Lululemon Athletica Inc (LULU) — Q2 2018 Earnings Call Transcript

Thank you, and good afternoon. Welcome to lululemon's second quarter earnings conference call. Joining me today to discuss our results are Glenn Murphy, Chairman of the Board; Calvin McDonald, our new CEO; Stuart Haselden, COO; PJ Guido, CFO; and Celeste Burgoyne, EVP of America, who will also be available during the Q&A portion of the call. Before we begin, I want to remind you that our remarks today will include forward-looking statements reflecting management's current forecasts about certain aspects of lululemon's future. These statements are based on current information, which we have assessed, but they are inherently dynamic and subject to rapid changes. Actual results may differ materially from those included in or implied by these forward-looking statements due to risks and uncertainties associated with our business, including those disclosed in our most recent filings with the SEC, such as our Annual Report on Form 10-K and our quarterly reports on Form 10-Q. Any forward-looking statements we make on this call are based on assumptions as of today, and we expressly disclaim any obligation to update or revise these statements due to 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 quarterly report are available under the Investors Section of our website, www.lululemon.com. Before we start, I encourage our investors to visit our investor site for a summary of our key financial operating statistics for the second quarter, along with our quarterly infographic. Today's call is scheduled for one hour. And now, I would like to turn the call over to Glenn.

Thank you, Howard, and good afternoon, everybody. We had a very strong second quarter, and because of that, I thought I'd just make a couple of brief remarks at the beginning and then pass the call on to a number of speakers you're going to hear from today, including our new CEO, Calvin McDonald. Obviously, I want to acknowledge the performance. The second quarter of this fiscal year was very strong. And it was very strong across all facets of the business, whether that's across different product categories, our channels of contact with our guests, and across all our markets. That was just an impressive second quarter result for lululemon. I want to thank people who made the contribution and made this happen. And that's our management team, our educators, and all other employees, whether in distribution centers, call centers, or in our offices, who worked together to produce these results. In particular, I do want to single out Celeste, Stuart, and Sun, who stepped up 6 months ago, and their leadership to the people I've identified earlier across our entire company. Their focus played an incredible role in the results that you're going to hear about later on. So I want to thank them on behalf of the Board of Directors. And now I want to welcome Calvin McDonald. This is Calvin's first call with investors and analysts, first of many. He is in an enviable position because the business is performing well. There's always more we can do and more opportunities for our business. But because we're in a strong position today, Calvin can take his time. He can do a lot of listening, meet with people, understand our strategy and processes, and what makes the company tick. He has the full confidence of the board. We did a very exhaustive search, and we believe he clearly is the right CEO for the future and will take us from strength to strength. So with that said, I want to welcome Calvin McDonald, the new CEO of lululemon.

Thank you, Glenn, for the introduction and for the support you have provided me as I jumped into my new role. I'm excited to speak with you from Vancouver as a member of the lululemon team. As this is only my second week on the job, I will keep my comments brief. First and foremost, I'd like to congratulate the team on the tremendous results we've just posted for quarter 2 and the strong momentum we're now seeing into quarter 3. I'm very excited to now be part of helping to create the next chapter of growth at lululemon as we continue to build on this success. Stuart and PJ will take you through the details of our quarter 2 results and forward guidance. But first, let me offer some color on what attracted me to lululemon and my initial impressions after 10 days on the job. Being the CEO of lululemon is my dream job. I've chosen to focus my career on retail and brand building because I love to work with people, create product, and innovate. I'm also an athlete. The opportunity to combine my professional passions with my personal ambitions makes this opportunity so exciting. Firstly, the people of lululemon are an especially inspirational group, which has been very clear to me over the past 2 weeks. The unique culture focusing on leadership, personal development, and driving results is at the root of our success. It's both humbling and energizing to join such a talented group, and I look forward to working with the leadership team to help take us to the next level. Secondly, the product at lululemon is exceptional. I've been an avid guest for years and a fan of the product. I believe the quality, fabric, fit, and technical innovation stand far above our competitors. It's thrilling to help develop these unique attributes into new areas. Finally, innovation at lululemon is a core component of our DNA. The brand is iconic, and our guests have given us permission to think about how we expand our offerings to them in both product and services. Combined with the talent on this team, the future opportunities are very exciting. I look forward to how we continue to develop our guest ecosystem, connected via digital across all of our channels and geographies, and extending our capabilities in loyalty where we have the opportunity to create something unique that will further differentiate our brand. The combination of these elements—people, product, and innovation—is my passion, and I'm thrilled to see where we can take them here at lululemon. Before I pass it over to Stuart, I'll conclude by telling you how I plan to spend my initial time at the company. I feel it's important to meet as many people in the organization as possible. In my initial weeks and months, I'll spend time in every part of the organization: in stores, our store support centers, our distribution centers, and our guest education centers. My approach is to listen to and learn as much as possible about the organization and our guests from the teams across the company and to become grounded in everything lululemon. This is a very exciting time indeed to be joining lululemon. It's great to speak with you all today, and I look forward to getting to know you over the coming weeks and months. And with that, I'll now hand it over to Stuart.

Thanks, Calvin. Let me also welcome you to lululemon. We're really excited to have you join the team and look forward to working with you on our next phase of growth. Our second quarter results mark another important step in the journey toward our 2020 goals, as well as the continuation of the top-line inflection that began last year, which we now see extending into Q3, reflected in our sales outlook for the quarter. In fact, we're now tracking to meet or even exceed a $4 billion revenue goal, with men's and e-commerce effectively ahead of schedule. Our product assortments and supply chain work continue to exceed expectations, contributing to our gross margin, which is now firmly reaching the mid-50s range. This result, combined with our solid SG&A management, has produced a trailing 12-month EBIT margin of nearly 21%, delivering on our goal of a low 20s operating profit. It's important for our investors to understand that we still see opportunities for margin expansion as we further invest in these already successful initiatives, including expanding our e-commerce business, segmenting our supply chain, reducing lead times, and expanding our distribution network. We believe our margins can continue to expand into the future. Turning to the headlines for Q2, we saw a broad-based acceleration in our business across an array of categories, channels, and geographies. We said on the Q1 call that our great results in that period were not simply a case of lapping weak prior year comparisons, and our Q2 results continued the story, reflecting the success of our ongoing structural investments. Combined comps for the quarter increased 19% on top of a 7% increase last year. This top-line growth, along with significant improvements in gross margin and SG&A, delivered an 82% increase in EPS for the quarter. By channel, we saw store comps increase 10%, and digital was up 47% versus a strong prior year comparison. This continued strength in our comps reflects the success we are seeing in our guest acquisition that increased 30% in the quarter, fueling traffic increases across all channels. Specifically in stores, we saw a high single-digit lift in traffic, while traffic to our e-commerce site grew over 20%. Improved product assortments and better brand and community-building efforts, including several successful activations, also contributed to these strong traffic trends. We're also particularly pleased with the ongoing strength in e-commerce, which posted double-digit conversion and average order value increases in Q2, as our digital business continues to benefit from last year's site relaunch in Q3. Our guests are responding well to the improved experience, and we still see opportunities to remove friction and increase efficiency on the site as we continue to improve the search and checkout functions as well as expand further into personalization. Our product assortments also performed well across practically every category in Q2, with double-digit increases across women's, men's, and accessories. Women's pants, which is our highest margin category, along with men's pants, both posted comps over 30%. And women's tops generated another healthy double-digit increase as we gain traction in this category. It's also exciting to see accessories delivering its strongest quarterly comps in the last 5 years at over 20%. Q2 saw several successful brand activations, and an important moment for all of us here at lululemon was how we celebrated International Day of Yoga. Stores in more than 50 cities around the world hosted successful yoga classes on June 21, and we donated over $1 million through our Here to Be social impact program. We are incredibly proud of Here to Be, which benefits nonprofit groups that increase access to yoga and meditation for communities facing barriers to well-being. We continue to invest in this program to effect positive change in the communities around the globe where we work and live. Turning now to our growth pillars, I'd like to offer some details on our strategic priorities, which continue to be extending our success in our digital channels, ramping our international expansion with a near-term focus on Asia, innovating our product assortments with a focus on accelerating growth in men's, and continuing to roll out stores in North America that build on our important store format innovations. Our teams continue to deliver great results across these areas, which is setting the stage for our next chapters of growth. I'll share some highlights on our progress within each of these pillars now. In digital, it's exciting to see our momentum continuing to build. Excluding the warehouse sale from last year's results, the constant dollar comp was 65% for Q2. As I mentioned, traffic and conversion continue to be strong as both new and existing guests are responding well to our enhanced online experience. Over the last 12 months, we've doubled the number of guests we can communicate with, and in Q2, we saw 80% growth in our email file. We continue to see significant opportunities to enhance our digital guest experience. You've heard us talk about improvements we're making this year in checkout, search, and personalization. Let me offer a couple of updates here. In checkout, in Q2, we saw a significant increase in the percentage of guests completing the checkout process, reflecting ongoing tactical improvements to the site. In personalization, we now have our initial data scientist teams embedded within our brand teams, who help deliver insights used to inform and drive our successful Father's Day campaign. We are making steady progress and expect to see ongoing improvements over the next several quarters. Turning to our international business, our combined comps in Asia increased 50% this quarter as we continue to build momentum in the region. Importantly, in China, our e-commerce business continues to lead the way with a comp increase of over 200%. We lost our WeChat store in China in Q2 and remain on track to launch e-commerce sites in Korea and Japan later this year. In Europe, comps were again better than planned, an increase in the strong double digits. While we still have much work to do in this region, we're excited to see that our brand is resonating. We opened our first store in Sweden in a key destination city, Stockholm. In London this quarter, we hosted another successful Sweatlife Festival in which we partnered with 13 studios to offer over 250 classes and attracted over 4,500 guests. Within product, we lead with innovation and continue to find success in our core classifications as we leverage our key franchises, including a line for women and ABC for men. Guests are also responding well to our newer office travel commute styles, including the 'on-the-fly' collection, which offers versatile and 'away from the body' silhouettes. Our men's business continues to accelerate, reaching a total penetration of 22% in the quarter, with great new styles planned for the second half. Looking forward to fall, we're really excited for the expansion of our outerwear business. Despite the heat in August, we're already getting great initial reads on our early jacket and outerwear offerings. Our North American stores continue to post impressive results, with store traffic accelerating sequentially for the past 5 quarters and now extending into the early part of Q3. We opened 4 net new stores and completed 7 co-located remodels in Q2. We expect to open approximately 40 new locations in total by year-end. Additionally, we're seeing great success with our seasonal store strategy with 23 opened at the end of Q2 and plans to more than double that number into Q4. We also remain on track with our 'buy online, pick up in-store' initiative, which will begin to roll out later this year. Combined with the ship from store and our endless aisle store app, these omnichannel capabilities allow us to better serve our guests while leveraging inventory across both our store and e-commerce channels. I also want to highlight our integrated brand-building efforts. We are now better able to combine the power of our community model with the improving power of our digital capabilities to better deliver our message to our new and existing guests. In Q2, building on last year's success, we sponsored 10k runs in Toronto and Edmonton. Across both races, we saw over 13,000 runners participate, including 4 Olympians, and garnered 9 million impressions on social media. Looking forward to Q3, we will continue our global outreach via a collaboration with Francesca Hayward of The Royal Ballet in London and we are thrilled about our plans to celebrate our 20th birthday, which started this month and continues through September. Without giving too much away, we plan a truly integrated celebration, which includes digital in-store events and a special capsule collection; a fitting way for us to recognize and celebrate our brand over the last 20 years while looking ahead to the next chapter. Before PJ provides the details on our financial results, I wanted to offer a few final comments. While we are pleased with our current performance, we're laser-focused on leveraging this momentum to enable a strong 2019 and beyond. Specifically, we are making a number of investments in the second half of the year, which PJ will speak to that will help us test strategies to potentially scale into next year. These tests consider multiple parts of our business, including experiential retail, digital guest engagement, and conversion drivers across all channels. More to follow on this, but we are excited to build on our current success with these investments to help shape our future. And finally, I would like to thank Glenn for his support during our transition period, and I especially want to thank Celeste and Sun for their invaluable leadership in driving these incredible results. We're now excited to have Calvin on board and look forward to supporting his transition. Importantly, we'd all like to express much gratitude to our teams and our educators, in particular, around the world. It is only through their hard work that any of this is possible. I will now turn it over to PJ.

Thanks, Stuart. Our brand-building efforts, guest engagement, and innovative product offerings continued to translate into very strong financial performance. Before I offer some highlights of that performance, I will refer you to the financial supplement posted on our investor site for additional details. For Q2, total net revenue rose 25% to $724 million, driven by great execution across all parts of the business. In our store channel, we delivered a 10% comp store increase on top of the 2% increase in Q2 of last year. Lululemon-branded stores square footage increased 13% versus last year, driven by the addition of 42 net new lululemon stores since Q2 of 2017. During the quarter, we opened 4 net new lululemon stores. In our digital channel, we saw strong traffic and higher conversion that resulted in a 47% comp increase. For the quarter, e-commerce contributed $167 million of top-line or 23% of total revenue. I will note that the impact of foreign exchange increased revenues by $2.8 million for the quarter. Gross profit for the second quarter was $396 million or 54.8% of net revenue, compared to an adjusted 51.6% of net revenue in Q2 2017. The gross profit rate in Q2 increased 320 basis points versus adjusted gross margin last year. This exceeded our expectations for the quarter and was driven primarily by the following: a 260-basis-point increase in overall product margin resulting from lower product cost, favorability in product mix, and lower markdowns versus last year. We're particularly pleased that this increase comes on top of a 260-basis-point improvement in product margin last year. Additionally, we realized 70 basis points of leverage on occupancy and depreciation, a result of the strong top-line results. We saw a 20-basis-point favorable impact related to foreign exchange in the quarter, partially offset by a 30-basis-point increase in product and supply chain administrative expense. Moving down the P&L, SG&A expense was $262 million or 36.2% of net revenue compared to 38.8% of net revenue for the same period last year. We're pleased that we were able to deliver leverage significantly higher than our expectations. More efficient spend in both our FSC and store channels, coupled with leverage from higher-than-planned sales generated approximately 280 basis points of leverage. This was partially offset by 20 basis points related to foreign exchange. Operating income for the quarter was approximately $134 million or 18.5% of net revenue, compared to an adjusted 12.8% net revenue in Q2 2017. This represents a marked improvement in overall operating profitability of 570 basis points. Tax expense for the quarter was $40 million or 29.5% of pretax earnings compared to an effective tax rate of 29.9% a year ago. Normalized for charges related to last year's ivivva restructuring, the adjusted effective tax rate for Q2 2017 was 29.6%. Net income for the quarter was approximately $96 million or $0.71 per diluted share compared to earnings per diluted share of $0.36 for the second quarter of 2017. Excluding charges related to the ivivva restructuring, adjusted EPS in Q2 2017 was $0.39. Capital expenditures were approximately $50 million for the quarter compared to approximately $30 million in the second quarter of last year. The increase relates primarily to IT investment in supply chain, data and analytics, and further enhancements to our e-commerce platform in addition to new store builds and store renovations. Turning to our balance sheet highlights, we ended the quarter with $778 million in cash and cash equivalents. Inventory grew 24% in line with sales and was $393 million at the end of Q2. Pursuant to a $600 million share repurchase authorization put in place in June, we repurchased a total of 3.4 million shares at a total cost of $406 million during the quarter. This included our participation in a block trade executed by one of our largest shareholders. As part of Advent's total sale of 10 million shares, we were able to repurchase 3.3 million shares at a total cost of approximately $400 million. Due to the opportunistic timing of the trade, we used a combination of available cash and short-term borrowings to fund the repurchase. As a result, we ended the quarter with $100 million of debt under our revolving credit facility, which has since been fully repaid. We expect to end the year with a debt-free balance sheet and continue to evaluate further share repurchases through a broader capital allocation lens that balances working capital, investments, and shareholder return considerations. We had $193 million of remaining authorization under the current share repurchase program at the end of Q2. Turning now to our outlook. Given our momentum and the recognition of what is currently working to drive our business, we are taking up our guidance for the year. And as a reminder, 2018 is a 53-week year for us. For Q3, we expect revenues to be in the range of $720 million to $730 million. This is based on a comparable sales percentage increase in the low teens on a constant-dollar basis compared to the third quarter of 2017. This also assumes 10 new store openings in the quarter. We anticipate gross margin to increase by approximately 100 basis points versus Q3 of last year. Although we are anniversarying strong increases in product margin, we are still focused on further gross margin expansion through incremental reduction in average unit cost, driven by ongoing supply chain initiatives and scale efficiencies. We expect to deleverage SG&A in Q3 by approximately 100 basis points. As you think about SG&A, please recall our comments from prior earnings calls regarding our expectation for SG&A pressure in Q3 related to strategic investments, including technology enhancements, data analytics, channel innovation, and guest acquisition—the impact of which is heavier in Q3. Additionally, the strong momentum we're seeing in our business offers us an opportunity to further fuel growth in initiatives that are working for us as well as testing initiatives across guest and channel that have the potential to become additional revenue drivers going forward. Assuming a tax rate of 30% and 133 million diluted weighted average shares outstanding, we expect diluted earnings per share in the third quarter to be in the range of $0.65 to $0.67 versus adjusted EPS of $0.56 a year ago. For the full year 2018, we now expect revenue to be in the range of $3.185 billion to $3.235 billion. This is also based on a comparable sales percentage increase in the low teens on a constant-dollar basis. We expect to open approximately 40 company-operated lululemon stores in 2018. This includes 20 to 25 stores in our international markets and represents a square footage increase in the low double digits. We now expect gross margin for the year to expand 100 to 150 basis points in 2018, primarily driven by the continued product margin improvement and leverage on occupancy and other fixed costs. Despite the investments we are making in Q3 to fuel future growth, we are still expecting SG&A for the full year to leverage modestly as we continue to realize efficiencies within our cost structure while leveraging investments in technology, brand building, and people. We now expect our fiscal year 2018 diluted earnings per share to be in the range of $3.45 to $3.53. Our EPS guidance is based on 134 million diluted weighted average shares outstanding for the year. We also expect our effective tax rate to be approximately 30% in 2018. We continue to analyze the impact of U.S. tax reform and its overall implications for capital deployment. We have assumed the Canadian dollar at CAD 0.765 to the U.S. dollar for 2018 as well as Q3. We continue to expect capital expenditures to be approximately $240 million to $250 million for the fiscal year 2018. The increase relative to 2017 reflects a ramp-up of our store renovation and relocation program, increased store openings in international markets, technology investments, and other general corporate infrastructure projects. In closing, I would like to call out our store, digital, and product teams who are all working in unison to elevate lululemon globally. I would also like to thank Glenn for his leadership during this pivotal period and also welcome Calvin to the team. There's a great deal to be excited about around here, and it is not very hard to acknowledge that the best days for this company are yet to come. And with that, let's open the call for questions. Operator?

You've all achieved a remarkable level of acceleration in your comparable performance, and the comparisons from 2016 and 2017 were certainly not poor. However, the acceleration this year is especially notable, and I would like you to explain it to us a bit more and help us understand what has truly changed in the business that has led to this significant growth. Any insights you can provide would be appreciated.

Kimberly, it's Stuart. So let me speak to your question. It really is a story around traffic in our stores. With our e-commerce business, it's a story of traffic and conversion. The underlying drivers of those traffic results are important to note. We mentioned on the call that we've seen 5 quarters of accelerating traffic trends in our stores, and that's not slowing down as we now enter the third quarter. We've spoken about this to a degree on prior calls. We did launch or implement new guest engagement strategies really last year. In particular, in the third quarter of last year, we implemented new technology at POS that enabled our store teams to more effectively engage with our guests and capture email and information, making them a part of our guest file and enabling us then to enroll them in digital communications and digital marketing that we just didn't have before. At the same time, we have raised our game. We're more sophisticated in how we are in fact engaging in digital marketing. We're leveraging new CRM capabilities. We're taking initial steps in data analytics to leverage personalization strategies in how we're engaging with our guests. That is driving traffic both to our stores and to our website. On the e-commerce side, I'm sure you'll recall the recovery efforts that we pursued last year, which culminated in the relaunch of our website at the end of the third quarter. The improvements to the website have been the drivers of the improvements in conversion that we've seen. That story extends into 2018 and likely into 2019. We've focused on checkout, search, and personalization on the website as areas where we can continue to drive those converging gains. As you look at the second quarter, if you exclude the online warehouse sale from last year, the comp in our e-commerce was driven equally by traffic and conversion. So those are the strategies we have developed and implemented in the recent period that have delivered this acceleration in our traffic trends. We're excited to see ways to extend those to make them bigger and amplify them; we feel like we're really just getting started.

I wanted to talk a little bit about the supply side of the equation. So I think, Stuart, at our conference, you had talked about the new distribution center that I think is going to be in Toronto as well as the Haiti manufacturing facility from a third party. So can you kind of help us understand or frame how much faster to market you can be with some of these new resources? Particularly as you get into Christmas, where you're so high volume, if that will have any impact by that time frame?

Sure. There are really 2 separate issues, Sharon. The first one, regarding the DC, the new DC we're opening up in Toronto, will help us improve the service commitments and experience of our guests in Eastern Canada. It will create additional strategic flexibility for us to evaluate more broadly across North America how we leverage our distribution footprint. That's something we continue to explore and can speak with more specificity in future calls. So we're excited about that, and it will yield a benefit in our gross margin; we'll likely be able to again speak with more specificity there in the future. As we look at the sourcing strategy and how we're leveraging nearshore capabilities, and you mentioned Haiti, that's among a number of elements of that strategy we're pursuing. We're excited to explore and implement a meaningful portion of our supplier base in geographies that will help us shrink and shorten our supply shipping times. That's a result we are just now beginning to see some benefits of. I would see that as a multi-year strategy that we haven't yet quantified exactly how much in terms of time advantage it will create for us. But suffice it to say, we're very excited about it. At this point in the Western Hemisphere, meaning the Americas and Caribbean, we source about 9% of our total production. We're excited to see that grow into the future.

I guess, Stuart, your trailing 12-month gross margin is now in the mid-50s, which will be at the higher end of the initial 2020 plan. The 21% EBIT margin would be at the lower end of the low to mid-20s you originally laid out. Help us think about the operating margin opportunity as we think about the next 2 years? Maybe just split between what you see on the gross margin front versus SG&A leverage opportunity.

Sure, Matt. We're thrilled with the results we've generated in gross margin. It has exceeded our expectations. We see additional benefits in a number of areas within our sourcing strategies, distribution strategies, and leveraging the fixed cost elements of our gross margin from sales increases. I would say there are modest improvements we see being able to capture in both gross margin and SG&A over the next couple of years, which would accrue to modest improvements in the run rate of our EBIT margin. We're excited about our strategies and the potential of the business beyond 2020, and that's something we look forward to speaking with our investors in more detail at year-end as we will share an updated view of our long-term plans. At this point, we're comfortable with modest improvements continuing for the next couple of years.

Great. And then just a follow-up on e-commerce. So e-commerce accelerated pretty materially on a stacked basis. As we think about that $4 billion 2020 plan and beyond, any change in the size or mix of e-commerce? What's the best way to think about the size and mix of e-commerce in that 20 billion, 24 billion versus how it was originally laid?

From an e-com standpoint, right now, we see continued acceleration outpacing our store business with our e-commerce business, if you will. We continue to expect e-commerce to grow faster than our store business. The composition will be largely the same across both channels in terms of the mix of product categories. We also expect to see benefits from the mix or the EBIT margin line as the e-commerce business continues to grow bigger. We'll be able to reset our view on the long term at year-end when we give that update on the long-term vision.

Curious about the implied fourth-quarter gross margins. I think only up, I don't know, 20 basis points. Is that a function of either tougher supply chain compares or a mix of business maybe away from bottoms to more outerwear? Maybe just talk a little about as we look ahead to what's implied in fourth-quarter gross margins? And then just curious on the international side. As you mix in more digital versus bricks-and-mortar, how are you thinking about the time it would take for the international business to be less dilutive? Is there a revenue target or sales or number of stores? Anything to help us think about when that could be more similar to the domestic profitability?

Brian, it's PJ. So on your question about Q4 gross margin, I think what we've been seeing is higher demand because our women's pants business has really been on fire. We are not planning for it to be as robust as it has been if it continues. We have the inventory to meet demand and flexibility in the business, but that's one thing. The other thing you mentioned is a tougher compare to last year gross margin-wise; yes, I think the combination of those two things helps plug your model. I'll ask Stuart to answer the question about international.

Yes, Brian. We remain really excited about international, and we're seeing strong growth in Asia in particular. We expect as that business grows, it will improve or is improving from a bottom-line profitability standpoint. You'll recall that we mentioned Asia will be soundly profitable, generating strong profits this year, so that in combination with profits from Australia, the international business overall, including Europe, is profitable this year. That will only continue to accelerate as we capture scale economies in Asia. We're also very encouraged by the Europe business and the double-digit comps we are seeing there. Maybe I'll invite Celeste to offer some comments.

Yes. In Asia to start with, we ended the quarter with a 50% combined comp. We're really seeing strong momentum in both stores and digital, which is good to see and makes us feel good about the momentum we have going into Q3. In China, we launched our WeChat store, which we're really happy with the initial results and have an aggressive plan for how digital will lead us into the future in China specifically. A big highlight from a community perspective, we have Unroll China happening beginning this Saturday and going through the month of September. For Unroll China, we'll take yoga across China with stops in 13 key cities, including Shanghai, Nanjing, and other key Tier 1 and Tier 2 cities. So again, really excited about the momentum we saw in Q2 and to continue to double down in both stores and digital to shift into the momentum we know is possible for us in Asia in particular. In Europe, again, it's a strong Q2. A couple of highlights; that business really also supported through a strong core London business, which has been our focus in the quarter. We had Sweatlife Festival happening, which brought together 4,000 people for a day of development, sweat, and community. We're really happy with those results. Regent Street, just for example, finished the quarter with a comp of over 50%. So really excited about what we are seeing in terms of momentum in those markets. We have a lot of plans for continuing that growth.

I wanted to ask a question of Calvin, if possible. Sephora really has been a leader in personalization and merging the physical and digital shopping experience. I was hoping you could speak to your view of lululemon's opportunity on those fronts and really what your vision for what lululemon could look like in 2 to 3 years' time and whether you think an acceleration in digital investments is needed to get there. Along those lines, it was mentioned of some strategies that are being invested in right now to test some things for next year, if you could maybe speak to the top couple that we could look forward to.

Great. Thanks, Mark. I'll start off and hand the last part of the question over to Stuart. But I'll start by sharing some of the similarities I think exist between lululemon and the Sephora business. The first one is the culture and values of both organizations. Lululemon is made up of an incredible, strong, talented group of individuals that are highly engaged across the entire organization. Retail is a people business, and when you have that level of engagement from stores to Store Support Centre, our ability to bring this brand to life and continue to build and develop it as a lovemark is very unique in retail. That's something both organizations share. There’s this disruptive innovator spirit, and I mentioned that it's core to the DNA. At lululemon, it lives throughout the entire organization. If you go back 20 years to how we came to be and that disruption, what was innovated to today, it permeates the organization. It allows us to approach problems differently and think differently. Third, I'd say both organizations put the guest at the center of all decisions on how we think about solving problems, growing, developing, and innovating. That’s key to a successful business today; barriers and silos don't truly exist. It's all about what’s right for the guest, regardless of the point of view or area of the business that lead. Finally, both have the ability to be exceptional experiential retailers. The product logically extends itself to creating something truly unique in this space, creating a connection between heart and mind. I’m excited about the core foundation to not only celebrate where we are today but how we continue to extend and build forward. There’s a ton of similarities, both in how the organizations are wired and how the guests interact with the brand. I’m excited to learn, listen, and work with this leadership team to author our next chapter of growth beyond the 2020 plan, which is equally exciting. I’ll let Stuart comment on progress on that.

Thanks, Calvin. As PJ mentioned in the prepared remarks, we’re making several investments in important areas of the business: data analytics, product, and guest engagement, which account for about half of the deleverage we described. There's about another quarter of deleverage related to opportunistic tests we've pursued in light of strong business momentum. That includes additional digital marketing investments, new elements of our seasonal store strategy, and new store conversion thrusts, along with an interesting holiday delivery test. All of these are things we’re excited to pursue. If you exclude those elements, we would be offering leverage on the low teens guidance we offered. It’s an opportunistic state we’re in to pursue investments given the strength of our profitability gains.

Quick question, Calvin. The accomplishments you've had in previous positions, I've studied and watched them. The things you've done with the loyalty program; how do you think of what you've had from previous positions to help lululemon, whether it's the loyalty programs? What do you see out there as some of the opportunities? And then, Stuart, as you talk about some of the new experiential influences that the business could have, how do you see that in terms of the real estate landscape?

Thanks, Dana. I've had many conversations with the leadership team and teams across the organization. There’s a ton of work that has been done. There’s so much enthusiasm around many areas you've identified. What I’ve enjoyed, and it’s been 2 weeks, is taking this opportunity over the next 100 days to remain curious and listen. What excites me is those similarities between the businesses. As I share my experiences, my general view is that experiences at this point are to be shared, and opinions are to be formed. In sharing the experiences and having incredible conversations with energetic, talented teams, I see a lot of the same similarities to continue to build guest experience through the work around experiential, to think about how to enhance the love our guests have for our brands through loyalty. Loyalty is the affection they have for the brand, and there are various ways to do that. Digitally, we can continue the great work and augment the relationship with guests and strengthen it even more. There's a lot of work happening, and I'm excited to join the talented teams and mine the incredible experiences at Sephora relevant here. I’m looking forward to working with them and continuing to build on this guest experience.

Dana, on experiential, we’ve begun to see exciting potential for expanding our offerings to our guests. We started with Queen Street and Flatiron, and we’re seeing exciting potential at these locations. This shows the opportunity for us to expand these ideas more broadly across our business in the future. We've begun some tests in Q3 and Q4 that will allow us to learn more about what's possible as we look into the future. Outside of Queen Street and Flatiron, we're pleased to see what we're seeing in the co-located expansions from last year and the new ones we've opened. In Q2, we opened up 7 co-located stores, and they are averaging over 40% growth and close to 70% growth in men's since opening. This gives us confidence to look to opening an additional 18 this year and more into next, allowing us to engage with our guests in bigger, more powerful, and engaging ways. So again, that’s one example of how we’re testing into experiential, and we're focused on leveraging the innovative store formats we've utilized in communities across North America. Coupled with the community work our stores do and the connection to local ambassadors, we see a great future in going deeper into experiential retail.

Stuart, can you talk about the pipeline for store openings in 2019? What’s already locked and loaded in terms of the mix between U.S. versus Europe versus Asia? And then, Calvin, I'm curious; you come into the organization with some ideas of what the next level looks like. Where do you think lululemon might be punching below its weight as you think about the next level?

Paul, it's Stuart. So for our store opening drive for 2019, think about our real estate expansion from a square footage growth standpoint. You'll see low double-digit increases in square footage for us. There will be a healthy number of new store openings in North America although those are diminishing versus prior years. An increasing number of new store openings will happen in Asia, with a healthy mix of co-located projects and new store projects.

Yes. I’ll share just a couple of observations I have as a guest. There’s a lot of good happening, and guests are responding positively, which is driving results. We all would agree that we have a big opportunity internationally, particularly in Asia, where the team feels this is a growth potential, a disproportionate growth for this business and brand. We can enhance the experiential aspect, as our stores can become even more experiential than today. And the loyalty ecosystem is another area where the guest loves the brand today, but we can build upon that in an innovative way. Community is something lululemon created 20 years ago and it's a powerful strength of the organization. These are areas where my conversations over the past 10 days have conveyed that the management team is aware of their strengths and opportunities. They have been working towards developing and innovating behind these pillars. I'm excited that my experiences at Sephora can allow for thought partnership with this team as we continue to create moving forward.

I want to talk about women's pants because a 30% comp is truly outstanding, and that’s on top of several years of really strong results in that business. You're prudently not expecting that growth or that strength to continue, but you probably didn't expect the strength you've seen over the last 3 years, so I was wondering how your thoughts on the total addressable market for your women's business have evolved with this kind of strength. How do you think about share of closet with this kind of strength occurring?

Matt, it’s Stuart. You're right; the performance in women's pants has exceeded our expectations. It's remarkable that the new Lulu fabric for our #1 style, the lined pants that we introduced 3 years ago, has eclipsed Luon and the wunder under that the company was built on in many ways. What it speaks to is that innovation matters. Where we innovate in fabric, function, and technical performance, it opens avenues for growth that are boundless. We don’t know how big that market is, and it would be somewhat shortsighted to put a limit on it. The overall success of that fabric and pant shows us that we think we can make it better, and we’re already working on that. New versions of that fabric will be introduced in the upcoming years. We're excited about the continued innovation, and we also believe that our product assortment has significantly improved. The work that the design and merchant teams have been leading is an essential part of this equation.

Thanks, everyone, for joining us. We appreciate your time, and we look forward to speaking with you in about 3 months when we report our third quarter results. Thanks.