Lululemon Athletica Inc. (NASDAQ:LULU) Q2 2023 Earnings Call Transcript

Lululemon Athletica Inc. (NASDAQ:LULU) Q2 2023 Earnings Call Transcript August 31, 2023

Lululemon Athletica Inc. beats earnings expectations. Reported EPS is $2.68, expectations were $2.53.

Operator: Thank you for standing by. This is the conference operator. Welcome to the Lululemon Athletica Inc. Second Quarter 2023 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 Athletica. Please go ahead.

Howard Tubin: Thank you, and good afternoon. Welcome to Lululemon’s second 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 second 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 would like to turn the call over to Calvin.

Calvin McDonald: Thank you, Howard. I’m pleased to be here with everyone to discuss our quarter two results. Today, I’ll share the highlights of our recent performance and speak to some of the exciting product launches and activations we have planned for the second half of the year. As you’ve read in our press release, our second quarter results exceeded our expectations as our core product and new launches continue to resonate strongly with guests in markets around the world. On today’s call, I will provide details on our quarter two performance, I’ll then speak to our outlook and the many opportunities we have across the business. Next, I’ll turn it over to Meghan for a review of the financials and the guidance update.

And then, we’ll take your questions. So let’s get started. Our business remained strong in quarter two with both revenue and EPS exceeding our expectations. Revenue increased 18% versus last year with strength across our portfolio. Comparable sales grew 9% in stores and 17% in our e-commerce business and adjusted EPS increased 22% versus the same period last year. These results demonstrate the strength of the business and how we are well positioned for the second half of 2023. In fact, we are seeing our strong momentum continue into quarter three and expect revenue growth in the 17% to 18% range for the quarter. Meghan will share our detailed guidance with you later in the call. Let’s now look at quarter two in more detail as I share some highlights on product innovation, brand building strategies and regional performance.

When looking at product, we posted strong double-digit growth across women’s, men’s and accessories as we bring newness and innovation into our assortment. Specifically in quarter two, women’s increased 16%, men’s was up 15% and accessories increased 44%. In women’s, guests are responding very well to our core franchises as well as our newer play activities. We continue to see strength in our key franchises, including Scuba, Define and our Dance Studio jogger. In addition, Softstreme has emerged as another meaningful franchise for us. In quarter two, we saw strength across the collection with guests responding well to our offering. Turning to play, our tennis and golf collections remain strong performers for us. As we’ve shared before, our strategy with play is to solve for our guests’ unmet needs across their secondary sweat activities.

We introduced styles designed specifically for these activities while continuing to leverage the versatility of our core assortment. In men’s, I’d like to highlight the ongoing strength we’re seeing in our ABC franchise, one of our most popular for him. Our teams continue to expand and evolve the assortment, which now includes 4 styles and 4 fits and is available in 3 proprietary fabrics, Warpstreme, Utilitech and WovenAir with additional fabrics and solves for unmet needs planned for upcoming seasons. As we expand this trusted franchise, we are gaining share of wallet from existing guests, while at the same time attracting new guests to our brand. In accessories, our entire bag assortment is performing well. Crossbody styles, backpacks and small pouches are helping drive these results and contributed to the 44% growth in accessories in quarter two.

Our teams will continue to create innovative solutions over the coming months and seasons as we realize the meaningful opportunity to expand our bag assortment. Looking specifically at the Everywhere Belt Bag, I am pleased we generated strong double-digit growth on top of last year’s strength. Consistent with our strategy to develop franchises from our most popular styles, our accessories team expanded our assortment of Everywhere Belt Bags across multiple sizes, color waves, prints and patterns and the guests are responding incredibly well. Turning to footwear. We are making steady progress in this category, and I’m excited with how our team continues to evolve the offering. We recently introduced Chargefeel 2, an update to our most versatile run to train style, and we are gearing up for the launch of men’s footwear next year.

Looking now at the second half of the year, I am pleased with our pipeline of innovation. In women’s, we will launch an exciting new collection in the fall, which will show our continued ability to address the unmet needs of our guests. Stay tuned for additional details. On the men’s side, recently in quarter three, we launched two new franchises, the Steady State and our Soft Jersey collection, both of which are exceeding our expectations. Steady State is constructed from the same fabric used in our Scuba franchise, and is a great example of how we can leverage our technical fabrics across genders. Our Soft Jersey collection includes several styles, all in our Jersey fabric, which provides guests with incredible softness in his quick drying, stretchy and sweat wicking.

These collections enhance our men’s lounge offering and are consistent with how we view our overall on-the-move assortment. These products are designed for lounge but made from technical fabric and offer performance features. Later in quarter three, we will expand our outerwear offering with new styles of vests, jackets and waterproof down. And in quarter four, we will launch a new performance fabric designed specifically for cold weather runs. These are just a few examples of how we consistently bring innovation into our core while at the same time, expand into new categories. We are still in the early innings of our product journey and have significant opportunity ahead of us as we continue to solve for the unmet needs of our guests. While product innovation is a key tenet of our Power of Three x2 growth plan, we also have a real opportunity to increase our brand awareness.

As we previously discussed, our unaided brand awareness is still only 25% in the United States. And with the exception of the UK and Australia, our unaided awareness remains in the single digits in every market in which we operate outside of North America. In 2023, we have accelerated our efforts to increase awareness and consideration for Lululemon, and we are seeing gains in key growth markets across the globe. Last quarter, we spoke about several initiatives, including the initial phases of our Get Into It campaign, our Dupe Swap event in Los Angeles, and the launch of the FURTHER initiative. In quarter three, we have several activations and campaigns on deck that will support our key product launches, begin to build excitement for the upcoming holiday season and increase overall awareness of the Lululemon brand across the globe.

Let me share some highlights. Given the positive reception to our Get Into It campaign, we’ll continue to highlight our leadership position in bottoms with another installment in quarter three. For women, the campaign will focus on our core franchises and feature our global ambassador and professional tennis player, Leylah Fernandez. And for men, we’ll elevate our ABC franchise with the support from some fun and exciting special guests. The campaign will include digital media assets across our stores and e-commerce sites as well will also test some targeted television in the U.S. In EMEA, we will build on our soft launch with Zalando in June with a larger consumer-facing launch on this popular e-commerce site. Our relationship with Zalando is not wholesale as we fulfill orders ourselves, and it is an excellent way for us to bring new guests into the Lululemon brand across Europe, where Zalando is a strong and leading player.

And finally, we’ll release our Global Wellbeing Index in the coming weeks to raise awareness and celebrate World Mental Health Day in October. We are excited about the ongoing opportunity to grow brand awareness in the U.S. and across all our international markets. Our grassroots approach to building community and engaging with guests remains unchanged, but we are also increasing the number and frequency of larger scale activations and global brand campaigns. And we are doing this within the confines of our P&L and keeping overall marketing spend relatively stable as a percentage to sales on an annual basis. In addition, the continued acceleration in our top line unlocks dollars that we are then able to strategically invest behind our initiatives to drive brand awareness, leveraging both earned and paid media in new and creative ways.

Shifting now to our regional growth drivers. We continue to see broad-based strength. Specifically, revenue in North America grew 11% in quarter two and international increased 52%. Within international, we delivered strong growth across all markets and continue to see great acceptance of our brand in Greater China, where revenue grew 61%. Within North America, we remain pleased with the underlying strength of the business with double-digit growth in quarter two, consistent with our Power of Three x2 target, and we continue to gain market share. In quarter two, the adult active apparel industry decreased its U.S. revenue compared to the same period last year. Over this time period, Lululemon gained 1.3 points of market share in the U.S. with gains in both men’s and women’s according to Circana’s consumer tracking service.

In the back half of 2023, as I mentioned, we have a compelling pipeline of innovation planned. We will continue to focus on acquiring new guests as we solve for their unmet needs. And thus far in quarter three, I can also share that we are seeing our business in North America accelerate relative to quarter two. Turning to international. Our business remains strong and balanced across regions. In quarter two, total international represented 22% of sales versus 17% in quarter two last year. And while expanding nicely, this penetration still remains below our long-term target, which reinforces just how early we are in our growth journey. Let me now share some recent regional highlights. In China, we celebrated the National Fitness Day in August with the third installment of our Summer Sweat Games.

Through this activation, our local teams hosted regional competitions across the country which culminated in a national final held this past weekend in Shenzhen. This year, the games included 3,400 participants from more than 100 stores in 36 cities. Our APAC and EMEA region also continued to perform well. In Australia, we are beginning to reap the benefits of our store optimization program as well as the recent rollout of ship from store in this market. This is our most mature market outside of North America, and we still have ample opportunity to drive growth this year and into the foreseeable future. We also opened our first store in Thailand in July, which marked the 100th location in the APAC region. The pent-up demand for the Lululemon brand in this market was clear and the opening of the store in Bangkok was our strongest ever in the APAC region.

In addition, we’ve seen a noticeable uptick in travel and tourism within APAC, which is also having a positive impact on our business. And in EMEA, in August, we opened our second store in Amsterdam, which reflects our expanding community and our ongoing investment in this key European city to grow the Lululemon brand. It’s incredibly exciting for all of us at Lululemon to see the strong acceptance of our brand across all markets within our international business. With each new store opening, we see a groundswell of support that welcomes Lululemon into the community. Our runway for growth is substantial, and I am optimistic about the future as we continue to expand our business. And with that, I’ll turn it over to Meghan for a review of our financials and our updated guidance.

Meghan Frank: Thanks, Calvin. Our momentum remained strong in Q2, enabling us to exceed both our top and bottom line guidance. In addition, our inventory growth continued to moderate, grew 14% versus our guidance of approximately 20%, and it remains well positioned from both the level and composition standpoint. I’m also excited to see our sales strength continuing into Q3 as guests are responding well to our back-to-school and early fall product innovations. Now, let’s dive into our Q2 financials. For Q2, total net revenue rose 18% to $2.2 billion, driven by broad-based strength across the business. Comparable sales increased 13% with a 9% increase in stores and a 17% increase in e-commerce. In our store channel, total sales increased 21% versus last year.

We ended the quarter with a total of 672 stores across the globe. Square footage increased 19% versus last year, driven by the addition of 72 net new Lululemon stores since Q2 of 2022. During the quarter, we opened 10 net new stores and completed 4 optimizations. In our digital channel, revenues totaled $894 million or 40% of total revenue. Within North America, revenue increased 11% versus last year. Within International, we saw a 52% increase versus last year with Greater China increasing 61%. And by category, women’s revenue increased 16% versus last year, men’s increased 15%, and accessories grew 44%. It’s also great to see ongoing strength in traffic across both channels. In both stores and digital channels, traffic increased over 20%.

This speaks to the strength of our omni operating model as we engage with our guests in ways most convenient to them. Gross profit for the second quarter was $1.3 billion or 58.8% of net revenue compared to 56.5% of net revenue in Q2 2022. The gross profit rate in Q2 increased 230 basis points versus last year and was driven primarily by the following: a 330 basis-point increase in overall product margin resulting from freight favorability. We remain pleased with the product margin strength we continue to realize on top of the strong gains over the last several years. The combination of product and supply chain costs and occupancy deleveraged 70 basis points in the quarter, driven predominantly by ongoing investment in product development and supply chain.

We also saw 30 basis points of unfavorable impact from foreign exchange. 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 $817 million or 37% of net revenue compared to 35.4% of net revenue for the same period last year. We achieved better-than-expected deleverage in the quarter, driven predominantly by our top line strength while 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 60 basis points of leverage in the quarter.

Operating income for the quarter was approximately $479 million or 21.7% of net revenue compared to adjusted operating margin of 20.9% of net revenue in Q2 2022. Tax expense for the quarter was $145 million, or 29.8% of pretax earnings compared to an effective tax rate of 28.2% a year ago. Net income for the quarter was $342 million or $2.68 per diluted share compared to adjusted EPS of $2.20 for the second quarter of 2022. Capital expenditures were approximately $146 million for the quarter compared to approximately $145 million in the second quarter last year. The spend in Q2 of this year relates primarily to store capital for new locations, relocations and renovations, technology and supply chain costs. 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 $1.7 billion at the end of Q2, up 14% versus last year. At the end of Q3, we expect inventory to be up in the high single to low double digits versus last year. The relatively low growth rate is due to the provision for Mirror Hardware we took in Q4 2022 and have not yet anniversaried. In Q4, we continue to expect inventory growth to be relatively in line with sales growth. We repurchased approximately 517,000 shares at an average price of $371. At the end of Q2, we had approximately $454 million remaining on our $1 billion repurchase program. Let me shift now to our guidance outlook.

We continue to be very pleased with the strength of our business as Q2 exceeded our expectations and Q3 is off to a solid start. The upside we’ve seen in the first half of the year allows us to invest into our strategic initiatives to set ourselves up for future growth, while at the same time, flowing some of that upside through to the bottom line. With that being said, we remain aware of the uncertainties that exist in the current macro environment. And consistent with our approach over the last several years, we continue to be prudent and plan the business for multiple scenarios. Now, let me begin with Q3. We expect revenue in the range of $2.165 billion to $2.19 billion, representing growth of 17% to 18%. We expect to open 23 net new company-operated stores in Q3.

We expect gross margin in Q3 to increase 160 to 180 basis points relative to Q3 of 2022. This will be driven by lower freight expense, 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 Q3, we expect our SG&A rate to deleverage by 200 to 220 basis points relative to Q3 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 Q3, we expect approximately 40 basis points of contraction relative to last year. Turning to EPS. We expect earnings per share in the third quarter to be in the range of $2.23 to $2.28 versus EPS of $2 a year ago.

Shifting to the full year 2023. We now expect revenue to be in the range of $9.51 billion to $9.57 billion. This range represents growth of 17% to 18% relative to 2022 and exceeds the revenue target in our Power of Three x2 growth plan. We now expect to open approximately 55 net new company-operated stores in 2023 and complete approximately 25 colocated remodels. This will contribute to overall square footage growth in the low 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 now forecast gross margin to increase between 190 and 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 210 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 continue to forecast deleverage of 150 to 170 basis points versus 2022. While we continue to plan the business prudently, our sales trend has been strong. As I mentioned earlier, this gives us the opportunity to invest into our Power of Three x2 growth pillars while also delivering operating margin this year ahead of our goal for modest expansion annually. When looking at operating margin for the full year 2023, we now expect it to increase 40 to 60 basis points versus last year. For the full year 2023, we continue to expect our effective tax rate to be approximately 30%.

For Q3, we expect our effective tax rate to be approximately 30.5%. For the fiscal year 2023, we now expect diluted earnings per share in the range of $12.02 to $12.17 versus adjusted EPS of $10.07 in 2022. Our EPS guidance excludes the impact of any future share repurchases. We now expect capital expenditures to be approximately $670 million to $690 million for 2023. This increase versus 2022 reflects investments to support business growth, including the 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% to 9%. With that, I’ll turn the call back over to Calvin.

Calvin McDonald: Thank you, Meghan. As these results demonstrate, we arrive at the midpoint of 2023 in a very strong position for what’s ahead. We continue to deliver sustained growth in the business through a steady drumbeat of product, category and market expansions that connects us with our guests on a regular basis. We recognize the significant opportunity in front of us and we remain focused on both delivering a successful 2023 and achieving our goals contained within the Power of Three x2 growth plan. My confidence in our leadership and our people remains extremely high as we consistently demonstrate our ability to deliver for our guests and our shareholders. I’m grateful to the many teams across Lululemon, who champion our brand every day and make these results possible. And now, we look forward to taking your questions. Operator?

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Q&A Session

Operator: [Operator Instructions] The first question comes from Matthew Boss with JP Morgan. Please go ahead.

Matthew Boss: Thanks. And congrats on another nice quarter. So, Calvin, could you elaborate on the broad-based global strength, notably customer demand that you saw in North America and China as the second quarter progressed? And then on more recent trends, could you just speak to drivers of the strong August momentum and the acceleration that you cited in North America?

Calvin McDonald: Great. Thanks, Matt. Similar to the success through the first half of this year, which is really driven from our core product as well as our new innovation across both performance and OTM categories across both women’s and men’s, so it continues to be that balanced growth across categories, channels, both stores, e-com and all markets that’s fueling the business. And heading into Q3, there’s really no change to that formula, and the team is doing a wonderful job and guests are responding to the new innovation that we are launching. I referenced a few on the call, the Soft Jersey, Steady State for him. We have some exciting innovation still to come. So, I think it’s just a continuation of low unaided brand awareness, and we are launching initiatives to get at that opportunity, incredible product opportunity and the teams delivering on that on unmet needs and our international business, which, in addition to North America is still performing very strongly, double-digit in line with our Power of Three x2 growth targets, seeing acceleration across every market in the globe we’re in.

So, it really is a reflection of my consistent message of us being early innings and balanced growth across all opportunity we have and a team that’s delivering on that potential.

Matthew Boss: That’s great. And then, Meghan, could you just speak to the overall health and composition of your current inventory position as we head into the back half? And just how best to think about markdowns in the third quarter, or are there any constraints to recapturing the markdown headwinds that you incurred in the fourth quarter a year ago?

Meghan Frank: Yes, absolutely, Matt. So, in terms of inventory, so we came in up 14 at the end of the quarter, our expectation was approximately 20. relative to our expectation, there were a few items that drove that balance lower. So the first would be revenue upside above our expectations, second being lower air freight costs and then the third being some timing implications. And in terms of how we’re looking at inventory for the balance of the year, at the end of Q3, we’re expecting high single to low double digits. And then in Q4 — end of Q4, relatively in line with sales as we move into 2024. So, I would say overall, we’re really pleased with the currency and also the level of our inventory. In terms of markdowns, nothing really to note on the quarters.

We’re still expecting markdowns to be relatively flat on an annual basis for ‘23 over ‘22, and that’s consistent also with our 2019 levels, which is a normalized healthy level for us. We run a low markdown penetration, high full price penetration business. We were flat in Q2, markdowns year-over-year, and I wouldn’t expect any anomalies in Q3 and Q4.

Operator: The next question comes from Adrienne Yih with Barclays. Please go ahead.

Adrienne Yih: Great. Thank you very much. Congratulations. The results are really — they really stand alone. Calvin, so — the business is being driven by innovation, product launches and newness, whereas sort of the competitive backdrop is a little bit more safe. And I’m just wondering how have you been able to sort of inspire that? It feels like you’re innovating faster. Every time you get on a call, there’s like another list of five new things that we didn’t know about. So I’m just wondering, how you accelerated the innovation turnover time, the pipeline or the investment? And then Meghan, if you can just talk to us about kind of the China, the opportunity there, the sales are almost double sort of what you have in Canada and the year-to-date sales are roughly similar at $0.5 billion, so just kind of talking about the improvement there and what you think about the opportunities there? Thank you very much.