Lululemon Athletica Inc.
Q4 2022 Earnings Call Transcript

Published: 28 Mar 2023

[Operator:]

Thank you for standing by. This is the conference operator. Welcome to the lululemon athletica inc. Fourth Quarter 2022 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 fourth 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 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 annual report on Form 10-K 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 annual report on Form 10-K 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 fourth 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:]

Thank you, Howard. I am pleased to be here today to discuss our strong finish to another strong year for lululemon. As you've seen from our press release, our adjusted quarter four results came in ahead of our January guidance update and our adjusted full year results represent a very solid start to our Power of Three x2 growth plan. I'm also excited that we continue to see strength and momentum across the business so far in quarter one. None of this would have been possible without our lululemon collective, our employees, our vendor partners, our ambassadors and our guests, all of whom are integral to our continued success. I want to express my gratitude on behalf of all of the senior leaders to our incredible teams around the world. Thank you for your ongoing commitment to lululemon. We are ready for all the future holds for our brand in 2023 and beyond. On today's call, I plan to cover several topics

[Meghan Frank:]

Thanks, Calvin. I'm excited to be here today to discuss our Q4 results. We finished 2022 on a strong note with our adjusted results exceeding the updated guidance we provided in mid-January. This was enabled by an acceleration in our sales trend, along with the normalization of purchasing behavior relative to full price and markdown product. Looking at Q1, our business continues to be robust. Our inventory growth will continue to moderate, and we expect to realize significant gross margin expansion driven by lower airfreight. Let me now share the details of our Q4 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 Q4 2022 with Q4 2021, adjusted earnings per share for Q4 2022 exclude $3.46 of expense related to impairment charges associated with the MIRROR business. Adjusted earnings per share for Q4 2021 exclude $0.01 of expense related to the acquisition of MIRROR. I will provide more detail on the Q4 2022 impairment charge shortly. And you can refer to our earnings release and Form 10-K for more information and reconciliations to our GAAP metrics. For Q4, total net revenue rose 30% to $2.8 billion. Comparable sales increased 30% with a 17% increase in stores and a 39% increase in digital. On a three-year CAGR basis, total revenue increased 26%. In our store channel, sales increased 26% on a one-year basis and 10% on a three-year CAGR basis. Productivity remains above 2019 levels. We ended the quarter with a total of 655 stores across the globe. Square footage increased 21% versus last year, driven by the addition of 81 net new lululemon stores since Q4 of 2021. During the quarter, we opened 32 net new stores and completed 13 optimizations. In our digital channel, revenues increased 46% on a three-year CAGR basis and contributed $1.4 billion of top line, or 52% of total revenue. Within North America, revenues increased 29% versus last year and 24% on a three-year CAGR basis. Within international, we saw a 35% increase versus last year and 39% on a three-year CAGR basis. And by category, men's revenue increased 22% versus last year and 26% on a three-year CAGR basis. Women's increased 30% versus last year and 23% on a three-year CAGR basis. And accessories grew 69% and 44% on the same basis. It's also great to see ongoing strength in traffic across both channels. In stores traffic increased over 30%; and in our digital business, traffic to our e-commerce sites and apps globally increased over 45%. On a three-year CAGR basis, traffic is up 7% in stores and 40% in e-commerce. 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 fourth quarter was $1.59 billion or 57.4% of net revenue compared to 58.1% of net revenue in Q4 2021. Adjusted gross margin decreased 70 basis points relative to last year. This was driven primarily by the following factors

[Calvin McDonald:]

Thank you, Meghan. In 2022, we passed $8 billion in revenue for the first time driven by balanced growth across categories, channels and markets. Our product pipeline driven by innovation is very strong. More than 9 million guests signed up for our Essentials membership program in the first five months, which further strengthens the opportunity to keep building our community, strengthen our guest relationship and drive long-term value. Our market share gains show our brand is able to expand and attract new guests and yet our unaided awareness remains low, which demonstrates the runway in front of us. And we're seeing strong momentum in every market where we operate, and we continue to successfully expand into new geographies. These are just some of the reasons I'm excited about all that's in front of us, both in 2023 and over the coming years. I look forward to taking your questions now. Operator?

[Operator:]

[Operator Instructions] The first question comes from Adrienne Yih from Barclays.

[Adrienne Yih:]

Thank you very much. And congratulations to everybody for stellar year and great momentum coming into the first quarter. Calvin, I was wondering if you can help expand upon that, that notion of unaided brand awareness. I think that's a really powerful concept there. What was your advertising spend as a percent of sales last year? And what avenues are you going to be using sort of to expand that brand awareness. And then Meghan, really quickly, if you can just expand upon the notion of flat promos, I think you said to last year and 2019, so just trying to understand those two comparisons? And that is a nice improvement, I think, from kind of ICR when maybe -- I think we were in a little bit more of a promotional kind of backdrop or notion of promotions coming into the year.

[Calvin McDonald:]

Thanks, Adrienne. In terms of unaided brand awareness, as you highlighted, it's exciting to see both our improvements in it, but also the runway of growth and potential we have. So we know that our approach is working as well as we know that it's going to continue to fuel our ability to acquire guests and drive the overall momentum in the business across all markets, including North America and the U.S. Our current spend is in and around the 4% range. And at this point, we're planning to maintain the percentage of sales, relatively consistent. How we deploy it? It's a combination of opening stores, which is a wonderful vehicle to drive that awareness and acquire guests, connecting with guests and ambassadors in our local communities and investing in both our community activations as well as these relationships. Expanding our relationships with lead athletes around the world, which we continue to make great contributions and add into our collective. And then finally, like you will see with the [Get Intuit] campaign, executing more deliberate and coordinated global brand campaigns which I'm excited for you to see that. Those are just some of the examples of the way in which we activate our brand and product first through most of the messaging in that we've seen our success and excited for what we have planned in '23.

[Meghan Frank:]

And -- hi, Adrienne, in terms of markdowns, our full year 2022 markdowns came in in-line with 2019. And we're expecting to be relatively flat in 2023 on a full year basis. We do have the biggest opportunity in Q4, which will be offset somewhat by Q1 through Q3 markdowns. But that 2019 water line we view is a healthy level for us. And then we'll also see inventory, as we mentioned, 30% to 35% growth at the end of Q1 and then coming in line with sales in the second half of 2023.

[Operator:]

The next question comes from Lorraine Hutchinson from Bank of America.

[Lorraine Hutchinson:]

I wanted to focus on China for a minute. It was about 8% of sales last year. How are you thinking about the growth cadence there? And can you give an update for us on profitability of the region?

[Meghan Frank:]

Lorraine, in terms of China, we haven't put a fine point on China in 2023. However, what I'd say is we still had a degree of COVID disruption in both Q4 and full year '22, and we were at a 30% growth rate. We have seen that trend accelerate as we moved out of Q4 and into 2023, particularly Q1. So we are above that 30% growth. And then in terms of profitability, we are profitable in China. We haven't put a fine point on it beyond that.

[Operator:]

The next question comes from Brian Nagel from Oppenheimer.

[Brian Nagel:]

Great quarter, congratulations. So I just want to -- my question -- I just want to focus on inventories because I know that has been a big topic for lululemon as well as the sector. So you had fantastic results here in the fourth quarter. I'm looking at the math you, you ended the year, inventory is up, I guess, just around 50%. So as we think about '23, within the context of the guidance you gave, how should we expect that inventory to moderate? And is it -- are your essentially saying you're just going to work through that primarily for the normal course of business without really any excess promotions?

[Meghan Frank:]

Yes. So in terms of inventory, we've been navigating obviously, the dynamic supply chain environment. And we did a number of core buys earlier to try and manage our airfreight expense. We do have a higher proportion of our inventory in core versus 40% historically. We also saw increased airfreight impacting our cost inventory balances. And then we also saw vendors who were shipping later than historically, pivot to shipping more on time. So the team is still navigating and adjusting to that new reality. And I would say, at the end of Q1, we're going to see inventory moderate to 30% to 35% growth, and we expect it to come in line towards the second half of the year. Our goal overall is to manage our inventory in line with our revenue growth and believe we'll be there over time.

[Operator:]

The next question comes from Paul Lejuez from Citi.

[Paul Lejuez:]

Just piggyback on the inventory question. Curious if you're a little bit heavier in certain geographies versus others? And if it's going to take a little bit more time to clear and get to where you want to be in certain geographies. And then just separately, curious what you're looking at from a product cost perspective this year, first half versus second half, if you can share what you're anticipating on the [ADC] side?

[Meghan Frank:]

Yes. I would say nothing notable by geography in terms of inventory balances. We're pleased overall with the content composition, and we plan to, as we mentioned, have a healthy full price penetration as we move throughout the year. In terms of product costs, we haven't experienced any significant increases, and we don't expect any significant changes as we move throughout 2023, relatively stable.

[Operator:]

The next question comes from Ike Boruchow from Wells Fargo.

[Ike Boruchow:]

Two-part question. Maybe first for Calvin. Just on the MIRROR hardware decision. Can you walk us through a little bit more about what you saw in the holiday, and I guess, the past several quarters, that kind of informed your decision that you guys ultimately made to eliminate the hardware piece of the business? And then Meghan, is there anything you can quantify in the P&L? What kind of revenue or operating losses are being removed by eliminating that piece of the business this year?

[Calvin McDonald:]

Thanks, Ike. On MIRROR, I just want to clarify, we're not eliminating the hardware, but we are adding an app feature that will allow a guest to sign up and pay a lower monthly subscription fee and acts the same content without having to purchase the hardware. So I just want to clarify that. And that will launch later this summer. And we think with the lower cost to entry, not being hardware restricted and the 9 million Essential members that we've built and will continue to build, it will allow us to more easily migrate and attract guests into it. We did see an improvement in our performance with the launch of lululemon Studio in October. But as we shared, it just didn't meet our expectations. And although tax are improving, they're still not proving fast enough that we didn't -- that we felt it prudent to make this pivot to open up the TAM and appeal to a broader audience within our collective.

[Meghan Frank:]

In terms of the P&L, we don't break out MIRROR separately given it's now embedded in our membership program. But what I will share is that it's a very small portion of our revenue this year and was also a very small portion of our five-year plan. We have moderated investment levels, and we'll continue to do so and continue to see dilution improving.

[Operator:]

The next question comes from Alex Straton from Morgan Stanley.

[Alex Straton:]

Congrats on another good quarter. Two quick ones from me. The first is just on the big increase you mentioned in new guests, I think a 30% level or so. Could you share any learnings you have on how those new guests compare to existing guests? And then secondly, on the 40% to 45% of the business that's core, any insight you can give us on the split of the rest of the business, I guess, the newer categories and what they represent? And whether they have similar full price sell-through rates to that legacy business?

[Calvin McDonald:]

Thanks, Alex. In terms of the new guests, we have -- one of the benefits of the brand is we see good success across guests across all age demographics. So that remains very healthy, both acquisition as well as engagement. We have seen a very healthy growth in our younger guest base, in particular, over the past 12 and 18 months, and that continued. But overall, we would wait a little bit on the younger but very healthy overall, and seeing, as I indicated, very healthy numbers in terms of engagement of existing guests, the new guests, how those cohorts are shopping and engaging on a frequent basis and migrating up through the category offering that we have.

[Meghan Frank:]

And I'd share in terms of category breakdown of the balance of inventory outside of the 40% to 45% core, we're pleased with the seasonal nature of our product and the aging of that inventory. And in terms of by category, it be positioned relative to our Power of Three x2 plan in terms of category growth.

[Operator:]

The next question comes from Rick Patel from Raymond James.

[Rick Patel:]

Congrats on all the progress. I was hoping you could talk about your expectations for growth in North America for the new year. You've made a lot of progress already in the market. So I'm curious what you see as the strongest growth levers as we think about channels and product segments.

[Meghan Frank:]

So in terms of North America, we're looking at achieving our low double-digit expectation that we shared as part of our Power of Three x2. And sorry, can you remind me the second half of your question?

[Rick Patel:]

Yes. Just with the strongest growth levers are as we think about channels and products

[Meghan Frank:]

Yes. I would say I'd frame that also in that context. So we have our 15% average growth rate annually as part of that plan, with a goal to 4x international business, double our men's business, double our e-commerce business, and that also included low double-digit North America growth as well as low double-digit women and store growth.

[Operator:]

The next question comes from Dana Telsey from Telsey Advisory Group.

[Dana Telsey:]

Congratulations on the results. As you think about the product margin puts and takes for 2023, how do you think about them and the markdowns which are normalized with 2019 levels, how do you see that evolving as we go through the year? Is there any cadence or shape that we should be mindful of?

[Meghan Frank:]

Dana, so we're -- we shared color of 140 basis points to 160 basis point increase in gross margin for the full year, and that would really be driven by a benefit from airfreight, down 150 basis points. We are expecting markdowns to be flat year-over-year, also flat to 2019 levels. And we have a little bit of pressure, as we mentioned in our distribution center strategy that's really aimed at servicing our demand over time. In terms of cadence by quarter, I had mentioned earlier, we have the biggest opportunity in markdowns in Q4, offset by Q1 through Q3. And then in terms of airfreight, our biggest opportunity will be Q1 in the range of 300 basis points to 400 basis points. We will be higher -- we will have opportunity relative to the last year in Q2 and Q3, and then we're expecting at this point in time, we'll be in line in Q4.

[Dana Telsey:]

Got it. And then just, Calvin, on the new product rollouts that are coming this year, where do you see the most opportunity to have an influence on the overall category given that you're gaining share in a category that's a little more challenged now.

[Calvin McDonald:]

In terms of the product, what I'm anticipating is similar to what we've been seeing, which is balanced growth across men's and women's across categories and activities. The innovation, a little bit of what I've shared is a balance of continuing to innovate on our core styles and franchises like the recent update to the men's and pace breakers short as well as adding additional styles to proven franchises like the Align campaign that I'm really energized and excited about. It's a fantastic expression of one of our powerhouses and excited to use it as a way to continue to recruit new guests. And then building on new launches like footwear and then bringing successes in our men's business with the license to train into our women's assortment. So I think it's another expression of the evolution we've had with our product strategy, which is early still, very balanced across the activities we identified expressed through categories and franchises across both men's and women's. So my anticipation is still very balanced growth both in North America, around the globe for product for us in '23 and beyond.

[Operator:]

The next question comes from Brooke Roach from Goldman Sachs.

[Brooke Roach:]

Calvin, I was wondering if you could contemplate the customer engagement that you're seeing with full price relative to discounted product? And how that engagement may have changed over the course of the last few months, combined with your expectation for that for the rest of the year, does that engagement rate differ by region, age or customer income demographic?

[Meghan Frank:]

Brooke, in terms of markdown and full price penetration, we did see that normalize as we move through the balance of January and then into Q1. We haven't seen any material differences by customer segment, and we do expect that we'll maintain that relationship of healthy full price in line with history, that's reflected in the color we provided on markdown staying flat year-over-year, also flat to 2019, which we view as a healthy water line for us.

[Operator:]

The next question comes from Michael Binetti from Credit Suisse.

[Michael Binetti:]

I will add my congrats on a nice quarter and a nice update since ICR, Meghan. I guess on China, you built a lot of stores there since pre-COVID. And I think you've done -- I think you haven't had much time over there over the past three years, those stores operating in any kind of normal capacity. So if China was 8% of sales but it's 15% of your global store count, I'm just curious if China was operating at normal productivity, would revenues be closer to that 15% store mix? Or do you think those stores -- any reason to think they should trend above or below global averages on sales per store or sales per flow. Just have you think any way for us to think about the opportunity there with the assets you already have? And then Calvin, on thoughts on pricing in 2023. I know this hasn't been the most urgent lever for you to pull in recent quarters. You talked about that. Any change to that for 2023?

[Meghan Frank:]

Yes. In terms of China stores, definitely, we were impacted by COVID as we move throughout 2023. So I would expect that percentage to be higher. I would say our stores are highly productive there. They tend to be smaller than the balance of our fleet, particularly in North America, and we view that as an opportunity over time. We continue to have a long pipeline of store openings there. We also are very early in terms of store expansion strategy, which we've employed in North America to capitalize on where we see very strong and healthy sales per square foot and opportunities to expand the market.

[Calvin McDonald:]

And Michael, on pricing, I'll start with what we shared last year, which is going to be similar to our approach this year. And I'll start with -- I'm proud of the approach that the team took, and that is knowing we're a full-price business. We only increased prices on a small percentage of our assortment so that we continue to lean in on full pricing and not rely on and have to pull the promo lever. What we saw in the industry was many other players price up and then heavily discount that back down. But it allowed us to manage margins, manage full price selling throughout with selective pricing. And heading into '23, it's a similar approach. We're not planning any drastic significant moves in pricing and continue to focus on full price with markdowns as a means to exiting seasonal product only.

[Operator:]

The next question comes from Omar Saad from Evercore.

[Omar Saad:]

Just a couple of quick follow-ups. Calvin, maybe you could touch on the strategy to use paid media? And how that's going for you guys, the efficacy? Is that something you're using in other markets like China as well? And maybe a quick update on some of the new categories, footwear, hike, golf, et cetera, would be helpful.

[Calvin McDonald:]

Thanks, Omar. In terms of our approach to media, we'll always and continue to use a balance between paid and earned. And I think we've really made gains in the last few years in leveraging both of those with earned media playing very, very heavily for us, which is great, on the back of innovation and some compelling story. So we're going to continue to leverage both of those, leading in when we do paid into digital and more direct and specific. And I think you'll see a lot of that expressed and executed through the -- [Get Intuit] Align campaign. And Nikki and the team are also doing a wonderful job working with the regions in getting expression right through to the digital campaign through to stores and in and around in local markets and amplifying that. So it just really fits and feels like a very omni expression and execution for the guests out of the store, in-store and across digital applications. So excited for you to see for that campaign expressed. And your second part of the question was...

[Omar Saad:]

Just update on some of the new categories, footwear, hike, golf?

[Calvin McDonald:]

Perfect. On the play activities, and I'll start there, they've respond -- the guest has responded very well to them. And I'm excited, as I've shared with you, in particular, on tennis and golf, how they're designed. We know that, that is how our guests also sweat and offering product and offering for them helps us strengthen the relationship and extend our share of wallet with them. And on those two, they're really designed to selectively innovate into and then leverage our core assortment. And in both of those executions last year when we really kicked off and then through the year and then into spring when we've recently brought tennis back as well as about to do so in golf, we're seeing that strategy execute very well where we sell a lot more core wrapped around a golf or tennis execution. We're going to continue to do that. So it allows us to manage assortment and SKU additions, while at the same point, drive productivity and credibility into these activities. And on footwear, it's a test-and-learn category for us. We've just cycled over the first year. Very pleased with early guest response. Very pleased with industry recognition to disrupt and innovate and create something new within footwear for women. We've just updated with our Blissfeel 2.0, and both the industry is very positive on it as well as our guest. And excited about continuing to sort of test and learn. And as I indicated, we'll be launching a Blissfeel Trail later an update to our charge fuel. And then next year in '24, the introduction of our men's footwear business. So we're excited with the response and continue to test and learn and innovate into the category.

[Howard Tubin:]

Operator, we'll take one more question.

[Operator:]

Last question comes from Jay Sole from UBS.

[Jay Sole:]

Just curious about the sales cadence for the year. Q1 looks like it's around high teens. And then it seems like the guidance implies the growth rate goes into the mid-teens range by the end of the year. Just wondering if there's like a specific driver that's part of that forecast or just assuming that you go back into the long-term algo? And then at the same time, just curious about accessories. You mentioned it's up 44% in Q4. Within that, I assume belt bag is a big driver, Calvin. I'm just worried about how you feel belt bags fits into the overall brand strategy and what you plan to do with that category going forward?

[Meghan Frank:]

Thanks, Jay. So in terms of cadence throughout the year, we are really pleased with our trends headed into Q1. And we're also mindful of the macroeconomic uncertainty. So our guidance reflects what we feel to be the appropriate direction at this time. The 15% to 16% growth rate for the full year is slightly above our Power of Three x2 average of 15%. So we feel well positioned headed into the year.

[Calvin McDonald:]

And on accessories and the Everywhere Belt Bag, our accessories business is very healthy, and it's very balanced as well. It's not a one-hit wonder. That team has done a great job in building a compelling total bag business. Not just that one particular item. We're pleased with that one item. Love the results. It's been a great driver of brand awareness as well as new guest acquisition. But we have an accessories business across all categories, not just bags, that continue to contribute and grow, and we're excited about its opportunity moving forward in our mix of the assortment for our guests.

[Operator:]

That's all the time we have for questions today. Thank you for joining the call, and have a nice day.