Lululemon Athletica Inc. (NASDAQ:LULU) Q3 2023 Earnings Call Transcript

Lululemon Athletica Inc. (NASDAQ:LULU) Q3 2023 Earnings Call Transcript December 7, 2023

Lululemon Athletica Inc. misses on earnings expectations. Reported EPS is $1.96 EPS, expectations were $2.27.

Operator: Thank you for standing by. This is the conference operator. Welcome to the Lululemon Athletica Inc. Third Quarter 2023 Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Howard Tubin, Vice President, Investor Relations for lululemon athletica. Please go ahead.

Howard Tubin: Thank you, and good afternoon. Welcome to lululemon’s third quarter earnings conference call. Joining me today to talk about our results are 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 source 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 1 hour, so please limit yourself to 1 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: Thank you, Howard. I’d like to welcome everyone to the call today, and I’m happy to discuss our quarter 3 results. On today’s call, I’ll share some highlights regarding our performance over the Thanksgiving weekend and the start of the holiday season. Next, I’ll speak to our quarter 3 results, then you’ll hear from Meghan with a review of the financials and an update on guidance. And finally, we’ll take your questions. So let’s get started with Thanksgiving. We are very pleased with our results over the holiday weekend. In fact, this Black Friday was the single biggest day in company history, with strength across our store and e-commerce channels. Along with several members of the leadership team, I visited stores in Houston, Dallas and Los Angeles, and we were thrilled to join our local teams and experience their energy and excitement firsthand.

Our stores were very busy, and our overall performance is driven by strength across both full price and markdown merchandise. This year, we extended an additional benefit to our Essentials members who received early access to our Black Friday styles via our shop app. This strategy drove a significant spike in app downloads with virtually no incremental marketing costs. We also visited several recently remodeled locations that show the benefits of our ongoing co-located optimization strategy, including enhanced merchandising of men’s, increased traffic flow and improved throughput due to additional guest services and fitting rooms. Finally, our overall success was enabled by the ongoing foundational investments we’ve been making to our DC network and IT infrastructure to enhance the guest experience, both in stores and online.

And while there is nearly 2/3 of the quarter still ahead of us, we are encouraged by our trends at the start of the holiday season. Now looking back at quarter 3. As you saw from our press release, our results remain strong and balanced as both our top and bottom line exceeded our expectations. Revenue increased 19% versus last year, comparable sales grew 9% in stores and 19% in our e-commerce business and adjusted EPS increased 27% versus the same period last year, and our Board recently authorized a new 1 billion share repurchase program, which reflects our optimism in the growth trajectory of the business. Meghan will share the detailed financials later in the call, and I think it’s clear our performance continues to speak to the strong response to the lululemon brand in our markets across the globe and how we remain in the early innings of our growth story.

Now let’s look at quarter 3 in more detail as I share highlights in 3 areas: product innovation, brand building strategies and regional performance. Let’s begin with product. One of our competitive advantages is our ability to consistently bring newness and innovation into our assortment. Our product teams work with our athletes and ambassadors leverage our science of field innovation platform and solve for the unmet needs of our guests. Quarter 3 was no exception as we introduced several new styles into our assortment. Let me highlight just a few. In quarter 3, our women’s business increased 19%, fueled by new product launches, strength in bottoms and ongoing performance in key franchises. As we shared on our last earnings call, we mentioned the launch of a new franchise for women.

In quarter 3, we introduced Wundermost, our new collection of bodywear made in our softest fabric ever. By leveraging our expertise in raw materials development, fabric innovation and technical construction, our product teams engineered a brand-new sensation and unique solve for our guests. I’m pleased to share that Wundermost launch has been met with great initial response from our guests and we’re excited to keep bringing innovation into this new franchise. Other quarter 3 product highlights on the women’s side include bottoms and second layers. Within bottoms, both tights and away from body styles performed well, including Align, Wunder Train and the Dance Studio Jogger. In addition, we continue to see success in our key second layer franchises, including Define, Scuba and Softstream.

Looking at quarter 4, you will see fresh seasonal takes on several of our guest favorite franchises, including Scuba, Align and Wunder Train. Shifting now to Men’s, we saw growth of 15% in quarter 3. Similar to during the COVID-19 period, we see that when there is some uncertainty in the macro environment, men can become a bit more conservative in their apparel purchases. However, growth in our international regions remains very strong. And in North America, our market share gains continue, and we know our guests respond well to product innovation and compelling marketing campaigns. In quarter 3, we launched 2 new men’s franchises, Steady State and Soft Jersey. These collections build out our lounge offering and continue to bring versatility across our men’s assortment.

Guest response has been very strong, and we are chasing into additional inventory for these 2 new hit franchises. Following the holidays, our stores and e-commerce sites will have a back to gym focus, for men will feature items from our Pace Breaker and License to Train franchises to support our guests as they live into their New Year fitness and well-being resolutions. We’re also gearing up to launch men’s footwear in the first quarter of 2024, which will be an important moment for lululemon. We’ll have much more to share as our pipeline of innovation continues to generate newness and versatility for our male guests. When looking at men’s brand awareness, it remains low, approximately 13% in the U.S., 12% in Australia and single digits everywhere else outside of North America.

Building awareness and consideration remains top of mind for us, and we see ample opportunity to increase the media and brand building commitment to the men’s business. An example of this strategy is our recent targeted TV campaign. In quarter 3, we tested TV in the U.S. with a campaign focused on bringing new male guests into the brand and featuring our iconic ABC bottoms. We are encouraged by the early results and the buzz created by this targeted investment, and we plan to continue the campaign next year. In 2024, our marketing calendar has other men’s moments planned, such as the footwear launch, and we will continue to leverage ways that paid media can raise our awareness among men who have yet to wear lululemon. I would also like to mention our accessories business, which continues to perform well.

In quarter 3, our bag assortment grew in the strong double digits, and the Everywhere Belt Bag posted solid growth on top of last year’s standout performance. I remain excited with our pipeline of innovation for the remainder of quarter 4 and into next year. Our foundational principle remains, when you feel your best, you perform your best. Our teams continue to live into that principle for our technical gear, and we are also leveraging it as we expand our lounge and On The Move offerings. I’d now like to spend a few minutes and share some of the ways we connect with our local communities in quarter 3. As we’ve discussed in the past, we continue to lean into our grassroots approach to building community and engaging with guests on a local and one-on-one basis.

In addition, we recognized the opportunity to raise unaided awareness and attract new guests through larger scale activations and brand campaigns, both within North America and across our international markets. Let me share a few examples. To bring attention to World Mental Health Day, we released our third annual global well-being report in September. This global survey conducted in 14 markets looks at how people around the world are approaching their physical, mental and social well-being. And while a majority of people say they are making well being a priority, if you feel it is where it should be. To support our guests we created well-being focused experiences in key markets and a highlight was a one-of-a-kind activation in China that encompass 32 cities and 76 stores.

The pinnacle expression took place in Shanghai as we took over the West Bund for an entire week with events and experiences over a 3-kilometer stretch of this popular destination on the waterfront. The results of this activation were phenomenal and included more than 1,600 pieces of press coverage with 3 billion impressions, significant engagement on social media and approximately 12,000 guests participating in person. This event was a very unique and compelling way to drive unaided brand awareness in the market. Also in October to support and help launch our new partnership with Peloton, we hosted a 3-day experience at our Lincoln Park store in Chicago. More than 2,000 guests joined us and it was exciting to see our local lululemon community come together with the Peloton community to celebrate our new relationship.

The success of this event represents the potential of the partnership to leverage the strength of both our highly engaged communities. As you can see, we are taking multiple paths to building brand awareness and consideration across our global markets. Quarter 3 was a terrific example of this strategy, and you can expect more of this type of marketing execution from us going forward. Shifting now to our regional performance. We continue to see solid results across markets with revenue in North America growing 12% and international increasing 49%. We remain pleased with our business in North America, which is in line with our Power of Three x2 targets despite the dynamic operating environment. The quarter began strong as guests responded well to our back-to-school product innovations and our strategies to connect with younger guests through dedicated digital marketing and targeted activations and our market share gains continued.

In quarter 3, 2023, the adult active apparel industry decreased its U.S. revenue compared to the same period last year. Over the same time period, lululemon gained 1.5 points of market share in the U.S. with gains in both men’s and women’s according to Circana’s consumer tracking service. North America remains a significant and compelling opportunity for lululemon with unaided awareness of only 25%, we have several ways to bring new guests into the brand, including ongoing innovation within our product assortment, new store openings and optimizations and our unique approach toward connection encompassing both local activation and larger-scale marketing campaigns. Switching now to international. We remain excited and optimistic regarding the potential for the lululemon brand.

In quarter 3, all regions grew in strong double digits, including a 53% increase in Greater China. While we are keeping a close eye on the macro environment in China, our business remains strong. We believe several factors benefit us in this important market, including our relatively small size with room to grow beyond our 114 stores in Mainland China at the end of the quarter, the localized nature of our brand as we leverage our relationships with local fitness studios, instructors and influencers and our local and community-based events. We are excited with the brand acceptance we’re seeing globally as we continue to execute against our plan to quadruple our international business from 2021 levels by the end of 2026. And with that, I’ll turn it over to Meghan for a review of our financials and our updated guidance.

Meghan Frank : Thanks, Calvin. We continue to be pleased with our performance across channel, geography and merchandise category. Despite an uncertain macro backdrop, our teams are executing at a high level, which contributed to our upside in Q3. As Calvin mentioned, we’re happy with our start to the holiday season, but with nearly 2/3 of the quarter still in front of us, we remain prudent in our planning. Let me now share the details of our Q3 performance. Please note that when comparing the financial metrics for Q3 2023 with Q3 2022, adjusted earnings per share for Q3 2023 excludes $72.1 million of after-tax expense related to the impairment and restructuring costs associated with the lululemon Studio business. I’ll provide more detail on these charges shortly, and you can refer to our earnings release and Form 10-Q for more information and reconciliations to our GAAP metrics.

For Q3, total net revenue rose 19% to $2.2 billion. Comparable sales increased 14% with a 9% increase in stores and a 19% increase in digital. In our store channel, sales increased 19%. We ended the quarter with a total of 686 stores across the globe. Square footage increased 17% versus last year, driven by the addition of 63 net new lululemon stores since Q3 of 2022. During the quarter, we opened 14 net new stores and completed 8 optimizations. In our digital channel, revenues totaled $908.1 million or 41% of total revenue. Within North America, revenue increased 12% versus last year. Within International, we saw a 49% increase versus last year with Greater China increasing 53%. By category, women’s revenue increased 19% versus last year, men’s increased 15% and accessories grew 29%.

It’s also great to see ongoing strength in traffic across channels, with stores up nearly 25% and e-commerce increasing 20%. This speaks to the strength of our omni operating model as we engage with our guests in ways most convenient to them. Adjusted gross profit for the third quarter was $1.28 billion, or 58.1% of net revenue compared to 55.9% of net revenue in Q3 2022. The adjusted gross profit rate in Q3 increased 220 basis points versus last year and was driven primarily by the following: a 250 basis point increase in overall product margin driven primarily by lower freight costs as well as lower air freight usage. Fixed costs deleveraged 20 basis points in the quarter. We also saw 10 basis points of unfavorable impact from foreign exchange.

Moving to SG&A. Our approach continues to be granted and prudently managing our expenses while also continuing to strategically invest in our long-term growth opportunities. SG&A expenses were $843 million or 38.2% of net revenue compared to 36.8% of net revenue for the same period last year. We achieved better-than-expected deleverage in the quarter, while at the same time continuing to invest behind our strategic initiatives to build brand awareness among additional investments we’ve accelerated to fuel our Power of Three x2 road map. Foreign exchange, both translation and revaluation, contributed 30 basis points of leverage in the quarter. Adjusted operating income was $436 million or 19.8% of net revenue, an increase of 80 basis points compared to Q3 2022.

Adjusted tax expense for the quarter was $125.3 million or 28.1% of pretax earnings compared to an effective tax rate of 27.6% a year ago. Adjusted net income for the quarter was $320.8 million or $2.53 per diluted share compared to $2 for the third quarter of 2022. Capital expenditures were approximately $163 million for the quarter compared to approximately $176 million for the third quarter last year. The spend relates primarily to store capital for new locations, relocations and renovations and technology and supply chain investments. Before turning to our balance sheet highlights, let me spend a moment on the charges we took related to the lululemon Studio business. As you know, in September, we announced a new 5-year partnership with Peloton.

Under this arrangement, Peloton has become the exclusive digital fitness content provider for lululemon Studio, and we have become Peloton’s primary apparel provider. In addition, while we will still provide service and support to owners of the lululemon Studio Mirror Device, we’ve recently stopped selling the hardware. As we will no longer be producing content or selling Mirror hardware, we recognized a post-tax asset impairment and other charges related to lululemon Studio, totaling $72.1 million during the third quarter. Turning to our balance sheet highlights. We ended the quarter with $1.1 billion in cash and cash equivalents and nearly $400 million of available capacity under our revolving credit facility. Inventory was $1.66 billion at the end of Q3, down 4% versus last year and lower than our guidance.

The lower inventory relative to our guidance relates predominantly to higher revenue. The provision we took against our remaining lululemon Studio hardware inventory, timing of certain receipts and foreign exchange. On a unit basis, inventory increased approximately 5%. We remain comfortable with both the quality and quantity of our inventory. At the end of Q4, we expect inventory on a dollar basis to be flat to down slightly versus last year, with units flat to up slightly. We repurchased approximately 553,000 shares at an average price of $381. At the end of Q3, we had approximately $243 million remaining on our prior repurchase program. In addition, as Calvin mentioned, our Board of Directors recently authorized a new $1 billion plan. We remain optimistic in our outlook for the business and continue to use share repurchases as our preferred method to return cash to shareholders.

Over the last 5 years, we have repurchased approximately $2 billion worth of our shares. Let me shift now to our guidance outlook. As I mentioned, we’re pleased with the trends we’ve seen at the start of the holiday season. That being said, the majority of the quarter remains in front of us. We remain aware of the uncertainties in the macro environment, and we continue to plan the business for multiple scenarios. So let me begin with Q4. We expect revenue in the range of $3.135 billion to $3.170 billion, representing growth of 13% to 14%. We expect to open approximately 25 net new company-operated stores in Q4. We expect gross margin in Q4 to increase 90 basis points to 120 basis points relative to Q4 of 2022. This will be driven by lower freight expense and regional mix, offset somewhat by strategic investments to support future growth, including supply chain distribution centers and product teams as well as modest deleverage on occupancy and depreciation.

In Q4, we expect our SG&A rate to deleverage by 160 basis points to 190 basis points relative to Q4 2022. This deleverage continues to reflect our strategic decision to invest in growth initiatives, including those to grow brand awareness globally. When looking at operating margin for Q4, we expect approximately 70 basis points of contraction relative to last year. Turning to EPS. We expect earnings per share in the fourth quarter to be in the range of $4.85 to $4.93 versus adjusted EPS of $4.40 a year ago. Shifting to full year 2023, we now expect revenue to be in the range of $9.549 billion to $9.584 billion. This range represents growth of 18% relative to 2022 and exceeds the revenue target in our Power of Three x2 growth plan. We expect to open approximately 55 net new company-operated stores in 2023 and complete approximately 25 to 30 co-located remodels.

This will contribute to overall square footage growth in the low to mid-teens. Our new store openings in 2023 will include approximately 35 stores in our international markets, with the majority of these planned for China. For the full year, we continue to forecast adjusted gross margin to increase between 190 basis points to 210 basis points versus 2022. The expansion relative to last year is driven predominantly by lower air freight expense. For the full year, we now expect airfreight to be down approximately 220 basis points versus 2022. When looking at markdowns for the full year, we continue to expect them to be relatively in line with last year in 2019. Turning to SG&A for the full year. We now forecast deleverage of 120 basis points to 140 basis points versus 2022.

While we continue to plan the business prudently, our sales trend has enabled us to invest into our Power of Three x2 growth pillars while also delivering operating margin ahead of our goal for modest expansion annually. When looking at adjusted operating margin for the full year 2023, we now expect it to increase approximately 70 basis points versus last year. For the full year 2023, we expect our effective tax rate to be approximately 29.5%. For Q4, we expect our effective tax rate to be approximately 30%. For the fiscal year 2023, we now expect adjusted diluted earnings per share in the range of $12.34 to $12.42 versus adjusted EPS of $10.07 in 2022. Our EPS guidance excludes the impact of any future share repurchases. We expect capital expenditures to be approximately $670 million to $690 million for 2023.

The increase versus 2022 reflects investments to support business growth, including a continuation of our multiyear distribution center project, store capital for new locations, relocations and renovations and technology investments. Our range of $670 million to $690 million is approximately 7% of revenue, in line with our current Power of Three x2 target of 7% and 9%. With that, I will turn it back over to Calvin.

Calvin McDonald: Thank you, Meghan. As you can see, lululemon had another strong quarter, and we are energized about the many opportunities ahead. We are pleased with the strength and resilience of our brand across markets, channels and categories, and are well positioned to deliver against our Power of Three x2 growth strategy. In addition, we are happy with the start to the holiday season, and our teams are ready to deliver for our guests in quarter 4. And I want to mention that as we have demonstrated over recent years, we are actively planning the business so that we respond to any changes in guest behavior that could occur related to the dynamic macro environment. In closing, I want to express my sincere gratitude to our people across the lululemon who make these consistently strong results possible as we deliver for our guests and build towards the future. With that, we can now take your questions. Operator?

Operator: [Operator Instructions] The first question is from Alex Straton with Morgan Stanley.

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Q&A Session

Alex Straton : Perfect. My question was actually on the remodeled locations with the colocations within them. I was wondering if there are any metrics you can share on how those stores perform compared to the legacy fleet. Then also, if you have any update on how much of the fleet is in that format now in North America, and if all the new locations are in that format?

Meghan Frank: Thanks, Alex. We’ve got about 150 stores co-located. Our plans this year have ticked up slightly to 25 to 30 co-located remodels, up from 25. These are stores where we have very high traffic and sales productivity and see an opportunity to capitalize on that traffic and drive incremental volume. We tend to look over a 2- to 3-year time horizon in terms of maturation of store, and we will see a slightly lower sales productivity from those boxes, but very strong returns and healthy sales per square foot. And so pleased overall with that strategy. And you’ll continue to see more of that from us. We are much further along on that in North America, and that strategy is still largely in front of us in our international business.

Operator: Our next question is from Rick Patel with Raymond James.

Rick Patel: Just had a question on what’s implied with fourth quarter guidance. So I’m just hoping if you can provide some guardrails on how we should think about stores versus direct and North America versus international. I’m curious which segments may have a different trend versus the growth that you’ve seen year-to-date.

Meghan Frank: Yes. Rick, so in terms of Q4 guidance, we’re guiding at 13% to 14% growth. As Calvin mentioned, very pleased with the Thanksgiving weekend, still have about 2/3 of the quarter in front of us, so being prudent in our planning there. We haven’t broken down specifics, but what I’d share is very strong continued double-digit growth in international and then on North America, high single digits.

Operator: The next question is from Lorraine Hutchinson with Bank of America.

Lorraine Hutchinson : I wanted to follow up on the prior question. The high single-digit North America sales guidance is below your typical algorithm as is the first quarter guidance? Can you talk to what you’re seeing in the business or hearing from your customer that’s informing this posture?

Meghan Frank: Yes. Thanks, Lorraine. Yes, I would say coming off of a strong Q3 performance, we did experience some very strong performance during our Cyber Five period. We are mindful of the macroeconomic environment as we move into the balance of Q4 and still with 2/3 of the quarter in front of us, being mindful of the pressures out there and contemplating that and how we are guiding. We are also planning the business for multiple scenarios to be able to capitalize on any potential upside.

Operator: The next question is from Brooke Roach with Goldman Sachs.

Brooke Roach : Calvin, I was hoping you could talk a little bit more about what you’re seeing in terms of the consumer behavior with the brand. You’ve talked a little bit about being mindful about the macro backdrop a few times. But has there been any shift in consumer behavior conversion or engagement with the brand that shifted relative to what you saw 90 days ago?

Meghan Frank: Brook. So in terms of guest metrics, we’re still seeing growth in both spend from new and existing guests. So still really pleased, I would say, overall, and just looking out over Q4, again, 2/3 of the quarter in front of us, so planning the business prudently. But I would say, overall, really pleased with what we’re seeing in terms of guest behavior.

Calvin McDonald: The only one I’d add, Brook, relative to when we look at the overall market is, as I mentioned, in the men’s business. And that is our business internationally remains very strong. our growth well above industry average and putting on share in North America. But when we look at the macro category within North America, we do see that he is spending less in apparel in general. We continue to put on market share. But if I was to point to just one trend that we’re observing and monitoring it is that guest behavior that we’re seeing in a macro condition.

Operator: The next question is from Matthew Boss with JPMorgan.

Matthew Boss : Great. And congrats on another nice quarter. So maybe, Calvin, could you just elaborate on the cadence of business that you saw as the third quarter progressed in North America? Maybe if you could speak to stores versus digital. And where do you see the largest market share opportunities next year across the assortment? And then Meghan, any constraints to modest operating margin expansion on the mid-teens revenue growth multi-year? Or are there just — are there any geography considerations on the margin front as we think about gross margin relative to SG&A beyond this year that we should be thinking about?

Calvin McDonald: Thanks, Matt. I’ll talk about sort of just the trends through the quarter and then share gains, and then I’ll let Meghan pick up the other part of — I think you snuck in 5 or 6 questions there, but let’s take our time. We have a little bit of — we have some time here, Matt. But on the quarter, we dropped some new innovation to begin in August, and had some targeted campaigns, both digitally, some activations around back-to-school and the guest both in our female and male guests responding incredibly well to that and the newness. I would say that momentum moderated a little bit in September and then accelerated again in October when once again, some newness and innovation was dropped with Wundermost. We activated with our men’s campaign around the ABC franchise targeted for top-of-funnel and guest acquisitions.

So it definitely sort of progressed through the quarter like that healthy across but with the peak sort of being in August and October and driven by either newness and our campaign to activate and go after unaided awareness. When I think of share next year, our plans are still very much reflective of the being early innings across our business. We do expect to see our men’s business continue to be strong and put on share at unaided awareness below 25%, it’s 13%. In fact, in North America, we’re going to continue to put on share across all of our categories and playing to our strengths in bottoms and some of our core franchises and the new franchises like Soft Jersey and Steady State, which is really resonating. We’re chasing into that inventory, and we’re seeing both our existing guests and new guests come in through that franchise.

And then with women’s and accessories, similar story. We have a lot of runway and opportunity in our bottoms business as well as tops and accessories. So there’s not a specific category that we think will drive share but a very balanced approach and performance as we’ve experienced and really pointed to the fact that we’re early innings of growth across all of those categories in both genders.