Good day, ladies and gentlemen, and welcome to the Lululemon Athletica Q4 2012 Results. [Operator Instructions] As a reminder, today's conference call is being recorded. I'd now like to introduce your host for today's conference, Mr. Joe Teklits of ICR. Please go ahead.

Thanks. Good morning. Thanks for joining us for our fourth quarter and fiscal 2012 conference call. Today, a copy of today's press release is available in the Investor Relations section of our website at lululemon.com or furnished on Form 8-K with the SEC and available on the commission's website at sec.gov. Shortly after end this morning, a recording of today's call will be available on our website as a replay for 30 days. Hosting our call today is Christine Day, the company's CEO; and John Currie, the company's CFO. Sheree Waterson, our Chief Product Officer, will also be available during the Q&A portion of the call. As a reminder, the statements contained on this call which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results might differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. [Operator Instructions] With that, I will turn the call over to Christine Day.

Thank you, Joe. Good morning. I'm joining you from Australia today, where it's actually just after midnight. Our board meeting was held here this quarter, and we have just finished a few days of meetings with our board and our team here in Australia. Before we talk about our fourth quarter and full year 2012 results, I will give you an update to the announcement made on Monday of this week regarding the sheerness in certain styles of our Women's black luon bottoms. Following my comments, John will speak to our guidance. We have not yet determined the specific cause for the sheerness and are pursuing several hypotheses in parallel with our manufacturing partners to determine the root cause. What is clear to us is that this is not the luon that we and our guests have come to love. The process for creating luon is complex and involves a specific set of proprietary ingredients and a multistep production process. Even the slightest changes to the process can create meaningful changes in the fabric. We had already begun putting more stringent specifications in place on the production of luon, and we will be redoubling our efforts in this area. We currently have a dedicated team working with our suppliers to identify and resolve the issue. We have recently added strong leadership in quality control, our liaison office and our commercialization and development teams. I expect these people and other investments to solidify our quality consistency and delivery capabilities. Our company is rooted in integrity, and we are ready to make the tough decisions and do the right things for our guests and our communities. I am confident that we will recover from the set back and be stronger than ever. Our confidence is based on the history of strong performance…

Thanks, Christine. I'll begin by reviewing the details of our fourth quarter of 2012, and then I'll update you on our outlook for the first quarter and full year of fiscal 2013. For the fourth quarter, total net revenue rose 30.7% to $485.5 million from $371.5 million in the fourth quarter of 2011. The increase in revenue was driven by: comparable store sales growth of 10% on a constant dollar basis, bringing our average store productivity at the end of the year to $2,058 per square-foot; the addition of 37 net new corporate owned stores since Q4 of 2007, 27 new stores in the United States, 1 store in Canada, 5 stores in Australia, 1 store in New Zealand and 3 ivivva stores; direct to consumer sales, which increased by 48% or $24 million. If we included e-Commerce as a store in our comp calculations, our comps would be reported as 16% on a constant dollar basis; a stronger Canadian and Australian dollar; and the effective increase in reported revenues by $5 million or 1%. And finally, the additional 53rd week of fiscal 2012 contributed $26.2 million in total sales, which included $4.2 million in e-Commerce revenue and $2.3 million from a warehouse sale. During the quarter, we opened 8 corporate owned lululemon stores in the U.S., 1 in Canada and 1 in Australia. We ended the quarter with 211 total stores versus 174 a year ago. There are 169 stores in our comp base, 42 of those in Canada, 103 in the U.S. and 19 in Australia and 5 ivivva. Corporate owned stores represented 77.9% of total revenue or $378 million versus $78.7 million (sic) [78.7%] or $292.6 million in the fourth quarter of last year. Revenues from our direct-to-consumer channel totaled $78.3 million or 16.1% of total revenue…

Thanks, John. This has been a challenging time for all of us. Disappointing our guests and shareholders and falling short of our own expectations is not something we take lightly and we deeply regret. With that, we will open it up for questions.

[Operator Instructions] Our first question comes from Erika Maschmeyer of Robert W. Baird.

Just to go back to the recall issue. If you identified the issue today, when would you expect to receive shipments into your stores? And then, can you talk about the revenue impact that you're assuming in your guidance in Q2? And then also, any thoughts on diversifying your vendor base?

In terms of the revenue impact in Q2, the amount that I guided to for the balance of the year, the bulk of the impact of that is in Q2. I'd say roughly 85%, 90% of that.

I think on the other one, we still have to find out exactly where the process broke down. And what I want to say is that it's a multistep process with multiple vendors involved. And we don't want to call attention to any one particular vendor because it would be unfair until we've completed the diagnostics, that -- or it's more complicated than it being just one individual or group. Regarding identifying or diversifying the supplier base, we have actually moved in that direction and we should have 2 additional sources up ready for manufacturing our key fabrics by the fall.

That's great. So do you think that by the end of Q2, you could have, potentially, shipments of fixed products coming into the stores?

Right now, what we're still waiting for is we have a lot of product on the water and so it was a little complicated to get the samples from that product. And we won't receive those for a couple of days. So I think our first step is to see what to correct or what we can use in that. And then -- and meanwhile, we're working with our suppliers to do some additional testing of any old stock that we have to see what we could do to flow in. And we won't have those answers probably for the next week or so.

That makes sense. And then on golf and tennis. Could you talk about how you expect to get the word out? Any -- I'm sure you have something creative in mind, but just your overall thoughts on PR and any type of sponsorships or events?

I'm sorry for...

For golf and tennis.

Oh, for golf and tennis. We actually have some social media campaigns ready to go with that and letting the guest out and doing some additional reach. We've also been working with our elite ambassador community. We had several of those on our Maui retreat that we did earlier this year. So we've already been infiltrating, I could say, those communities in fun and unique ways so that everybody will know that they are out there. And they are small capsules. So as I said, they're not going to be truly incremental. They are just driving a lot more energy into the store. And they're not made of luon, so we're good.

Our next question comes from Adrienne Tennant of Janney Capital Markets.

I wanted to know if you can tell whether the quality issue is isolated to luon? As you do these vendor checks, is there any other chatter that you've heard from the websites and blogs on any other particular product? And then just in terms of dealing with sort of -- I've looked at a lot of the blogs and the website reviews and the chatter seems to be taking on a very negative tone, particularly when people are returning stores -- returning products back to the stores. I'm wondering how you're dealing with training the store ambassadors to handle this in the best manner?

Yes. We have put all of our educators on high alert. And making it really seamlessly easy for the guests as well as our GECs. So communication and training calls with every store manager have already occurred to make it seamless for the guests to return the product that we believe is affected. And for right now, we primarily see this as an issue with luon. There are a couple of other fabrics that occasionally will have issues, but that's fairly minor and nothing that we see as significant as what we've seen in the luon.

Our next question is from Lorraine Hutchinson of Bank of America.

Switching topics to the international expansion opportunities. I was hoping you could give us an idea of what types of investments you'll need to make over the next couple of years to get the infrastructure ready to open stores? And then also maybe a timeline of when you'd expect to be opening stores abroad?

I'm sorry, you cut out a little bit just before the last part. So you said investment in infrastructure, and then you blanked out and said, stores abroad. So sorry, we didn't hear that.

Sorry, maybe just a timeline of when you'd expect to start opening more stores abroad?

Okay, so mainly, we have a couple of different levels of investment. One is the significant investment that's already occurring in our legacy systems, preparing them for a more complex environment of multichannel and international. And we've -- that's already been baked into our capital investments that we've laid out. In terms of directly in markets, there's 8 or 9 markets where we're doing what we call pre-seeding, where we participate in events such as I described on the call, in Shanghai. Those are pretty low costs measures, where we're really doing community work. And then we are getting those ready for showrooms. So that's pretty non-capital-intensive. Then there's markets which we've already identified, such as Hong Kong and London, where we are engaged more at that showroom level. Again, those aren't a lot of capital and it's more just some small headcount expense, and it's pretty revenue expense-neutral once they're up and running for at least 6 months. So we've already built out the international e-Commerce site, which we've already preannounced. And we'll only be adding one additional international website this year, which will be in Shanghai.

Our next question comes from Betty Chen of Wedbush Securities.

I was wondering if you can talk a little bit about some of the learnings you've gleaned from pricing last year? What have you heard from your customers and guests regarding sort of how they view the merchandise, not only from the core, but also some of the new capsules and new product extensions that you have been expanding into?

Definitely, the #1 learning over the holiday, particularly in the Canadian market, was that those more $100 price point cottons was -- that they're used to having, particularly the scuba hoodie, and we usually have something called the cozy up and the cuddle up. And there's a variety of versions of that, that we offer, which we did not this year, significantly affected that holiday purchase in particular. And then we felt that we also got a little too aggressive in pricing our what the fluff? line. So we pulled that back to the same pricing it had been the year before. So this year, the holiday architecture will include more of those $100 price points and the kind of cotton layering pieces that, that guest is looking for.

Our next question comes from Sharon Zackfia of William Blair.

I guess, Christine, it will be helpful if you could maybe walk through the quality control process so we can understand how the product made it to the stores. And then, secondarily, I'm assuming the guidance for the full year doesn't have any kind of pent-up demand in the second half of the year, if you could confirm that. And then how are you planning on communicate with your guests -- communicating with your guests kind of the return of the black luon and kind of getting people back in the stores that might be disappointed in the next several months?

I think just like the still pants, as soon as we get something up there, they'll eagerly know. And of course, we'll communicate through our product notification system and our other social media channels as soon as we have other product back in stock. For the quality control, there are -- we've had a very standard metrics-based system for the luon for a very long time that controls it within the environment of the manufacturer. There are a couple of gaps that we found in that, particularly in the overfeed process, which creates the fluff, that are harder to measure and really are more subjective. And that's certainly one area that we feel that we can do a better job of controlling. And then the environment after it leaves, we have to do a better job of controlling or creating standards for that process, as we're shipping to more locations to manufacture it. And then I think the quality control around the lycra chip itself, if it's stale or not stale. So there's things that I feel that we didn't have as much standard controls in place that created some variables. And I think also, the transition with patterns. So more protocol. And we've hired a very seasoned head of QA, who just recently started with us. And she's already been of tremendous assistance during this process. And we're definitely looking to make some more significant hires, particularly in the raw materials area, going forward.

And Sharon, just to confirm. No, we did not assume a benefit of pent-up demand in the second half guidance.

Our next question comes from Sam Poser of Sterne Agee.

Can you give us -- you gave us same-store sales guidance for the quarter. Can you give us some form of how you're looking at the full year same-store sales? Number one, I guess, is on share.

Yes, obviously, the second quarter is probably the most impacted in the guidance. Our expectations would be a very low single-digit comp, close to flat for Q2 as a result of the luon issue. The balance of the year, I'm not giving quarter-by-quarter guidance, but it comes out to roughly high single to low double digits.

And then, secondly, I guess the question is this. I understand that you don't understand the -- how this exactly happened. But I guess the question is, is how did it both get to where it was shipping without somebody trying on a pair of pants, like the first batch, to make sure that this wasn't an issue, I mean, and stopping it before it got so out of control? And then what is going to be, sort of, do you see as the incremental cost of adding the different people, the new QA and so on and so forth, to -- at the different factories and so on to ensure that something like this doesn't happen again?

Well, that was already reflected when John mentioned some incremental cost in the SG&A. So we've already built that number in. And some of these were already planned hires, so we have people on site in every factory. The truth of the matter is the only way that you can actually test for the issue is to put the pants on and bend over. So just putting the pants on themselves doesn't solve the problem. So because it passed all of the basic metric tests and the hand feel is relatively the same, so it was very difficult for the factories to isolate the issue. And it wasn't until we got it in the store and started putting it on people that we could actually see the issue.

Our next question comes from Kimberly Greenberger, Morgan Stanley.

It sounds like quality is going to be priority #1 at lululemon. And I'm wondering if there are some permanent investments in gross margin that you think you need to make in order to make sure that your quality standards are strictly adhered to? And then, as you think about the -- this is sort of the second quality issue, I think, in 9 months. Is there some sort of an organizational effort to make sure that whenever there are quality issues that appear anywhere, either in the supply chain or at the stores, that there is a concerted effort to sort of raise those issues to senior management and make sure that their -- that behavior is really encouraged so that the issue can be identified early on and with the least impact to the guests?

Absolutely. Project Canary, as we're referring to it. We have made significant investments last year. I mean, the issue we're referring to in the dye issue, where we brought the experts in, rewrote the whole process for dye, and working in partnership with our manufacturers solved the problem. And so we no longer have dye issues. And so we can very much say that with confidence. And I feel that we'll accomplish the same thing here with the fabrics once we identify exactly where in the chain the breakdown was and have long-term solutions for this. And we -- this big shift for us is making sure that we have people actually on site, in the mills and the other environments. And that's the infrastructure that we started investing in this year and will continue to do so this coming year. And we've had -- the whole organization is very devastated, obviously, by what happened. And so everybody understands the sense of urgency of making sure that we alert the small noise and symptoms that we see, the little canary chirps, getting those to us as quickly as possible so that we can deploy the resources to avoid anything like this again.

Our next question comes from Liz Dunn of Macquarie.

Just like a several kind of follow-up questions. It sounds like this is really related to inputs, not manufacturing, because it's multiple factories. But it sounds like it's more the inputs. Could you just confirm that?

I wouldn't -- I don't think that I could say that at this point in time. That's one possibility. But because it's touched by so many people across the line that -- at different stages, this could have happened in any 1 of 4 stages. So that's what we're looking at right now. And so I don't think it's fair to say that it's inputs.

Okay. And then, I'm sorry, it was a little unclear to me. Are you opening a store or stores in U.K. and Hong Kong this year?

We're opening -- our goal is to open a store in Hong Kong. We're evaluating several sites right now, but those usually take a little bit long to negotiate. But we're confident we'll have it some time within like a 12-month period. And then, London, the goal is to open additional showrooms this year and then move to stores the next year or so.

Okay. And then just, finally, one for John. Was the 500 basis points that you called out in the first quarter just related to the write-down? And what impact, if any, should we see from deleverage on the lower comp? I would assume that'd be mostly a Q2 impact.

Yes. I mean, based on the magnitude of the revenue drop there, as a result of lower revenue on the luon issue, we do deleverage based on occupancy and depreciation, et cetera, primarily Q2. But there's some impact in Q1. The other thing, just to get a little more granular on the overall impact of -- on the gross margin. A lot of these are key styles and tend to be higher product margins. So the impact is a little bit larger than it would be if it was just more seasonal items.

Our next question comes from Camilo Lyon of Canaccord Genuity.

What's happening to all the excess luon? Is that a product that you could considerably sell to your outlets at a discounted price?

Right now, we are holding all the products because there are actually might be some treatment solutions that we're investigating that actually could solve some of the problems. So until we get those test results back, we haven't made a decision at this point in time.

And we're assuming none of that is embedded in your guidance currently?

That's correct.

Okay. And then are you able to tell us what the tie ratio or the add-on purchase historically has been when a customer buys a pair of pants, what else do they buy in that basket?

Yes, that would be a little bit more precise than the information we have. I mean, the average number of units per transaction is between 1.5 and 2. But I couldn't break that down to when there's black luon pants, what's the add-on. We don't have that detailed information at this point.

I was just going to say, normally works the reverse, right? So somebody comes in, they're attracted by one of the new items, and then they pick up additional core. So because they're looking for an outfit or as they pay say, "Okay, I want the extra pair of Wunder Unders." But so I think that what we're seeing so far is that the color has been really well received. And so that at least, I think, has been some of the good news. As well as the fact that the timing of this, we normally shift in spring to a lot more of our swift and other lighter fabrics for run and for spring. So that is the good news, is that we do have a lot of other products that's available just based on the timing of this and the shift in spring.

Our next question comes from Dana Telsey of Telsey Advisory Group.

Can you talk a little bit about the people that you're adding in quality control. How many are you adding? Where do they come from? Is it here, is it in Asia? And as you think about basis going forward, do you see pricing at all changing on basics? And is there a greater percentage of the basics sold in new markets versus mature, or online versus stores?

Some of the individuals that we've added, Joan comes to us from, most recently, at jcpenney, and she's worked for Nordstrom before that. So she's our new director of QA, just recently joined us, completed her training, and has, unfortunately, had to hit the ground running very hard over the last 2 weeks for this. And we also made a significant hire as Vice President of Commercialization and Development, which is really critical in the raw materials area. And we've also made a deep hire in our R&D department, Dr. Tom Waller, who comes from the Speedo group. And so he also works on developing raw materials. So those are just an example of 3 key senior leaders that we've hired. We've also put a person on the ground in Taiwan and he's already been in place. And he is building a team there that will actually be at the factories where we produce. And as well as just doing, in addition to the outside third-party testing which we do, we will also have people at our manufacturing sites. So those were already all planned investments for this year.

Our next question comes from Howard Tubin of RBC Capital Markets.

Just a question on your lead time. So if you decide to offer this luon today and you started from scratch today, how long will it take for that product to get in stores and be available for sale?

We were working with the manufacturer today. But first, we have to certify that everything that's coming off that line does actually meet the specs. So we have some sample product that's being made up and sent to us, which we'll then conduct the complete test on. And once that's done, then we'll feel more comfortable setting that date. But in general, if we said that was 100% perfect, we could begin flowing at least the simple Wunder Unders and group pants within no more than 28 days. But we need to make sure that, that product is something we can stand behind.

Our next question comes from Janet Kloppenburg of JJK Research.

A couple of questions. I was wondering, Christine or Sheree, what the substitution potential would be. When a client can't buy a luon pant, is there a likelihood or high likelihood that they may substitute for a different fabrication? Also, Sheree, I was wondering if perhaps your innovation level in fabric and product design may have something to do with this quality control issue. Obviously, you've been very innovative. Maybe that's put some risks into the product production and quality control. Are you examining that situation for a potential change? And for John, I'm wondering if we should be expecting gross margin decline in the second quarter to be deeper than you're forecasting for the first quarter. And I have a follow-on.

Janet, I'll go ahead and answer the product questions. Right now, there are luon pants that are not affected. So there are luon pants in the store. It just is particular to the group pants and the Wunder Under and then a couple of seasonal styles, a couple of crops that match those and a couple of shorts. So there still are luon. There's still printed luon and there's luon that's colored. So it's just the black pants in particular. And then for the innovation level, because this was around our core fabric and not any the new fabrics, I wouldn't say that, that is the root cause. And it's not something that we feel that we need to drag into all the different tests that we're conducting because this is really about the core product. And then, John?

Yes, Janet, the biggest gross margin hit is actually Q1 because as I said in the prepared remarks, we'd be taking a reserve to write down any expected faulty product in Q1. The impact on gross margin in Q2, therefore, comes primarily from deleverage on fixed costs and, to some extent, there's a shift in margin, as I said. The items impacted our typically higher margin than the average, so there's a little bit of averaging down. So again, not to get too granular, I'd expect gross margin in the second quarter in the low 50s.

Our next question comes from Jim Duffy of Stifel.

John, thanks for the average store productivity information. Can you share the run rate productivity of new stores in '12? And then looking forward, how we should think about new store productivity, e-Commerce and the other revenue line items as contributors at the full year guidance?

Okay. As has been the case throughout most of the year, we talk about it every quarter, the new stores are still running in that about $1,150 a square foot plus or minus range, which, again, is what we expect. There's a lot of new stores in new markets where the guest is very early on in the discovery of us. So it's a lower percentage of the mature store productivity. But again, that's expected. But it's maintaining that level that it's been at for the last 12 to 18 months of new store experience.

Okay. And then would you expect that percentage rate to be consistent in the guidance for '13? And then one of the things I've been struggling with is some volatility in the other revenue line item. And trying to get my arms around how to think about the trajectory of the e-Commerce business in '13 off of what was a great year in 2012.

Okay. So the first part, yes, we continue to expect that new product, new store productivity to be similar looking forward. Some noise in the other channels. I mean, just in general, it goes up and down based -- we had 2 warehouse sales in Q4. We've closed a lot of the strategic sales accounts in some markets. There's no franchises anymore. So it's not a big line item in our revenue in general. So maybe on a follow-up, I can walk you through some of that up and down. But I understand how it's hard to model it.

Okay. And then how about e-Commerce, John? Any thoughts on the growth rate for that?

I guess what I'd say is Q4, we're, for the first time, over 16% of total revenue. I tell you, it's a little bit higher in Q4. As we have said, we certainly see growth, e-Commerce growing to 20% and beyond in the foreseeable future. For 2013, I'd expect it to be mid-teens, maybe 15%, 16% of total revenue against the overall growing base of revenue.

Our next question comes from Roxanne Meyer of UBS.

As far as the luon product goes, did it hit every region of the country in the entirety of your store base or just some specific segments? And then do you have a sense of how many consumers transactions were actually tied to those purchases in the first 3 weeks of March that may have been impacted and that you could think about being disgruntled and maybe pulling back a bit in the near term?

It was across the entire store base, it wasn't regional. And no, we don't, at this point, have good data on the number of transactions or guests that would have bought it before the pullback.

We haven't seen any significant return uptick at this point in time, but the word is still getting out. And so -- we did catch it relatively quickly and acted quickly to go through the stock. So I think we'll see within the next week or so, as guests learn about it and begin exchanges, whether or not that impact or how many guests were affected.

Our next question comes from Faye Landes of Cowen.

Sorry to harp on the same thing [ph], but I just want to -- it sounds like you were starting at sort of ground zero. In other words, for other manufacturers, the idea that you have to put the pants on and bend over to test them out is something that would happen before they hit the stores. So do you think that there was sort of -- is that correct? I mean, were you sort of behind the curves on processes in general beforehand, do you think?

I don't know of anybody else who has people actually -- I mean, a final proto in garments where we make up those, of course, you would produce all of those tests. And we do wash tests and do a lot of other things at that stage. And then when it goes to the bulk manufacturing, you'll do random sample pulls. But again, I'll stress that this product passed all initial testing that we're aware off. So the whole conversation at this point is then where did it break down from that initial testing. And that's what we're trying to figure out. You wouldn't notice the change from hand feel. And it's not a simple put it over a mannequin or put it on, it has to be engaged in a four-way stretch for the sheerness to appear. So it's a very complex thing to test for. And that's what we're looking at what can we do better job of to make sure that we can identify that earlier in the process.

Our final question comes from Edward Yruma of KeyBanc Capital.

I believe that you said you're not expecting any recovery on some of your inventory write-downs. But I guess is there the potential for you to go back to your supplier and manufacturing partners for a compensation in this process?

I think once we identify with certainty the real issue. And in the past, we've worked very closely like on the dye issue and amicably settled whatever we need to settle with our manufacturers, where we were both happy with the outcome. And I think as we identify where that is with our partnerships that we have in place, I'm confident that we will resolve it in an amicable way. If the mistake was ours through something like a pattern change or whatever, then obviously, we're on the hook for that. But at this point in time, we don't know specifically what the issue was.

Great. And one underlying question. It seems like you've changed some of your philosophies around Men's sizing to, perhaps, have more accommodating or athletic fit. How does that change the addressable market that you're attacking for the Men's business?

We definitely think that it makes it broader because our core market is that athletic males and the styles should be styled slim, not a slim fit. And as we've made that modification and brought back things like the favorite Kung Fu pants, that's sold out very quickly, and we went back to reorder on that.

I'd now like to turn the conference back over to management for any closing remarks.

Thank you. Thank you for joining us this morning and we look forward to updating you with more information as soon as we get it. We want to just reiterate our commitment to being completely transparent and passing along the information as we learn it, so that you can have confidence and faith in us that you will always be the first to know whenever we have an issue. So thank you for joining us today.

Ladies and gentlemen, this does conclude today's conference. You may all disconnect and have a wonderful day.