Lululemon Athletica Inc. (LULU) CEO Calvin McDonald on Q1 2019 Results - Earnings Call Transcript

Lululemon Athletica Inc. (NASDAQ:LULU) Q1, 2019 Earnings Call June 12, 2019 4:30 PM ET

Company Participants

Howard Tubin - Vice President, Investor Relations

Calvin McDonald - Chief Executive Officer and Director

Stuart Haselden - Chief Operating officer and VP of International

PJ Guido - Chief Financial Officer

Conference Call Participants

Matthew Boss - JPMorgan

Ike Boruchow - Wells Fargo

Kate Fitzsimons - RBC Capital Markets

Adrienne Yih - Wolfe Research

Paul Lejuez - Citi

Omar Saad - Evercore ISI.

John Kernan - Cowen and Company

Camilo Lyon - Canaccord Genuity

Kimberly Greenberger - Morgan Stanley

Brian Nagel - Oppenheimer

Dana Telsey - Telsey Advisory Group.

Operator

Thank you for standing by. This is the conference operator. Welcome to the Lululemon Athletica Inc First Quarter 2019 Conference Call. As a reminder, all participants are in a 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 Inc. Please go ahead, sir.

Howard Tubin

Thank you, and good afternoon. Welcome to Lululemon's first quarter earnings conference call. Joining me today to talk about our results are Calvin McDonald, CEO; Stuart Haselden, Stuart Haselden and EVP International; and PJ Guido, CFO.

Before we get started, I'd like to take this opportunity to remind you that our remarks today will include forward-looking statements reflecting management's current forecasts of certain aspects of Lululemon'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 our business, including those we have disclosed in our most recent filings with the SEC, including our annual report on Form 10-K and our quarterly reports on Form 10-Q.

Any forward-looking statements that we make on this call are based on assumptions as of today, and we expressly disclaim any obligation or undertaking to update or revise any of these statements as a result of new information or future events.

During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our quarterly report on Form 10-Q and in today's earnings press release. The press release and accompanying 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 Investors site where you'll find a summary of our key financial operating statistics for the first 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 turn the call over to Calvin.

Calvin McDonald

Thank you, Howard and welcome everyone to our first quarter earnings call. As we begin, I'd first like to say how much enjoyed hosting our recent Analyst Day meeting in New York. We are incredibly excited about the growth opportunities we have in front of us. And we look forward to delivering on our five year growth plan. Lululemon had another successful quarter driven by many strengths in our business across product, channel and geography. Our innovative merchandize assortments and our engagement with guests around the world enable us the financial results we are proud to report you today.

On today's call, I'll start by sharing some of our key highlights from quarter one including how we are leaning into our product innovation and omni guest experience growth pillars. Going forward, I'll periodically ask a member of senior leadership to join the call and provide an update on key strategic areas of the business. Today, Stuart Haselden will join us to provide an update on our opportunities in China and other key international markets. As you know, earlier this year, Steward's responsibilities were expanded to include serving as our EVP of International in addition to his role as Chief Operating Officer.

Following the global update, PJ Guido will provide a detailed financial review, as well as our guidance outlook. I'll then wrap a few closing comments and will be happy to take your questions.

Let's have a look at our first quarter results. We are very pleased to see continued strong momentum in the business. The Power of Three Growth plan which we detailed at Analyst Day is serving as a driving force to move us forward to achieve our five year growth plan. Across the company, teams are executing at extremely high levels. In Q1, our total revenue grew by 20%, constant dollar comps increased 16% on top of 19% increase last year and earnings per share increased 35%.

Our guest responded well to both our men's and women's assortments. They engaged with us across channels as our store and digital businesses were both strong. And our brand continues to resonate well in our core North American market as well as in Europe and APAC. Supporting our growth, we are leveraging the strategic infrastructure investments we're making across the business. Our focus over the last several years to create efficiencies and to further segment our supply chain is paying off, intangibly contributing to our success. As an example, our newest distribution center in Toronto opened on schedule in May enables us to deliver product more effectively and efficiently in Eastern Canada

As you know, the growth plans we discussed during Analysts Day are long-term in nature, and the financial targets we provided are annual. I'm pleased 2019 is off to such a strong start and we're beginning to live into our five-year vision. I'd now like to speak specifically about the power of three growth pillars, product innovation, and omni guest experience and market expansion. As you recall, our five-year vision details our path to double our men's business, double our digital business and quadruple our international business during this time.

Let me now provide some highlights from quarter one for these drivers. When looking at our product innovation pillar, over the next five years we expect annual growth in our core women's business to be in the low double digits while men's is planned to grow at 20% per year. In quarter one, we continue to see robust performance in our women's business with particular strengths in bottoms. This category remains one of our strongest with comps up over 19% driven by both leggings and jogger styles. Within the men's business, comps grew 26% with ongoing strength in both tops and bottoms. The business was led by our ABC franchisee and three core short styles.

T.H.E short, Paced Breaker and Surge. Guests are responding well to our new boxers designed to address all three elements of the science of feel, touch, temperature and movement. Looking forward, I'm excited with the innovation we intend to bring into our assortment for both men and women. Just to preview some of the upcoming highlights for men, we plan to launch a new and improved Metal Vent Tech collection and for women we plan to further expand our technical bra offering with two high support styles in the coming months.

The final component of our product innovation plan is to test into new categories. The main driver continues to be our core categories across both men's and women's. However, we've identified several areas of white space where we can test the waters and bring innovation to our guests. One example of this is self-care, which we will roll out to 50 stores and online next week.

Shifting now to omni guests' experience, we had strong results across our channels with our store comps increasing 8% on top of 6% increase last year. Our digital business grew 35% which represents a more than doubling of the business over the last two years. Increased traffic in quarter one is driving our comps both in-store and online with increases of 8% and 41% respectively. We're excited about our vision to be the experience of brand that ignites a community of people living the Sweatlife. Next month, you'll see our first truly experiential store when we open Lincoln Park in Chicago. This 20,000 square foot store captures who we are as a brand as it will embody the Sweatlife through multiple studios, a meditation space, a healthy juice and food offering and areas for community gatherings.

This distinct environment will provide us additional opportunities to explore and learn as we connect with our guests in a range of new and exciting ways. We also continue to test our membership program and in May we expanded to our third pilot city in Austin, Texas. We are very encouraged by the results in each city and our tests have brought new learnings and innovations as we look to scale the program. Looking now at our digital business, we further expanded our online only size and color offerings for both men and women. We expanded our buy online, pick up in store capability from 35 stores to 115 in quarter one with 80% of the orders ready for guest pickup in one hour.

We remain on track for a full rollout by the end of quarter three. We also significantly improved our mobile point-of-sale capabilities so educators can complete our guests purchases from anywhere in the store. Our strengths and unique position is to activate great product across our omni guest experiences, leveraging our stores, community and events. Run is the key strategy for us and a great representation of how we will activate across our entire business to deliver an exceptional guest experience.

In addition to our strong and light bra franchise ,we rolled out the fast and free run oriented collection for men. We highlighted the strength of our technical apparel with our global run campaign featuring our first global run ambassador, Charlie Dark. Our run focused activations during the quarter included a presence at the Boston, Los Angeles and London marathons and just last week we celebrated a global running day by rallying our community to participate with their local run clubs or to join our 5k challenge on Strava.

In the coming weeks, you'll see a sponsor our 10k runs in Toronto and Edmonton as we've done in the last several years. And we plan to add more events going forward. Run is an important category for us with significant potential. And we see opportunities to expand our share of wallet with current and future guests.

Shifting gears now to our markets. Let me share some highlights regarding performance in our core region of North America and then turn it over to Stuart to discuss growth in our international markets. First, our opportunities in North America, our largest region remain significant. Our innovative merchandise assortment, agile store formats, inspiring brand activations and unique event offerings provide ample ways to engage with existing and new guests.

In quarter one, revenue in North America grew 18% as the momentum in this region remained strong. We open six stores in the US and Canada and remain on track to open 15 to 20 in 2019. Our guest stats remain robust with continued growth in new guest acquisition and increased spending across existing guests. Traffic to our stores in North America was strong and grew in the high single digit range. Last month, Stuart and I had the opportunity to visit our team in China and to see the incredible growth opportunities firsthand. I'll let him share our insights and some of the results this quarter internationally. Stuart?

Stuart Haselden

Thanks Calvin. In May, I was able to spend nearly two weeks with our team in China. And while we are seeing exciting momentum across all of our international markets, China in particular is on track to post impressive growth this year. In Q1, our China team delivered nearly 70% market growth and entered three new cities with strong store openings in Chongqing, Xi'an and Xiamen. And we remain on track to open 10 to 15 stores in China this year.

We also continue to invest in our digital capabilities here with the relaunch of our .cn site in Q1 to complement our presence on Tmall and WeChat. And these investments are paying off as we saw our China e-com revenues increase over 100% in Q1. These results also include the great success of our super Brand Day Event with Tmall in April. As part of this event, we invited 400 guests to join us at the Intercontinental Shanghai Wonderland for sweat sessions, meditation classes and also a function show. The event garnered significant attention from the media and on social channels. And it was a great way for us to connect with both new and existing guests.

All of this contributed to a strong performance for Asia-Pacific region overall in Q1 with revenues for the region increasing approximately 40%. Other highlights include the launch of our dot JP and dot KR websites both of which are seeing strong starts.

Turning now to Europe. We posted strong double-digit comps across all channels driven by ongoing robust traffic increases. These results helped us deliver over 40% market growth in Q1 across Europe. We're pleased to see our business gaining momentum as our community and brand building efforts accelerate. We also opened a great new store in Amsterdam at the grand opening which I was able to attend in March. It was exciting to see firsthand the energy that our team and Europe is creating which is reflected in the strong results we are now experiencing.

And we remain on track to open 5 to 10 new stores this year across Europe. Overall, our international growth remains strong and accounts for an increasing portion of our total company growth. And finally, I'd like to offer my gratitude to our teams around the world. It's only with their great work that any of this is possible. And now I'll pass it to PJ.

PJ Guido

Thanks Stuart. Before I provide highlights on Q1 and our guidance outlook, I will refer you to the financial supplement posted on our Investor site for additional details. For Q1, total net revenue rose 20% to $785 million, driven by strong execution across all parts of the business. In our store channel, we delivered an 8% constant comp store sales increase on top of a 6% increase in Q1 of last year. Square footage increased 15% versus last year driven by the addition of 44 net new Lululemon stores since Q of 2018. During the quarter, we opened 15 new stores.

In our digital channel, we posted 35% in constant dollar comp increase on top of a very strong 60% increase last year. For the quarter, E-COM contributed approximately $210 million of top-line reaching nearly 27% of total revenue. And I'd add that the impact of foreign exchange decreased revenue by $12.5 million in the quarter. Gross profit for the first quarter was $421.7 million or 53.9% of net revenue compared to 53.1% of net revenue in Q1, 2018.

The gross profit rate in Q1 increased 80 basis points versus gross margin last year and was driven primarily by the following. A 190 basis point increase in overall product margin resulting from lower product costs, favorability and product mix and lower markdowns. We are pleased with the product margin strength we continue to realize on top of the strong gains over the last several years. This increase was partially offset by a 60 basis point increase in product and supplied team costs driven by ongoing investment in product development and supply chain, and an increase in occupancy and depreciation expense of 20 basis points.

We also saw 30 basis points of unfavorable impact from foreign exchange. Moving down the P&L, SG&A expenses were $293 million or 37.4% of net revenue compared to 37% of net revenue for the same period last year. In Q1, we continued to use the strength in the business to invest in strategic priorities, brand awareness and initiatives that fuel current and long-term growth. This includes digital loyalty and self care. Foreign exchange both revaluation and translation leverage by 30 basis points in Q1. Operating income for the quarter was approximately $129 million or 16.5% of net revenue compared to 16.1% of net revenue in Q1, 2018.

Tax expense for the quarter was $34.6 million or 26.4% of pretax earnings compared to an effective tax rate of 29.9% a year ago. The decrease in our effective tax rate relative to our guidance reflects the impact of higher tax deductions related to stock-based compensation. These deductions benefited EPS in Q1 by approximately $0.02. We still expect our tax rate for 2019 to be approximately 28%.

Net income for the quarter was $96.6 million or $0.74 per diluted share compared to earnings per diluted share of $0.55 for the first quarter of 2018. Capital expenditures were approximately $68 million for the quarter compared to approximately $34 million in the first quarter last year. The increase relates primarily to store capital for new locations, relocations and renovations and IT and supply chain investment.

Turning to our balance sheet highlights. We ended the quarter with $576 million in cash and cash equivalents. Inventory grew 19% and was $443 million at the end of Q1. I'd also note that pursuant to the new lease accounting standard ASC 842, we added a lease related asset of $627 million and lease related liabilities totaling $665 million to our balance sheet. This new accounting standard has no impact on our income statement or cash flows.

We repurchased 1 million shares during the quarter at a cost of $163.5 million. Coming into 2019, our Board authorized a new $500 million share repurchase plan of which approximately $337 million of authorization remains. We believe that repurchasing our shares is an efficient and effective way to return excess cash to shareholders and will continue to be opportunistic with our repurchase activity.

Turning now to our outlook. For Q2, we expect revenues to be in the range of $825 million to $835 million. This is based on a comparable sales percentage increase in the low double digits on a constant dollar basis, compared to the second quarter of 2018. This also assumes five new store openings in the quarter. We expect gross margin to be flat to up modestly versus Q2 of last year. Our guidance reflects a modest impact from potential new tariffs and also additional costs to airfreight product in order to avoid anticipated port congestion in the Asia region due to the pending tariff increases.

The negative impact of these costs will be approximately 20 to 25 basis points within gross margin and approximately $0.04 to $0.05 on EPS for the full year 2019. Most of the impact would come in the back half of the year with the majority in Q3. I should note that roughly $0.02 to $0.03 of this impact would be incurred regardless of whether new tariffs are imposed. We are committing to higher airfreight usage at the hedge against disruption in ocean shipping lanes as we approach the key dates related to tariff increases.

This will ensure delivery of new product for our guests on time. We expect the SG&A rate in Q2 to be flat as we continue to invest in growth drivers for our business that fuel top-line momentum. We see larger opportunity to leverage this SG&A in the back half of the year and we continue to expect modest leverage on the year. Assuming a tax rate of 28% and approximately 131 million diluted weighted average shares outstanding, we expect diluted earnings per share in the second quarter to be in the range of $0.86 to $0.88 versus EPS of $0.74 a year ago.

For the full year 2019, we now expect revenue to be in the range of $3.73 billion to $3.77 billion. This is based on a comparable sales percentage increase in the low double digits on a constant dollar basis. We continue to expect to open approximately 40 to 50 company operated stores in 2019. This includes 25 to 30 stores in our international markets and represents a square footage percentage increase in the mid-teens range. We expect gross margin for the year to expand modestly, primarily driven by continued product margin improvement. We expect SG&A for the full year to leverage modestly.

We expect our fiscal year 2019 diluted earnings per share to be in the range of $4.51 to $4.58. Our EPS guidance is based on 131 million diluted weighted average shares outstanding for the year. This range takes into account approximately $0.04 to $0.05 of additional cost within gross margin related to the tariffs and airfreight that I mentioned earlier. We expect our adjusted effective tax rate to be approximately 28% in 2019. We assume the Canadian dollar at $0.75 to the US dollar for 2019, as well as Q2. We continue to expect capital expenditures to be approximately $265 million to $275 million for the fiscal year 2019.

This increased versus 2018 reflects a ramp up of our store renovation and relocation program, new store openings, technology investments and other corporate infrastructure projects. In closing, we remain excited with the momentum we're seeing in the business as our teams are executing our new power of three strategic plans. And now back to Calvin for some closing remarks.

Calvin McDonald

Thanks PJ. While it's been reported there is some recent softening in the apparel space, there is no doubt that 2019 is off to a great start for us. We're building upon the momentum of the past year and instilling confidence in our long-term growth plans. With each new market and innovation, we are inspired by the way in which our guests, both existing and new to the brand are responding to Lululemon. Our vision to ignite a community of people to live the Sweatlife is resonating strongly with guests and provides many growth opportunities for us ahead.

We remain laser focused on leveraging our strengths and creating opportunities to ensure Lululemon continues to rise above the near term challenges being faced by others. I'd like to thank our teams around the world for the passion and spirit they bring with them to work every day. Their dedication to our guests and energy for our brand makes us level of sustained performance possible.

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

Question-and-Answer Session

Operator

[Operator Instructions]

The first question comes from Matthew Boss of JPMorgan. Please go ahead, sir.

MatthewBoss

Thanks and congrats on another great quarter, guys. I guess maybe first could you elaborate on the current momentum that you're seeing in the business? If you've seen any impact from the recent lateral apparel softness that you mentioned. And just how you rank back half opportunities maybe by category?

CalvinMcDonald

Yes, sure, Matt. In terms of Q2, we remain very happy with the momentum we're seeing in the business which is reflected in our comp guidance of the plus low double-digit, which is on top of a 19% last year. So the business has continued to see very strong trading into the quarter. And that growth is coming across all levers of the power of three. In product, our men's business as we shared up 33% continues to be very strong across all categories. Tops, boxers and the bottom business and our women's business equally are showing very solid and very strong growth and particular bottoms driven by leggings and joggers. And we -- with what we're going to be launching in terms of newness that momentum we believe will continue as we continue to feed the core with more innovation and test and learn into new categories and build out the key categories we want to win being yoga, train and runs.

So we feel we feel very good about the product launches that are dropping and the momentum and the way the guest is reacting to the product as they see it.

Operator

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

IkeBoruchow

Hey. Let me add my congrats. I guess I'm going to throw this question to Stuart, it's very compelling stuff you've got on China with the .cn roll out. I guess this over time, Stuart, can you maybe talk about how you see the mix of your digital business in China the .cn site versus Tmall and may be relative profitability between the two? If there's any nuances we should keep in mind. Thanks.

StuartHaselden

Sure, Ike. So the business vision that we have for China is certainly more heavily considered from a digital standpoint than North America. As we've said in some of our prior conversations, we can see the business in China being 50% online and the structure of the industry in China is also important and creating that environment to make that possible. And when I say that structure I think part of that is the marketplace structure that we're all aware of with WeChat and Tmall and the dominance that they have in the Chinese market.

So we participate in that but we're very cognizant of how our brand is being introduced and developed, and where we take important steps to ensure that we have a very premium positioning for the brand. We see Tmall continuing to be an important part of the overall digital business mix for us, but we see our own .cn site and our WeChat site emerging and taking a larger proportion of our digital business in time. We're making investments now to make that possible and we'll share those details with you as they develop. But the launch of the .cn site or the relaunch I should say of the dots cn site that we mentioned in the first quarter is an important part of that.

And generally just the expansion of the store footprint will drive brand awareness. We're seeing great traction broadly across China and a lot of signals that are suggesting that our brand is gaining traction. So that will --that will support and fuel truck traffic and our business across all channels. So I think those are things I'd point to in terms of just how we're thinking about the digital part of our business there.

IkeBoruchow

And could you just elaborate on the margin structure of the .cn versus Tmall over time opportunity?

StuartHaselden

Yes, for sure. Overall, there is an advantage from a digital versus stores that is directionally consistent with what we see in North America in terms of the bottom-line contribution margin for the digital business versus stores. That said, there is incremental cost that we incur to operate on the Tmall platform but it's still an attractive contribution margin that is still higher than what we see in our store business.

Operator

The next question comes from Kate Fitzsimons of RBC Capital Markets. Please go ahead.

KateFitzsimons

Yes, hi, guys. Congratulations on the strong results. I guess my question would be the 2019 outlook on gross margin. Just how should we factor in some of these non merchandize items. PJ, you did mention the 20, 30 the headwind from flying in goods ahead of the port congestion, but we think about these other merchandise items such as rent, occupancy and the product and supply chain cost as well? Thank you.

PJGuido

Yes. Hey, Kate, this is PJ. So what's driving gross margin going forward so the biggest driver does remain lower product cost. We did have a pickup and markdown and mix. Would you see remaining opportunities in scale segmenting the supply chain, greater efficiency across the distribution network. That said so there are some pressures and those pressures are related to DC investment. So we open Toronto. There was some start-up costs there - are co-located in our international stores carry higher rent. So we'll see a little bit of pressure from occupancy and depreciation, but that for the quarter was relatively minimal.

And then going forward, we're going to continue to develop product, right. So with the new categories bras, outerwear. So we are spending money to continue to build out our product assortment. So again net-net we will see modest expansion as we've guided to but there will be a little bit of pressure from those items I just mentioned.

Operator

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

AdrienneYih

Good afternoon. Congratulations, great quarter. Calvin, I was wondering if you can give us an update on the Robert Geller and lab collections. And any learning thus far for your go forward strategy? And then PJ just to clarify the comments you made on the tariff were those increase from 10% to 25% on list three or is this predicated on the list four? And can you give us the amount of sourcing directly out of China at this point? Thank you.

CalvinMcDonald

Great. I'll kick off and just comment on both Robert Geller and lab. On Robert Geller, we're very pleased with the results of the collaboration and similar to many of the collaborations we've done, our guests are responding very favorably in general to this newness in an opportunity to either buy into a new category or a unique aesthetic. With Robert Geller in particular, some of the key learnings was this one showed up very strong from an international perspective in particular in our Asia-pacific markets, which is really exciting when we think of the opportunity for these collabs going forward.

The marketing buzz through social was significant behind this collaboration which is exciting as we look for ways to continue to leverage our marketing and create an impact in acquiring new guest and raise the awareness of the brand which then leads to the final in a learning which is -- it responded very well with recruiting new guests into the brand, but equally our current guests were heavily engaged in the product which is a great opportunity for us as we look for ways to continue to broaden and increase the share of wallet with our highly loyal and high spenders.

So overall the collaboration performed very well with a lot of key learnings. In the lab, those ideas will feed into our lab of which we shared earlier we're planning some shopping shops in the fall. And we'll continue to expand and roll out from there.

PJGuido

Great and then on the second question about tariffs, I'll point out just a few things. So first, I think it's important to mention that our direct exposure to China is relatively small with 6% of our total finished goods exported for China to the US and so for tariff. To answer your question, so currently under the Tranche Three tariffs only 1% of our finished goods are subject to that. The balance, the additional 5% would be subject -- that would be part of the transport tariff.

So that's the direct impact. The better part of the expense is really coming from this indirect exposure we have. We're anticipating port congestion right around the timeframe starting in that mid to late July timeframe and we think it's prudent and important to deliver new product for our guests and protect the sales associated with those goods. So really the larger airfreight that I mentioned.

Operator

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

PaulLejuez

Hey, thanks guys. I'm curious as you open stores in some of your less mature markets, if you're seeing a lift to your e-com business in that market? If there's any way could you quantify that? And second what percent of your product sales come from new SKUs and what was that number in 1Q and if you do try to quantify it that way. And I'm curious about what is your philosophy about what that percentage should be over time coming from new SKUs versus existing winners? Thanks.

StuartHaselden

Hey, Paul. It's Stuart. I'll speak to your first question on our less developed markets. What we see in our international region is consistent with our experience in North America in that. As we open new stores we see our web business, our e-com business accelerate in and around the trade area where we open the stores. And we -- but we also use our digital business, our e-com business as a guide to understand where we might open, look to open new stores, where our demand and brand awareness is gaining traction. That is an indicator that factors into how we rate markets and trade areas as potential candidates for new stores.

So that experience has proven consistent in our international markets. And we really see a positive synergistic effect of the footprint, the growing footprint of the store, the store fleet in driving awareness in traffic across both channels.

CalvinMcDonald

And Paul relative to the second part of your question, the majority of our sales growth is coming from our core products. Our core franchises that we either continue to innovate on or introduce new color palettes which the guests are responding very favorably to. We do introduce a number of drops on a weekly basis, the guest responds very well to those. We monitor but don't share sort of the makeup as a percentage of sales, but overall core is driving our business. We take franchises and innovate behind them and I think we shared metal bend that's coming in Q3, tail end of Q2 which is a wonderful innovation on a very powerful strong franchise that will continue to drive.

And as we test and learn into new categories as we expand into yoga, train and run, an OTC which is the areas that we mentioned our focus areas for the merchants and our product teams to design into. The growth is coming from core.

Operator

The next question from Omar Saad who's with Evercore ISI. Please go ahead.

OmarSaad

Hey, thanks for taking my question. I wanted to ask about the most recent round of the loyalty launch. What you're learning from that? Now I think it's in the third iteration. When do you expect to roll it out more broadly/ How are -- what kind of data are you accruing from the program at the local market level? It's pretty incredible to me the results you're putting up without even really having that data, customer level data behind some of the decision-making. So intrigued to hear more and how big of a lever that could be? Thanks.

StuartHaselden

Great. Thanks, Omar. We did roll out so we're now testing in Edmonton in Denver and Austin and each market we tweak the programs slightly from the product that we make available to the guests to the price point that we make available to the guests to the price point as you know we raise the price point in our later tests to see how the gust would respond. We are playing with the events which are the primary benefit from joining in to the membership. And in each market, the results have been well above our expectations going in very favorable from the guests and we continue to tweak and learn and do plan to roll into more markets. And we'll have more to announce at a later point in time.

But 2020 is year in which we see expanding into more markets and we are very excited about the potential of this membership in the platform to drive new guest acquisition, which is what we're seeing with the program which is super exciting, driving guest loyalty and engagement into the brand, which is what we expected. But also on the back of having to be a revenue stream for the business in a way in which we can achieve and drive that engagement through that system.

Operator

The next question comes from John Kernan who's with Cowen. Please go ahead, sir.

JohnKernan

Good afternoon. Thank you taking my question. I wanted to go back to the buy online, pick up in store. I think it's scaling from 35 to 150 stores and it's a full rollout I think you said by the end of the third quarter. What are your learnings from this and how much of it incremental driver of demand do you think this can be?

CalvinMcDonald

And I think -- so you're right, we rolled up to 150 stores and our plan is to have all stores up and running by end of Q3 which will put us in great standing for the holiday. And I think we'll learn a lot when that happens and as we're rolling out, we're happy with the results, equally internally operationally 80% of the orders that are placed are ready for pick up within one hour, which I think is an important internal metric for us because it just sort of talks to the operational readiness and engagement so that as the demand from the guests accelerates, we're ready to be there to service them. As we roll out to more stores we're able to position it differently within the website experience and the checkout making it a lot more known and really start to market it.

So early indication is encouraging. We think it's a necessity and leveraging our omni strategy which is one of our pillars of growth. So we know we need to do it and I think this fourth quarter when we're in full rollout and we're marketing it aggressively on our website and in the checkout a guest really know it's an option across the full fleet will really learn, but I'm encouraged by it and I think it would be a wonderful way to continue to drive our traffic into the store, drive that incremental pickup and in contribute to the top-line.

JohnKernan

Got it and then just on that topic, obviously the Lincoln Park store opening in Chicago, is this a test or is this like larger scale experiential type store something you think is that you're considering scaling even greater?

CalvinMcDonald

Well, it's definitely a test. We, as you know, our vision is just to be an experiential brand and we know we can deliver those experiences both within the store and outside of the store. And we do that very effectively across the fleet today. What Lincoln Park will allow us to do is to bring a lot of those experiences inside the four walls into the community on a consistent basis. So it is a test and we will learn from that. And then figure out how within our flexible fleet that we have today from seasonal stores to small up to our large format. This we believe could become just another mix within our portfolio of how we go into a market and deliver our experience to our guests. But it's a test we're going to learn and we'll go from there.

Operator

The next question comes from Camilo Lyon who's with Canaccord Genuity. Please go ahead.

CamiloLyon

Thank you. Good afternoon, everyone. Really great job here. Calvin, I think in your comments about the strength of the women's business, you talked about the bottoms category continuing to be a leading category for you. But what was interesting to us was the mention and call out of joggers. Can you talk about how your female consumer is expanding their aperture with respect to your offering such that you're giving the larger share of closet? It seems like that is starting to manifest in a way that could serve you well from the perspective of creating a bigger moat around the customer that you've invested in all these years.

CalvinMcDonald

Yes. No for sure. What I would tell you in terms of our business both across men's and women's, but I'll speak specifically to women's is the number of new guests we're seeing, as well as our reactivated guests in addition to a current active guests. So bottoms continues to be the number one driver of new guest acquisition and both leggings and joggers are performing incredibly well at achieving that, as well as we dial up our digital marketing initiatives and our email campaigns, we're proving that many of those tactics are proving very effective to reactivate guests into the brand.

And then as you've mentioned to grow that share wallet which is equally something that we're focused on in exciting. So bottoms really are a very balanced growth across those three pillars. When we look to building out our core and filling in the assortment opportunities we have around yoga, train and run as well as OTC, we expect that much of that will drive the share of wallet with our existing guests because what we're doing is truly bringing incremental assortment in choice to her and him but in this case to her in the categories in which she sweats today, where we don't have product offering but we know we have an opportunity to deliver it through our unique lens of science of fields.

So moving forward we expect to continue to grow that share of wallet. And as you mentioned depth of wardrobe and see a lot of opportunity to do that by just expanding into the sweat categories we already have a relationship for or with her today.

CamiloLyon

Great, thank you. And my following question relates to the differences between your existing guests purchasing behavior and the new guests that you're bringing into the store and into the brand. So is there any color you can provide in terms of this -- the average trend between those two cohorts? I think it would be helpful in determining what the opportunity is of taking that new guests up that spend curve and have that person or that guest look like a more mature higher spending consumer over x amount of time or month or what have you.

CalvinMcDonald

Yes. We don't share sort of the average spend across our different guests. What I can tell you are directionally that our email file growth continues to be very strong, as well as our new guest acquisition. And as we're building our CRM capability, our ability to then migrate or trade up those guests into new categories or deeper into the categories they're in is proving to be a very effective way in which we're keeping the guests very engaged and active, as well as increasing the share of wallet. But equally focus on our high value guest which we have incredible loyalty retention numbers within retail.

So they're highly engaged. Their retention numbers are very high and getting them to continue to engage in the category and drive growth is proving very [Technical Difficulty] is a big area focus for us and something that we're really excited about as we look to yoga, train and run and OTC as categories where we can expand the assortment with that engagement and retention to be able to increase the share of wallet that whole CRM initiative is a big area. We're seeing some really good success from it.

Operator

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

KimberlyGreenberger

Great. Thank you so much. PJ, I wanted to just follow up on the potential port congestion. I'm wondering what you're hearing from your production department around the risks of port congestion. Is it the ocean cargo capacity is tight right now or is there other signals that your production department is seeing that suggests we could see this port congestion either late second quarter early third quarter? And with regard to your early third quarter and with regards to your deliveries in particular, it sounds like you've protected all of your deliveries from these potential delays but I just want to confirm that you don't have any inventory on order that would be at risk of late delivery.

And then I wasn't sure if I missed it but did you offer any color guidance on the second quarter SG&A? Thanks so much.

PJGuido

Yes. Thanks, Kimberly. So I'll pick those one at a time. So with regards to the airfreight, you're exactly right. We are protecting our fall deliveries. And that's why we're doing it, it's a hedge. So we're eliminating the risk. I mean there's always summers but we're eliminating most of it by utilizing airfreight and not getting caught up in the congestion which is we've seen this before due to tariffs companies trying to get out ahead of it, but there is also a broader issue with carriers consolidating cargo. They refer to it as trans shipments but that's a separate issue that's related more to carriers but that is an issue we're dealing with as well.

So hopefully that answers your question on port congestion. On SG&A, so we are committed to modest SG&A leverage for the year. We remain focused on that. As we mentioned before, we're using strong performance to invest in current and long-term growth. And we're seeing a result from that. During this quarter, we leaned into digital marketing, focused on building brand awareness, driving the guest acquisition as Calvin talked about we're expanding our testing of new growth vehicles, loyalty, self care focus. And then we continue to invest in our North American online guest experience. And that data and analytics to drive conversion.

So the last few quarters have seen -- we've ramped up our investment. We'll start to see the benefit of those in the back half and for Q2, we're calling for flat on SG&A and we see the bigger opportunities in our biggest quarters Q3 and Q4 to add leverage to SG&A. But for now we're still making investments and we still feel like that's the right strategy for the business.

Operator

The next question comes from Brian Nagel who's with Oppenheimer. Please go ahead, Brian.

BrianNagel

Yes. Congrats on very nice quarter. I want to get a little [Indiscernible] if you look at the gross margin trajectory here in Q1 clearly still very solidly positive year-over-year, but the rate of your increase has moderated that over the past a few quarters or so. My question there is if we can understand better with what's occurred to sort of say facilitate that more modest rate of -- more modest pace of gross margin expansion. And how should we think about that line going forward?

StuartHaselden

Hey, Brian, it's Stuart. Let me speak to that in terms of the drivers within our supply chain that are -- that had delivered the improvement over the last few years. And then I think more specifically to your question more recently, so we were able to build the programs that delivered the larger more step function improvement in 2016 and 2017. And we've been able to take that forward into 2018 and 2019 and it's a part of our long-term guidance that PJ outlined at our Analyst Day to deliver modest gross margin improvement over the next few years.

There are really four things that are driving that. Scale, price breaks from volume increases. Second thing is segmentation of our supply chain as we are able to drive more of our assortment into the lower cost segments of our sourcing strategy. The third thing is transparency as we're able to drive greater degree of specific production standards and costing negotiations across a broader part of our assortment. And the fourth thing is the distribution efficiencies that PJ also mentioned. So those four things are the drivers of our gross margin improvement. They -- we are lapping some very significant improvements. They will naturally moderate into the future but we still see significant opportunities over the next several years reflected in our guidance.

BrianNagel

That was very helpful, I appreciate it. If I could slip in maybe a quick follow up then. Just with regards to sales, I think Calvin I think you mention in your prepared comments in which you made reference to some of the soft lines or apparel type weakness out there and clearly that did not occur in the Lulu results as we are looking at the results day, but the question I have is as you look closer to business whether it be geographically across the country or even month-to-month, week-to-week, could you see any signs at all behind these very, very strong numbers of some stress on that consumer within the category.

CalvinMcDonald

I think when we look at Q1 and as we've shared the balance across our product categories both men's and women's, both bottoms and tops, our brand activations be at some of the tests with membership or the event activity that we're doing being able to leverage our improved data analytics and digital marketing. I mean our guest was responding and as we shared store traffic of plus 8% in over 40% in e-commerce is a good healthy metric of a highly engaged guest. And we did not as we don't typically see in our business significant swings week-to0week or season-to-season or holiday-to-holiday.

So I would through Q1 we were very pleased with the momentum consistent with traffic driving a big piece of that business in both new guests as well as existing guests and balanced across our product range.

Operator

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

DanaTelsey

Good afternoon, everyone and congratulations on the terrific results. As you look at the comp beyond the traffic how are the other components of comp and how did they compare the last quarter what you're seeing? And is there any more color on the merchandize margin and the progress there? Thank you.

PJGuido

Hey, Dana, it's PJ. So with regard to comp drivers, it is predominantly a traffic story. Again traffic in stores update percent online over 40%. The North American conversion online has shown significant improvement due to our ongoing investment there. So we're seeing a result there. As far as AUR and UPT, they have effectively -- we have a relatively stable average order value or basket size. So it's predominantly a traffic story.

End of Q&A

Operator

This concludes time allocated for questions on today's call. I'll now turn the conference back over to Howard Tubin for any closing remarks.

Howard Tubin

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

Operator

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

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