Lululemon Athletica (LULU) Q3 2024 Earnings Call Transcript

Lululemon Athletica (LULU 0.74%)
Q3 2024 Earnings Call
Dec 05, 2024, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Thank you for standing by. This is the conference operator. Welcome to the lululemon athletica inc. third quarter 2024 results conference call.

As a reminder, all participants are in listen-only mode, and the conference is being recorded. After the presentation, there’ll 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. Please go ahead.

Howard Tubin — Vice President, Investor Relations

Thank you and good afternoon. Welcome to lululemon’s third quarter earnings conference call. Joining me today to talk about our results are Calvin McDonald, CEO; and Meghan Frank, CFO. Before we get started, I’d like to take this opportunity to remind you that our remarks today will include forward-looking statements reflecting management’s current forecast of certain aspects of lululemon’s future.

These statements are based on current information which we have assessed, but by which its nature is dynamic and subject to rapid and even abrupt changes. Actual results may differ materially from those contained in or implied by these forward-looking statements due to risks and uncertainties associated with our business, including those we have disclosed in our most recent filings with the SEC, including our annual report on Form 10-K and our quarterly reports on Form 10-Q. Any forward-looking statements that we make on this call are based on assumptions as of today, and we expressly disclaim any obligation or undertaking to update or revise any of these statements as a result of new information or future events. During this call, we will present both GAAP and non-GAAP financial measures.

A reconciliation of GAAP to non-GAAP measures is included in our quarterly report on Form 10-Q and in today’s earnings press release. In addition, the comparable sales metrics given on today’s call are on a constant dollar basis. 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’d like to remind our investors to visit our investor site, where you’ll find a summary of our key financial and operating statistics for the third quarter, as well as our quarterly infographic.

Today’s call is scheduled for one hour, so please limit yourself to one question at a time to give others the opportunity to have their questions addressed. And now, I’d like to turn the call over to Calvin.

Calvin McDonald — Chief Executive Officer and Director

Thanks, Howard. I’m happy to be here today to discuss our Quarter 3 results, which exceeded our expectations, as well as our outlook for the holiday season and the fourth quarter overall. On today’s call, I’ll start with some highlights from Thanksgiving and Black Friday weekend. I’ll then discuss our Quarter 3 performance beginning with North America and the progress we are making in our U.S.

business. Next, I’ll share insights on our international business where momentum remains very strong. Then, I’ll speak to product. Meghan will review our financials and guidance outlook, and we will close by taking your questions.

So, let’s get started. We are pleased with our business over the extended Thanksgiving weekend and the traffic trends we saw across both our store and e-commerce channels. In fact, on Black Friday, we had the most visits ever to our shop app and e-commerce site. Unlike others in this space, we do not run sale events across our entire store.

We leverage the increased traffic over this period to clear through product we are not taking forward and to feature full-price styles. We are happy with how the guests responded to both, with full price sales driven by some of our key franchises, including Define. While we feel good about the start of the holiday season, we still have large volume weeks in front of us. And given the shorter holiday shopping season, we continue to be thoughtful in our planning for Quarter 4 overall.

Now, looking at Quarter 3. Total revenue increased 9%, or 8% in constant currency. By region, China Mainland increased 39%, or 36% in constant currency. The rest of the world grew 27%, or 23% in constant currency, and the Americas increased 2%.

By merchandise category, men’s increased 9%, and women’s and accessories both increased 8%. Adjusted operating margin increased 70 basis points to 20.5%, and adjusted earnings per share increased 13%. In addition, demonstrating our continued confidence in the business, our board recently authorized a $1 billion increase in our share repurchase program. In Quarter 3, we repurchased $409 million of stock, which brings us to $1.4 billion year to date.

Including the additional authorization, we have $1.8 billion available to repurchase our shares. I’ll now turn to the details about our Quarter 3 beginning with our performance by region. In the Americas, revenue increased 2% on both a reported and constant currency basis. Positive momentum continued in Canada where revenue increased 9%.

In the U.S., revenue was flat, which was consistent with our performance in Quarter 2 and in line with our expectations. Last quarter, I laid out our plans to drive improvement in our U.S. business. These plans include implementing a new reporting structure within our product team, increasing the penetration of seasonal newness within our assortments by Quarter 1 2025, and chasing into updated colors, prints, and patterns to provide guests with more options in the second half of this year.

So, let me share the progress we are seeing. When looking at our product team, we are beginning to see the efficiencies and anticipated benefits of our new reporting structure with our global creative director reporting to me and our chief merchandising officer reporting to Nikki Neuburger in her expanded role as chief brand and product activation officer. Our merchandising and brand teams are now more fully integrated, which leads to better coordination and faster decision-making regarding how we bring our innovation to life. I’m proud of how our leaders and teams pushed forward this quarter and how we have made meaningful progress in creating the product organization to drive our future success.

When looking at the composition of our assortments, we are on track with our efforts to increase the penetration of seasonal newness and expect to be in line with historical levels in quarter one 2025. I feel good about the quality and quantity of newness the teams have planned, and I believe we are well-positioned for spring. Finally, our teams have been agile and have been chasing into seasonal colors, prints, and patterns. I’m sure you’ve seen several examples across our key franchise.

These efforts have contributed to the sequential improvement in newness within our assortment in the back half of the year. We continue to see significant potential for growth in the U.S. Our guest retention remains high, and we see an opportunity to drive higher revenue per guest with more newness in the assortment. We continue to grow our membership program, and we are now 24 million members strong.

Our variety of benefits including early access, partner perks, and members-only events are resonating well. And our unaided brand awareness remains low in the U.S. at 36%, which provides a significant opportunity for growth as we continue to open and optimize stores and launch new brand campaigns and activations. In summary, I’m pleased with our progress so far as our teams are in action to return our level of newness back to historical levels in Quarter 1 2025.

In addition, we are benefiting from and seeing the efficiencies from the new leadership structure within our product team. With the rest of our regions performing well, I feel confident in our growth plans and strategies for 2025. Turning to our international business, momentum remains strong in all of our markets as we continue to see great acceptance of the lululemon brand across the globe. Overall, we saw international revenue increase 33%, or 30% on a constant currency basis.

Here are some highlights. In China Mainland, our brand positioning of Made to Feel allows us to authentically connect with guests by offering technical product that helps enable them to live an active and healthy lifestyle and bring to life compelling activations focused on movement and wellbeing. This aligns well with the government’s Healthy China 2030 initiative. In Quarter 3, our local team executed our largest activation yet centered around World Mental Health Day and the release of our fourth annual global wellbeing report.

We hosted events in nine cities, anchored by our activation in Shanghai. For one week in early October, we hosted a variety of sessions for guests, including sweat sessions and experiences along the West Bund. In total, we had 15,000 guests participate in our activations across the mainland, and we generated 3.8 billion impressions. I’m excited with the success and scale of this activation.

One example of many from our team in China, Mainland, which are intended to increase brand awareness, which remains low but is growing, bring new guests into the brand and increase engagement and loyalty with existing guests. Now let’s focus on the rest of the world segment, which is comprised of APAC and EMEA regions. We remain in the early stages of growth in these markets and have significant opportunity to expand our footprint through new store openings and expansion of key locations. In our more established international markets, we are leveraging the success of our North America optimization program.

For example, in Australia, we are seeing meaningful benefits from the strategy, including an enhanced and more premium shopping experience for our guests, an increase in our men’s business through additional square footage and improved visual merchandising, and an increase in online sales as these stores help attract both local guests and tourists into the brand. Our new store in the Emporium mall in Melbourne is a terrific illustration of the effectiveness of this strategy. At 11,000 square feet, it is our largest store in APAC and is on track to be our No. 1 store in the region in terms of revenue.

We opened our first store in Australia more than 20 years ago, and this shows the growth that is possible even within our more established markets. In EMEA, we are also executing against our store optimization strategy as we recently increased the size of our stores in Berlin and Oslo, and we’re happy with the performance of both. I’m thrilled with the response we are seeing from guests as we improve the shopping experience in markets where we currently operate. This is a key strategy for us across all regions, including North America, as it allows us to better position our store portfolio to support our product plans; continue to drive success in key growth categories, including men’s, accessories, outerwear and footwear; and drive overall sales while continuing to deliver best-in-class store productivity.

In addition to maximizing existing markets, we have significant opportunity to bring lululemon to new countries across the globe. Our plans for 2025 include opening in Italy as a new company-operated market, and in Denmark, Belgium, Turkey, and the Czech Republic under a franchise model. Let me shift now and spend a few minutes on product. In Quarter 3, in women’s, we saw strength in short skirts and leggings in seasonal colors, while in men’s, guests continue to respond well to our pace breaker and zeroed-in franchises and performance and key lounge franchises.

In accessories, bags continue to perform well, driven by backpacks and the cross-body styles. We built upon our success this past spring in golf by focusing on another play category, tennis, when we dropped our lululemon tennis club collection during the U.S. Open in New York this quarter. Based on the strong guest response, we continue to see an opportunity to grow our play activities and intend to evolve our strategy from a seasonal approach to one where we introduce newness into these collections consistently throughout the year.

And we have been pleased with the performance of two strategic partnerships we launched recently, Fanatics in the National Hockey League and Disney. As you are aware, we have a targeted strategic sales business where we sell product to select partners including fitness studios and university bookstores. Our Fanatics and NHL partnership builds upon the success of our campus strategy. We know there’s an opportunity to bring a premium option to sports fans which allows them to celebrate their favorite teams through our most iconic styles.

Our limited-edition product collaboration with Disney combines iconic Disney imagery with our best-in-class technical apparel and taps into the appreciation guests have for both brands. As I step back and look at our entire product assortment, I’m excited with the newness we have planned. Our technical product is a key competitive advantage for us, and our positioning as a premium athletic brand offering high-style, high-performance product truly differentiates us from others. Before I turn it over to Meghan to discuss our financials, let me say that we remain committed to delivering on our Power of Three x2 revenue target of $12.5 billion in 2026, and we remain ahead of schedule.

Using our revenue guidance for 2024, which we updated today, our three-year revenue growth CAGR from 2021 through 2024 is 19%, ahead of the 15% CAGR target in our plan. The solid results this quarter show the inherent strength of our brand and highlight the continued opportunity for lululemon around the world with existing and new guests. Mehgan, now over to you.

Meghan Frank — Chief Financial Officer

Thanks, Calvin. In Q3, both revenue and EPS exceeded our expectations. Top-line strength was driven by continued momentum in our international regions in Canada, while EPS also benefited from stronger-than-expected growth margin. Looking at Q4, as Calvin mentioned, we’re pleased with the results over Thanksgiving weekend and the start of the holiday season.

I would also keep in mind that nearly two-thirds of the quarter remains in front of us, and the macro environment remains dynamic. As such, we continue to plan the business prudently, and I’ll share our detailed Q4 guidance shortly. Let me also mention that we closed on the purchase of our Mexico franchise. The transaction closed on September 10th and had an immaterial impact on our Q3 financials.

However, you will see an increase of 15 stores in our company-operated store count related to Mexico. These stores were not included in our new store opening plans or square-footage growth guidance for the year, hence, they are additive. Let me now show the details of our Q3 performance. For Q3, total net revenue rose 9%, or 8% in constant currency, to 2.4 billion, and constant dollar comparable sales increased 3%.

Within our regions, the results were as follows. America’s revenue increased 2% with a comparable sales decline of 2%. China Mainland revenue increased 39%, or 36% in constant currency, with comparable sales increasing 24%. And in our rest of world segment, revenue grew by 27%, or 23% in constant currency, with comparable sales increasing by 20%.

In our store channel, total sales increased 13%, and we entered the quarter with 749 stores globally. Square footage increased 16% versus last year, driven by the addition of 63 net new lululemon stores since Q3 of 2023. During the quarter, we opened 13 net new stores and completed 14 optimizations. In addition, as I mentioned, we added 15 stores in Mexico, which are included in the 63 net new stores and 16% for our footage growth metrics.

In our digital channel, revenue increased 4% and contributed 945 million of top line, or 39% of total revenue. And by category, men’s revenue increased 9% versus last year, while women’s and accessories both increased 8%. Gross profit for the third quarter was 1.4 billion, or 58.5% of net revenue, compared to adjusted gross margin of 58.1% in Q3 2023. The adjusted gross profit rate in Q3 increased 40 basis points, ahead of our guidance and was driven primarily by the following: a 50 basis-point increase in product margin driven by lower inventory provision expense versus last year and favorable IMU offset by higher freight costs.

Markdowns were flat year over year. Twenty basis points of net deleverage on fixed costs and 10 basis points of favorable impact from foreign exchange. Relative to our guidance, which was for a decline in gross margin of 50 to 60 basis points, the upside was driven predominantly by prudent management of fixed expenses within gross margin, better IMU, lower DC operating costs, and the timing of expenses related to certain store real estate projects. Moving to SG&A.

Our approach continues to be grounded in prudently managing our expenses while also continuing to strategically invest in our long-term growth opportunities. SG&A expenses were approximately 910 million, or 38% of net revenue, compared to 38.2% of net revenue for the same period last year. SG&A was slightly worse than our guidance of 40 to 50 basis points of leverage due to approximately 20 basis points of negative impact from foreign exchange. Operating income for the quarter was approximately 491 million, or 20.5% of net revenue, compared to adjusted operating margin of 19.8% in Q3 2023.

Tax expense for the quarter was 153 million, or 30.2% of pre-tax earnings, compared to an adjusted effective tax rate of 28.1% a year ago. Net income for the quarter was 352 million, or $2.87 per diluted share, compared to adjusted EPS of $2.53 for the third quarter of 2023. Capital expenditures were approximately 178 million for the quarter compared to approximately 163 million in the third quarter last year. Q3’s fund relates primarily to investments that support business growth, including our multiyear distribution center project, store capital for new locations, relocations and renovations, and technology investments.

Turning to our balance sheet highlights. We ended the quarter with 1.2 billion in cash and cash equivalents. Inventory increased 8%, lower than our guidance for an increase in the midteens. We repurchased 1.58 million shares in Q3 and an average price of $259.

Year to date, we’ve repurchased approximately $1.4 billion of stock. Share repurchases remain our preferred method to return cash to shareholders, and we currently have approximately 1.8 billion remaining on our repurchase program, including the recent 1 billion increase in authorization. Let me now share our detailed guidance outlook for the remainder of the year. As I mentioned, we are pleased with our performance at the start of the holiday season.

But given fewer shopping days between Thanksgiving and Christmas and an uncertain macro environment, we continue to plan the business prudently. Starting with full year 2024, we now expect revenue to be in the range of 10.452 million to 10.487 million. This range represents growth of 9% relative to 2023. Excluding the 53rd week that we have in the fourth quarter, we expect revenue to grow 7%.

I’d also note that our revenue range now includes an incremental $20 million of negative impact related to recent fluctuations in foreign exchange rates. We expect to open approximately 40 net new company-operated stores in 2024, excluding Mexico, and complete approximately 40 co-located optimizations. Excluding Mexico, we expect square footage to grow in the low double digits. And including Mexico, we expect overall square footage growth in the low teens.

Our new store openings in 2024 will include approximately 10 stores in the Americas, inclusive of two company-operated stores in Mexico in Q4, with the rest of our openings planned in our international markets, primarily in China Mainland. For the full year, we now expect gross margin to increase approximately 10 to 20 basis points versus our adjusted gross margin in 2023. We continue to expect markdowns to be relatively flat with last year. Turning to SG&A for the full year, we now expect it to be 20 to 30 basis points higher versus 2023.

We’re prudently managing our expenses while continuing to invest strategically into our Power of Three x2 roadmap, including investments in marketing and brand building aimed at increasing our awareness and acquiring new guests, investments to support our international growth and market expansion, and continued investment in technology infrastructure and data analytics capabilities. When looking at operating margin for the full year 2024, we continue to expect a decrease of 10 to 20 basis points versus adjusted operating margin in 2023, which expanded 110 basis points versus 2022. For the full year of 2024, we continue to expect our effective tax rate to be approximately 30%. For the fiscal year of 2024, we now expect diluted earnings per share in the range of $14.08 to $14.16 versus adjusted EPS of $12.77 in 2023.

Our EPS guidance excludes the impact of any future share repurchases but does include the impact of our repurchases year to date. When looking at inventory, we continue to expect dollar inventory to increase in the mid-teens in Q4. We continue to expect capital expenditures to be approximately 670 million to 690 million for 2024. This spend relates to investments to support business growth, including a continuation for a multi-year distribution center project, store capital for new locations, relocations and renovations, and technology investments.

Shifting now to Q4. We expect revenue in the range of 3.475 billion to 3.51 billion, representing growth of 8% to 10%, or 3% to 4% excluding the 53rd week. This range includes the incremental negative 20 million impact from foreign exchange I’ve previously mentioned. We expect to open 18 net new company-operated stores in Q4, including two in Mexico.

We expect gross margin in Q4 to decrease 20 to 30 basis points relative to Q4 2023. The decrease will be driven predominantly by deleverage on fixed costs and our ongoing investment in store growth and our multiyear distribution center project. We expect product margin to increase 60 to 70 basis points inclusive of approximately 40 basis points of higher freight costs. We continue to expect markdowns to be slightly improved versus Q4 2023.

In Q4, we expect our SG&A rate to deleverage by 90 to 100 basis points relative to Q4 2023. This will be driven predominantly by increased foundational investments and related depreciation, and also strategic investments, including those to build brand awareness to support future growth. When looking at operating margin for Q4, we expect deleverage of approximately 110 to 130 basis points. Turning to EPS.

We expect earnings per share in the fourth quarter to be in the range of $5.56 to $5.64 versus adjusted EPS of $5.29 a year ago. We expect our effective tax rate in Q4 to be approximately 29.5%. And with that, I will turn it back over to Calvin.

Calvin McDonald — Chief Executive Officer and Director

Thanks, Mehgan. As you can see from our results, our business continues to deliver across our international markets, and we are pleased with the start to the holiday season in North America. Looking ahead, we are excited about the work underway across our product organization to create the pipeline of newness that guests expect from us, both in the near and long term. And as we build our brand awareness and continue to strategically expand globally, the opportunities in front of us are significant.

As we head into the final weeks of the year, I want to thank our teams around the world who made these results possible. I continue to be impressed by the agility and resilience of our teams who demonstrate why lululemon is one of the enduring growth stories within retail. Thank you all for joining us. Mehgan and I look forward to taking your questions now.

Operator?

Questions & Answers:

Operator

[Operator instructions] Our first question is from Alex Straton with Morgan Stanley. Please go ahead.

Alex Straton — Analyst

Perfect. Congrats on a great quarter. Thanks for taking the question. I just wanted to focus on U.S.

sales. Looks like they stabilized on a quarter-over-quarter basis. So, I’m just curious, do you view this kind of as a bottom for that geography and should it improve from here? And maybe thoughts on the longer-term growth rate of that business. Thanks a lot.

Calvin McDonald — Chief Executive Officer and Director

Thanks, Alex. In terms of Quarter 3, as you mentioned, performance was what we had expected, and our plan on our newness was equally on our expectations. In Q4, our newness is getting sequentially stronger. And as mentioned, we’re off to a good start the holiday, and happy with our regular price performance over the Thanksgiving weekend.

We continue to see good response to newness from our guests, and we’re on plan to hit that historical number by Quarter 1. And when I look at our guests, I’m happy with the absolute growth number. Our retention with our guests remains very strong, and the opportunity remains, as I’ve spoken to in the past, revenue per guest related to newness. And when I look at brand awareness and our opportunities of category expansion, we still see growth in the U.S.

market and know that it’s within our control and focused on the product decisions. And that’s what the team is focused on. And in terms of our Power of Three x2 growth guidance numbers and our view of North America, nothing has changed.

Alex Straton — Analyst

Thanks a lot. Good luck.

Operator

The next question is from Lorraine Hutchinson with Bank of America. Please go ahead.

Lorraine Hutchinson — Analyst

Thank you. Good afternoon. Mehgan, can you talk about the reasons for the midteens inventory growth in the fourth quarter? How much of this is holding on to slower moving core versus chasing seasonal color and pattern? And how are you planning inventory for the first half of ’25?

Meghan Frank — Chief Financial Officer

Thanks, Lorraine. So, we came in at plus 8% at the end of Q3. We actually guided to the midteens for inventory. And our view on Q4 hasn’t changed.

We’re expecting to end Q4 in the mid-teens growth rate. You know, I would say over the longer term, we aim to manage inventory in line with our sales growth. We are chasing into seasonal newness. So, definitely it’s impacting.

I would say, our growth rate at the end of the year to set us up for our goal of inflicting the business and specifically the U.S. as we move into the first half next year. As you — if you look at our inventory turns, they’re pretty much in line with history; a little bit slower than history, actually. So, we feel well positioned as we move into Q4 and then into ’25 as well.

Operator

The next question is from Ike Boruchow with Wells Fargo. Please go ahead.

Ike Boruchow — Analyst

Hey, good afternoon. Let me add my congrats. Calvin, maybe just to piggyback on Alex’s question, just, you know, comps are still negative, which is obviously not ideal, but your tone and your confidence on the trajectory of what’s going on in the region sounds better. It sounds like the confidence is building.

So, maybe, can you just maybe unpack some of the KPIs or whatever it is you look at that can kind of help us understand, you know, exactly why we should be confident that the negative comp trend will, in fact, inflect come next spring?

Calvin McDonald — Chief Executive Officer and Director

OK. Thanks, Ike. It — the confidence is rooted in a few of the key data points that I have shared. All point to a guest who is still very engaged with our brand, remain very loyal, and are reacting very well to the newness that the teams are delivering.

And we know that that newness as a percentage of our overall assortment and mix is below our historical levels. So, when we see the newness, he and she is responding well to it. And seeing the work the team has been doing, the quality and quantity of that newness as a mix of our core assortment heading into Q1 of next year and through 2025 is where I get the confidence that we’re back at this whole historical levels, that we have a guest that’s still very much engaged in the brand and, quite frankly, is waiting for us to hit those historical levels. And we’re seeing that through their spending pattern.

Our overall guest growth has been strong. I’m pleased with it. We now have over 24 million members in our central membership program. And we’re continuing to see, you know, very good matriculation per our plan of our younger, recently acquired guests.

And then, it’s the core guests that the team is very much focused on who’s responding but waiting for us to bring that newness so she can continue to add to her lululemon collection. That’s what gives me the confidence. I truly believe it’s decisions made with our product, and we are addressing it with the new structure, the talent, the new talent, and the team and feel good with what I see heading into 2025.

Ike Boruchow — Analyst

Thank you.

Operator

The next question is from Janine Stichter with BTIG. Please go ahead.

Janine Stichter — Analyst

Hi. Thanks for taking my question, and congrats on the progress. I want to ask a bit more on the women’s business. It picked up nicely from Q2.

Maybe a little bit more about what’s going on there. And then, I think you called out leggings, which is the first time we’ve heard that as a positive call out in a while. So, just we’ll love some more color around what’s going on with the legging business and what we can expect for Q4 into next year. Thank you.

Calvin McDonald — Chief Executive Officer and Director

Thanks, Janine. You know, our women’s business globally, and I’ll start globally, is performing very well, as is our men’s, as well as our accessories business. Really balanced growth globally. And we continue to see in all of our international markets growth across all the categories, including our bottoms and our leggings business.

In North America, particularly in the U.S. because we saw, you know, very strong growth in Canada, the women’s business — and when we look at newness, again, we saw good growth. It’s the missed historical levels of newness where we see that opportunity. When we look at the legging business, the bottom business, and how she’s responded to newness through color, prints, and pattern, she responds very well.

And we did gain share in both men’s and women’s globally, as well as in the U.S. in the premium active wear category. So, we know that she is responding well to that newness, and that’s what the team is focused on to continue to bring. But we are seeing growth across those categories.

And I just want to, you know, remind that when we talk newness, it is colors on top of our core colors and core franchises. It’s not, you know, unseen, unproven newness. We do bring that in as a percentage of our overall assortment, but a lot of what drives the newness and our guest responds to is the franchises, the silhouettes, and the hero items that he and she loves, but bringing it through different colors and prints and trims and other ways in which we are adding newness to those that have always been a good driver of our business. And we’ve done that lower than historical levels, and that’s what the team’s focused on in driving.

Janine Stichter — Analyst

Thanks so much, and good luck for holiday.

Operator

The next question is from Michael Binetti with Evercore. Please go ahead.

Michael Binetti — Analyst

Hey, guys. Thanks for taking our question. Congrats on the next quarter. Just a quick one on the model.

Let’s take one of the key drivers. The gross margin in third quarter was lower inventory provisions. Would you just remind us how influential that could be in the fourth quarter? And then, maybe just stepping back a little bit on the gross margin, unpacking a little bit more, maybe what’s under the surface on the product margin. I think you said one of the big pieces there, Mehgan, was — upside to the guidance was good control of fixed costs on the product side.

Is that — I’m curious how sustainable that is with the high fixed cost base in North America and the negative comps in that market. Is that something that’s as controllable in the fourth quarter? Or is there something unique to third quarter that let that be a bigger lever for you while the comps remain negative in your biggest market?

Meghan Frank — Chief Financial Officer

Great. Thanks, Michael. In terms of inventory provisions, so we provided for some inventory that sold through in the quarter, and we released some provisions. We’re also lapping a higher comparison last year.

And we’re not expecting to see big movement year over year in inventory provisions specifically when we move to Q4. If we look at what drove our Q3 margin, you know, 50 basis points was from product margin. It was from the lower provisions as you mentioned. We saw some benefit in higher IMU, partially offset by higher freight and the markdowns were flat.

We did have a little bit of deleverage on fixed costs and then a little bit of a favorability on FX. So, 10 basis — 20 basis points deleverage on fixed costs, 10 basis points favorable on FX. When we look at Q4, we guided to a decrease of 20 to 30 basis points. In that, we are expecting a benefit in product margin of about 50 to 60 basis points as marked down slightly under last year, and then offset partially by some deleverage on fixed costs with store growth in DC specifically on a little bit of a lower revenue trend.

Michael Binetti — Analyst

Thank you very much.

Meghan Frank — Chief Financial Officer

Thanks, Michael.

Operator

The next question is from John Kernan with TD Cowen. Please go ahead.

John Kernan — Analyst

Hey, good afternoon. Thanks for taking my question, and congrats on a solid quarter. You know, we’re all over in China — or most of us were over there with you back in October. Can you talk to what you’re seeing on the ground in China, both from a top line and margin perspective? I think in the first half of the year, the China segment contribution margin was in line with Americas.

Just wondering how you’re planning it for the back half of the year.

Meghan Frank — Chief Financial Officer

Yeah. Thanks, John. So, we’ve been really pleased and continue to be pleased with our China performance. So, our China Mainland growth on a cost and currency basis is 37% in Q2, 36% in Q3.

And we saw a positive impact — from a bottom-line perspective, we are seeing really healthy operating margin expansion with revenue exceeding our expectations to a degree. I think, as I’ve mentioned before, it’s not a region where we’re looking right now to optimize operating margin. I’m really focused on driving our long-term trend but certainly see opportunity there over the longer term. And I think we’ll put a final point on how we see the regions playing out as we get into March and then 2025.

And then, I would share we continue to be pleased with our China trends as we move into Q4. And we do expect that we’re not offering, you know, specific guidance for our region, China, to be above 30 percent growth rate again in the quarter.

John Kernan — Analyst

Got it. Maybe just a quick follow-up on the rest of the world. It sounds like you’re more confident in store openings in some new markets. Maybe talk to some of the investments you’re making there and the confidence you have in those markets.

Calvin McDonald — Chief Executive Officer and Director

Yeah, as I mentioned, plan for next year, which will be a known market, is Italy. And then, on the success of some of the markets with our franchise model, we’ll be opening Denmark, Belgium, Turkey, and Czech Republic through our franchise model and partnerships. And it really is the confidence we have in the brand momentum in every market we’re in globally. And we continue to monitor markets and look for opportunities to expand.

We look for readiness in terms of, obviously, spending power, but also interest within the activities that we play into. So, that sort of sweat readiness in these markets. And we know we’re early in the markets we’re in, both in terms of awareness and market share, and we want to continue to fuel and drive those. But these are markets that have definitely we’ve seen a nice progression in readiness for our business and our brand and want to continue to add to our international portfolio and build on that momentum we’re seeing.

As you know and I’ve spoken to, our international business is performing incredibly well in every market. We’re getting pulled into markets versus pushing ourselves into. And it’s still a low percentage of our overall mix of revenue. And we’re excited about continuing to drive it, grow it, and see it representing a much greater percentage, the overall revenue of the company.

And these market growths are just addition to that momentum that we see coming in ’25 and beyond.

John Kernan — Analyst

Awesome. Thank you.

Operator

The next question is from Matthew Boss with JPMorgan. Please go ahead.

Matthew Boss — Analyst

Great. Thanks. So, Calvin, could you elaborate maybe on the cadence of traffic in North America as the third quarter progressed and into holiday? And maybe just speak to new customer acquisition and also the start to holiday internationally.

Meghan Frank — Chief Financial Officer

In terms of traffic trends throughout the quarter, we don’t actually disclose monthly traffic. But I’d say overall there, Matt, we were pleased globally with traffic across both channels. And in terms of the U.S. specifically, e-com channel remains positive, and our stores were slightly lower than last year.

But the U.S. did come in overall in line with our expectations for Q3. And as Calvin mentioned earlier, guest retention continues to be strong. The opportunity remains in revenue for guests, as well as conversion.

And we’ve been pleased with the holiday period.

Calvin McDonald — Chief Executive Officer and Director

Yeah, I’ll just add. And, you know, I know it’s been a few calls since we shared the membership number. And I’ll remind you that 24 million membership base. That is just North America.

So, we’re really, you know, excited in terms of that number and that initiative as a driver of guest engagement retention. We’ve recently added membership perks to it using some of our third-party partners and studio players. So, we’re excited about continuing to build that out to drive engagement, loyalty, and retention are being an additional factor. But guest growth in the U.S.

and North America and, obviously, internationally has been good this year, and we’re very pleased with that. And internationally, holiday in general for us, we’re pleased with the start. It’s early. There’s still a lot of the quarter ahead, and we’re on a shortened holiday period.

But pleased with the start, pleased with the mix between markdowns and regular price. As you know, we really drive and will always drive our business through regular price through newness and innovation. Markdowns we use as a means to clear out end of season. But, you know, pleased with the results and arguably a promotional period.

I think it just shows the way the brand resonates, the way newness resonates with our guests, and how we continue to build a premium brand and allow our unique differentiated product. And that’s resonating around the world. And we’re pleased with the start to the holiday.

Matthew Boss — Analyst

Great. And then, Mehgan, just what’s your confidence in your modest annual operating margin expansion target multiyear? Or is there a way to think about areas of expense flexibility relative to different revenue scenarios?

Meghan Frank — Chief Financial Officer

Yeah, I mean, I would say we’re deep in planning for ’25. Too early to put a fine point on that. We still remain committed to our modest operating margin target over the five-year time horizon. We’ll obviously come back in March and share more and certainly revenue dependent.

The team’s really focused and energized on driving the inflection into ’25. And, you know, I think we’re pleased with our results this year despite revenues being lower than we expected. We’ve done quite a bit of management of expenses and managed operating margin pretty much in line with last year. So, I’m pleased with where we’re rounding up.

Matthew Boss — Analyst

Great. Best of luck.

Meghan Frank — Chief Financial Officer

Thank you.

Operator

Our next question is from Paul Lejuez with Citi Research. Please go ahead.

Paul Lejuez — Analyst

Thanks, guys. I think you mentioned e-com in the U.S. is still positive. Stores, you said, were lower.

Can you talk about that e-com versus store dynamic in your other key regions? And then, second, can you also talk about the competitive landscape, what you saw in terms of promotions out there during the third quarter and what you expect for 4Q? Thanks.

Meghan Frank — Chief Financial Officer

Yeah, so in terms of traffic, that was specific to the U.S., my color. I would say overall traffic trends, both positive in the rest of world in terms of e-commerce stores.

Calvin McDonald — Chief Executive Officer and Director

Yeah, Paul. And in terms of the overall promotional intensity, I think it’s — we know it’s a very promotional period, more intense than throughout the year. From a year-over-year perspective, I don’t think the overall market is any more intense. There’s pockets where certain brands and retailers are more promotional and where others are less.

I think it obviously depends on the momentum in their business coming in of how they’ve chosen to play that. But when I look at the premium athletic space, you know, we’ve continued to play a nonpromotional markdown-only reg price business unlike others within this space, and pleased to see the results to kick off the holiday and the way the guest responds to our products.

Paul Lejuez — Analyst

Maybe just on the e-com versus stores, can you just frame which are outperforming in your major regions?

Meghan Frank — Chief Financial Officer

We haven’t broken down the specific regions in terms of traffic by e-com and stores.

Paul Lejuez — Analyst

All right. Thanks. Good luck.

Meghan Frank — Chief Financial Officer

Thank you.

Operator

The next question is from Sharon Zackfia with William Blair. Please go ahead.

Sharon Zackfia — Analyst

Hi. Good afternoon. You know, I guess I’m curious, given the election paradigm in the U.S., how you’re thinking about any potential tariff impact as it relates to next year and if you think you’re better or worse positioned than your peers on the dynamic.

Meghan Frank — Chief Financial Officer

Thanks Sharon. So, we’ve obviously been closely monitoring and early to say what will come to fruition, but I can share, we have very limited exposure in China. It’s approximately — we outsource approximately 3% of goods from China so exposure there is relatively small. Our sourcing from Mexico is less than half a percentage, and we don’t source anything from Canada.

It’s also very small exposure there as well. So, I would expect those are probably under some of the competitive landscapes. And then, obviously, if tariffs were levied on imports from all countries into the U.S., that would obviously have a more significant impact on our costs. We are closely monitoring and will look at opportunities across our P&L to manage through that as well.

Operator

The next question is from Brian Nagel with Oppenheimer. Please go ahead.

Brian Nagel — Analyst

Hi. Good afternoon. I, too, would like to add my congratulations on a nice quarter.

Meghan Frank — Chief Financial Officer

Thank you.

Brian Nagel — Analyst

The question — the question I have, and I know it’s going to be a little repetitive, so I apologize. We were talking a lot about newness, particularly as you look toward early ’25. So, is there a way to quantify, I mean, as you think about with the product, particularly domestically, what the product is going to look like in early ’25? I mean, how different is going to be than what you’ve had historically? You know, so just maybe quantify better than this newness dynamic. And then, along those same lines where you have introduced new products already, could you quantify how much better, you know, the sales have been there versus, say, a baseline?

Calvin McDonald — Chief Executive Officer and Director

Thanks, Brian. We don’t — we don’t share the absolute number, but I have indicated in terms of the internal views that we look at. So, when I reference newness, it’s a percentage of our overall merchandising mix. That could be a combination of core with different colors, different patterns, and prints.

It could be new franchises, hero items that we’ve introduced that we plan to carry forward. Good example, zeroed in, soft jersey, to name a few. Or it could be items that we just sprinkle in on the season to just sort of provide that unpredictable. And some of those could be test and learn for future seasons.

The bulk of newness is still in that new, innovative hero items or franchises, as well as color, pattern, print, extensions of core. So, when we look at it from a — and that’s why our markdown management is something we’re able to continue to do because this is building upon the items that the consumer knows, but giving them, through silhouette, other ways, reasons to purchase. We’ve been below those historical numbers as a percentage of our mix through much of this year. It’s sequentially getting stronger.

And come Q1 of next year, we’ll be back at this historical level. So, although I’m not sharing a number with you, if it’s to say what would I see when I come into the store, I would say the mix of the assortment will feel more historically ’23, ’22 in previous years, because that’s what the team’s working to as a ratio, obviously, breadth of color and, as I mentioned, across those. So, those are the parameters that we look at internally. And I think that’s what you should expect to see when you go into our store today versus when you go into our store in the quarter is back to that historical mixture of color and the other items that I described of how we think of newness across color but also truly newer just in and out for the season.

Brian Nagel — Analyst

That’s very helpful, Calvin. And then, maybe just the — what you’re seeing now. So, I think you have mentioned that, you know, clearly, like you just said, the bigger shift in newness is going to happen early next year, but you’ve had some new product now. How is that product performing?

Calvin McDonald — Chief Executive Officer and Director

Yeah, no, as I mentioned, you know, we are very pleased and seeing a good guest response to the newness that we put in. It is still below our historical levels. But if you were to go into the stores today or look online, some of the holiday items that we bring in, the detailing on our defined jackets or the velvet scuba collection, the Shine Align collection building on the Align franchise, the Wundermost tops, and the Satin Shine running tight and short are examples where we bring that in, and the guest is responding very well to that. As well as in our performance with our waffle knit styles across long sleeve and jogger silhouettes, tops in the Swiftly, Rulu, and Restless franchises and our Fast & Free and in our footwear as well.

So, there is lots across — and those are for our women’s business. And then similar on our men’s, we have the newness, and the guests is responding well to it. And as I mentioned on the Thanksgiving weekend, we saw and were very pleased with our regular business growth in a very heavily promoted period of time. So, good in — good response.

Still below historical, still below where we’ll be in Q1. But throughout this year, the guest has always responded to newness. It’s been the level that we’ve had which has been the opportunity, and we’ve been addressing and chasing and all the Initiatives I shared with you in terms of structure that the talent changes and the focus of the team. But that’s where I get confident in what I’m seeing in Q1, as well as confident in the metrics as to what we control and what the team’s focused on to drive the inflection in our women’s business in the U.S.

Brian Nagel — Analyst

I appreciate all the color. Thank you.

Howard Tubin — Vice President, Investor Relations

Operator, we’ll take one more question.

Operator

Certainly. The last question is from Brooke Roach with Goldman Sachs, please go ahead.

Brooke Roach — Analyst

Good afternoon, and thank you for taking my question. Calvin, can you speak to your learnings on the increased investment in marketing spend this year? How should we be thinking about advertising and marketing going forward as a person of sales as you look to expand that brand awareness? And then, perhaps, as a related follow-up, wondering if you can talk to the results of the targeted strategies that you’re implementing to reengage lapsed customers in the U.S. Thank you.

Meghan Frank — Chief Financial Officer

Hey, Brooke. I’ll just take the marketing spend quickly. So, we have been managing marketing essentially in line with 4.5% to 5% of sales. We do expect we’ll pick up a little bit closer to 5.5% this year, given we have held our marketing campaigns intact just as we’ve navigated the top-line pressure because we’re really focused on driving into the long term there.

And then, I’ll have Calvin add some color here.

Calvin McDonald — Chief Executive Officer and Director

Yeah, in terms of the overall initiatives that we deploy the incremental investments in, it really is across a lot of the levers that have driven and grown this brand. And that is in all markets, but it’s including North America. In community events, at the local level, with our ambassador relationships in pool, they’re — and into more mid top of funnel initiatives as we look to acquire and keep acquiring new guests, we use ROAS as a measurement against all and most of those spends, and we’re pleased and that’s why we continue to lean in. And on top of funnel, you know, we’re pleased with not just our new guest acquisition, but as well as the movement we’ve seen in all markets with our unaided brand awareness, which, in the U.S., is now at 36%.

So, we’ve continued to move that needle in a meaningful way. So, we’re going to continue to sort of play and test and learn across those initiatives, leading with community, leading with relationship, and playing with initiatives at top of funnel to keep acquiring, knowing that product is our ultimate hook. So, always leading in these campaigns with a product message. In terms of lapsed guests, the teams are always working on a variety of direct initiatives.

What I would tell you, where I’m excited about, you know, Q1, when we continue to bring newness and get back to those historical levels is our opportunity is not in incremental or growth in our lapsed guests. We have very strong, high loyal guests, high retention. The opportunity is in our revenue per guest bed because we’ve had less newness to bring to her. So, the team’s ability to bring that newness to her in a way that she has continued to respond this year to the newness we have had, when we get back to having more of the historical by having quite a bit of that newness in our performance activities across yoga, run and train, and tennis and play, I’m, you know, encouraged with the opportunity because we’re not trying to bring a guest back into the brand.

She’s remained. What we are doing is leveraging newness to have her continue to engage and spend the way she has knowing that we have more at the historical level. So, that is where I feel, you know, excited about what the team’s planning and what we’ll be able to do.

Operator

That’s all the time we have for questions today. [Operator signoff]

Duration: 0 minutes

Call participants:

Howard Tubin — Vice President, Investor Relations

Calvin McDonald — Chief Executive Officer and Director

Meghan Frank — Chief Financial Officer

Alex Straton — Analyst

Lorraine Hutchinson — Analyst

Ike Boruchow — Analyst

Janine Stichter — Analyst

Michael Binetti — Analyst

John Kernan — Analyst

Matthew Boss — Analyst

Matt Boss — Analyst

Paul Lejuez — Analyst

Sharon Zackfia — Analyst

Brian Nagel — Analyst

Brooke Roach — Analyst

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