Lululemon Athletica Inc. (NASDAQ:LULU) Q3 2022 Earnings Call Transcript

Lululemon Athletica Inc. (NASDAQ:LULU) Q3 2022 Earnings Call Transcript December 8, 2022

Lululemon Athletica Inc. beats earnings expectations. Reported EPS is $2, expectations were $1.97.

Operator: Thank you for standing by. This is the conference operator. Welcome to the Lululemon Athletica Inc. Third Quarter 2022 Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. I would now like to turn the conference over to Howard Tubin, Vice President, Investor Relations for Lululemon. 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 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. 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, 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 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.

See also 11 Best ADR Stocks To Buy and Most Advanced Countries in Artificial Intelligence

Calvin McDonald: Thank you, Howard. I’m happy to be here today to discuss our third quarter results, which, as you’ve seen from our press release, continue to be strong and resilient while we navigate an external environment that remains challenging. At Lululemon, innovation is at our core. We create apparel, footwear and a gear that offers technical solutions to our guests as well as versatility and comfort with a variety of end uses, but that’s just the starting point for us. Lululemon is a brand that stands for community with connection firmly at our core. We connect with guests through our educators and ambassadors through our well-being offerings and local events and now through our new membership program in Lululemon Studio.

It is this combination of innovation and connection that differentiates Lululemon from our peers and contributes meaningfully to the continued and sustained momentum we see across the business. Over the next few minutes, I’ll highlight for you the trends we’ve experienced over the recent thanksgiving weekend on what we’re seeing in our business at the start of the holiday season. Then I’ll discuss quarter three and speak to the balanced strength we continue to see across our business in terms of geography, channel and merchandise categories. Next, I’ll update you on the supply chain environment and our inventories, and then I’ll speak to our product pipeline. And finally, I’ll speak to the benefits of our direct-to-consumer model and several of the unique ways we enabled connection with our community.

So let’s jump in. I will start with our performance over Thanksgiving as I’m sure it’s top of mind for all of you. I’m pleased with our results and performance over the extended Thanksgiving weekend and as we start the holiday season. Over the past two weeks, I have traveled with several senior leaders across North America to cities, including Phoenix, Tampa, Orlando, New York and Toronto. We visited several stores in each market and saw a tremendous level of engagement from our team members, our guests in every store. In fact, Black Friday was the biggest day ever in our history in terms of revenue and traffic driven by our results in both North America and around the world, with guests responding well to the innovation we offer across our product assortment.

Our performance across markets and geographies shows that consumers are seeking brands like Lululemon that offer innovative, versatile product and a strong community connection that they can’t find anywhere else. We also recognize that the external environment remains challenging with several high-volume weeks still in front of us. That being said, I’m encouraged with the beginning of our holiday season and I am confident in how our brand is positioned in the near and long term. Now I will speak to our performance in quarter three. Meghan will go through the details in a few moments, but I’ll share with you some of the financial highlights. Our revenue growth remains strong and balanced across several drivers as follows: all on a three-year CAGR basis.

Stores increased 16%, while e-commerce grew 46%, by region, North America grew 24% and international increased 42%. Revenue in Mainland China grew nearly 70% and we experienced strength across merchandise categories with men’s up 28%, women’s up 23% and accessories growing at 52%. Adjusted earnings per share increased 23% versus last year and 28% on a three-year CAGR basis. And our market share gains continue. While the adult active apparel industry decreased its U.S. revenue by 4% in fiscal quarter three ’22 compared to the same period last year, Lululemon gained 1.5 points of market share in the U.S. over this time, the most of any brand in this market according to the NPD Group’s consumer tracking service. These results are only possible due to the strength and dedication of our people around the world.

To our teams in our stores, in our distribution centers and call centers and in our store support centers, I’d like to express my gratitude on behalf of the entire leadership team. You connect with our guests every day, execute against our growth plan and continue to support one another, all of which enable the financial results we deliver quarter after quarter. Turning now to supply chain and our inventories. We continue to see improvements across our supply chain. Our factories have now returned to pre-pandemic levels of production efficiency. In addition, ocean delivery times are continuing to improve from the 70 days we experienced last quarter. I’m also excited to share that we recently opened our Tilbury distribution center located near Vancouver to support demand in Western Canada.

This DC is a great example of our ongoing investment in strategic foundational infrastructure projects that will help fuel our Power of Three x2 growth plan. In terms of inventory, we ended quarter three with dollar inventory up 85% on a one-year basis and units up 38% on a three-year CAGR basis, both metrics in line with our expectations. As we discussed, our inventory levels were too lean last year, and we made the strategic decision to build inventories this year, which enabled the strong top line growth we have delivered. Meghan will share additional details, and we remain comfortable with both the quality and quantity of our inventory. We continue to leverage our core styles, which account for approximately 45% of our total inventory and carry limited seasonal markdown risk.

I’d also note that quarter three will represent the high point for our inventory on a one-year dollar basis. And as we enter quarter four, we are well positioned to be in stock throughout the holiday season. I will now spend a few minutes speaking about product. As you know, innovation at Lululemon is fueled by our Science of Feel development platform. Our team’s focus first on identifying the unmet needs of our guests and then we view them through the lens of activities to develop new franchises and other hero items that are versatile and innovative. Quarter three had some great examples of how we bring this strategy to life. In footwear, we launched our fourth style Strongfeel. Like the other technical styles rolled out this year, Strongfeel was designed for women first which differentiates us from many of our peers who create shoes for men and then adapt them for women.

Strongfeel is a technical training shoe designed to keep the foot anchored and secured during workouts and we’re encouraged by the initial guest response. As I’ve mentioned before, footwear is a test-and-learn category for us, and it represents a small portion of the growth we anticipate over the next five years. This allows us to build into the potential at an appropriate pace as we learn and make adjustments. That being said, we’re excited about the potential opportunity in this category, and we were pleased to be recognized by Footwear News with the Launch of the Year Award presented during their 36th Annual Achievement Awards last week in New York. Turning now to franchises. It’s great to see how our teams continue to build out our range of Wonder puff offerings.

We started with a single women’s jacket and have expanded into 11 styles within this outerwear franchise across women’s, men’s and accessories. Our results show that our guests respond extremely well to the breadth of options. While last year, we were constrained in terms of inventory, particularly in outerwear, we are well positioned with wonder pops for the holiday season and expect to meet guest demand. As we look forward, franchise development represents a unique and distinctive opportunity for Lululemon with Align, Scuba and Define as a few examples, all of them beginning with a singular style and then expanding into popular multiple style offerings. And this is just the beginning. We will continue to introduce, expand and grow our franchise business into the future.

Let me now shift gears and speak to another one of Lululemon’s key competitive advantages, our D2C model. Our ability to connect directly with guests in real time and across both our physical and digital channels gives us a number of ways to engage beyond a purchase transaction. In quarter three, we launched our new membership program, began to hold local 10-K races for the first time since the pandemic began, and we brought focus to World Mental Health Day around the world with a notable activation in China. Some highlights are — in early October, we successfully launched our new two-tier membership program in North America. The Essentials tier is free to everyone and offers unique benefits to members, including early access to product drops, exchange or credit on sale items and invitations to virtual community events.

The premium tier of the program, Lululemon Studio represents the evolution of Mirror into a much more engaging hybrid fitness offering. We’ve extended our collective by partnering with some of the best fitness studios and instructors to bring even more classes to our members, both digitally and in real life. To join, members purchased a Lululemon Studio Mirror agreed to a $39 monthly subscription and received many exciting new benefits. Another way we engage with guests is through our 10-K runs. We sponsored two races in Atlanta and in Houston and we’re excited by the response. We paused these experiences during the pandemic. So I’m thrilled that we have been able to hold these large-scale community activations once again, bringing together our guests, local teams and ambassadors to extend our community connection.

And in China, we brought attention to World Mental Health Day in October with a month-long campaign aimed at inspiring people to take positive actions towards improving their physical, mental and social well-being. This included in real life events focused on wellness, media partnerships and the launch of a digital well-being hub on WeChat. These examples bring to life the unique ways we connect with our guests and our communities across the globe. This enduring strength of Lululemon demonstrates our ability to be globally strong and regionally relevant as we foster a deeper relationship with Lululemon for existing and importantly, new guests. All of this increases brand awareness, drives traffic to our stores and websites and ultimately results in higher purchase consideration engagement with Lulemon.

Before handing it over to Meghan, I wanted to speak further about our international business. As you know, our plans call for a quadrupling of international revenue over five years from 2021 to 2026, and I’m very pleased with how our leaders and local teams are executing against that goal. This was reinforced for me during my recent visits to the United Kingdom and Australia. I toured both markets with our local leaders and team members and got to experience firsthand the energy and excitement of our stores in our recently optimized locations in Australia. It’s also exciting to see how we are elevating the guest experience in these markets with the recent rollout of ship from store and enhanced endless aisle capabilities in both regions. With strong leaders in each of these markets and across our international business, I’m energized by our ability to continue to strategically expand Lululemon across geographies.

The potential is considerable. And building upon the momentum from our recent market entry into Spain, we opened another iconic location in Europe just last week with a store on the Champs-Élysées in Paris, in the heart of one of the city’s main shopping districts, this store will enable us to grow brand awareness, both in France and across Europe, given this is such a popular tourist destination. While our growth prospects are balanced across geographies, international represents a key piece of our Power of Three x2 growth plan. We’re off to a great start, and I look forward to sharing more with you on future earnings calls. With that, I’ll now turn it over to Meghan.

Meghan Frank: Thanks, Calvin. I’m pleased that our momentum continued in Q3, and we were able to deliver both top and bottom line results, which exceeded our guidance. The holiday season is also off to a good start with strong traffic over the extended Thanksgiving weekend, and a positive guest response to our holiday merchandise assortment. In addition, we’re in a much better inventory position this year to meet guest demand. However, I also want to acknowledge that we have several large volume weeks ahead of us, and our teams remain focused on connecting and engaging with our guests. Let me now share the details of our Q3 performance. I will also discuss specifics on our balance sheet, including our inventory and cash position.

Please note that when comparing the financial metrics for Q3 2022 with Q3 2021, the adjusted operating results for Q3 2021 exclude $0.18 of expense related to the acquisition of Mirror. You can refer to our earnings release for more information and reconciliations to our GAAP metrics. For Q3, total net revenue increased 28% to $1.86 billion, ahead of our guidance. Comparable sales increased 25% with a 17% increase in stores and a 34% increase in digital. On a three-year CAGR basis, total revenue increased 27%. In our store channel, sales increased 28% on a one-year basis and 16% on a three-year CAGR basis. Productivity continues to trend above 2019 levels. And although we had 22 stores closed in Mainland China in the last week of November, we currently have 99% of our fleet open globally.

We ended the quarter with a total of 623 stores across the globe. Square footage increased 19% versus last year, driven by the addition of 71 net new stores since Q3 of 2021. During the quarter, we opened 23 net new stores and completed seven co-located optimizations. In our digital channel, revenues increased 46% on a three-year CAGR basis and contributed $767 million of top line or 41% of total revenue. Within North America, revenue increased 24% and within international, we saw a 42% increase, both on a three-year CAGR basis. And by category, men’s revenue increased 28% on a three-year CAGR basis. Women’s increased 23% and accessories grew 52% on the same basis. I’m also excited that we continue to see strength in traffic across both channels.

In stores, traffic increased nearly 25%. And in our digital business, traffic to our e-commerce sites and apps globally increased nearly 50%. On a three-year CAGR basis, traffic is up 9% in stores and over 41% in e-commerce. This speaks to the strength of our omni operating model as we engage with our guests and we have most convenient to them. Gross profit for the third quarter was $1.04 billion or 55.9% of net revenue compared to 57.2% of net revenue in Q3 2021. Our gross margin decrease of 130 basis points relative to last year was driven primarily by 60 basis points of deleverage from foreign exchange within gross margin, which was somewhat offset by a 20 basis point FX benefit within SG&A. A 40 basis point decrease in product margin, driven primarily by higher markdowns and inventory provisions relative to low levels last year, partially offset by lower air freight expense.

And 30 basis points of deleverage on fixed costs, driven primarily by investments in our product teams and distribution centers, offset somewhat by leverage on occupancy and depreciation. When looking at markdowns versus 2019, they were relatively flat and in line with our expectations. The decline in gross margin was larger than our guidance of 50 to 70 basis points, driven predominantly by FX and regional revenue mix. From a regional standpoint, while revenue growth in China was strong for the quarter, it was below our expectations due to COVID-19 impacts. 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 $684 million or 36.8% of net revenue compared to 37.6% of net revenue in Q3 2021.

The leverage in the quarter versus Q3 2021 resulted from leverage in our stores and other channels on corporate SG&A and on foreign exchange. This was offset somewhat by an increase in depreciation and amortization. Operating income for the quarter was $352 million or 19% of net revenue compared to adjusted operating margin of 19.4% last year. Tax expense for the quarter was $97 million or 27.6% of pretax earnings compared to an adjusted effective tax rate of 25.1% a year ago. The increase relative to last year is due primarily to an accrual for withholding taxes on a portion of fiscal 2022’s Canadian earnings and a decrease in tax deductions related to stock-based compensation. Net income for the quarter was $255 million or $2 per diluted share compared to adjusted earnings per diluted share of $1.62 in Q3 of 2021.

Capital expenditures were $176 million for the quarter compared to $123 million in the third quarter last year. Q3 spend relates primarily to investments to 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 $353 million in cash and cash equivalents and nearly $400 million of available capacity under our revolving credit facility. Inventory at the end of Q3 was $1.7 billion, in line with our expectations. This reflects one-year dollar growth of 85% and a three-year unit CAGR of 38%. In-transit inventory is up relative to 2019 and is contributing approximately three percentage points to the three-year unit growth rate.

I’d also note that core seasonless product continues to make up approximately 45% of our inventory. We remain pleased with our inventory levels, which position us well to fulfill guest demand in Q4. Looking forward, on a one-year dollar basis, we expect the inventory growth rate at the end of Q4 to begin to moderate and increase approximately 60% relative to last year. On a three-year CAGR basis, we expect unit growth to be approximately 39% at the end of Q4. During the quarter, we repurchased approximately 55,000 shares at an average price of approximately $311. At the end of Q3, we had approximately $812 million remaining on our recently authorized $1 billion repurchase program. Let me now shift to our guidance outlook. We’re pleased with the start of the holiday season.

However, the environment remains dynamic, and we still have approximately 2/3 of the quarter ahead of us. For Q4, we expect revenue in the range of $2.605 billion to $2.655 billion, representing one year growth of 22% to 25% and a three-year CAGR of 23% to 24%. We expect to open approximately 30 net new company-operated stores in Q4. We expect gross margin in Q4 to increase 10 to 20 basis points relative to Q4 of 2021. We expect to see an improvement year-over-year in product margin, driven by lower airfreight expense which will be partially offset by continued FX pressure and the timing of expenses related to our supply chain investments. We expect markdowns to be in line with 2019 levels. In Q4, we expect our SG&A rate to leverage 30 to 50 basis points relative to Q4 2021.

Turning to EPS. We expect adjusted earnings per share in the fourth quarter to be in the range of $4.20 to $4.30 versus adjusted EPS of $3.37 a year ago. For the full year 2022, we now expect revenue to be in the range of $7.944 billion to $7.994 billion. This range assumes our e-commerce business continues to grow approximately 30% relative to 2021. When looking at total revenue, our guidance implies a three-year CAGR of 26%, which continues to be higher than our three-year revenue CAGR of 19%, leading up to 2020 and higher than the target of approximately 15% growth we set forth in our new Power of Three x2 growth plan. We now expect to open 79 net new company-operated stores in 2022 up modestly from our prior guidance of 75. Our new store openings in 2022 will include 45 to 50 stores in our international markets and represents a square footage increase in the low 20% range in total.

For the full year, we forecast gross margin to decrease between 100 and 140 basis points versus 2021. The reduction relative to last year is driven predominantly by foreign exchange. A more normalized level of markdowns relative to the low levels we experienced last year and increased investment in our DC network. Turning to SG&A for the full year. We forecast leverage of 100 to 140 basis points versus 2021 driven predominantly by increased sales. And when looking at adjusted operating margin for the full year 2022, we expect it to be approximately flat versus last year. For the full year 2022, we expect our effective tax rate to be 28% to 28.5%. For Q4, we expect our effective tax rate to be approximately 28.5%. For the fiscal year 2022, we expect adjusted diluted earnings per share in the range of $9.87 to $9.97 versus adjusted EPS of $7.79 in 2021.

Our EPS guidance excludes the impact of any future share repurchases and the gain on the real estate sale we realized in Q2. We now expect capital expenditures to be approximately $630 million to $655 million for 2022. The increase versus 2021 reflects increased investment in our supply chain, digital capabilities, new store openings and renovations as well as other technology and general corporate infrastructure projects, including our multiyear project to increase our distribution capabilities to support our future volume and growth. And we are also ramping up our square footage growth relative to last year and now intend to open 79 stores versus our prior expectation of 75. Our range of $630 million to $655 million is approximately 8% of revenue in line with our current Power of Three x2 target of 7% and 9%.

Thank you. And with that, I’ll turn it back over to Calvin for some closing remarks.

Calvin McDonald: Thank you, Meghan. In closing, I just want to reiterate how pleased we are to see the continued momentum in the business and our strong start to our Power of Three x2 growth strategy. As we look to quarter four and into 2023, I am confident in both our near- and long-term plans that will enable us to deliver on our goals while continuing to successfully navigate whatever comes our way. I look forward to taking your questions now. Operator?

Q&A Session

Operator: Our first question is from Adrienne Yih with Barclays. Please go ahead.

Adrienne Yih: And may I say congratulations, very well done. Calvin, I wanted to focus a little bit on China. You talked about kind of strong growth there. You’re opening a broad throughout the stores kind of they’re committed to it this year, and obviously, I think probably for next year. What are you seeing then — what is the breakdown between stores and e-commerce and what percent is it for the total business at this point?

Calvin McDonald: Hi, Adrienne, thanks for the question. We’re seeing very good growth across both store channel and our dot-com channel. We don’t share the ratio between those two but both contributed to growth in the quarter. And as you indicated, the market continued to grow very strongly for us even with their ongoing challenges with COVID where we saw store closures, reduced operating hours comparable to what we saw in quarter two. They’re improving, but just recently, and the team is doing a wonderful job managing through that. But the momentum in the brand across the categories in both genders and both channels remains very strong. And we’re very excited about the potential of the brand to be able to continue to drive it through this year as we have and how the guest is responding to it.

So we remain very, very excited about the potential and the role that will play in quadrupling our international business with Mainland China playing a big part of that performance.

Adrienne Yih: Okay. Can you get the percent of sales by any chance?

Calvin McDonald: In terms of growth in the quarter or…

Adrienne Yih: Yes.

Calvin McDonald: No, no, sorry, we don’t share that.

Operator: The next question is from Alex Straton with Morgan Stanley. Please go ahead.

Alex Straton: Great. And of course, congrats on another great quarter. I wanted to just start with what you mentioned on the early holiday performance. It sounds like you guys have been delivering a really impressive result compared to what we’ve heard across other specialty retailers this earnings season and even at our conference earlier this week. So you guys are really kind of bucking the trend here. What would you attribute Lulu’s quarter-to-date outperformance to so far?

Calvin McDonald: Thanks for the question. I’ll break it into two parts that are driving the momentum both in Q3 as well as to the start of Q4, where our guest metrics have been consistent, as I’ve shared and remain very healthy across traffic, new guest acquisition, dollar spend, and the balance across our regions, our channels, our categories and activities. But I think one of the primary drivers of our brand and momentum relative to others really sits with the brand positioning and the uniqueness of our brand with product focused on technical solutions, fabrics through our innovative approach of science of feel and the versatility of how the guest uses our product from not just sweating but through on the move. Our D2C model and community and that connection that we have with the guest in quarter three, we were able to turn some of those physical connections back on and connected to the launch of membership.

So they’re really distinct aspects of the brand that separate us from many others in this space and within the athletic, within retail, hence, I think the share gains and the overall success. I also think some of the decisions we made as a management team early on. Decisions around pricing, decisions around balance of air to have the products and our decision around inventory has allowed us to continue to deliver on the demand side that we’re seeing as we continue to see new guest acquisition strong and the pricing decisions to really manage pricing. To not move pricing aggressively has allowed us to continue to sell our regular price not be forced into unnecessary markdowns or course correcting with promotional play like we’re seeing happen in the marketplace.

So great products, regular price is still selling, driven off of the uniqueness of the overall brand and position in the market.