Dec 6, 2017
Executives
Howard Tubin - Vice President of Investor Relations Laurent Potdevin - Chief Executive Officer, Director Stuart Haselden - Chief Operating Officer, Chief Financial Officer Celeste Burgoyne - EVP, Retail, Americas
Analysts
Ike Boruchow - Wells Fargo Matthew McClintock - Barclays Brian Tunick - RBC Oliver Chen - Cowen and Company Matthew Boss - JPMorgan Paul Lejuez - Citi Mark Altschwager - Baird
Operator
Thank you for standing by. This is the conference operator.
Welcome to the Lululemon Athletica Third Quarter 2017 Conference Call. Participants are in listen-only mode and the conference is being recorded.
After the presentation, there will be an opportunity to ask questions. [Operator Instructions].
I would now like to turn the conference over to Howard Tubin, Vice President, Investor Relations for Lululemon Athletica. Please go ahead.
Howard Tubin
Thank you and good afternoon. Welcome to Lululemon's third quarter earnings conference call.
Joining me today to talk about our results are Laurent Potdevin, CEO, Stuart Haselden, COO and Celeste Burgoyne, EVP, Retail, Americas. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements reflecting management's current forecasts of certain aspects of the company's future.
These statements are based on current information, which we have assessed, but which by its nature is dynamic and subject to rapid and even abrupt changes. Actual results may differ materially from those contained in or implied by these forward-looking statements due to risks and uncertainties associated with the company's business.
Factors that could cause these results to differ materially are set forth in the company's 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 undertake no obligations to update 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 quarterly report on Form 10-Q are available under the Investors section of our website, at www.lululemon.com. Before we begin the call, I would like to note to our investors that in addition to the summary of key financial and operating statistics we began providing last month, we are now providing a supplemental slide deck which provides highlights on our quarter.
You can find both on our investor site. Today's call is scheduled for one hour.
So please limit yourself to one question at a time to give others the opportunity to have their questions addressed. And now, I would like to turn the call over to Laurent.
Laurent Potdevin
Thank you Howard and good afternoon everyone. I am very pleased to report strong Q3 results and an increase in our full year guidance.
Before we cover this in detail, I wanted to contextualize the strong momentum in our business and the unique position we are always in the market we created. The retail landscape is experiencing unprecedented disruption characterized by increasingly commoditized transaction and short term focus, but disruption also equates to tremendous opportunity and Lulu remains at the forefront of unlocking the future often defines a new era of human connection and a powerful evolution of retail.
Across the globe there was a behavioral shift to leave an active mindful lifestyle. Guests are drawn towards the brand focus that reflects who they are and who they want to be.
Lululemon empowers our guest to design the life they love. This is our [Indiscernible] and has been for almost 20 years now.
Our stores are at the heart of this community, where guests immerse themselves in the brands or products brought to life by our educators and localized experiences, such as our Mindfulosophy lounge, or in-store yoga led by our ambassadors. The constant [ph] from Bend Oregon to Chengdu China is a distance of connection to and being part of a local community.
Online, we greatly enhance the digital experience to our guests at the end of Q3, satisfying today’s consumer of needs to explore and be inspired and also transact from any device, anytime, anywhere. Delivering on our strategy enabled us to drive an acceleration in our business in Q3.
Comps were up 7% on a constant dollar basis, adjusted gross margin improved 110 basis points and adjusted EPS grew 19%. These results exceeded our guidance and keep us on our path towards delivering $4 billion in revenue in 2020.
I am energized by the momentum we are seeing at the start of the holiday season and grateful for the incredible enthusiasm I see everyday from our team serving our growing collective around the world. Today, I will share key highlights of the quarter and update you on our plans for Q4 and the holiday season.
Stuart will provide additional details on the quarter, review our financials and provide Q4 and full year guidance. We will then take your questions.
When looking at our model, our vertical integration is a core competitive advantage. We had end to end control of our every aspect of our business.
From every guest interaction anywhere in the world to a margin structure that allowed us to stay position at the pinnacle of the market we created investing in levels of quality and functional units that are unmatched in the industry. Our nimble and constantly evolving store portfolio from locals to co-located and experientials are highly attuned to each market needs, reflecting industry leading productivity while our footprint remains underpenetrated with only 388 locations across the globe.
Online, we saw a significant acceleration this quarter, with constant dollar comps up 25% fuelled by double digit increases in traffic, transactions and delivering our best conversion this year. Our digital journey has much runway ahead, it is the conduit to how we amplify our uniquely human connection with the growing collective, and we are thrilled with the guest reaction to the enhanced new experience and committed to delivering a compelling online, off-line ecosystem to our guest.
In Q3, through focused marketing efforts, our active contactable profile list grows by 60%. We both retained and acquired more new guests and so increased transactions from our most loyal guest year-over-year.
As we scale and grow internationally, a continued focus on inside and understanding of our guest will enable us to also increasingly relevant guest journey. We create market disrupting product at the intersection of function and fashion, delivering innovation in technical performance were unique science of feel.
Reflecting our unparalleled leadership in woman’s pants, in Q3, we launched our newest fabric innovation Everlux, incredibly well received by guests, it created a hell of our women pant category, which calls up an impressive 24% in Q3. Going into holiday, on Black Friday we launched another unique castle collection for guests.
Collaborating with Foster Run, one of Europe's premier couture lace house which contributed to our biggest week ever for pant sale in North America. And I am also pleased to see our jackets and outerwear assortment pumping 26% in Q3.
On the men’s side, we saw a 21% increase in new male guest transacting with us this quarter. Due to additional focus on our co-located store, our expanded ABC franchise to including slim and joggers style and our first ever men’s campaign.
I am excited to say that total sales in our ABC franchise doubled in Q3 versus last year, listed by this initiative. Our international growth pillar continues to reflect one of our most significant long-term opportunities.
At the beginning of this journey, the market growth across Asia was nearly 100% in Q3, while China itself grew over 450%. I visited China in late Q3, and I’m always in awe of the pace and scale of change how digital is so intrinsically woven into every experience, seamlessly moving from online to offline, reimagining the future of retail.
Current guest behaviour informs my belief that our e-commerce penetration in China could approach 40% to 50% of our business as we continued to grow and enhance our distribution channel, including Tmall and WeChat and as evidenced by Tomball's singles this year where we tripled our business relative to last year. Turning to Europe, in Q3 we experienced market growth of 40% and continue to focus our energy on the accelerating shift towards an active mindful lifestyle in Northern Europe, and we are excited by the market response to our first store in Munich, Germany which has been incredibly positive.
No matter where we are across the globe, our digital ecosystem fuelled our insight on market readiness allowing us to build awareness, energy and connections in a community before pinning our physical presence. This strategy effectively supports our Q3 new store openings and looking to Q4 informs [ph] how we are targeting six additional stores in Asia.
In North America we are realizing the untapped potential in our core market, across store and digital, symbolic of the opportunity ahead, Fifth Avenue in New York and West Fourth Street in Vancouver are both performing extremely well with little to no cannibalization, further validating our co-located store strategy and reflecting the opportunities that we see in both the U.S. and Canada, due to our agile and relevant store formats.
Whether online or offline, we value and prioritise the direct connections we have with our collectives. The rapport that exists between our guests, educators, ambassadors, across all our markets is the heartbeat of the brand.
This quarter, the growth rate, a 5 mile community race powered by the Strava app is a great example of online to offline community buildings, [Indiscernible] Lululemon to the number one run community on Strava despite being active activated across on these 15 cities. Looking at Q4, and as we head into the holiday, I am excited and inspired by the product experiences and connections we are bringing to our guests.
In North America, we are opening 22 seasonal stores nimbly meeting our guest where they are and as the holiday season kicks off, we experienced our highest traffic and largest revenue day ever on Black Friday and on cyber Monday, our largest day ever of online sales. And reflective of how our guest values our brand, our product and the experiences we provide our top-selling products all weekend with the aligned [ph] pants at regular price.
Amongst these backdrop, I know our holiday campaign is a breath of fresh air, breathe it all in reminds our guests to take a moment to be present and guests are desiring this com and connection like never before. It is just a few weeks in and is our most powerful campaign state.
Our collective has downloaded a quarter of a million minutes of meditation. We are on track to acquire our most significant number of new guest in the quarter ever and our personalized emails are driving 15% conversion.
In closing, the trends we exhibited in Q3 and at the start of Q4 validates our strategy, demonstrate the power of our brand and the connection we have with our growing global collective. We’ve strengthened foundations, re-invested in the brand and innovation and focussed on operational excellence and efficiency to build the platform to creating to a future not yet realized.
The momentum in our business validates our position as an originator brand leading the market we created and capturing the accelerating global shift towards an active mindful lifestyle. We have exciting opportunities ahead of us as we expand into new international markets, deliver category disruptive product innovation and continue to explore how our brand deepens its connection across both men’s and women’s.
Looking forward, I am more confident than ever in our gross strategy and our ability to execute powerfully against this pillar. As we head into the holidays, I want to extend gratitude to our teams around the world who put the guests at the heart of everything they do.
Stuart.
Stuart Haselden
Thank you Laurent. As you mentioned, we are pleased with the accelerating momentum we saw in Q3 that is now extending into Q4.
The strength in our business was fuelled by positive performance in both our store and digital channels as well as strength in both mens and women’s. We saw a solid performance across an array of KPIs, notably traffic and conversion improved in both stores and e-commerce.
Constant dollar comps were up 7%, adjusted gross margin expanded 110 basis points driven by continued strength and above plant performance and product margin, which improved by 70 basis points and EPS increased 19%. Also worth noting is the moderating growth rate in SG&A, up just 70 basis points of this quarter, which contributed to our adjusted EBIT margin expansion.
Inventory also remains well-controlled and was up 9% at the end of Q3. Before taking you through our Q3 results in detail, I’d like to update you on the charges and costs associated with the evolution of our ivivva business.
We now estimate that total costs associated with the transition will be $45 million to $50 million, down from our prior estimate of $50 million to $60 million. In Q3, we realized $22 million in impairment and restructuring costs related to the ivivva restructuring.
Now turning to the details of Q3, total net revenue rose approximately 14% to $619 million with the increase in revenue resulting from strong performance across all parts of the business. In our store channel, we delivered a 1% comp store sales increase on top of a 4% store comp in Q3 of 2016.
We are also pleased with the 25% comp we posted in e-commerce. Our team executed and refined the new processes implemented in Q1 and Q2, which enabled this acceleration in our digital business, so on a combined basis we delivered a 7% constant dollar comp increase.
Excluding the ivivva store closures, square footage increased 12% versus last year driven by the addition of 46 net new company operated stores since Q3 of 2016. 26 net new stores in the U.S.
10 in Asia, 4 in Canada, 3 in Europe and 3 in Australia and New Zealand. The impact of foreign-exchange increased revenues by $6.8 million while the hurricanes which hit the U.S.
during the quarter decreased revenue by approximately $2.5 million. Gross profit for the third quarter was $322 million or 52% of net revenue compared to 51.1% of net revenue in Q3, 2016.
The gross profit rate in Q3 was adversely impacted by 20 basis points related to the ivivva restructuring. Excluding these items, adjusted gross margin increased 110 basis points versus last year.
This exceeded our expectations for the quarter with the primary driver being a 70 basis point increase in overall product margin resulting from favorability and product mix and lower product costs offset somewhat by modestly higher markdowns versus last year. I’ve noted that this increase comes on top of a 450 basis point improvement in product margin last year.
As our supply chain capabilities improve, we are continuing to identify margin opportunities to gain cost efficiencies across a number of areas. We saw a 20 basis points favorable impact related to foreign exchange in the quarter and also posted 20 basis points of leverage in occupancy, depreciation and product and supply chain costs, as these cost and aggregate came in better than expected.
SG&A expenses were just over $215 million or 34.8% of net revenue compared to 34.1% of net revenue for the same period last year. The deleverage in SG&A was generally in line with our expectations, approximately 60 basis points of the increase relates to the planned costs associated with the improvements to our e-commerce platform that we previously outlined.
Foreign exchange, including the translation and revaluation exposures contributed an additional 60 basis point increase. These were offset by lower professional fees versus last year, coupled with more efficient store and headquarters related spend.
Separately as a result of our transition of the ivivva business, we incurred $21 million in asset impairment and restructuring costs associated predominantly with lease exits. Operating income for the quarter was approximately $86 million or 13.8% of net revenue compared to 17.1% of net revenue in Q3 2016.
Excluding the pretax charges of $22 million related to the planned closures of the ivivva stores, adjusted operating income for the quarter increased to approximately $108 million or 17.4% of net revenue. As a reminder, operating margin this quarter includes approximately 60 basis points of costs associated with enhancements to our e-commerce business as previously mentioned.
Tax expense for the quarter was $28 million or 32% of pretax earnings compared to an effective tax rate of 27% a year ago. The adjusted effective tax rate for the quarter was 30.8% versus 31.3% last year.
Net income for the quarter was approximately $59 million or $0.43 per diluted share compared earnings per diluted share of $0.50 for the third quarter of 2016. Net income in Q3, 2017 included $16.4 million or $0.13 per share in after-tax ivivva related charges.
Excluding these charges, adjusted EPS was $0.56 per share compared to adjusted EPS of $0.47 per share last year. We repurchased approximately 140,000 shares that remained on our $100 million authorization during the quarter at an average price of $60.27 per share.
By the end of the quarter, we had completed our authorization putting our weighted average diluted shares outstanding at 135.6 million. With that plan complete, we are pleased that our board recently approved a new $200 million share repurchase plan.
Capital expenditures were approximately $57 million for the quarter compared to approximately $35 million in the third quarter of last year. The increase relates primarily to higher investment in IT and new store capital.
Turning to our balance sheet highlights, the end of the quarter was $650 million in cash and cash equivalents. Inventory at the end of the third quarter was $397 million or 9% higher at the end of Q3, 2016 and below our forward sales outlook.
Looking forward, we continue to expect inventory growth to generally grow in line with our forward sales trend. Before taking you through our guidance, I’d like to provide some additional color on our Q3 performance.
On the men’s side of our business, as Laurent stated, our ABC pant franchise increased 100% in the quarter and helped drive a 26% comp in our men’s bottoms business. And we were likewise pleased with results in women’s pants, our most iconic category which continued to deliver strong results in comps up 24% in Q3.
Our Everlux launch helped drive this trend, but core styles offered in our Nulu and Nulux fabrics also performed well. We are also excited that the momentum we saw in both men’s and women’s jackets and outerwear at the end of Q2 continued into Q3 as their evolved offering is resonating well with guests.
We continue to seek outerwear and jackets as an important opportunity for us in Q4. In our e-commerce business, the 25% constant dollar comp we achieved in Q3 was an important acceleration relative to the 16% comp we reported in Q2, when excluding the online warehouse sale.
As Laurent mentioned, our digital business benefited as our teams continue to develop the new processes we put in place during Q1 and Q2, focused on better photography, more intuitive merchandising and more disciplined planning. It’s also important to note that we did not launch the new website until the end of Q3.
We’ve been happy with our guest response to the revamped site, and believe this combined with the process improvements mentioned earlier can help drive double-digit gains in our digital business in Q4, and into 2018 and beyond. Turning now to our outlook for the fourth quarter and the resulting updated outlook for the fiscal year 2017.
Please note that the guidance we are sharing excludes costs related to the ivivva restructuring where applicable. We are pleased with the momentum we are seeing the business across all channels as we entered Q4.
In the U.S. we have seen positive store traffic in the first five weeks of the quarter and sequentially improved store traffic in our Canadian business.
And our newly enhanced e-commerce site is delivering important improvements in conversion that will support continue double-digit increases in our digital business. For Q4, we expect revenues to be in the range of $870 million to $885 million, this is based on a comparable sales percentage increase in the mid-single digit range on a constant dollar basis compared to the fourth quarter of 2016.
This also assumes the Canadian dollar at $0.78 to the U.S. dollar and 16 new store openings in the quarter.
We anticipate gross margin to increase up by approximately 100 basis points versus Q4 of last year. Despite the strong increases in product margin last year that were now anniversarying, we continue to see AUC opportunities driven by our ongoing supply chain initiatives and the great work that our sourcing, logistics and distribution teams are delivering.
We expect to leverage SGA in Q4 by 50 to 100 basis points now that the expenses related to our digital acceleration work are predominantly behind us. Assuming a normalized tax rate of 30.4% and 135.6 million diluted weighted average shares outstanding; we expect normalized diluted earnings per share in the fourth quarter to be in the range of $1.19 to $1.22 versus $1 a year ago.
For the full year 2017, we expect revenue to be in the range of $2.590 billion to $2.605 billion. This is based on a comparable sales percentage increase in the mid-single digit range on a constant dollar basis.
As we stated in prior quarters, the guidance range takes into account the closures of our ivivva stores and the associated production in revenues. We expect to open 46 company operated Lululemon stores in 2017.
This includes 16 stores in our international markets, and represents a normalized square footage increase in the low to mid double-digits. We expect normalized gross margin for the year to increase approximately 100 basis points to 150 basis points from 2016, primarily driven by product margin improvement and the benefit of mix.
We expect SG&A for the full year to deleverage by approximately 100 basis points versus 2016. This includes the digital related investments incurred this year which accounts for approximately 50 basis point of the increase.
We now expect our normalized fiscal year 2017 diluted earnings per share to be in the range of $2.45 to $2.48. This reflects the Q3 upside along our confidence in our outlook for Q4.
Our EPS guidance is based on 136.2 million diluted weighted average shares outstanding and also assumes a normalized effective tax rate of 30.4%. We now expect capital expenditures to be approximately $170 million for the fiscal year 2017, reflecting new store openings, renovations, relocation capital and also strategic IT investments.
In closing, I’m encouraged by the success achieved in Q3 as our teams executed well across all parts of the business. We see the story continuing now into Q4 and although the key holiday weeks remain ahead of us, I’m excited by what we are seeing so far which has enabled us to raise our guidance.
And with that, let’s open the call for questions. Operator?
Operator
Thank you, sir.[Operator Instructions]. Our first question comes from Ike Boruchow with Wells Fargo.
Please go ahead.
Ike Boruchow
Hi, everyone. Congrats on the really fantastic quarter.
Stuart Haselden
Thanks, Ike.
Ike Boruchow
Just a quick question, Stuart, on the gross margin line. You’re guiding a mid-single digit comp in Q4 similar to what you did in Q3, but you’re seeing a much more gross margin opportunity, up 100 point, I think you guided Q3 flat.
Just can you help us understand why there is so much more optimism start Q4 relative to where we were three months ago for Q3?
Stuart Haselden
Sure, Ike. And just to offer a little context on Q3 and I think it sets us up for the guidance that we’ve offer on Q4.
So let me please with the ability to post the margin – the gross margin expansion that we saw in the three quarter lapping the big increases that we saw in 2016. And as we mentioned, the beat to our expectations really came through the favorable selling mix.
In particular the great comp that we’ve seen in pants both men’s and women’s and those category brings with them some of the best margins in our assortment. And AUC was also been quite favorable and this reflects the ongoing work for our supply chain team.
As we’ve talk about over the last couple of years the work on the segmentation of our supply chain, the reduction of fabric liability, the better management of airfreight, the elimination and reduction of cancellations, all these things are continuing to extent the benefits that we been able to capture. I think we have been pleased by the runway that we’ve been able to build on the margin improvement really exceeding our original expectations over the [Indiscernible].
On line share the improvement really happening second half of 2016, first half of 2017 we’ve been able to beat our own expectations there and the teams have been able to identify opportunities for the future which is really a part of the gross margin guidance in the fourth quarter. I would say, those opportunities don’t end in the fourth quarter of this year.
So, the fourth quarter guidance reflects all those factors that I’ve just mentioned in terms of where we’ve been able to identify efficiencies in our supply chain and its worth noting that the selling mix benefits that we saw in the third quarter was – that was not how we grew up the quarter, we’re pleased with how it performs. It will extend – do we see selling mix favorability in the fourth quarter, it could be some upside.
In generally we’re pleased with the results that we’ve been seeing not only in the third quarter but into the first period of the fourth quarter. I think what we’re seeing now really reflects the new margin architecture of the business and this is a key element of the EBIT margin equation that we’ve been talking about for while that will get us to an EBIT margin that starts with the two.
Ike Boruchow
Got it. Really helpful.
Thank Stuart.
Operator
The next question comes from Matthew McClintock with Barclays. Please go ahead.
Matthew McClintock
Hello, everyone. Hope everyone is well.
Couple of questions. The first question is just, Laurent, organizational structure for merchandizing, seems like there’s some changes there.
Can you kind of talk about what the right structure is for that part of your business and maybe where there might be some hold in leadership that you might what to fill?
Laurent Potdevin
Yes. It’s a good question.
With lease departure, I mean, obviously [Indiscernible] with the credit director and we are incredibly grateful for the work that we’ve done with lease for the past three years and where we’ve been able to take product and during the transition we’ve been able to launch Spring 19 [ph] and do the credit kick-up within, so there’s really not change in strategy or direction, I mean, that’s a departure that was really driven by personal reasons. But when I look at the organization, I mean, you’re going to see one announcement next week on the women’s design side which could be really powerful, but I think about ahead of design in men’s I think about how we’re leading on the localizing side or from an innovation side, I mean, really the full – when you say about the pillar, are function, design and merchandizing I feel like we’re in really, really strong shape and obviously 2018 is very much planned already with the exception of some cap sold and collaboration that we’re excited about.
And the Spring 19 kick-up that we had just a couple weeks ago was probably one of the strongest that I’ve seen, so we’re going to look for credit director, but clearly when no loss to feel that. So it's a very, very important role.
Its not easy role to fill and we’ve got incredible talent and keep all in key roles to continue to deliver and accelerate on the performance that you have seen so far, so I feel really very good.
Matthew McClintock
Thank you for that color and then if I may one more quick one. Just on China outstanding growth in that region and throughout 40% to 05% longer-term penetration potential there.
Can you maybe talk about your ability, how fast can you ramp that business up without initially overheating it? Or is there a level of growth that sustainable that we should be thinking about for that region or is it something that -- it’s a land grab in some way?
Laurent Potdevin
Every time I go I learn so much and I’m amazed by – I think it’s hard to understand the scale unless you are on the ground. And so having been there and visiting Guangzhou, spending a day on the Alibaba headquarter and then being in Beijing and Shanghai, I mean, its really interesting to see you’ve got 450 million millennials.
You’ve got the government that has a really strong plan, there are 230 health plan which is pushing people to be more active. You’ve got 130 million Chinese people traveling the world year around.
So picture of Germany and France like spending the whole year and travel and its massive. So when you see this group of millennials more and more interested in an active mindful lifestyle.
More and more interested in experience. I mean, in many ways they are leapfrogging, what we have experienced with brick-and-mortar retail in North America and Europe.
So we’ve got a brand with little awareness at this point. We’ve got a large sale that that is really inspirational to this group and so it's really discuss the limit.
So I mean, I think it’s hard to say when we’re going to mature, but seeing single day like tripling year-over-year and I think we’ve actually sum up the work that we’ve done with ambassadors or some of our influence, we can actually accelerate that growth. It was really very exciting to land in Shanghai and work by then you stand in see our product on the cover of Harper Bazaar, something that has not happened in North America.
And I think it really speaks through how well, who we are and what we stand for resonate with that guest.
Matthew McClintock
Thanks again for that. Best of luck.
Laurent Potdevin
Thanks, Matt.
Operator
The next question is from Brian Tunick with RBC. Please go ahead.
Brian Tunick
Great. Good afternoon.
I’ll add my congrats as well guys.
Laurent Potdevin
Thank you.
Brian Tunick
I guess one for Laurent, Laurent, maybe on the $4 billion or this high-teen sales growth CAGR the next couple of years that you keep laying out, I guess was curious between the buckets of North America international men’s and digital, sort of what line item in there are you most confident in you know to get you to that $4 billion revenue number? And maybe, Stuart, can you maybe talk about how we should be thinking about SG&A dollar growth going forward now that the e-comm and some of the contractor work is behind us.
Is the fourth quarter a good proxy for how we should be thinking about SG&A dollar growth or leverage? Thanks very much.
Laurent Potdevin
Brian, when I think about the – thanks for your question. When I think about the 2020, I think about it in very simple terms and I think we’ve outlined that in the past.
But I think that by 2020 we’ve got a billion dollar digital business. We’ve got a billion dollar men’s business and we’ve got a billion dollar like international market.
And within international obviously it’s going to be more heavily weighted on Asia. Within Asia it’s going to be more heavily weighted on China.
And within China it’s going to be more heavily weighted on digital. But I think one really simple way to think about it is a million in men, a million in digital, a million in international and obviously the balance is pertaining to do what we do so well with the rest of the business especially with women’s and driven by innovation which we've seen that incredibly well in Q3 with the launch of Everlux in women's pants.
Stuart Haselden
Okay. Brian, let me try to answer your question on SG&A.
So, as we’ve talked about previously we are calling for SG&A leverage to help us achieve the EBIT margin rate in the low 20s and as we’ve talked about previously Q4 was an important period for us, its begin delivering on SG&A leverage. As we look forward and I’ll give you a little more color on Q4 in a second, but as we look for beyond the fourth quarter we’re going to plan a modest degree of leverage in our five-year plan.
And the rationale there being at a mid-teens total revenue growth, we want to ensure that we are providing the dollars to fund our growth initiatives each year so that we’re – we’re not harvesting the business, we’re continuing to reinvest at a healthy pace that will help sustain that topline trajectory, but also very disciplined manner allow those topline increases to flow through to earnings. So that is definitely how we’ve drawn up the plan.
We think that Q4 and I would also point to Q3 as well an important evidence of achieving that plan. As you look at the third quarter we had 70 basis points to de-leverage, 60 basis points of that was related to the e-commerce recovery.
We had another 60 basis points from FX, offsetting that was 50 basis points of leverage from some of the cost management actions that we’ve been taking. So the overall picture in the order if you take out sort of one-time recovery for a digital business is pretty healthy from an SG&A standpoint.
And then as you – then if we look into the fourth quarter, largest quarter from a revenue standpoint, easier for us to leverage our fixed costs, we’re also getting past those digital acceleration one-time cost, so we don’t had that laying on the SG&A picture in the fourth quarter. The full benefit of the cost management actions that we began in the beginning of the year, this connects to SG&A’s leverage improvement that we guided to, but it’s a definitely part of our thinking for the business model we look forward, continue to invest in growth and doing so in a discipline manner.
Brian Tunick
Makes a lot of sense. Good luck for holidays guys.
Stuart Haselden
Thank you.
Operator
The next question comes from Oliver Chen of Cowen and Company. Please go ahead.
Oliver Chen
Hi. Thank you.
Great quarter. Our question is about digital and digital plus stores, and what you’re thinking about for the next opportunities for innovation in digital and also as you about driving community in mindfulness and the integration of your online and your physical stores.
And then I had a product question, Laurent, what are your thoughts -- you had a such great momentum in the bottoms business, how are you feeling about the tops and synergies there and the presentation of color relative to the past, that would be great? Thank you.
Laurent Potdevin
Thanks Oliver. So the first question was about digital, right.
When you think about our unique point of differentiation and really heart beat of this brand of our educators, our guests, our ambassadors and our ability to create the most amazing human connection and deliver incredibly products and when you think about products, I mean, I don’t think product is necessarily limited to three-dimensional product that we were. And so without saying too much I mean, we think that we’ve got a tremendous opportunities to enhance and amplify that possibility to in China right now.
We’ve got an opportunity to really enhance the connected issue between our guests, our ambassadors and our educators. And I think that one really good example of that is – an O2O, what they referred do O2O in China and offline to online event that we did with Alibaba where we sold 250 tickets for you guys in Beijing so they were sold on Tmall.
They sold down in 30 second. It was pouring rain [ph] 247 people sold out.
It was live screen, 225,000 people and I think that day we did about $700,000 in sales as a result of that. I mean that’s where you can really see our ability to amplify what we do so well at the community levels, on a global scale.
So that and again when we talk about creating transformational experience for our guest it goes beyond product, the way product today. So I think that gives you enough hints as to how we think about our digital strategy.
And I totally forgot what that second.
Oliver Chen
The second question was about tops and the parts of your assortment where you still see some opportunity. You had such really awesome growth rates on the bottoms business.
And then, Stuart just functionally combined line pickup in store and inventory accuracy what are some of the tactical opportunities and thinking about omnichannel that you’re testing in that world, harvest some results potentially over the next few quarters?
Laurent Potdevin
Just quickly Oliver on the product question, I mean, clearly what we’ve done with the Enlite Bra and what we've seen since then, really speaks to our ability to be just as strong in the bra category as we are in women pants. And I’m actually really excited about the innovation that’s coming in 2018 in the bra categories.
So when you think about owning her bras and her cloths for both bottoms and bras, I mean, those are two anchor categories and that really – that trust expand across every other category. So I think we’re on a really good track there, but I’m excited about the innovation that’s coming in 2018.
Sensing with starts when you think about new fabrication, and new construction, we know that there is a – you want to see more natural fabric and you’re going see natural fabric from us which will be a real technical functionalities incorporated, so you’re going to see the best of both worlds, so we’re excited about that as well.
Stuart Haselden
And however on your question on omnichannel, we’re excited for the new functionality we’ll introduce in 2018, with buy online pick up in store. We’re thrilled that we’ve seen on other omnichannel initiatives, ship from store has been very successful.
VDR is our higher camping channel as we think of those turns in the company. Our business model continues to become more and more omnichannel.
Our stores and digital business has become more and more every day. So we’re excited that we’re able to recognize demand in one channel and somewhat in another in a more and more seamless manner as we develop these capabilities.
I'm going to invite Celeste to also offer some comments as she is with us today.
Celeste Burgoyne
Yes. Thanks, Stuart.
I mean, I think, Stuart, you spoke to the highlight in terms of omni, the way we know it today in terms of ship from store, VDR and Buy online, pick up in store we’ll launch next year, I think what I guess the most excited about is how first of all agile our stores are in terms of really been able to adapt and to be able to integrate omni into everything they do. Again for us, the way I really look at is obviously omni and digital go hand in hand with stores and its becoming more of a way as we operate and every touch point is really touch point that we own and we’re leveraging those channels for what their best able to delivery for us.
As we look at our store portfolio rollout, as well as our digital business we see kind of all those rise and our ability to be easy channel strategically allows for that. And I don’t know if you guys have seen today, but we actually won the glass store number one retailer in both Canada and the U.S.
from a retail employee satisfaction perspective which again to me really is one of our key competitive advantages and allow us to really play local and leverage digital at the same time. So again I think omni is kind of in lot of ways our middle name and really how we look at the business.
Oliver Chen
Thanks for that. Happy holidays.
Best regards.
Stuart Haselden
Thanks Oliver.
Operator
The next question comes from Matthew Boss with JPMorgan. Please go ahead.
Matthew Boss
Great. Congrats on a nice quarter, guys.
Stuart Haselden
Thank you, Matt.
Matthew Boss
Stuart, as we think about gross margins from here more on a longer-term basis, any structural impediments which would prevent the model from returning to the mid-50s prior peak margin that we saw years back? And just how would you rank the gross margin drivers of expansion next year?
Stuart Haselden
Sure. As you look at the peak gross margins in the company few years back, the assortment was very different.
The mix of men’s and women’s was very good and within women’s you had a much simpler raw material palette that the designers and merchants were working with. We have seen many more fabric today that gives different profile from a structure and economic standpoint.
So I don't see the CS returning to that gross margin in the mid-50s. I do see room for improvement in product margins in particular from where we are today and that’s part of the comments they offered earlier, I would also add as you look below just the product margin line and you look at the cost for the product team and the supply chain teams I do see substantial opportunities to leverage those costs.
We’ve made a lot of bit investments over the last couple of years. So we do see opportunities there.
And likewise in occupancy, and we saw that in the most recent quarter, where I think we reported 20 basis points of occupancy leverage in the third quarter. If you go back a couple of years ago we were reporting like 100 basis points of occupancy of depreciation deleverage.
So I think as our real estate portfolio has matured particularly as we expanded the international part of the portfolio and that -- those stores have seasoned in the overall portfolio in terms of the incremental additions of rents. It’s a place where we can begin to leverage those costs into the future.
So we’ll certainly talk more on the next call about where we see gross margin with more specificity in the 2018 and beyond, but the drivers that I would point to with the same thing that I mentioned earlier, in particular the segmentation of the supply chain and what I mean by that is as we separates the different products in our assortment based on their lifecycle on our selling flow would able to source them differently and more efficiently. And so that’s been a big part of the savings and the improvements, efficiencies we’ve seen up to this point that continues to be an opportunity, although not as large, not the big step function that you saw in 2016 and early 2017, but its still an opportunity, and more exciting to us as we transition our supply chain path just getting efficient and more continuing, we’re beginning to be able to quite offense and implement – begin to test and implement speed models which will compress our development cycle times.
And we also have the opportunity to build the stronger capabilities for Fast Turn and Chase, which again will enable us to have more precise and accurate assortment in inventory decisions which will reduce markdowns, which will in turn benefit margin. So those are things I would point to.
And again when were together again to the fourth quarter call we’ll able to offer you additional details.
Matthew Boss
Great.
Laurent Potdevin
And Matt, if I can just – I mean, today you’ve got a very different organization that you had at the time of big margin. I mean, today we’ve got a runway of international growth, you’ve got men’s business, you’ve got a digital opportunity.
I mean, we’ve got a real strong runway and like – within our hands and that’s really driven by a rich pipeline of innovation and so that’s a very – so that’s be a sustainable and profitable model. And that’s done with big margin that you’re referring to, I mean, you did have opportunities ahead and you had a pipeline of innovation that was really drives.
So I mean I think today you’re in position that is far more sustainable with far more scale as we look to the foreseeable future.
Matthew Boss
Great. And then just on the balance sheet net cash position annual free cash flow generation seems to really be nicely ramping here.
Can you just talk us some of the priorities for access cash going forward as we move into next year and beyond?
Stuart Haselden
Sure, absolutely. The priorities for cash really number one priority is funding the organic growth of our business and we are excited that we continue to identify great investment opportunities whether its category explanation within men’s or the international expansion into Asia and Europe.
Those are the number one priority for our cash. But even with you’re correct, we’re generating significant free cash flow.
The next elements that – or the next parts of the use of cash strategies is first creating financial flexibility for us to evaluate number of different ongoing strategies and that would include a healthy return of cash strategy that you’ve seen in the last couple of years with a share repurchase program. So, as that cash builds we’ll evaluate the priorities across those elements that I just mentioned determine how fast to deploy it, but again I think as we wrap up the year and on the fourth quarter call, we probably offer a little more detail on our use of cash strategy and what you should expect into next year and beyond.
Matthew Boss
Great. Good luck.
Laurent Potdevin
Thank you.
Operator
The next question comes from Paul Lejuez with Citi. Please go ahead.
Paul Lejuez
Hey guys. So can you talk about what was store traffic in the third quarter in the U.S.
and Canada, also what you assume for store comp within your fourth quarter comp guidance? And then just separate, can you talk a little bit about the performance of the Fifth Avenue store, has that store compared to some of your higher volume stores?
Is it teaching you anything about what the brand might resonate, that you weren’t thinking previously, and what percent of that stores traffic [ph]?
Stuart Haselden
Sure, thanks Paul. Store traffic in the U.S.
and Canada as I mentioned in the prepared remarks has sequentially improved in the third quarter. There were periods in the third quarter where we saw positive store traffic in the U.S.
and but for the overall quarter, U.S. store traffic is nearly negative.
Canada was a bit tougher and while we saw the Canadian store traffic results improve from the second quarter to the third quarter is still negative. As we look at the fourth quarter call guidance, there’s a few things I would point to.
The – we have seen quarter to date through the first four weeks in the U.S. positive store traffic, so that’s been very encouraging to see.
It’s been tougher in Canada similar to the relationship that we saw in the third quarter, sequentially improve but not as strong in Canada as it has been in the U.S. and still negative in Canada.
We are not seeing necessarily you know a deceleration as you look in the mid single-digit comp versus what we recorded in Q3 of [Indiscernible] we are not seeing a deceleration embedded in fourth quarter guidance. What I would say is we are seeing peak periods so far in the fourth quarter like in the Black Friday week outperforming expectations with the other periods you know that are not as peak as that being slower.
So the trend overall has been choppy if you will with the high being higher and the lows being lower. And as we sit today, we still have 70% of the quarter in front of us, some massive weeks coming up in the next four or five weeks so we feel like the guidance and we offer a mid-single digit is appropriate.
So, and I’m going to differ to Celeste on the Fifth Avenue question
Celeste Burgoyne
And just on the traffic, the one thing I would want to add on the traffic is we’re also going where traffic is, so there is traffic comp and then how we are looking at our store portfolio, is we’re really also and super open to deepening our experiences within these markets and we have a strategy that is our seasonal store strategy. So this holiday we’ve opened up 22 pop up seasonal stores that will be in good traffic, a decent malls and really capturing business where traffic is.
So again when you look at traffic comp, that’s one piece of it, and we are also really looking to be how we become and continue to be really agile. Those stores from a seasonal perspective we are really happy with the results so far, and from an acquisition perspective and they are trending at about 50% of their gas or and new gas.
So, again just shows one of the strategies we are doing and it complements our other strategies from a community perspective to drive our store comp traffic. In terms of Fifth Avenue, really happy with Fifth Avenue, is quickly risen to the number one store in the U.S.
We are seeing really good AOV and really good PPT [Ph]. In terms of [Indiscernible] I mean it is over inducting our other New York stores in terms of the percentage of tourists that tourist is international as well as U.S, so mainly mid-west and then international.
So really happy and definitively over inductive in tourist and new acquisitions, and again as an example for us of how we can conducted [Ph] a merged hedged point end market. So in New York city we have seen very very very little cannibalization from opening Fifth Avenue and we actually have Time Warner on the books to open in the second half of 2018.
And you know another good example of our ability to kind of go deeper in markets is Robson in Vancouver. Robson is our number one store in Canada and we opened the Pacific Center which is three blocks away, and again a really good example of what we are not seeing cannibalization and we’re seeing an ability to, I really believe, in trying [Ph] to vary our distinct businesses with really great community impact.
Paul Lejuez
Great.
Howard Tubin
Operator, we’ll take one more question.
Operator
Yes sir, the last question is from Mark Altschwager with Baird. Please go ahead.
Mark Altschwager
Very good afternoon and congrats on the quarter. A couple of product questions.
First on accessories, that assortments really ramped over the last few months, it seems like a nice opportunity over the holiday gifting period. Just curious what the penetration of accessories is today and how much do you think that it can expand over the next few years the year.
And then separately on footwear, just curious on the learning’s from the pilot and whether that can be a needle mover here in the short run?
Laurent Potdevin
Yes, thank you. On the accessory, I mean we’ve – our penetration right now I think is around like 7% or 8% and I’ve said before that for the brand that is as strong and as inspirational as we are.
I mean, we have the potential to be in the 12% to 15%, so certainly we have a lot of runway. We’ve seen a nice acceleration in the latter part of Q3 probably as a result of the assortment that you are referring to, and we’ve seen the bulk of the opportunity really in bags, socks, yoga mat and head veil.
I mean obviously we’ve got sort of other accessories on the side but that’s where you are going to see the bulk of the business coming from, so a nice, a nice opportunity for us which is a great guest acquisition strategy and it’s a high margin category. So that’s the penetration and what we see as the potential.
And the second question was....
Mark Altschwager
The footwear....
Laurent Potdevin
Footwear, I mean, it’s been -- it’s an interesting pilot. I mean what we are learning is that our stores are incredibly nimble and that they can adapt to new categories very quickly, but that was rolled out in a matter of weeks really.
So, that speaks to the agility of our store and it also speaks to the fiber our guest trust us beyond the category that we are in currently. So we are taking those learnings and we are thinking about what category this would apply to in the future, but not necessarily footwear.
Mark Altschwager
Thanks for the color. Best luck for the holiday.
Laurent Potdevin
Thank you so much.
Stuart Haselden
Thanks, Mark.
Operator
This concludes the time allotted for questions. I will turn the conference back over to the presenters for any closing remarks.
Laurent Potdevin
Thanks for joining us everyone. We look forward to speaking with you in about three months when we report our fourth quarter results.
Thanks.
Celeste Burgoyne
Good bye.
Operator
This concludes today’s conference call. You may disconnect your lines.
Thank you for participating and have a pleasant day.