Lululemon Athletica Inc.
Q3 2015 Earnings Call Transcript

Published: 9 Dec 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the Lululemon Athletica Third Quarter 2015 Results Conference Call. At this time, all participants are in a listen-only mode. Later, there will be a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today's call is being recorded. I would now like to do turn the conference over to Chris Tham, Senior Vice President of Finance. Sir, you may begin.

[Chris Tham:]

Thank you and good morning. Welcome to Lululemon's third quarter 2015 earnings conference call. Joining me today to talk about our results are Laurent Potdevin, CEO; Stuart Haselden, CFO; along with Miguel Almeida, EVP of Digital, who will be available during the Q&A portion of the call. Before we get started, I’d like to take this opportunity to remind you that our remarks today will include forward-looking statements reflecting management's current forecast of certain aspects of 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 obligation 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 today's earnings press release. The press release and accompanying quarterly report on Form 10-Q will be available under the Investor section of our website at www.lululemon.com. 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, Chris and good morning, everyone. Today, I will provide an overview of our third quarter performance, as well as highlight our progress against various initiatives, which incorporates the recent changes to our organizational structure. Stuart will then walk you through our financials and guidance in more detail. First, our topline perspective, the third quarter was in line with our expectation. We delivered $480 million in net revenue for the quarter, up 14% above the third quarter of 2014 and up 20% in constant currency. We achieved a 9% global combined comp, the result of strong performance across our channels and regions. Once again in Q3 store comps across all regions were positive and we delivered a global e-Commerce comp of 21%. This solid topline performance is a testament to the continued strength of our brand and loyalty of our guests. Our gross margin and inventory position came in within our expectation for the quarter and we reported EPS of $0.38 per share. In line with microeconomic trends, the start of Q4 has been mixed. We saw lower traffic in the final weeks of Q3 and into the first couple of weeks of Q4, with steady improvement in Thanksgiving. Given the current environment, we're taking a conservative stance with revenue in Q4, while taking the necessary actions to manage inventory and control expenses. Our work to be a scalable global supply chain is beginning to pay out and we saw an inflection of our product margins beginning in Q4. I would like to start by emphasizing that this year of investment in our product engine and supply chain remains very much on track. We're now seeing sequential improvement in product margin and remain focused and confident in our goals. We continue to strategically invest in people, processes and technology that will delivery strong, long term profitability and support our global expansion and 10-year vision. Stuart will provide more detail within his comment on our strategic investment and progress on margin expansion along with an outlook on our inventory level. Our women's business has continued to be strong with an acceleration in pants and bras, where both categories delivered double-digit comp for the quarter. On our last call, we had just launched our new women's pant wall. This was among the company's most significant global launches combining education, innovation and a re-imagination of this category. We've seen a fantastic response from our guests with women's pants generating a 27% comp in Q3 and bras were not also far behind with a strong comp of 18%. With new creative leadership and direction, the design seems laser focused on delivering new styles and innovation for the top and ten categories that will give our guests varying levels of support, coverage and fit options. Our men's business continues to outpace our overall growth, comping 24% for the quarter. This performance was and continues to be attributed in large part to our sweat category, the anchor of the men's business. The technical function of our sweat assortment, combined with our deep community relationship with our ambassador, is what gives us long term relevance and continues to set us apart. Our Ivivva brand also posted double-digit comp growth with a 23% combined comp for the quarter. This strong performance continues to demonstrate how aesthetically this brand resonates with our young guest and for those of you who are listening from New York, we just opened our first Ivivva prop-up location in Union Square and I would encourage you to drop in and discover it for yourself. Turning now to creating amazing experiences for our guests, we've fully deployed RFID to all North American stores. This technology is a powerful new tool in creating seamless guest experiences across all channels and has greatly enhanced our ability to access inventory quickly across all channels and locations. Our in-store ability to access our incoming inventory through our bag backroom app accounted for 8% of eCommerce revenue for the quarter. We continue to engage new communities as we open new location across the world. In November, we opened our Flatiron Flagship in New York City. This amazing location hosts our largest store to date and also has dedicated consumer services delighting guests with everything from booking the most product classes to discovering the best runs in the city. This location serves local New York guests and is a platform for the rest of the world to discover Lululemon. Located on the lower level of the store, Hub 17 is a 3,000 square foot space dedicated to connecting our guests with ambassador amongst many other things. This is an incredible space for our collectives to engage with friends, sweat and enjoy the work of local office and live music. Throughout Q3 we made further progress expanding our global collective. We opened our first store in Dubai at the mall of Emirates and have a second store planned by the end of the year. In Europe, we opened two new stores including Marylebone in London as well as two new showrooms. In Asia we opened our second location in Hong Kong at Hysan Place and are extremely pleased with its performance since opening. In the second week of Q4, we launched our shop-in-shop on Tmall attracting a 165,000 unique visitors on the first day, clearly validating the strength of the platform as key to building our brand awareness in China. Tmall provides an opportunity to introduce new guests to our brand and support our existing showroom locations as we continue to build our community in China. In addition, the performance of our showroom in South Korea continues to far exceed our expectations and we're excited to open two new stores in Seoul in the first half of next year. On the brand and community side, we launched a number of engaging initiatives, OM Canada with the celebration of our roots and included community events across the country. I recently visited Toronto and was amazed at the thoughtful execution of this program among our six stores and our continued commitment to our home market. We're seeing this focus clearly payoff as Canada posted another positive store comp in Q3. Finally, I am thrilled to share the progress we've made to our organizational structure. Over the past 18 months, we've build a global world-class Management Team that is diverse and culturally aligned to drive our strategic global priorities and successfully position us to leave into our 10-year vision. In October we appointed Lee Holman as our Creative Director, uniting both men's and women's vision under one overarching design. Lee brings a perfect balance of function, design and craftsmanship making its ability to solve problems for athletes second to none. Dr. Tom Waller was promoted to Senior Vice President Whitespace, our R&D facility. Tom will continue to lead our team of scientists and engineers and be the catalyst for innovation across the entire organization. By elevating our passion for design and innovation we will continue to strength our position as a global market leader in the category we created. Stuart Haselden has added Executive Vice President, Operations, to his title assuming broader responsibility focused on driving operational excellence. And we are well along in the process of selecting a Chief Supply Chain Officer who will take on the work we started to optimize our global supply chain. Last but certainly not least, this November we announced the appointment of Gina Warren as Executive Vice President, Culture and Talent, reporting directly to me. Patience is paying off and after a lengthy search I am beyond thrilled to have Gina join us with her exception track record of driving global culture rooted in leadership and development. Our people are the core that will drive this brand into the future. A true visionary, I look to Gina to nurture, lead, and evolve our unique culture as we grow our global collections. As we near the end of the calendar year, our work is starting to pay off. We are relentless and focused in driving our priorities, thanks to a passionate group of leaders and an entire collective of smart, engaged driven individuals throughout the organization, including our educators, store managers, ambassadors and support teams around the globe. I’m more confident than ever that we will continue to build on our current momentum and deliver long term profitable growth. Finally before turning it over to Stuart, I would like to take a moment to acknowledge the passing of Tom Stemberg. Tom was not only the retail legend we all know and a critical member of the Lululemon Board since December of 2005, he was also a dear friend of the company and truly loved Lululemon. As the Chairman of the Lululemon Compensation Committee, Tom's passion for building unique programs focused on health and wellness, knew absolutely no bounds. I will be forever grateful for his commitment to making me a better leader and Lululemon a better company. We will all miss him dearly. I'll now turn things over to Stuart to review our financial results and product guidance for the upcoming quarter and full fiscal year.

[Stuart Haselden:]

Thank you, Laurent. I’ll begin today by reviewing the details of our third quarter of 2015 and then I’ll update you on our outlook for the fourth quarter and the full fiscal year of 2015. For Q3, total net revenue rose 14% to $479.7 million from $419.4 million in the third quarter of 2014. The increase in revenue was driven by total constant dollar comparable sales growth of 9% comprised of a bricks and mortar comp store sales increase of 6% and online growth of 21%. Also square footage growth of 22% versus last year driven by the addition of 65 new company-operated stores since Q3 of 2014, 33 new stores in the United States, two stores in Canada, one store in Australia, five in Europe, four in Asia and 20 Ivivva stores and offset by the foreign exchange impact of a weaker Canadian and Australian dollar, which had the effect of decreasing reported revenues by $24.7 million or 5.2%. During the third quarter, we opened 18 new company-operated stores, nine in the U.S., two in Europe, one in Asia and six Ivivva. We ended the quarter with 354 total stores versus 289 a year ago. There are now 266 stores in our comp base, 42 of those in Canada, 173 in the United States, 30 in Australia and New Zealand, one in Europe and 20 Ivivva. At the end of Q3 we also had a total of 86 showrooms in operation, 27 lululemon showrooms in North America, 19 internationally and 40 Ivivva showrooms. Company operated stores represented 73.7% of total revenue or $353.4 million versus 73.9% or $310 million in the third quarter of last year. Revenues from our digital channel totaled $89.3 million or 18.6% of total revenue versus $77.2 million or 18.4% of total revenue in the third quarter of last year. Other revenue, which includes strategic sales, showrooms, popup stores, warehouse sales and outlets totaled $37 million or 7.7% of revenue for the third quarter versus $32.2 million or 7.7% of revenue in the third quarter of last year. Gross profit for the third quarter was $224.8 million or 46.9% of net revenue compared to $211.1 million or 50.3% of net revenue in Q3 of 2014. The factors which contributed to this 340 basis point decline in gross margin were 130 basis points of overall product margin decline as the port related product costs and selling mix pressures observed in Q2 continue to be meaningful in Q3, but were offset by improved air freight usage. 70 basis points attributable to higher mark downs, 90 basis points of decline due to the foreign exchange impact of a weaker Canadian and Australian dollar and 120 basis points deleverage from occupancy and depreciation, which is related to new stores including international locations and higher lease costs associated with major renovations, relocations and regular renewals. These items were offset by 70 basis points of leverage in supply chain overhead cost. SG&A expenses were $156.6 million or 32.7% of net revenue compared to $129.9 million or 30.9% of net revenue for the same period last year. This 21% SG&A dollar increase is due to the following

[Operator:]

Thank you. [Operator Instructions] Our first question is from Paul Lejeuz with Citi Research. You may begin.

[Paul Lejeuz:]

Hey guys. Stuart, you mentioned the opportunities on the supply chain. Can you maybe just talk about the different buckets maybe dig in a little bit to some quantification on where you're farthest along and just the timing on see those come through? It sounds like maybe some are happening earlier than planned in the fourth quarter, but just wondering how we should think about the total by bucket in F'16, thanks?

[Stuart Haselden:]

Yes, hey Paul, it's Stuart. So as we think about the margin improvement in the order of magnitude, we still see the potential we still expect to achieve the area of 300 basis points of product margin improvement versus 2014 pre-FX. But I think what we're seeing now that we're a little farther into 2015 and have more visibility on the first half of '16 that it will likely take us into the first half of 2017 to fully achieve that level of margin recovery. But as we mentioned, we are seeing the opportunity taking shape in 2016 particularly beginning in the second quarter and again, but we will see improvement in margin in the first quarter, but a greater inflection accelerating into the second quarter and so we feel like the overall story is intact. We try to lay out in my prepared remarks some of the primary buckets for how we'll deliver that and I can give you a little color now on each of those. So as you look at the reductions in air freight, that’s a big piece of the equation and one of the more tangible that we’ve been able to make probably the most progress on in 2015. As I mentioned we’re seeing air freight utilization in the fourth quarter less than half of what it was in 2014. So that’s going to translate into an important point of leverage for gross margins in the current quarter in Q4. We see that extending into 2016 and to quantify we’re looking at air utilization rates that are under 25% where in much of the prior year they were approaching 50% north of 40% easily north of 40%. So that’s a critical element that is tangible that we’re seeing the current benefits. The other areas, the improved logistics and duty costs, so on the logistic side there is programs we've identified to optimize our mode utilization. All air freight isn't created equal, and there's different tiers of air that you can leverage at different levels of cost of the company. So we’ve identified ways to optimize that where we choose to use it. The same thing for ocean freight/ It's not all created equal and we've again identified where we can do a better job of flowing inventories through the supply chain, through the logistics elements of how we move product. And duty cost there is just some pretty straightforward first sale opportunities we’ve identified there weren’t worked on now. So again those are again meaningful opportunities from a cost reduction standpoint. FOB cost improvement; this is really us getting our house in order. We've talked about this earlier in the year. Improving our demand planning being able to look forward and have a more reliable estimate of our production requirements that we can take to our suppliers to deliver more consistent production requirements, reducing the amount of cancellations that we’ve seen and as well late stage change orders. All those things will improve our ability to lower our FOB costs. And then also as I mentioned the go-to-market process, more discipline around how we manage our fabric liability. We've taken some steps earlier in this year to clean up our position. We feel like we should be in a good place to enter 2016 in that regard and also as our internal processes for product development improve, we can improve our development ratios as I mentioned, which again is an important part of the liabilities that we generate to support our product process. So those are the big areas we would like to identify and not going to break out sort of the details around each in terms of what they're worth, but each of those are meaningful and will be part of the overall recovery that we see really accelerating in Q2 of next year.

[Laurent Potdevin:]

And Paul, this is Laurent. What I might want to add quickly is with the structural changes that we’ve made and on the product side, being design led certainly doesn’t come at the expense of great merchandising and I’ve already seen much greater collaboration between design and merchandize resulting in a much more focused approach to the assortment, which will create better experiences for our guests, but also much more efficient targeted sourcing up of our product resulting in greater margin. So I've seen the impacts that it will have both on the guest standpoint, but also the laser focus on a more streamlined supply chain.

[Paul Lejeuz:]

Great, thanks guys. Good luck.

[Laurent Potdevin:]

Thanks Paul.

[Operator:]

Thank you. Our next question is from Brian Tunick with the Royal Bank of Canada. You may begin.

[Brian Tunick:]

Thanks, good morning, guys. One question on the product side and then one on the expense side, I guess on the product side bottoms up I think you said 27% bras up 18%. Can you maybe talk about what are the biggest opportunities in the women’s assortment next year? Where do you think there's the most white space to either relaunch or have a new category? And have you learned anything about your price opportunities given the newer high price point in the compression pants. And Stuart, on the expense side, can you maybe talk about the SG&A dollar growth? Obviously, there was some consulting costs in there, how much they may have been for the third or the fourth quarter, and are there any other management holes besides the Supply Chain Head that we need to think about for 2016 SG&A dollar growth? Thanks very much.

[Laurent Potdevin:]

Well this is Laurent. I’ll take the first part of the question. Clearly what we’ve learned and what we've known along and where we probably lost our way is about when we were bold and we're innovative, our guest responds really well and the responses the launch of the pant wall has been fantastic. So both from a fabrication, from an innovation standpoint and we have actually seen the price elasticity that was much greater than what we had originally anticipated meaning that our guests really responded well to the value that we provided. So when you look the success of being both innovative and really delivering that kind of value, when you look at the comps that we've had in pants and bra, it's obvious that the category that we need to be really focused on right now is pants. And with Lee coming on as Creative Director his first area of focus is clearly do deliver the same type of innovation both from a fabric, styling and construction standpoint that we have with the pant. So that is a very substantial opportunity for growth for us as you think about spring summer 2016 and beyond.

[Stuart Haselden:]

Great and Brian its Stuart. I’ll speak to the -- to your SG&A question. So SG&A did come in high for the quarter versus our prior expectations. There were a few factors that explain where we landed, a couple of which we mentioned in the prepared remarks. But these -- there is only three things I'll call out. First we did see about $3.4 million of increase in FX revaluation loss versus Q3 of last year. We also had about a $1 million in severance that was not incorporated in our earlier estimates and finally consulting fees, which in total were around $2.5 million in the quarter related to our supply chain initiatives primarily came in above our prior estimates. A portion of that was contemplated in the guidance, but there was some portion of that was above what we expected. The combination of those factors accounted for over 100 basis points of the deleverage that we saw in the quarter and essentially bridge us back to our original estimates. We’re comfortable that these costs are one time in nature and do not represent a permanent increase in our cost structure and really offer us an opportunity to leverage as we lap these costs into next year. And as we think about Q4, we do anticipate a meaningful amount of SG&A deleverage in Q4 and that’s implied in the guidance that we gave. But to a somewhat lesser degree than what we see in Q3, you also heard in our prepared remarks some of the factors that we pointed to that will affect SG&A in the fourth quarter, the biggest of these being the $7 million in FX gains in Q4 last year that we're now lapping that by itself is about 100 basis points of pressure. Otherwise we're continuing to invest in our supply chain initiatives that’s probably the largest of the factors otherwise, but we also have important investments in website redesign and our digital marketing efforts. As we look into 2016, we'll certainly give more detailed guidance around 2016 on our Q4 call. We’ll continue to make investments to support the supply chain initiatives, which will likely be heavier in the first half of the year as we draw closer to completing those key investments in that timeframe. So hope that’s helpful.

[Brian Tunick:]

Yeah that’s super. Thanks very much. Good luck for holiday.

[Stuart Haselden:]

Thanks.

[Operator:]

Thank you. Our next question is from Sharon Zackfia with William Blair. You may begin.

[Sharon Zackfia:]

Hi. Good morning. I was hoping to get an update on the idea of having gross margin parity or merchandise margin parity between seasonal and core. I haven't heard you talk about that in a while and I'm not sure where you are in that initiative at this point.

[Stuart Haselden:]

It’s not a great way I think that we would explain what’s going on in our gross margin picture. I think we believe our seasonal products and our core product should both offer great margins that should lead to margin expansion from where we currently are. I guess what I would say is we're five, six weeks now into Q4 and we're excited to see that the efforts that we’ve been making over the course of the year are starting to get traction from a product margin standpoint. As we mentioned in the opening we’re seeing stabilizing product margins that are happening now in the fourth quarter as we begin to clear some of these port related issues. As I just mentioned few minutes ago air freight is an important source of leverage for us as the utilization are coming in line with our targets and our supply chain begins to normalize. Occupancy and depreciation will also be a big part of leverage for our gross margin in Q4 and then even a greater source of sequential improvement into 2016 and just to be clear there will still be deleverage in Q4, but just not as much as what we've seen in the earlier parts of the year related to occupancy and depreciation. FX will continue to be a headwind. We will have some increased markdowns in the fourth quarter, so that we can stay on top of the inventory movement. We are committed to an aggressive ensuring that we get our inventories rebalanced, but coming back to your question Sharon on core versus seasonal, we're developing a merchandized segmentation strategy that will enable us to balance the product -- different elements of our assortments based on the anticipated life of those -- the product life of those different parts of the assortment. And that should give us an advantage in how we build supply chains to deliver those and capture margin opportunity. So again I guess the punch line here is that we think we should be able to deliver great margins on both seasonal and core products and that’s how we’re drawing up our plan.

[Laurent Potdevin:]

And Sharon looking at it just from a pure product standpoint, I mean looking at what’s coming in spring and summer from a print technique, from a fixture, from a construction standpoint, I mean really not said that all along they have no reason why seasonal should deliver less margin and core especially when you compound that with our scarcity strategy around seasonal product. So we feel very confident that there shouldn’t be any margin discrepancies between seasonal and core and I actually think we’re not even thinking about seasonal and core in that way anymore. And I’d love to take this opportunity to remind all of you that Miguel Almeida, who is leading Digital is on the call with us and over the next few calls, I'd love to expose all of you to more of the Management Team. So, obviously digital ether center of excellent that we're building Miguel has got a massive experience in that area. We're we’re excited about it and it's obviously a great opportunity for us. So if you've got question for Miguel, don't make him feel bad for being silent here. Just ask him some questions.

[Operator:]

Thank you. Our next question is from Oliver Chen with Cowen and Company. You may begin.

[Oliver Chen:]

Hi. Thank you. On the success of pants and bras and men's, what were the product classifications that had more opportunity this quarter in terms of getting to your overall comp? And Stuart, on the markdown front, which classifications had the markdown and as you guided to markdowns for the Q4 period, does that mainly have to do with what you've articulated with your warehouse sales, or what should we expect in store? And then Miguel, on your side, buy online pick up in store in mobile, they are major ideas for integrating bricks and clicks. Just curious on what are the next major hurdles in the flagship? The Flatiron flagship has a lot of interactivity, so wondering what we can see there for the innovation ahead. Thank you.

[Laurent Potdevin:]

So Oliver, I'll take the least amount of time to answer your question. The largest opportunity right now for us is women’s pants and Lee and Dugan the communities that have actually put a fully dedicated team to just look at that opportunity and quickly bring product to life that we'll proud and that we love. So I would leave it at that. That's clearly the biggest opportunity, one we’re focused on.

[Stuart Haselden:]

Hey and Oliver, its Stuart. On the markdown question, there is a couple of pieces there. Certainly we have added activities namely the physical warehouse sales, the online warehouse sale that we did earlier in the year and the two warehouse sales we now have teed up for the fourth quarter. Those certainly serve to increase the amount of markdowns that we have in our part of the guidance that we gave and the results in Q3 and otherwise we are taking steps with regards to markdowns to make sure that we are staying on track with the clearance goals that we have to move through the inventory we have in a orderly manner. So in October, we did see -- we saw traffic slow in the final weeks of October and there was some incremental markdown activity there to again stay on top of the inventory movement. We in the guidance we have given for Q4 reflects the quarter-to-date activity, and as well, our expectations at this point for the balance of the quarter in terms of actions we’ll need to take again stay on top of that inventory movement.

[Miguel Almeida:]

And this is Miguel, on the buy online and pick up in store, it’s one of our critical initiatives to improve the guest experience across channels, something that our guest have been telling us that they really want to see from us. The RFID that we have in North America will enable us now to accelerate the testing, learning of those experiences. And I'm mostly excited about what the RFID technology, Beacon technology will help us learn about guest behavior as they're buying and browsing products in our stores. So it’s one of the key priorities for us. We’ll learn significant things about the best way to implement these that testing and learning on top of the RFID will help us do the right expansion in North America.

[Oliver Chen:]

Great. Best regards. Happy holidays. Thanks.

[Miguel Almeida:]

You too.

[Operator:]

Thank you. Our next question comes from Matt McClintock with Barclays. You may begin.

[Matt McClintock:]

Yes, good morning everybody.

[Laurent Potdevin:]

Good morning.

[Matt McClintock:]

Miguel, I will actually take the opportunity to ask you a question because I'm very interested in the upcoming website relaunch. Can you maybe give us a little bit of highlight of some of the functionality that you're adding, maybe content that you plan to add or add over time, and how you plan to improve the overall experience comprehensively online with digital with this new website? Thanks.

[Miguel Almeida:]

Thank you for the question Matt. So we're very excited about the redesign coming in on Q1. It's an outstanding opportunity for us to bring our brand content and commerce together. The current experience is very decoupled with a commerce and content perspective. The new website will allow us to bring those two elements in Q1 cohesive experience for our guests, both across web and the mobile experience as well. But then and that the read is on itself will be just step one in terms of our digital experience evolution. What gets me most interested is then the personalization capability that will come over the course of the year, We're investing significantly in building our CRM and analytics capability and the new website will allow us to really deliver contextually relevant experiences to our guests that bring the story telling of our product and brands into the digital space and then we'll connect those guests back with our stores as well through some of the capabilities that we were discussing before. So we're very excited about seeing the new sites coming to life in Q1.

[Matt McClintock:]

Thanks a lot, Miguel. Can't wait to see it.

[Miguel Almeida:]

Perfect. Thank you, Matt.

[Operator:]

Thank you. Our next question is from Matthew Boss with JPMorgan. You may begin.

[Matthew Boss:]

Hey, good morning. So as we think about the 300 basis points of product margin opportunity, is basically what you're saying you're expected aggregate gross margins positive in the first quarter of next year for us to think about a larger inflection in the second quarter? And then just on the phasing, is it fair to think about 200 of the 300 in 2016 with the remainder in 2017?

[Stuart Haselden:]

Hey Matt, so let me try to sharpen what we said a little bit there. In Q1 we expect to see sequential improvement in gross margin year-over-year versus the prior quarter meaning that Q4. So I think we're seeing -- we're going to see a nice sequential improvement in Q4 versus the quarter we just reported, but still will likely be down year-over-year. As we get into Q1 of 2016, we'll see a further sequential improvement in gross margin again as our work to improve our supply chain efficiency and all the things we mentioned gets farther along. I didn't say necessarily that gross margin in Q1 would be up. We'll give more specific guidance on our Q4 call, but I think what we're comfortable committing to is that we'll see a sequential improvement in Q1. We see greater opportunity in Q2 and beyond in 2016 and see a greater inflection in our product margin and gross margin opportunities and that's a combination of again just being farther along in the initiatives that we have. The FOB cost improvements in particular are going to be more second half weighted than first half and there will likely be some actions we'll take that will weigh on margins related to just getting our inventories aligned in the first quarter. So I am not going to put a number on what that product margin improvement looks like in 2016 today. I'll be able to speak with more precision to that again on the Q4 call, but I guess conceptually we're just saying given what we know now about inventory flows into the first half of 2016, we still feel confident about the order of magnitude of inflection that we can achieve being consistent with that 300 basis points pre-FX product margin back to 2014, but it's likely going to take us a little bit more time into 2017, first half of 2017 to fully achieve that.

[Matthew Boss:]

Great. And then just a follow-up. To circle back on the inventory, what's the best way to think about the content of the excess product? And then just to be clear on that, so are you basically saying that versus your initial plan for the on-hand reduction, you really only stand 10,000 units behind plan, which is about 4% below that game plan to clear 260? Is that the best way to think about where you're at today versus what you had laid out three months ago on just the go-forward content?

[Stuart Haselden:]

That's right. I think what we had laid out was a 100,000 units in Q3 when we came at around 90,000. So still feel good directionally that keeps us on track and we'll be able to complete that part of the plan in the fourth quarter as we had described. But again the biggest change in the inventory outlook for Q4 is really that in transit and the decisions we made around it, we feel strongly that those are the right calls we think otherwise it would be short sighted to not ensure that we're protecting our flows into the first quarter and otherwise not take advantage from a margin standpoint of our ability now to shift from air to ocean the consequence of that unfortunately increases our in transit at the end of Q4. But nonetheless again we feel strongly those are the right decisions. I think what we will plan to do at the end as part of our Q4 call, we'll break out and provide some details on our on-hand inventory levels versus the in transit, so that we can demonstrate the degree to which our on hand inventories are coming in line and also quantify what the impact of the in transit increase will have been.

[Matthew Boss:]

Okay. Great. And then just one housekeeper. Are same store sales quarter to date in line with the fourth quarter mid-single-digit guidance?

[Stuart Haselden:]

I am sorry. Can you repeat that?

[Matthew Boss:]

Are same store sales so far quarter to date in line with the fourth quarter guidance for mid single digits?

[Stuart Haselden:]

Yes, so I think I would answer that, the next few weeks of the quarter in December are huge weeks from a volume standpoint. We're also up against a little tougher comparison in these weeks and our comp assumption is probably just under the mid single digit range. So we're a little more conservative of the next few weeks in regards to the comp in that timeframe, more conservative than we are for the quarter overall if that makes sense.

[Matthew Boss:]

Okay. Great. Best of luck. Great. Operator, we've run out of time for questions. Again thank you everyone for joining us today. We'll talk again soon. Thank you.

[Operator:]

Ladies and gentlemen, this concludes today's conference. Thanks for your participation and have a wonderful day.