm happy to report strong Q4 results in North America where both store comps and store traffic increased by a low single-digit percentage. As Stuart mentioned we now see store traffic trends accelerating into Q1, and while their reach our environment has somewhat improved we believe much of our momentum is the result of our omni-channel initiative as well as our investments in digital and brand marketing.

In 2017 our square footage growth was 14% excluding the ivivva closure and our plan calls for low double-digit growth in 2018. Our multiple store format enables us to reach guest where they live delivering localize tailored experiences. We continue to be happy with the performance of our co-located stores.

In 2017, we completed 12 co-located projects in which we expand the size of some of our most productive stores to allow for a more complete expression of our men’s collection and create space for potential future category expansion. In 2018 we plan to accelerate this program with approximately 20 to 25 stores in this powerful format.

I would also like to highlight our successful seasonal stores strategy for the holiday season this year we opened 24 pop-up locations. Not only did these stores allow us to fulfill holiday demand but they were also a way to attract new guest and in fact 40% of the guests in these seasonal pop ups were new to Lululemon.

As Stuart mentioned, our digital and e-commerce business, saw structural changes with transformative investment across people, process and technology. In short, it's working. Our Q4 performance reflected this with total constant dollar eComm, up 42%, which is on top of the 12% increase last year. Traffic was up in the double digits and we saw our past quarterly conversion result of the year.

The sequential comp acceleration in Q4 was enabled by the release of our new website at the end of Q3. This release offered improved functionality, more compelling content and storytelling, and improved product imagery.

A few KPIs I would like to share since the relaunch include, a 20% increase in site traffic and 19% increase in conversion with mobile conversion increasing 21% and 19% increase in direct visits and a 32% increase in email business.

And as a complement to our digital strategies, our Omnichannel capabilities continue to expand. Our analyst IO functionality allows us to fulfill in-store demand with our e-commerce inventory. We have the ability to ship from store in 186 locations and will further expand this capability in 2018. We will also rollout buy online pick up in store functionality during the second half of the year.

Switching now to international. We continue to see a strong guest response as we expand our footprint and drive in that. In Asia for instance our combined comps were 52% in Q4, in particular we saw strength in digital where comps grew in the triple digits. We continue to go after local e-commerce experiences which in China will soon include a reach out store to augment our very successful team all e-commerce business in the region. We ended the year with 23 stores in Asia with our comping stores generating higher sales per foot than our overall corporate average.

Looking toward 2018 we plan to open 15 to 20 new locations in this region. In Europe our total market growth was 42% in Q4. In 2018 we plan to open five to 10 stores in the UK, Germany and France, with four planned for Q1. We are encouraged by recent trends in Europe and continue to see this as a major opportunity for us although likely a slower build versus Asia.

Turning now to digital and brand marketing. This past holiday with our most successful to date in terms of reach, engagement and collective growth, we acquired approximately 1million new guest with the largest growth coming from 18 to 35-year-old. And by the end of the year, we doubled our email file versus last year, expanding an important vehicle for us to directly engage in our gap and drive traffic across both stores and online.

And finally, I want to share gratitude for our educators and employees around the world. Our people are competitive advantage. We know that when our people grow our business grows and these results are a testament to our amazing collective. Now to you Sun.

[Sun Choe, SVP, Merchandising]

Thanks, Celeste. I’m excited to speak to you about our Q4 merchandise strategies which continue to gain momentum and set us up well for 2018.

First in women's, guest response to our holiday assortment was fantastic. As demonstrated by the strength we saw across categories. Outerwear and accessories are key for the fourth quarter and our assortments clearly resonate it. Jackets and outerwear comps up in the low double digits led by puffer and parka shape and our new collection of seasonal bags or standout giftables.

Women’s tops were also strong which comped up 8% driven by our seamless programs. Our core business in women’s pants was up 19% with continued growth driven by our engineered Naked Sensation.

In Q1 we’ve injected newness into our number one women’s pants style, via line expanding the print and pattern offering on top of the new line introduced in Q4.

We’ve also leveraged our new fabrication in the launch of the [indiscernible] bra.

In January we excited our guests with new product flows that previewed our spring color palette and we’re encouraged by the response thus far to greatly improve balance of color, print and pattern now in store and online relative to our offering this time last year.

Looking forward I am thrilled by our product pipeline which delivers a unique blend of function and fashion that speaks to our guests and continues to scale our recent technical innovation.

Turning to men's, trends remain robust posting double digit comps in Q4. This was driven in part by ongoing strength in bottoms, where comps increased 21% and we’re happy to share that this overall momentum in men's has accelerated into Q1.

Our guests continue to lever expanded ABC offering. The jogger is now our number one pant style in men's and as of Q1 available in a broader color range. We’re further scaling our ABC technology with all of our men's fixed waist bottoms now featuring this construction. Our men's outerwear business was also strong in Q4 comping up 20%. We’re building on the strength of this spring with a new collection of light weight jackets.

In addition, we’re executing targeted strategies to drive guest awareness for men's. One recent example is the new caps collection in partnership with [Rhoden Grey] [ph], a leading Vancouver based menswear boutique which was successful and sets the stage for larger product collaborations over the course of the year. We’re proud of the guest response to our products and we’re determined to build upon the success going forward.

And now I’ll hand it back over to Stuart.

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

Thanks, Sun. Before taking you through our Q4 financial results I’d like to update you on certain nonrecurring charges and expenses incurred during the quarter.

First, we realized the final charges and costs associated with the evolution of our ivivva business, these totaled $1.9 million in Q4 and $47.2 million for the full year and were in-line with our most recent estimate of $45 million to $50 million.

Second, we recognized a one-time income tax expense of $59.3 million related to the recent U.S. tax reforms.

I’ll now provide some further highlights of our Q4 results. Please see the Q4 financial supplement posted on our investor site for additional details.

Total net revenue rose approximately 18% to $929 million, with increase in revenue resulting from strong performance across all parts of the business. In our store channel we delivered a 1% comp store sales increase on top of the 6% store comp in Q4 of 2016.

We’re also pleased with the 42% comp we posted in e-commerce that reflected the enhancements to our website mentioned earlier. Normalized for ivivva, square footage increased 14% versus last year driven by the addition of 46 net new company operated stores since Q4 of 2016. 24 in the U.S., 12 in Asia, six stores in Canada, two in Europe and two in Australia and New Zealand.

The impact of the foreign exchange increased revenues by $11 million. Gross profit for the fourth quarter was $523 million or 56.3% of net revenue compared to 54.2% of net revenue in Q4 2016. The gross profit rate in Q4 was positively impacted by 10 basis points related to the ivivva restructuring.

Excluding this benefit, adjusted gross margin increased 200 basis points versus last year. This exceeded our expectations for the quarter with the primary driver being 130 basis point increase in overall product margin resulting from favorability and product mix, lower product costs and lower markdowns versus last year.

I'm particularly pleased that this increase comes on top of a 410-basis point improvement in product margin last year. We continue to see opportunity to gain cost efficiencies within our supply-chain. For example, this year as we've further improved our planning processes we're able to ramp down a portion of our air freight usage and increased ocean freight. This shift will help us continue to expand product margin into 2018.

We saw 30 basis points of favorable impact related to the foreign exchange impact in the quarter and also realized 40 basis points of leverage on occupancy and depreciation.

SG&A expenses were just over 264 million or 28.4% of net revenue compared to 29.3% of net revenue for the same period last year. We are pleased that we are able to deliver expense leverage in Q4 at the high end of our expectations. Approximately 60 basis points of the decrease relates to more efficient spend in both our home office and store channel while foreign exchange including both translation and revaluation exposures contributed an additional 30 basis points of leverage.

Operating income for the quarter was approximately 256 million or 27.6% of net revenue compared to 24.9% of net revenue in Q4 2016. Excluding the pretax charges of 1.9 million related to the planned closures of the ivivva stores adjusted operating income for the quarter increased to approximately 258 million or 27.8 of net revenue.

Tax expense for the quarter was approximately 138 million or 53.5% of pretax earnings compared to an effective tax rate of 31.1% a year-ago. Tax expense included a onetime income tax expense of 59.3 million related to the recent U.S. tax reforms. The adjusted effective tax rate for the quarter was 30.6% versus 30.6% last year.

Net income for the quarter was approximately 120 million or $0.88 per diluted share compared to earnings per diluted share of $0.99 for the fourth quarter of 2016.

Net income in Q4 of 2017 included $59.3 million or 0.44 per share for the aforementioned U.S. tax reform and 1 million or $0.01 per share in after tax ivivva related charges. Excluding these charges adjusted EPS was $1.33 per share compared to adjusted EPS of $1 last year.

Capital expenditures were approximately $51 million for the quarter compared to approximately $43 million in the fourth quarter of last year. The increase relates primarily to higher investments in IT relative to last year.

Turning to our balance sheet highlights. We ended the quarter with $991 million in cash and cash equivalents. Inventory at the end of the fourth quarter was $330 million or 10% higher than at the end of Q4 2016 and below our forward sales outlook.

Based on improved deficiencies in our supply chain and the better planning capabilities that I mentioned earlier we expect to use less air freight in 2018 versus 2017, this will benefit product margin as our all in per unit freight costs are expected to be lower due to the shift.

As a result, we will be taking delivery earlier in the cycle relative to last year and will likely see inventories grow modestly in excess of sales in the first half of the year before moderating into the second half. To be clear, we have not altered our practices in managing inventory levels, and we are comfortable with how we are positioned for the year.

Turning now to our outlook for the fiscal year 2018 and the first quarter. We’re pleased with the start we’re seeing through the year and momentum building across the business. As a reminder, our guidance includes the 53rd week and reflects a modest benefit to sales and earnings for the year.

For the full year 2018 we expect revenue to be in the range of $2.985 billion to $3.22 billion. This is based on a comparable sales percentage increase in the mid to high single digit range on a constant dollar basis.

We expect to open 40 to 50 company operated Lululemon stores in 2017, this includes 20 to 30 stores in our international markets and represents a square footage increase in the low double digits. For the year, we expect gross margin to expand modestly primarily driven by product margin improvement.

We expect SG&A for the full year to also leverage modestly as we will not anniversary the one-time digital acceleration cost from 2017 and we realize efficiencies within our cost structure.

We expect our fiscal year 2018 diluted earnings per share to be in the range of $3 to $3.08. Our EPS guidance is based on 136.3 million diluted weighted average shares outstanding.

Our effective tax rate will decrease from 31% in 2017 to approximately 29% in 2018, reflecting our estimate of the impact of the U.S tax reform. Our estimate could change as we finalize our review of the additional interpretations and guidance. We've historically benefited from a relatively low tax rate due to the transfer pricing ranges that we have in place. And as such we will see only a modest reduction in our ECR this year. Furthermore, we will continue to analyze the impact of U.S tax reforms on our overall strategies for capital deployment.

We had assumed the Canadian dollar at $0.78 to U.S dollars in 2018, as well as the first quarter. We expect capital expenditures to be approximately $240 million to $250 million for the fiscal year 2018. The increase relative to 2017 reflects a ramp up of our renovation and relocation program increase store openings in international markets, technology investments and other general corporate infrastructure projects.

For Q1, we expect revenues to be in the range of $612 million to $617 million, this is based on a comparable sales percentage increase in the low double-digit range on a constant dollar basis compared to the first quarter of 2017. This also assumes eight new store openings in the quarter.

We anticipate gross margin to increase by approximately 50 to 100 basis points versus Q1 of last year. Despite the strong increases in product margin last year that we are now anniversarying, we continue to see [AC] opportunities driven by our ongoing supply chain initiatives. We also expect to leverage SG&A in Q1 by 50 to 100 basis point as we gain efficiencies in our cost structure.

Assuming a tax rate of 29% and 136.3 million diluted weighted average shares outstanding; we expect diluted earnings per share in the first quarter to be in the range of $0.44 to $0.46 versus $0.32 a year ago.

And with that let’s open the call for questions. Operator?

[Operator]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Oliver Chen of Cowen and Company. Please go ahead.

[Oliver Chen, Cowen and Company]

Great quarter. The traffic was very impressive, what are your thoughts on what has driven traffic and also as we look at the year ahead, what's kind of incorporated for your view on traffic? Would you expect it to be volatile?

And just another question on Big Data, Glenn you mentioned in the beginning. I was just curious about how that will manifest with customer engagement supply chain and how we should think about that opportunity as it applies to gross margins to over a longer time horizon?

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

So, let me first address your question on traffic, so really pleased with the momentum that we have seen not only in Q4 but now into Q1, it’s hard to overstate also the impact of the product assortment improvements that we have seen. Improved color palette, improved newness and style across the assortment has been really strong.

It’s also important to note the guest acquisition strategies that we have been pursuing or driving traffic across both stores and e-commerce. As you look at it by channel it’s certainly -- in the store business the traffic story is really what’s driving the comps and certainly in e-commerce it’s a conversion story. So, as we look at store traffic specifically we saw total store traffic in Q4 was slightly positive across all regions, we saw sequential improvements across all regions, as well in the fourth quarter and now into the early part of the first quarter.

So, we’re pleased with that traffic picture in general and the thing that I would point to, that are driving that certainly the macro environment has improved to a degree, but more importantly, we see the efforts in our digital marketing, our omnichannel capabilities and improvements that we have seen driving increases in our email file.

These are driving as I mentioned traffic across both channels and continuing to see momentum in each of these into the first quarter. And from an e-commerce standpoint the traffic story is important also, but the conversion story is more pronounced. So just to mention briefly the drivers there are related to our website. Improvements in load times, better navigation and more flexibility in how we can make changes to the website. So, the traffic story is important across both channels and we’ll continue as I mentioned into the first quarter as we continue to pursue those strategies.

On your second question related to data analytics, as Glenn mentioned this is something that we’re focused on, when we met with the board last week, it was one of the few priorities that we have been looking to build new capabilities and to complement our existing competitive advantages.

Our approach is to bring data driven insights into core decision making across three areas, guest engagement, merchandising, channel operations. So, each of those three areas where we are focusing leveraging data. So, we are not as far along as we would like to be in these areas, we're building a talented team, we've committed to some significant resources this year to pursue the strategy and we're seeing some nice early wins in our email and digital marketing efforts, so this is something we look forward to sharing more with investors later in the year as our programs develop here.

[Operator]

The next question comes from Brian Tunick of Royal Bank of Canada. Please go ahead.

[Brian Tunick, Royal Bank of Canada]

Two questions. I guess on maybe excited to hear about the women's tops and outerwear business is turning the corner in Q4. Can you maybe talk about what's changed specifically in those two categories and how you are planning introductions in 2018 maybe versus 2017?

And then Stuart maybe you can help us bridge the Q1 guidance on gross margin and SG&A thanks to the help to what we are coming up with for the full-year. Where in the rest of the year maybe are you giving some of the margin expansion back?

[Sun Choe, SVP, Merchandising]

In the case of tops we really saw a nice turnaround based on our balance of color and pattern which you spoke too earlier in the call and I also think that from a portfolio standpoint we have a really nice balance of core franchises and a variety of silhouettes that's what really driving the turnaround in tops and that is something that we continue to invest in and go forward for Q1 and beyond for 2018.

In outerwear specifically, we've really doubled down on new innovation and water proof down for Q4 which really resonated well and created nice halo for the overall category and as we look into -- and I would also say that color showed up really well in outerwear too. The year prior I would say we probably mostly invested in really dark neutrals and this year we did offer lighter neutrals which has been resonating well and it's also a trend that we continue to see going into Q1 in 2018 and beyond. I would say but really can't emphasize the innovation piece to both tops and outerwear as being a really nice halo for our product.

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

Let me address your question by gross margin and SG&A for the year relative to our guidance, so we're pleased with the trends that we're seeing in the first quarter in both of these areas but what I would call out is the comparison to get generally tougher as we began to the balance of the year and there are a couple of anomalies by quarter that are worth mentioning.

In the second quarter we will see some gross margin pressure related to occupancy where we have some specific real estate initiatives in the second quarter that will weigh on our gross margin leverage.

And then in the third quarter there will be also some SG&A pressure as we lap FX benefits from 2017 and we also have some timing related to certain strategic initiative investments in the third quarter that will also pressure SG&A.

So those account for some of the differences that we see by quarter as we look past the first quarter and to the balance of the year, these will effectively dampen the overall gross margin and SG&A rate improvements for the year. So those are the headlines I would offer in terms of how the Q1 guidance connects to the full-year guidance and gross margin and SG&A.

[Operator]

The next question comes from Matthew Boss of JPMorgan. Please go ahead.

[Matthew Boss, JPMorgan]

If you broke down your 1Q and full year guide, I guess what’s the embedded growth for digital versus stores that you have within the comp guidance. And then on them profitability side, help us to think about margins between these two channels both today and also over time, given the growth of digital that you’re seeing from the size and scale perspective.

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

Sure, thanks for your question. On the comp guidance, we obviously have more visibility on the first quarter and we’re excited at the momentum we are seeing there that we talked about and its really across all parts of the business. We have the easiest comparisons certainly in the first quarter, the compressions will get tougher in the balance of the year, especially given what we just reported for the fourth quarter and as we think about how we will drive those comp results certainly, we start with the product assortments and the improvements early in the year with regard to product -- with regard to color and units that we mentioned. But there's also a strong channel tailwinds that we’re seeing, we mentioned the traffic drivers and the conversion drivers, those are both part of the story and so where we feel good for the first quarter and as you look at, probably get to look at the comp picture on a two-year basis and you can see that there is some acceleration into the second half of the year with regards to the comp trajectory. And it's really, I would point to the runway that we have between now and the second half of the year to develop some of the initiatives that we have more completely whether it's just getting further along into the product strategies, the community strategies and just there's a number of co-located openings that we will begin to ramp up into the second half of year. So, there's a number of things within just channel strategies and the product strategies that we will have and more full expression into the second half of the year that will benefit the comp trajectory. So those are the things I would point to in terms of trying to offer some dimensions by quarter.

And then as we look at your second question with regard to gross margins or margins by channel. Overall, we feel great about the continued improvement that we see in product margins, we will see some benefit in the first quarter with regard to leveraging our occupancy and depreciation that will be muted into the later quarters of the year and that's reflected in the guidance that we gave.

As you think about margins by channel certainly e-commerce carries higher operating profit margin that will benefit and flow-through our EBIT margins and certainly as we over index we drive faster growth in e-commerce that will be a good thing in terms of helping to leverage operating margins.

And we really take an omni-channel approach to the business looking to engage guests where they choose to shop with us, certainly there is a lot of investment and effort around digital and e-commerce that is fueling the outsize growth trajectory that we have, that will continue.

So, I think those are the comments that I offer there and we’re pleased with how gross margins are shaping up and we’re pleased with our progress towards and an EBIT margins that starts with a two [ph].

[Operator]

The next question comes from Paul Lejuez of Citi. Please go-ahead Paul.

[Paul Lejuez, Citi]

Couple of quick ones, just curious if you can maybe breakout in which regions was store traffic positive, was it in every region. Second on CapEx number for this year, you got the new run rate that we should be thinking about in future years, beyond ’18. And then last, wondering if you could talk about the level of newness in the bottoms business this year versus last year, how much would you be relying on updates to your proven winners versus new launches on the bottom side of the business?

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

Let me try to tackle your first two questions first, and then I’ll invite Sun to speak to the bottoms trend. Store comps by region were generally strong, across the board. I would say we saw particularly strong store trends in the southeast in the fourth quarter, little weaker comps in the northeast. I think weather was certainly a part of that, and in general the trends in the U.S. were stronger than the trends in Canada and within Canada the Alberta region continues to be a softer area for us from a comp trend standpoint.

And from the CapEx standpoint, we did see a significant increase in our plans for CapEx for the year and that’s really reflective of our growth strategies. So, the store investments not only in new stores but in our collocated projects, our international expansion, investments in technology to fuel our ecommerce and digital strategies, and supply chain, we continue to evaluate investments in our distribution network, to make sure that we are positioned in a very competitive manner with regard to how we are servicing our guests. So, all those things are connecting to increased levels of investment that we believe will help us achieve our growth plans.

[Sun Choe, SVP, Merchandising]

In respond to your question on newness and bottom, overall we really like to look at our total portfolio of bottoms to make sure that we have enough and the ideas feeding, which is really where newness comes in and so while I don’t really want to give a number that said we try to target x percentage, we do just want to make sure from the portfolio standpoint that we do have enough feeding that drives newness to the assortment.

[Paul Lejuez, Citi]

And Stuart on CapEx, is it a one-time increase this year or is that the right number you’d be using in future years?

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

I think it’s a good number to use. I am reluctant to say that's the right number to use for subsequent years, there were some particular technology investments that we had this year that we won't necessarily repeat into following years, but it's not a bad number.

[Operator]

The next question comes from Adrienne Yih of Wolfe Research. Please go ahead.

[Adrienne Yih, Wolfe Research]

My questions are on ecom, in the prior year, you had reported an ecom EBIT margin that was about 1,700 basis points higher, 40% range, and then the stores are already really productive, of unit [ph] perspective mid-20. Can you talk about that differential there, where that extra call it 1,700 basis points is coming from, and then as you grow that e-com channel do you get gross margin pressure at that top line or at the gross margin line offset than in the EBIT line.

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

So, I mean the simple answer on the e-com is that we don’t have rent or so or payroll which is the big items in the cost structure that distinguish the two channels.

We have seen pressure on a year-over-year basis with the e-com P&L contribution related to increases in digital marketing and we're comfortable with that as we dealing it or were seeing that as an important vehicle to acquire new guests. so, we're investing aggressively in digital marketing and as I mentioned in the opening question that's an important part of how we are driving traffic across the company broadly.

The gross margin profiles are largely the same. we do as you are aware, we have been leveraging the website as a clearance vehicle and by virtue of having the ship from store ability to connect the store clearance to the website is a very efficient and profitable way for us to clear excess inventory. so that does flow through the e-com P&L as well but in general the gross margin profiles are comparable between the channels it's really the cost structures that are different and the year-over-year pressure that I mentioned on digital marketing is notable as well.

We expect that structure, that sort of margin structure, P&L structure will continue there is no reason now to expect that and as we increase the percentage or penetration of our ecommerce business is a benefit to the overall company EBIT. so, I hope that offers some color on your question there.

[Adrienne Yih, Wolfe Research]

Just two housekeeping questions. 53rd week, how should we think about that for fourth quarter of this coming year. and then on the transfer pricing is there an opportunity to do I guess the reverse inversion and bring back the EBIT back to the states now that the tax rate here is lower.

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

Our 53rd week, there is about just over a 40 million revenue impact in the fourth quarter and that connects to about a $0.01 to $0.02 impact in earnings and really that's a result of this weak following into a mark down a higher mark down period for the fourth quarter.

So that's really the impact of the 53rd week and on the tax rate question there is more flexibility now obviously with the repatriation. we will be evaluating the current structure into the future and taking this as an opportunity to take a look at it. Right now, the new tax rate in U.S. versus Canada is essentially on parts and there is really no reason to make any changes to the transfer pricing agreements but will certainly be taking a look at going forward what makes sense in terms of our cash disposition.

[Operator]

Our next question comes from Omar Saad of Evercore ISI.

[Omar Saad, Evercore ISI]

[Technical Difficulty] pretty miraculous turnaround from where you were a year ago, may be improve from functionality and investments you made, can you elaborate what’s going on over there, giving range of EBITDA is obviously having a hugely material impact in your overall business and kind of figure out, how much more [indiscernible] from that standpoint. Thanks guys.

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

On our e-com business it's been quite a journey from the first quarter as Glenn had mentioned. There was a very quickly response and we were able to begin making improvements throughout 2017 and really the improvement that we made in second quarter and the third quarter were more process related and things that were less technology dependent.

We certainly began immediately improving a photography and some of the visual merchandising elements of the website in the second and third quarters, but I would say more importantly how the teams were working together was the most important factor. We broke down the [silence] if you will, between merchandising, brand, eComm operation and technology and created a very cross functional team that works in a different manner. So that led to better decision-making faster decision-making.

We also identified early in the year the technology impediments that we had with the existing website and commission workers with that that we talked about last year as well, where we essentially have the front end of the website rewritten with help, we been integrated that in the third quarter and we launched the new website at the end of the third quarter.

And so, we saw those process and sort of low hanging fruits steps in second and third quarter and then in the fourth quarter the inflection that we just reported is related to the new website. And we’re pleased with all the hard-work that our team's put into making that happen. We launched that website just shortly before peak season into the fourth quarter and really had no interruptions in the business, so it’s a pretty remarkable achievement.

But as you look at the website and the improvements that we had in the fourth quarter, I mentioned a few of those in that opening question but is really related to performance, faster load times, better navigation, visual that I just mentioned is a more intuitive interface and how the site shops, there was some checkout optimization, not a lot and now but the most factor that we fixed in the current version of the website, we’re just creating a more flexible format where we can make changes to the website, in hours of days were used to take as weeks or months even. So, there was some big issues that we’re able to address with that update to the website.

And as we look forward into 2018 we have some important projects teed up that will continue to drive conversion and all the things I just mentioned have really been focused on driving improvements in conversion on the site. But this year, later this year we will have a big effort around check out as well as search and personalization. And so those enhancements will benefit and fuel further improvements in conversion and performance on the site into 2018, and you combine that with the big investments that we made in digital marketing to drive traffic and get a pretty powerful outcome from an e-commerce standpoint. So, we would agree it's been a remarkable turnaround and there is a lot more in front of us in terms of how we’re going to drive that business into 2018.

[Operator]

The next question comes from Mark Altschwager of Baird Capital. Please go ahead.

[Mark Altschwager, Baird Capital]

I guess this dovetails a bit into the discussion you’re just having there, but on the data analytics and CRM project could you characterize the efforts as catching up and early last year when you realized you fell behind in digital, you caught up quickly, it drove SG&A higher, but really paid off on the top line. so, I guess is there an opportunity to take similarly aggressive actions to catch up quickly on the CRM and omnichannel capabilities front, just curious how you’re thinking about that, and whether that might need some acceleration in spending plans in CRM as you build that team out this year?

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

So, it is a big focus. We are seeing benefits in the guest aspect of how we’re applying data to drive the business, we’re getting smarter and how we’re being able to engage our guests via email and other social media. And so, I would say we’re going to see that benefits benefit the business from a guest acquisition and retention standpoint. We think we can scale that, we can amplify it as we get smarter and have stronger capabilities in data analytics. There’s some foundational investments that we need to make in technology that will help us be able to amplify that to a greater degree, those investments are underway as part of the plan that we talked about, certainly the CapEx and the expense plans that we’ve outlined. We feel like we can we can drive this new capability with the financial resources that are reflected in the guidance.

So, we’re not expecting -- there's some new one-time project that we have to commit the company to, that we’ll need to share outside of the expense guidance we just offered. So, we feel good about resources we have to drive that particular initiative. And the focus has initially been around our guests and our CRM capabilities. We will then extend that effort into merchandising and channel optimization as I mentioned. And it’s a big focus, and we’re recruiting here. We have recruited some key leaders that will help us build that strategy internally and bring new expertise that we didn't have before, and as I mentioned we’re going to make important investments in the infrastructure to support it. So, look forward to sharing more with you guys as we go through the year and we make progress against those goals.

[Operator]

The next question comes from Ike Boruchow of Wells Fargo. Please go ahead.

[Ike Boruchow, Wells Fargo]

Just two questions, just the performance of the seasonal pop ups you guys had, this holiday, just kind of curious, can you let us know what revenue that generated, what your plans are maybe this year in terms of pop ups during the holiday, do you plan to accelerate the 24 that you did in Q4? And then Stuart just a quick one, can you maybe quantify the benefits on the gross margin line that you hope to see from the strategy that you laid out to improve the freight costs, this year just kind of – just to look at one piece of the gross margin, just curious?

[Stuart Haselden, Chief Operating Officer, Chief Financial Officer]

On the seasonal pop ups, really happy with how those performed. I think with the 24 in fourth quarter and we have one more than double that into 2018 and there was a number of those that we've actually kept open into the first quarter based on the strong performance that we saw of the 24 that we did I think all that 4 or 5 action be plan and we're very successful we're not going to quantify the sales impact which you can probably get to a good estimate just given the number that we have and using some of the average as you might expect from a typical Lulu store.

And the other thing I would say about the seasonal is that it's as much a guest acquisition vehicle for us as it is a sales driver and Celeste mentioned in the prepared remarks we had about 40% of our guests that shop in the seasonal stores were new to the brand, so that was an important element for us as well and the general philosophy is there are a lot of locations where we may not want to have a store year around but in a holiday season it's still a relevant place to operate as it captures demand, and so it's a good addition to the array of store formats that we have to employ.

And then on your gross margin question, the benefit is going to be sort of reflected in what we said in the gross margin guidance broadly. That is going to be one of a few factors that will benefit product margin and help us deliver that modest improvement for that overall year. We are not going to break it out specifically but it's meaningful, it's related to reductions in the air freight that I mentioned. We had previously offered a target for air freight around 25% of our total mode and we think we can do better than that in certain periods in a year. so, I think that's as much I willing to say on that specific item but we appreciate your question.

[Operator]

This concludes the time allotted for questions on today's call. I will now like to hand the call back over to Howard Tubin for any closing remarks.

[Howard Tubin, Vice President of Investor Relations]

Thanks for joining us everybody. We appreciate your time and we look forward to speaking with you in about three months when we report our first quarter results. Thanks.

[Operator]

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