Lululemon Athletica Inc

NASDAQ:LULU

Earnings Call Transcript 2022-Q4

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the lululemon athletica inc. Fourth Quarter 2022 Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. [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, 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 Calvin McDonald, CEO; and Meghan Frank, 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 but 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 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 annual report on Form 10-K and in today's earnings press release. In addition, the comparable sales metrics given on today's call are on a constant dollar basis. The press release and accompanying annual report on Form 10-K 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 fourth 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, Chief Executive Officer]

Thank you, Howard. I am pleased to be here today to discuss our strong finish to another strong year for lululemon. As you've seen from our press release, our adjusted quarter four results came in ahead of our January guidance update and our adjusted full year results represent a very solid start to our Power of Three x2 growth plan. I'm also excited that we continue to see strength and momentum across the business so far in quarter one. None of this would have been possible without our lululemon collective, our employees, our vendor partners, our ambassadors and our guests, all of whom are integral to our continued success. I want to express my gratitude on behalf of all of the senior leaders to our incredible teams around the world. Thank you for your ongoing commitment to lululemon. We are ready for all the future holds for our brand in 2023 and beyond.

On today's call, I plan to cover several topics: our quarter four and full year results; our product pipeline for 2023; an update our membership program; our recent market share gains; and finally, insights across our international business. So let's get started.

Our momentum continued in quarter four, with revenue increasing 30% versus last year and 26% on a three-year CAGR basis. We managed the business very well through an environment that was highly promotional and our markdowns were only up a modest 40 basis points versus 2019. I am pleased that as we progressed out of the holidays and began to transition to new spring merchandise, regular price sales returned to our normal levels. This speaks to the power of our brand, the appeal of our merchandise assortment and the strength of our operating model. And as you can see from our guidance, business remains good in quarter one and we are looking forward to another strong year in 2023.

Our business continues to be well balanced across product category, channel and region. Revenue increased in quarter four on a three-year CAGR basis as follows. Women's was up 23%. Our men's business was up 26%. And accessories was up 44%. We saw a 10% increase in company-operated stores and our e-commerce grew 46%. And by region, North America grew 24% and international increased 39%. When looking at adjusted earnings per share, we continue to deliver strong gains as well, with quarter four EPS increasing 31% versus last year and 25% on a three-year CAGR basis.

I would also like to spend a moment on our full year 2022 results. As you know, we launched our new five-year Power of Three x2 growth plan last spring. At the highest level, this plan assumes 15% CAGR revenue growth and modest operating margin expansion annually. In 2022, our revenue increased 30% compared to 2021 and 27% on a three-year CAGR basis. Adjusted operating margin increased 10 basis points, while adjusted EPS increased 29% and 27% on a one and three-year CAGR basis, respectively. It is a testament to the strength of our brand that for the full year 2022, we were able to significantly exceed our annual revenue goal and deliver adjusted operating margin in line with our target. And we achieved these results despite the challenging macro backdrop, supply chain issues and the pressure of COVID-19 in China.

Now let's shift to product innovation. 2022 was a strong year for product newness and innovation. We continue to expand our core categories with the launch of SenseKnit fabric technology and cold weather run styles. We grew our play categories with our golf, tennis and height capsules, and we entered a new category with the launch of footwear. Looking forward into 2023, I continue to be incredibly excited by the pipeline of innovation developed by our product teams. Several of our ideas this year include franchise growth, category expansions and building upon the success of some recently launched collections.

First, in the coming weeks, we will launch our [Get Intuit] campaign, featuring our popular and versatile Align franchise. As you know, Align began with a single style, a legging, which we grew to be our #1 performing bottom. We then expanded the collection to include shorts, pants and bras. More recently, we added away from body styles, including wide leg and mini flare. We will support this product story with an integrated global marketing campaign. We will also be expanding our Men's franchise licensed to train into women's later this year, which will complement our accessible Wunder Train franchise. In men's, we continue to innovate within our core activities with new versions of the Metal Vent T and the Pace Breaker Short. Updates to fit function and aesthetic have modern guest favorites. And in footwear, we recently introduced an updated version of Blissfeel, which incorporates learnings from the initial launch, and it's already receiving the same kind of positive media reviews that we have seen throughout our footwear rollout.

In May, we will launch Blissfeel Trail, our first road to trail shoe, and this summer, we'll introduce an updated version of Chargefeel. Related to footwear, we are pleased with our performance and guest response. Looking forward, we're excited to continue expanding our offerings for her and also launch our men's lineup in 2024.

These are just a few examples of how we solve for the unmet needs of our guests. The versatility of our merchandise assortment is one of the key competitive advantages for lululemon. One thing to add is that we do not drive our client growth through discounts or promotions, and we have no intentions to do so. We run a full-price business with markdown strategically used to clear seasonal and other select product, and this will remain our approach in the future.

Now I would like to update you on membership. We launched our new 2-tier membership program in North America this past October, and throughout the holiday season, we gained many learnings and insights regarding how our guests engage with our brand.

Let me start with our Essentials program, which is offered to guess at no cost. While we do not intend to release this metric regularly, I wanted to share that the number of sign-ups is significantly exceeding our expectations. In the first five months, we have already enrolled more than 9 million members. This demonstrates the significant potential behind this program. While the Essentials tier offers several compelling benefits and access to content, no discounts are involved. The rapid rate of sign-up speaks to the incredible loyalty of our guests, and the early results show our membership program increases the frequency of guests engaging with us. For example, more than 30% of members have already participated in at least one of the benefits of the program, and we expect this engagement to drive retention and incremental purchasing behavior going forward.

Related to the lululemon Studio tier of our membership program, we have also gained valuable insights that are informing our next steps. As we mentioned in our press release, we are taking an impairment charge related to assets and goodwill associated with MIRROR. Meghan will share more details with you in a moment.

As you know, we tested a paid city-based membership program in North America prior to our acquisition of MIRROR. Through that experience, we saw how guests were eager to engage with us through some of the sweat options we provided to participants. Not only did members enjoy these benefits, but we also saw increased member engagement, new guest acquisition and an increase in member spend. These learnings were the basis for our acquisition in 2020.

The recent launch of lululemon Studio has provided a new way to scale a paid membership program. Our best-in-class content helps build on our community of engaged guests, deepens our connection with them and drive incremental purchases of lululemon product. In fact, after studying the behavior of members, our initial analysis suggests that their spend on lululemon product increases approximately 9%, and this 9% is incremental. However, as you know, since our acquisition, the at-home fitness space has been challenging. While members love our content, hardware sales did not match our expectations. And even though our CAC has continued to improve, it has not improved enough to maintain the current level of investment.

As we continue to invest prudently in this business, we are evolving the model from being focused on hardware only to offering content through a digital and app-based solution as well. The new more efficient app-based model will launch this summer at a lower monthly subscription rate, and when combined with our 9 million in growing Essentials members will allow us to expand our total addressable market for potential members. We view lululemon Studio in the same way we view any innovation. We test, we learn and we evolve as necessary. Although the acquisition has not fully materialized as originally intended, we're in a much better position in our understanding of the community and our new membership program as a result.

Shifting gears, I want to speak to the strength of the lululemon brand and the gains we are seeing in market share. Let me share a few metrics with you. When looking at transactions, our growth continues to be well balanced across new and existing guests. In quarter four, we delivered a nearly 30% increase in transactions by new guests and more than 35% increase in transactions by existing guests. For the full year, these results contributed to a mid- to high 20% increase for both metrics.

Next, I will touch on our recent and continued gain in market share. In fiscal quarter four, 2022, the adult active apparel industry decreased its U.S. revenue by 5% compared to the same period last year. And over this time period, lululemon gained 2.3 points of market share in the U.S., the most of any brand in this market according to NPD Group's Consumer Tracking service. This is the highest quarterly market share gain we've achieved since we began tracking these numbers in 2020, and it caps a year in which we grew our market share every quarter. This speaks to our growth in the U.S., a key market within North America. And as we detailed at Analyst Day, we have significant opportunity to grow our brand awareness in North America and markets around the world.

Just since last April, we have seen increases in awareness in some of our key growth regions. We added 5 points to our unaided awareness in Australia from 19% to 24%; 2 points in China from 7% to 9%; and 2 points in the UK, taking us to 16% in the market. As you can see from these numbers, significantly more consumers in these regions are currently unaware of our brand compared to those who are, which highlights this meaningful opportunity.

As I mentioned earlier, our business remained strong in both our North America and international markets. In quarter four and full year 2022, revenue in North America increased 29%, while our international business generated 35% growth in quarter four and for the full year as well.

I would like to turn to our results in China where our potential continues to be significant. We have been investing in foundational infrastructure, people in stores that have fueled considerable growth in the market. As the impacts of COVID-19 normalize, we are seeing our momentum accelerate, and we are excited for the opportunities in the region in 2023 and beyond.

In quarter four, revenue in China increased more than 30% versus last year and over 50% on a three-year CAGR basis. While COVID-19 impacted revenue in December, we had a strong finish to the quarter and have seen momentum accelerate in quarter one. We have a solid foundation in the region across our brick-and-mortar and digital channels and is supported by exceptional talent on which we continue to build. We recently opened our largest store in Asia Pacific, the Kerry Center in Shanghai. It's an incredible expression of our brand, reflecting our commitment to the market, and it now brings our store count in China to nearly a 100 locations. It's clear our growth strategies are on track, and we remain early in our journey across our international markets.

With that, I'll now turn it over to Meghan.

[Meghan Frank, Chief Financial Officer]

Thanks, Calvin. I'm excited to be here today to discuss our Q4 results. We finished 2022 on a strong note with our adjusted results exceeding the updated guidance we provided in mid-January. This was enabled by an acceleration in our sales trend, along with the normalization of purchasing behavior relative to full price and markdown product.

Looking at Q1, our business continues to be robust. Our inventory growth will continue to moderate, and we expect to realize significant gross margin expansion driven by lower airfreight.

Let me now share the details of our Q4 performance. I will also discuss specifics on our balance sheet, including our inventory and cash position. Please note that when comparing the financial metrics for Q4 2022 with Q4 2021, adjusted earnings per share for Q4 2022 exclude $3.46 of expense related to impairment charges associated with the MIRROR business. Adjusted earnings per share for Q4 2021 exclude $0.01 of expense related to the acquisition of MIRROR. I will provide more detail on the Q4 2022 impairment charge shortly. And you can refer to our earnings release and Form 10-K for more information and reconciliations to our GAAP metrics.

For Q4, total net revenue rose 30% to $2.8 billion. Comparable sales increased 30% with a 17% increase in stores and a 39% increase in digital. On a three-year CAGR basis, total revenue increased 26%. In our store channel, sales increased 26% on a one-year basis and 10% on a three-year CAGR basis. Productivity remains above 2019 levels. We ended the quarter with a total of 655 stores across the globe. Square footage increased 21% versus last year, driven by the addition of 81 net new lululemon stores since Q4 of 2021. During the quarter, we opened 32 net new stores and completed 13 optimizations.

In our digital channel, revenues increased 46% on a three-year CAGR basis and contributed $1.4 billion of top line, or 52% of total revenue. Within North America, revenues increased 29% versus last year and 24% on a three-year CAGR basis. Within international, we saw a 35% increase versus last year and 39% on a three-year CAGR basis. And by category, men's revenue increased 22% versus last year and 26% on a three-year CAGR basis. Women's increased 30% versus last year and 23% on a three-year CAGR basis. And accessories grew 69% and 44% on the same basis.

It's also great to see ongoing strength in traffic across both channels. In stores traffic increased over 30%; and in our digital business, traffic to our e-commerce sites and apps globally increased over 45%. On a three-year CAGR basis, traffic is up 7% in stores and 40% in e-commerce. This speaks to the strength of our omni operating model as we engage with our guests in ways most convenient to them.

Adjusted gross profit for the fourth quarter was $1.59 billion or 57.4% of net revenue compared to 58.1% of net revenue in Q4 2021. Adjusted gross margin decreased 70 basis points relative to last year. This was driven primarily by the following factors: 50 basis points of deleverage from foreign exchange within gross margin, which was offset by a 50 basis point FX benefit within SG&A and 50 basis points of deleverage on fixed costs. This was driven primarily by investments in our product teams in DC, offset somewhat by leverage on occupancy and depreciation. These were partially offset by a 30 basis point increase in product margin. This increase was driven primarily by lower air freight expense, partially offset by higher markdowns in merchandise mix.

When looking at markdowns relative to 2019, for Q4, they were up 40 basis points, contributing to markdowns being relatively flat for the full year versus 2019. Adjusted gross margin was favorable to our updated guidance, which was a decline of 90 basis points to 110 basis points due predominantly to favorability and markdowns in air freight in addition to leverage from higher-than-planned sales.

Moving to SG&A. Our approach continues to be guarded in prudently managing our expenses while also continuing to strategically invest in our long-term growth opportunities. SG&A expenses were approximately $803 million or 29% of net revenue compared to 30.2% of net revenue for the same period last year. The leverage in the quarter versus Q4 2021 resulted from leverage in our operating channels and a benefit from FX, I mentioned earlier. This was offset somewhat by increased corporate SG&A and a modest increase in depreciation and amortization.

Adjusted operating income for the quarter was approximately $785 million or 28.3% of net revenue compared to 27.8% of net revenue in Q4 2021. Adjusted tax expense for the quarter was $226.5 million or 28.7% of pre-tax earnings compared to an adjusted effective tax rate of 26.4% a year ago. The increase relative to last year is due primarily to accruing for Canadian withholding taxes on a portion of fiscal 2022 Canadian earnings and some benefit we had last year upon the filing of income tax returns. Adjusted net income for the quarter was $562.5 million or $4.40 per diluted share compared to adjusted earnings per diluted share of $3.37 for the fourth quarter of 2021.

Capital expenditures were approximately $207 million for the quarter compared to approximately $128 million in Q4 of last year. Q4 spend relates primarily to investments that support business growth, including our multiyear distribution center project, store capital for new locations, relocations and renovations and technology investments.

Before turning to our balance sheet highlights, let me spend a moment on the charges we took related to the MIRROR business. As you know, the overall at-home fitness space remains challenged. MIRROR hardware sales during the holiday season came in below our expectations, therefore, we ran an impairment test at the end of Q4. Based upon this test, we took charges related to the impairment of goodwill and certain long-lived assets and a provision for MIRROR hardware. These charges totaled approximately $443 million, net of tax, or $3.46 per share. The valuations used in the impairment calculation are based on an evaluation of MIRROR on a standalone basis.

We are pivoting away from the hardware-centric business that we acquired to also focus on a more efficient app-based model. While we see Studio as a key component of our membership strategy, which will help drive incremental revenue, the standalone valuation of MIRROR doesn't fully reflect the incremental revenue. Looking forward, we remain excited about our membership program. As Calvin shared, we already have over 9 million members in our Essentials program, and we continue to see opportunity to build our community, increase engagement and drive incremental spend.

Turning now to our balance sheet highlights. We ended the quarter with $1.2 billion in cash and cash equivalents and nearly $400 million of available capacity under our revolving credit facility. Inventory at the end of Q4 was $1.4 billion, modestly under our expectations for 60% growth. This reflects one year dollar growth of 50% or 57% excluding the provision for MIRROR hardware.

I would also like to note that core seasonless product continues to make up approximately 45% of our inventory. We remain pleased with our inventory levels. In 2023, our inventory growth will continue to moderate, while we maintain our full price selling model, and we remain well positioned to fulfill guest demand. At the end of Q1, on a one-year dollar basis, we expect inventory to increase approximately 30% to 35% relative to last year. Looking further out, we expect inventory growth to be relatively in line with sales growth in the second half of 2023.

During the quarter, we repurchased approximately 213,000 shares at an average price of $323. At the end of Q4, we had approximately $744 million remaining on our $1 billion repurchase program.

Let me shift now to our guidance outlook. While we are mindful of the ongoing macro uncertainties and we continue to plan the business prudently, we're excited with our sales trends in Q1 and also the benefits we expect to realize in 2023 from the lower airfreight and our new lululemon Studio model. We have the opportunity to invest into our Power of Three x2 growth pillars while also delivering operating margin in 2023, slightly ahead of our goal for modest expansion annually.

In 2023, we expect revenue to be in the range of $9.3 billion to $9.41 billion. This range represents growth of 15% to 16% relative to 2022 and is in line to slightly better than our Power of Three x2 growth plan. We expect to open 45 to 50 net new company-operated stores in 2023 and complete approximately 25 co-located remodels. This will contribute to overall square footage growth in the low double digits. Our new store openings in 2023 will include 30 to 35 stores in our international markets, with the majority of these planned for China.

For the full year, we forecast gross margin to increase between 140 basis points to 160 basis points versus 2022. The expansion relative to last year is driven predominantly by lower air freight expense. For the full year, we expect airfreight to be down approximately 150 basis points versus 2022. When looking at markdowns for the full year, we expect them to be in line with last year and 2019.

Let me also share some additional detail on our multiyear distribution center project. We began this project in 2022 with the opening of our new Tilbury DC near Vancouver. For the year overall, this project had a negative 30 basis point impact on gross margin. In 2023, we will continue investing in our distribution network to support future growth. Projects include building a new DC in the Greater Los Angeles area and also expanding two of our existing DCs in Columbus and Toronto. Included in our gross margin guidance for the year is 20 basis points of deleverage associated with these initiatives.

Turning now to SG&A for the full year. We forecast deleverage of 120 basis points to 140 basis points versus 2022, driven predominantly by increased investments to support market expansion, improve our guest experience by enhancing our omni capabilities and continuing to make foundational investments to support future growth. In addition, we expect higher depreciation due to current and prior year investments.

When looking at operating margin for the full year 2023, we expect it to increase by 20 basis points to 40 basis points versus last year. This would be slightly ahead of our Power of Three x2 long-term target of a modest expansion annually. For the full year 2023, we expect our effective tax rate to be approximately 30%, an increase over the 2022 adjusted effective tax rate of 28.1%. This is in line with our longer-term tax rate expectations we provided as part of our Power of Three x2 plan and reflects the increase we expect as a result of accruing for Canadian withholding taxes. For Q1, we expect our effective tax rate to be approximately 30%.

For the fiscal year 2023, we expect diluted earnings per share in the range of $11.50 to $11.72 versus adjusted EPS of $10.07 in 2022. Our EPS guidance excludes the impact of any future share repurchases. We expect capital expenditures to be approximately $660 million to $680 million for 2023. The increase versus 2022 reflects investments to support business growth including a continuation of our multiyear distribution center expansion, store capital for new locations, relocations and renovations and technology investments. Our range of $660 million to $680 million is approximately 7% of revenue, in line with our current Power of Three x2 target of 7% to 9%.

Shifting now to Q1. We expect revenue in the range of $1.89 billion to $1.93 billion, representing one year growth of 17% to 20%. We expect to open 5 to 10 net new company-operated stores in Q1. We expect gross margin in Q1 to increase 290 basis points to 320 basis points relative to Q1 of 2022. This will be driven by lower airfreight expense, offset somewhat by strategic investments in supply chain and distribution centers as well as foreign exchange. In Q1, we expect our SG&A rate to deleverage by 60 basis points to 80 basis points relative to Q1 2022, related to the investments I just described.

When looking at operating margin for Q1, we expect expansion of approximately 200 basis points. We expect earnings per share in the first quarter to be in the range of $1.93 to $2 versus adjusted EPS of $1.48 a year ago.

With that, I will wrap up my remarks and turn it back over to Calvin.

[Calvin McDonald, Chief Executive Officer]

Thank you, Meghan. In 2022, we passed $8 billion in revenue for the first time driven by balanced growth across categories, channels and markets. Our product pipeline driven by innovation is very strong. More than 9 million guests signed up for our Essentials membership program in the first five months, which further strengthens the opportunity to keep building our community, strengthen our guest relationship and drive long-term value. Our market share gains show our brand is able to expand and attract new guests and yet our unaided awareness remains low, which demonstrates the runway in front of us. And we're seeing strong momentum in every market where we operate, and we continue to successfully expand into new geographies. These are just some of the reasons I'm excited about all that's in front of us, both in 2023 and over the coming years.

I look forward to taking your questions now. Operator?

[Operator]

[Operator Instructions] The first question comes from Adrienne Yih from Barclays.

[Adrienne Yih, Barclays]

Thank you very much. And congratulations to everybody for stellar year and great momentum coming into the first quarter. Calvin, I was wondering if you can help expand upon that, that notion of unaided brand awareness. I think that's a really powerful concept there. What was your advertising spend as a percent of sales last year? And what avenues are you going to be using sort of to expand that brand awareness. And then Meghan, really quickly, if you can just expand upon the notion of flat promos, I think you said to last year and 2019, so just trying to understand those two comparisons? And that is a nice improvement, I think, from kind of ICR when maybe -- I think we were in a little bit more of a promotional kind of backdrop or notion of promotions coming into the year.

[Calvin McDonald, Chief Executive Officer]

Thanks, Adrienne. In terms of unaided brand awareness, as you highlighted, it's exciting to see both our improvements in it, but also the runway of growth and potential we have. So we know that our approach is working as well as we know that it's going to continue to fuel our ability to acquire guests and drive the overall momentum in the business across all markets, including North America and the U.S. Our current spend is in and around the 4% range. And at this point, we're planning to maintain the percentage of sales, relatively consistent. How we deploy it? It's a combination of opening stores, which is a wonderful vehicle to drive that awareness and acquire guests, connecting with guests and ambassadors in our local communities and investing in both our community activations as well as these relationships. Expanding our relationships with lead athletes around the world, which we continue to make great contributions and add into our collective. And then finally, like you will see with the [Get Intuit] campaign, executing more deliberate and coordinated global brand campaigns which I'm excited for you to see that. Those are just some of the examples of the way in which we activate our brand and product first through most of the messaging in that we've seen our success and excited for what we have planned in '23.

[Meghan Frank, Chief Financial Officer]

And -- hi, Adrienne, in terms of markdowns, our full year 2022 markdowns came in in-line with 2019. And we're expecting to be relatively flat in 2023 on a full year basis. We do have the biggest opportunity in Q4, which will be offset somewhat by Q1 through Q3 markdowns. But that 2019 water line we view is a healthy level for us. And then we'll also see inventory, as we mentioned, 30% to 35% growth at the end of Q1 and then coming in line with sales in the second half of 2023.

[Operator]

The next question comes from Lorraine Hutchinson from Bank of America.

[Lorraine Hutchinson, Bank of America]

I wanted to focus on China for a minute. It was about 8% of sales last year. How are you thinking about the growth cadence there? And can you give an update for us on profitability of the region?

[Meghan Frank, Chief Financial Officer]

Lorraine, in terms of China, we haven't put a fine point on China in 2023. However, what I'd say is we still had a degree of COVID disruption in both Q4 and full year '22, and we were at a 30% growth rate. We have seen that trend accelerate as we moved out of Q4 and into 2023, particularly Q1. So we are above that 30% growth. And then in terms of profitability, we are profitable in China. We haven't put a fine point on it beyond that.

[Operator]

The next question comes from Brian Nagel from Oppenheimer.

[Brian Nagel, Oppenheimer]

Great quarter, congratulations. So I just want to -- my question -- I just want to focus on inventories because I know that has been a big topic for lululemon as well as the sector. So you had fantastic results here in the fourth quarter. I'm looking at the math you, you ended the year, inventory is up, I guess, just around 50%. So as we think about '23, within the context of the guidance you gave, how should we expect that inventory to moderate? And is it -- are your essentially saying you're just going to work through that primarily for the normal course of business without really any excess promotions?

[Meghan Frank, Chief Financial Officer]

Yes. So in terms of inventory, we've been navigating obviously, the dynamic supply chain environment. And we did a number of core buys earlier to try and manage our airfreight expense. We do have a higher proportion of our inventory in core versus 40% historically. We also saw increased airfreight impacting our cost inventory balances. And then we also saw vendors who were shipping later than historically, pivot to shipping more on time. So the team is still navigating and adjusting to that new reality. And I would say, at the end of Q1, we're going to see inventory moderate to 30% to 35% growth, and we expect it to come in line towards the second half of the year. Our goal overall is to manage our inventory in line with our revenue growth and believe we'll be there over time.

[Operator]

The next question comes from Paul Lejuez from Citi.

[Paul Lejuez, Citigroup]

Just piggyback on the inventory question. Curious if you're a little bit heavier in certain geographies versus others? And if it's going to take a little bit more time to clear and get to where you want to be in certain geographies. And then just separately, curious what you're looking at from a product cost perspective this year, first half versus second half, if you can share what you're anticipating on the [ADC] side?

[Meghan Frank, Chief Financial Officer]

Yes. I would say nothing notable by geography in terms of inventory balances. We're pleased overall with the content composition, and we plan to, as we mentioned, have a healthy full price penetration as we move throughout the year. In terms of product costs, we haven't experienced any significant increases, and we don't expect any significant changes as we move throughout 2023, relatively stable.

[Operator]

The next question comes from Ike Boruchow from Wells Fargo.

[Ike Boruchow, Wells Fargo]

Two-part question. Maybe first for Calvin. Just on the MIRROR hardware decision. Can you walk us through a little bit more about what you saw in the holiday, and I guess, the past several quarters, that kind of informed your decision that you guys ultimately made to eliminate the hardware piece of the business? And then Meghan, is there anything you can quantify in the P&L? What kind of revenue or operating losses are being removed by eliminating that piece of the business this year?

[Calvin McDonald, Chief Executive Officer]

Thanks, Ike. On MIRROR, I just want to clarify, we're not eliminating the hardware, but we are adding an app feature that will allow a guest to sign up and pay a lower monthly subscription fee and acts the same content without having to purchase the hardware. So I just want to clarify that. And that will launch later this summer. And we think with the lower cost to entry, not being hardware restricted and the 9 million Essential members that we've built and will continue to build, it will allow us to more easily migrate and attract guests into it. We did see an improvement in our performance with the launch of lululemon Studio in October. But as we shared, it just didn't meet our expectations. And although tax are improving, they're still not proving fast enough that we didn't -- that we felt it prudent to make this pivot to open up the TAM and appeal to a broader audience within our collective.

[Meghan Frank, Chief Financial Officer]

In terms of the P&L, we don't break out MIRROR separately given it's now embedded in our membership program. But what I will share is that it's a very small portion of our revenue this year and was also a very small portion of our five-year plan. We have moderated investment levels, and we'll continue to do so and continue to see dilution improving.

[Operator]

The next question comes from Alex Straton from Morgan Stanley.

[Alex Straton, Morgan Stanley]

Congrats on another good quarter. Two quick ones from me. The first is just on the big increase you mentioned in new guests, I think a 30% level or so. Could you share any learnings you have on how those new guests compare to existing guests? And then secondly, on the 40% to 45% of the business that's core, any insight you can give us on the split of the rest of the business, I guess, the newer categories and what they represent? And whether they have similar full price sell-through rates to that legacy business?

[Calvin McDonald, Chief Executive Officer]

Thanks, Alex. In terms of the new guests, we have -- one of the benefits of the brand is we see good success across guests across all age demographics. So that remains very healthy, both acquisition as well as engagement. We have seen a very healthy growth in our younger guest base, in particular, over the past 12 and 18 months, and that continued. But overall, we would wait a little bit on the younger but very healthy overall, and seeing, as I indicated, very healthy numbers in terms of engagement of existing guests, the new guests, how those cohorts are shopping and engaging on a frequent basis and migrating up through the category offering that we have.

[Meghan Frank, Chief Financial Officer]

And I'd share in terms of category breakdown of the balance of inventory outside of the 40% to 45% core, we're pleased with the seasonal nature of our product and the aging of that inventory. And in terms of by category, it be positioned relative to our Power of Three x2 plan in terms of category growth.

[Operator]

The next question comes from Rick Patel from Raymond James.

[Rick Patel, Raymond James]

Congrats on all the progress. I was hoping you could talk about your expectations for growth in North America for the new year. You've made a lot of progress already in the market. So I'm curious what you see as the strongest growth levers as we think about channels and product segments.

[Meghan Frank, Chief Financial Officer]

So in terms of North America, we're looking at achieving our low double-digit expectation that we shared as part of our Power of Three x2. And sorry, can you remind me the second half of your question?

[Rick Patel, Raymond James]

Yes. Just with the strongest growth levers are as we think about channels and products

[Meghan Frank, Chief Financial Officer]

Yes. I would say I'd frame that also in that context. So we have our 15% average growth rate annually as part of that plan, with a goal to 4x international business, double our men's business, double our e-commerce business, and that also included low double-digit North America growth as well as low double-digit women and store growth.

[Operator]

The next question comes from Dana Telsey from Telsey Advisory Group.

[Dana Telsey, Telsey Advisory Group]

Congratulations on the results. As you think about the product margin puts and takes for 2023, how do you think about them and the markdowns which are normalized with 2019 levels, how do you see that evolving as we go through the year? Is there any cadence or shape that we should be mindful of?

[Meghan Frank, Chief Financial Officer]

Dana, so we're -- we shared color of 140 basis points to 160 basis point increase in gross margin for the full year, and that would really be driven by a benefit from airfreight, down 150 basis points. We are expecting markdowns to be flat year-over-year, also flat to 2019 levels. And we have a little bit of pressure, as we mentioned in our distribution center strategy that's really aimed at servicing our demand over time. In terms of cadence by quarter, I had mentioned earlier, we have the biggest opportunity in markdowns in Q4, offset by Q1 through Q3. And then in terms of airfreight, our biggest opportunity will be Q1 in the range of 300 basis points to 400 basis points. We will be higher -- we will have opportunity relative to the last year in Q2 and Q3, and then we're expecting at this point in time, we'll be in line in Q4.

[Dana Telsey, Telsey Advisory Group]

Got it. And then just, Calvin, on the new product rollouts that are coming this year, where do you see the most opportunity to have an influence on the overall category given that you're gaining share in a category that's a little more challenged now.

[Calvin McDonald, Chief Executive Officer]

In terms of the product, what I'm anticipating is similar to what we've been seeing, which is balanced growth across men's and women's across categories and activities. The innovation, a little bit of what I've shared is a balance of continuing to innovate on our core styles and franchises like the recent update to the men's and pace breakers short as well as adding additional styles to proven franchises like the Align campaign that I'm really energized and excited about. It's a fantastic expression of one of our powerhouses and excited to use it as a way to continue to recruit new guests. And then building on new launches like footwear and then bringing successes in our men's business with the license to train into our women's assortment. So I think it's another expression of the evolution we've had with our product strategy, which is early still, very balanced across the activities we identified expressed through categories and franchises across both men's and women's. So my anticipation is still very balanced growth both in North America, around the globe for product for us in '23 and beyond.

[Operator]

The next question comes from Brooke Roach from Goldman Sachs.

[Brooke Roach, Goldman Sachs]

Calvin, I was wondering if you could contemplate the customer engagement that you're seeing with full price relative to discounted product? And how that engagement may have changed over the course of the last few months, combined with your expectation for that for the rest of the year, does that engagement rate differ by region, age or customer income demographic?

[Meghan Frank, Chief Financial Officer]

Brooke, in terms of markdown and full price penetration, we did see that normalize as we move through the balance of January and then into Q1. We haven't seen any material differences by customer segment, and we do expect that we'll maintain that relationship of healthy full price in line with history, that's reflected in the color we provided on markdown staying flat year-over-year, also flat to 2019, which we view as a healthy water line for us.

[Operator]

The next question comes from Michael Binetti from Credit Suisse.

[Michael Binetti, Credit Suisse]

I will add my congrats on a nice quarter and a nice update since ICR, Meghan. I guess on China, you built a lot of stores there since pre-COVID. And I think you've done -- I think you haven't had much time over there over the past three years, those stores operating in any kind of normal capacity. So if China was 8% of sales but it's 15% of your global store count, I'm just curious if China was operating at normal productivity, would revenues be closer to that 15% store mix? Or do you think those stores -- any reason to think they should trend above or below global averages on sales per store or sales per flow. Just have you think any way for us to think about the opportunity there with the assets you already have? And then Calvin, on thoughts on pricing in 2023. I know this hasn't been the most urgent lever for you to pull in recent quarters. You talked about that. Any change to that for 2023?

[Meghan Frank, Chief Financial Officer]

Yes. In terms of China stores, definitely, we were impacted by COVID as we move throughout 2023. So I would expect that percentage to be higher. I would say our stores are highly productive there. They tend to be smaller than the balance of our fleet, particularly in North America, and we view that as an opportunity over time. We continue to have a long pipeline of store openings there. We also are very early in terms of store expansion strategy, which we've employed in North America to capitalize on where we see very strong and healthy sales per square foot and opportunities to expand the market.

[Calvin McDonald, Chief Executive Officer]

And Michael, on pricing, I'll start with what we shared last year, which is going to be similar to our approach this year. And I'll start with -- I'm proud of the approach that the team took, and that is knowing we're a full-price business. We only increased prices on a small percentage of our assortment so that we continue to lean in on full pricing and not rely on and have to pull the promo lever. What we saw in the industry was many other players price up and then heavily discount that back down. But it allowed us to manage margins, manage full price selling throughout with selective pricing. And heading into '23, it's a similar approach. We're not planning any drastic significant moves in pricing and continue to focus on full price with markdowns as a means to exiting seasonal product only.

[Operator]

The next question comes from Omar Saad from Evercore.

[Omar Saad, Evercore ISI]

Just a couple of quick follow-ups. Calvin, maybe you could touch on the strategy to use paid media? And how that's going for you guys, the efficacy? Is that something you're using in other markets like China as well? And maybe a quick update on some of the new categories, footwear, hike, golf, et cetera, would be helpful.

[Calvin McDonald, Chief Executive Officer]

Thanks, Omar. In terms of our approach to media, we'll always and continue to use a balance between paid and earned. And I think we've really made gains in the last few years in leveraging both of those with earned media playing very, very heavily for us, which is great, on the back of innovation and some compelling story. So we're going to continue to leverage both of those, leading in when we do paid into digital and more direct and specific. And I think you'll see a lot of that expressed and executed through the -- [Get Intuit] Align campaign. And Nikki and the team are also doing a wonderful job working with the regions in getting expression right through to the digital campaign through to stores and in and around in local markets and amplifying that. So it just really fits and feels like a very omni expression and execution for the guests out of the store, in-store and across digital applications. So excited for you to see for that campaign expressed.

And your second part of the question was...

[Omar Saad, Evercore ISI]

Just update on some of the new categories, footwear, hike, golf?

[Calvin McDonald, Chief Executive Officer]

Perfect. On the play activities, and I'll start there, they've respond -- the guest has responded very well to them. And I'm excited, as I've shared with you, in particular, on tennis and golf, how they're designed. We know that, that is how our guests also sweat and offering product and offering for them helps us strengthen the relationship and extend our share of wallet with them. And on those two, they're really designed to selectively innovate into and then leverage our core assortment. And in both of those executions last year when we really kicked off and then through the year and then into spring when we've recently brought tennis back as well as about to do so in golf, we're seeing that strategy execute very well where we sell a lot more core wrapped around a golf or tennis execution. We're going to continue to do that. So it allows us to manage assortment and SKU additions, while at the same point, drive productivity and credibility into these activities. And on footwear, it's a test-and-learn category for us. We've just cycled over the first year. Very pleased with early guest response. Very pleased with industry recognition to disrupt and innovate and create something new within footwear for women. We've just updated with our Blissfeel 2.0, and both the industry is very positive on it as well as our guest. And excited about continuing to sort of test and learn. And as I indicated, we'll be launching a Blissfeel Trail later an update to our charge fuel. And then next year in '24, the introduction of our men's footwear business. So we're excited with the response and continue to test and learn and innovate into the category.

[Howard Tubin, Vice President, Investor Relations]

Operator, we'll take one more question.

[Operator]

Last question comes from Jay Sole from UBS.

[Jay Sole, UBS]

Just curious about the sales cadence for the year. Q1 looks like it's around high teens. And then it seems like the guidance implies the growth rate goes into the mid-teens range by the end of the year. Just wondering if there's like a specific driver that's part of that forecast or just assuming that you go back into the long-term algo? And then at the same time, just curious about accessories. You mentioned it's up 44% in Q4. Within that, I assume belt bag is a big driver, Calvin. I'm just worried about how you feel belt bags fits into the overall brand strategy and what you plan to do with that category going forward?

[Meghan Frank, Chief Financial Officer]

Thanks, Jay. So in terms of cadence throughout the year, we are really pleased with our trends headed into Q1. And we're also mindful of the macroeconomic uncertainty. So our guidance reflects what we feel to be the appropriate direction at this time. The 15% to 16% growth rate for the full year is slightly above our Power of Three x2 average of 15%. So we feel well positioned headed into the year.

[Calvin McDonald, Chief Executive Officer]

And on accessories and the Everywhere Belt Bag, our accessories business is very healthy, and it's very balanced as well. It's not a one-hit wonder. That team has done a great job in building a compelling total bag business. Not just that one particular item. We're pleased with that one item. Love the results. It's been a great driver of brand awareness as well as new guest acquisition. But we have an accessories business across all categories, not just bags, that continue to contribute and grow, and we're excited about its opportunity moving forward in our mix of the assortment for our guests.

[Operator]

That's all the time we have for questions today. Thank you for joining the call, and have a nice day.