Lululemon Athletica Inc.
Q2 2015 Earnings Call Transcript

Published: 11 Sep 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the lululemon athletica Q2 2015 Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] I would now like to do turn this conference call to Mr. Chris Tham, you may begin.

[Chris Tham:]

Thank you and good morning. Welcome to lululemon's second quarter 2015 earnings conference call. Joining me today to talk about our results are Laurent Potdevin, CEO; and Stuart Haselden, CFO; along with Tara Poseley, our Chief Product Officer, who will be available during the Q&A portion of the call. 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 the Company's future. These statements are based on current information, which we have assessed but which by 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 the Company's business. Factors that could cause these results to differ materially are set forth in the Company's 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 undertake no obligation to update 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 today's earnings press release. The press release and accompanying quarterly report on Form 10-Q will be available under the investor section of our website at www.lululemon.com. 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 Laurent.

[Laurent Potdevin:]

Thank you, Chris and good morning everyone. Today, I will provide an overview of our second quarter performance, as well as give you an update on our progress surrounding our key strategic initiatives planned for the remainder of the year. Stuart will then walk you through our financials and guidance in more detail. As we enter the second half of the year, our team has made significant progress to grow our global collective, by relentlessly innovating our product, and continuing to create transformational experiences for our guests. We have many exciting milestones to cover today. The redesign of our women’s pant wall launched last week, our fourth annual SeaWheeze marathon was another exceptional success here in Vancouver, and we supported new market seeding by hosting locally relevant events in our vibrant communities around the world, including in South Korea, Scotland and Germany. On the people front, we recently welcomed Miguel Almeida to lead our global digital transformation. Miguel is a global citizen with a great background and, as an avid endurance runner is a superb fit for our culture. Miguel is a passionate champion of using the digital platform to deepen our connection with our guests to personalize experiences, while also extending and amplifying brand resonance globally. I am thrilled to welcome Miguel to lululemon and truly start to leverage our digital opportunity. From a business standpoint, our momentum continues to build out and our fundamentals are strong. As you will recall, we entered Q2 with a robust in-stock position and we’re confident that our guests would response favourably to our product assortment. This translated into a positive impact on our top-line results with $453 million in net revenue for the quarter, up 16% over the second quarter of 2014 and up 21% in constant currency. We delivered an 11% global combined comp with strong performances both in our store and e-commerce channels. The trends that we called-out during our last quarter, continued. In Q2, stock comps across all our regions around the world were positive and we delivered a global e-commerce comp of 35%. Our women’s business continues to build momentum with a particularly strong performance in pants and bras, where both categories delivered double-digit comp for the quarter. Our men’s business was up 31% on a combined comp basis, driven by our sweat category. Ivivva also posted double-digit comp growth with a 27% combined comp this quarter. As we build a global, iconic brand, we are extending our footprint globally. International expansion is a key growth driver and we continue to increase our brand presence in major cities both in Europe and Asia. Later this month, I will be heading to Dubai for our first opening in the Middle East, which will be followed by second store before year-end. Within Asia, we have seen all of our new stores exceed initial plans. Our first store in Hong Kong which opened this past quarter at IFC Mall is in contention to be the most productive store in the company on a per square foot basis. We are opening our second store in Hong Kong later this quarter with a larger format in an exceptional location at Hysan Place. This early performance combined with our Singapore performance and the success of our showroom in Seoul validates the demand for our product and brand in Asia and leaves us confident with our development plan and its trajectory. Looking to Europe, our first store in Hamburg Germany opened late last week and another store in the London area will open tomorrow. Our Covent Garden store which was our first store to open in the London region and our newer King’s Road store both continues to perform well. In addition, we see this store driving incremental traffic and sales to our UK e-commerce site. Outside of the UK, we continue to drive brand awareness in key European markets. We have opened stores in Germany, the Netherlands, Sweden, Switzerland and France. All showrooms are performing on target and will trigger store roll-out in the next 12 to 18 months. Turning to product

[Stuart Haselden:]

Thank you, Laurent. I will begin today by reviewing the details of our second quarter and 2015 and then I’ll update you on our outlook for the third quarter and the full fiscal year 2015. For Q2 total net revenue rose 16% to $453 million from 390.7 million in the second quarter of 2014. The increase in revenue was driven by

[Operator:]

[Operator Instructions] Our first question comes from Brian Tunick with the Royal Bank of Canada.

[Brian Tunick:]

I guess two questions, I guess Stuart first. Just looking at your current gross margin guidance now for 2015, has your view changed on the opportunity I think we’ve talked about 300 basis points, I think our merchandised margin recovery for next year, or what bucket maybe that’s going to come from. So just curious there on has your view changed for next year’s opportunity? And then on the comments that all regions are comping positive, so just thinking about your most mature store in Canada what would you point to as being the biggest changes you’ve made there in re-stimulating that oldest class of stores? Thanks very much.

[Laurent Potdevin:]

Brian this is Laurent. Before having Stuart digging through the gross margin question I mean I think what you’re seeing in Canada is really the result of the work that we’ve done across product innovation, guest experience and branding community and the quality of the assortment. So, we are very-very pleased that after 12 quarters of declining comp in Canada we are actually seeing positive comps and we’re seeing the same result in Australia. So, I think it’s really we’ve been speaking for quite some time now about just the triangle of guest experience, branding community and products coming together and when you think about the recent launch of our new pant wall I mean that was a prime example of the power of our team’s collaborating and coming together and really delivering what we’re known for. So, -- and it’s certainly paying up in most mature markets in Canada. And before we get into the detail of gross margin I mean I think it’s and I am sure we’ll have a lot of questions on gross margin. I mean it’s really-really important for everybody to understand that the short-term gross margin pressure that we’re experiencing is not the result of higher markdown of quality issues. We’re building a very scalable complex platform at a time when we’re growing internationally and we’ve added resources to team and we’ve validated that not only we will see the margin expansion that we’ve committed to but still see it in 2016 and beyond as we have stated before.

[Stuart Haselden:]

And Brian we remain confident in the product margin opportunities that we have identified for 2016. We continue to build-out the details of our implementation plans this year. As a reminder, that opportunity we identified was 300 basis point improvement in product margins in 2016 versus 2014 the full year amounts for those annual comparisons, that’s on a pre-FX basis and it’s the same things we’ve been talking about. We’ll capture this through primarily the improvements of our go-to-market calendar process, improvements that will deliver lower airfreight, improved raw material management and better costing. And additionally as you look at gross margin, the other buckets that -- and there are other things weighing heavily on gross margins this year, we’ll begin to leverage our infrastructure investments that we’ve been making this year. We should also see markdowns normalize. And occupancy and depreciation cost should moderate into next year, we expect it’ll still be a headwind but not to the same degree as it has been this year and it will be more in line with what our historical experience has been. As you then think about those goals and connecting that to the results we just announced for Q2, the guidance for Q3 and Q4, I think the issues that are weighing on product margins this quarter and in Q -- and that we see extending into Q3 are not structural that we’ll be able to clear the port-related items that we’ve seen weighing our margins and the other fact is that I just mentioned as we get into next year. In Q4 specifically we’ll clear those port-related issues that will not weigh on our margins. We’ll see some modest product margin recovery in Q4 that will combine with better leverage on our fixed cost in the fourth quarter just from the higher sales levels in the fourth quarter. So, hopefully that’s addressing your question.

[Operator:]

Our next question comes from Paul Alexander with BB&T Capital Markets.

[Paul Alexander:]

Just wanted a clarification on current trends in the comp guidance, there has been some comments that sales trend continue to build and accelerate sequentially. But the comp guidance for third quarter of high single-digits, while only a small moderation does imply a moderation from 2Q. So, is there something we should be thinking about or did you maybe see deceleration in August related to the later Labor Day or something like that that we should be thinking about? Thank you.

[Laurent Potdevin:]

So, on the comps we continue to see strong trends in traffic and conversions, sequential improvements in both of those and that’s across all our regions. So I would not want you to take away anything from the guidance that our comp momentum is slowing down in any way.

[Operator:]

Our next question comes from Jim Duffy with Stifel.

[Jim Duffy:]

Can you talk to the -- can you please speak to the tactical strategies to bring inventory more in line with expectations and then related to that for much as to the response of new pants offering has been exceptional, but we've some instances of out of stocks is the product rolled to the new pants offering in line with your expectations?

[Stuart Haselden:]

Yes so I'll tackle the inventory clearance question first. So we’re on-track what we had talked about last quarter. So, we had described, I think we’d reiterated in our prepared remarks that we had about a third of excess identified to be pushed through our normal exit channels, and about two-thirds to be reflow into our assortments in the second half. We had a successful online warehouse sale in the second quarter that enabled us to clear a little less than half of the excess overhang that we had from Q1. We have two physical warehouse sales planned for the balance of the year one in Q3 and one in Q4. And we also are opening eight additional factory outlet stores this year. So the combination of those factors gives us the bandwidth of the capability to easily work through that excess on plan with what we had previously outlined.

[Tara Poseley:]

And then this is Tara and I can answer about out of stock. We've had really initial reads on the pant wall, but we absolutely have inventory that we’re in the process of allocating to stores, so those out of stocks may have perhaps seen we did a big push in inventory prior to Labor Day weekend and you should see those level out as we get into the coming weeks.

[Operator:]

Our next question comes from Matt McClintock with Barclays.

[Matt McClintock:]

Laurent, first question bigger picture, I have seen new pant wall looks great, as we think about you reintroducing product, launching new innovation, new products going forward, how are we thinking about pricing? Can you just talk higher level your thoughts on updating pricing strategies overall? Thank you.

[Laurent Potdevin:]

But I think I'll go back to our strategy is always to be at the top-end of the journey of the market that we've created and as we look at new categories or at innovation of our current categories, I mean we’re very much pushing our team both from a design standpoint and from a functional standpoint to these wide space and in collaboration with our ambassadors to really create products that’s going to drive function and design at the top-end. So I mean we’re not seeing ourselves being limited by pricing at all at the moment as we deliver the value of our guest both from a functional and from a design standpoint.

[Matt McClintock:]

And Stuart if I just a housekeeping question, the re-launch of the Web site now that that’s I believe in the first quarter of next year is that having any impact at all on your comp guidance for the full year?

[Stuart Haselden:]

Not really. I think it was more of a decision to allow a little more runway to get the Web site exactly where we wanted it. We also have the benefit now of having Miguel on the team and his leadership is just critical in that area and it helps the team remain focused on optimizing business in the critical fourth quarter, as well versus trying to manage also a major Web site implementation. So just felt like the right decision given those circumstances and it really isn't -- it's not weighing on the comp guidance in any way.

[Operator:]

Our next question comes from Dana Telsey with Telsey Advisory Group.

[Dana Telsey:]

You have had acceleration in the men's business, wondering anymore detail there on the pant wall here I believe you're introducing the tank wall in the fourth quarter. Pricing on the tank wall versus pricing of tanks now and how do you expect that to be different than the introduction of the pant wall. And just lastly you mentioned a bit about occupancy, how is renegotiating of existing leases changing your overall occupancy cost? Thank you.

[Tara Poseley:]

Hi Dana it's Tara. So we’re really pleased with the men's business as you heard from the Laurent's prepared remarks 31 comps in the men's business. And we’re really seeing acceleration across all categories within men's, but a real highlight that we’re excited about is the sweat category and continue to see strength in that area which is really the foundation of our men's athletic business and we've been introducing new fabrics this year that are reinforcing our sweat class when we had a new fabric Intersec in Q1, we've Kinematic coming in Q3, very pleased with that. As for the tank wall, and just to remind everybody we had focused on the tank wall for Q2 due to the port strike slowdown we didn’t get our tanks out in until the very end of Q2. We saw nice response in comp trend change when we finally got our full range of support in tanks out in the stores. You will continue to see new styles throughout Q3 and Q4 being added to the tank wall and we’re taking all of the great learnings that we're getting right now and incorporating that into our assortment for next year in 2016 and as for pricing as Laurent said, where we are adding innovation where we feel that we have that balance as really driving something new and different to our guests we will be pricing it appropriately within our tank pricing structure.

[Stuart Haselden:]

And Dana on your question on occupancy I think that the remodel or the renewals are a element of the pressure we've seen, we have great landlords, great relationships and are driving I think good terms there. As you look at the pressure particularly in Q2, the new store opening cadence is really a bigger factor, we opened 20 stores in the second quarter compared to seven last year, so just that the year-over-year increase in new store openings is a bigger factor. Also the international stores are opening, we've mentioned this before come at a little higher occupancy cost and often times includes key money which gets factored into that occupancy amortization so, those are probably bigger factors for us, we'd also -- we're excited about the major renovations and relocations that we've also been pursuing and that also weighs into it but it is smaller than just the new store opening cadence.

[Operator:]

Thank you. Our next question comes from Rob Drbul with Nomura Securities.

[Rob Drbul:]

I'd just like to ask about the international expansion a little bit, I think you talked -- and pretty happy with the some of the stores that you're seeing Asia exceeding initial plans, can you talk a little bit about the profitability ramp that you see and do you believe you'll be able to get to current or peak prior operating margins and how the store opening expenses are trending from that perspective?

[Stuart Haselden:]

On international, some very exciting new store openings, I think Laurent mentioned the IFC centre in Hong Kong, that store is contending for the highest sales per square foot in our company, on a four-wall basis very attractive operating four wall profit. And so in general we're happy with the new stores are opening internationally, pleased with the results in Europe, Asia has been really off the charts. That's on a four-wall basis. We are making significant investments in terms of the management teams to drive those regional businesses, marketing to support the store openings and building supply chains to support those businesses. So, it'll take us a while to get a critical mass to deal with the leverage of those investments. I think what we've said earlier in the year in regards to just the operating profit profile, we believe international will weigh on the Company's operating margins, at least in the near to medium-term. We're expecting to over the next few years to return to that low to mid-20s EBIT margin range with the North American business being more in the mid-range of the 20% to 25% range and international averaging it down, if that makes sense. So, it will continue to weigh on it, we're excited in terms of just the four-wall profit, we're excited about that is a long-term growth strategy for the Company and we're confident that we'll be able to drive operating profit improvements into the near-term.

[Laurent Potdevin:]

And Bob, may be to add to that a little bit, I think we are very -- when it comes to our international strategy and we're very-very positive on capital CDs where we know we've got a lot of demand and we're generating a lot of traffic and transactions and as we deal with centre of excellence with digital and Miguel for coming up with some very exciting and nimble ways to really build brand resonance and brand awareness beyond those major cities without necessarily spreading stores very rapidly throughout many countries. So, I think we've been very strategic in focusing on the major cities and leveraging digital growth, brand resonance and awareness beyond those cities.

[Operator:]

Thank you. Your next question comes from Dorothy Lakner with Topeka Capital.

[Dorothy Lakner:]

Just a question on the store renovations and relocations, just wondered how many -- just remind us how many you're doing this year? How many you might do in next year? And how those -- the new formats are performing? Santa Monica looks great by the way.

[Stuart Haselden:]

So, we're going to do 10 of those major renovations, re-models this year, that's on top of the three from last year that we had mentioned. Some of the 10 that we'll do this year include expansion of our Park Royal store here in Vancouver, the opening -- the relocation of our Union Square store in New York to a location on 5th Avenue in the Flatiron area, expansion of our Chinook Center and expansion of our West Edmonton store. So, those are all major remodels, extensions where the square footage is growing by at least 50% or in that range or higher in some cases and the majority of those are still teed up for the second half of the year. So, I can't really give a good indication on how those particular projects are performing, but I will say that the ones that we mentioned from last year Robson, Santa Monica, Lincoln Road, all continued to exceed our expectations, in fact Robson Street is on-track to become the highest grossing sales producing store in the chain at over $20 million this year. And I might remind you that before we relocated that store, it was an $11 million store. So, a pretty strong outcome in that relocation it gives us a lot of enthusiasm to continue to look for opportunities similar to that throughout the chain. We think this will be an important part of the square footage growth story of the Company in a very profitable manner in the years to come, but we're excited to that. We'll be able to speak with more details around how the openings this year and the projects this year are performing on our next call.

[Operator:]

Thank you. Our next question comes from Thomas Filandro with Susquehanna.

[Thomas Filandro:]

Let me add my congratulations on the top-line performance. Two questions, one is on the direct-to-consumer front nice growth again, you got expansion in the margins there, I'd be curious if you can give us some insight on what drove the acceleration and expansion. And with the OPM and DTC now it's 40% plus, is that a sustainable rate? And then a question I think for Tara, I believe there's been some pricing adjustments on TAM, some up and some down. If that's correct, can you just give us another standing of what's happening, frame for us the adjustments and how should we think about averaging the retail in the second half of the year?

[Stuart Haselden:]

I'll tackle your direct question first. So, we continue to see strength in traffic and conversion in our e-commerce business, it's really the continuation of the story that we saw from Q1 and we think a big piece of this is simply the improved inventory position that we're now in. We're able to better meet demands and I think in the second quarter we had some interesting product flows that supported just the conversion. As we talked about we have major Web site remodel or re-launch I should say teed up for next year. So, we feel good about where our Web site is today, we think we can be better. So, we're very excited to see the continued momentum in the direct business and we by no means think we stopped out there, we believe there's still opportunity we have as we continue to enhance and improve not only the Web site capabilities but just how we engage with our customers via digital marketing and otherwise.

[Tara Poseley:]

And then this is Tara and I'll take on the pricing with -- we had an opportunity recently to just really clean up our pricing architecture within the pant classification. So, you are right there are some prices that came down and some prices that came up as we really just cleaned up the architecture to make it easier for our educators to educate against our different styles and then obviously you could see the innovation that we launched in the pant wall and we're very excited about that and very excited with our guest’s response and continue to reinforce as we deliver innovation to our guest. She's excited about it and sees the value in it and as per that average unit recount for the remainder of the year, probably slight increase but really that was not the reason for this. It was really just cleaning up our pricing architecture and really continuing to make way for us to bring in more innovation into all of our assortments.

[Operator:]

Thank you. Our next question comes from Oliver Chen of Cowen and Company.

[Oliver Chen:]

Stuart, in terms of the supply chain in the next chapter if you just brief us on catalyst as you think about the sourcing partners, the go-to-market timing and when that maybe which classifications are timing may that be implemented and then as you think about omni-channel on your supply chain I was just curious. And Tara and Laurent, I was just curious about the pant wall in the men's as a percentage of mix, do you expect those classifications to change overtime? And then Tara on core versus basics, were there any thoughts about on how you're feeling about that mix at the moment and going forward? Thanks.

[Stuart Haselden:]

So yes on the supply chain catalyst, the things we've been talking about in terms of how the go-to-market counter will synchronize our design and sourcing activities, enable us to be a better partner to our vendors, more predictable demand management in a better synchronized process where we can reign efficiencies and reduce waste in fabric and expedited shipping cost. So, those all remain the focus. Our planning continues to ramp this year and the teams and the capabilities to support that are the investments that we’re making this year. The timing remains the 300 basis points as I described it earlier over the course of 2016 in comparison to 2014.

[Tara Poseley:]

So the catalogue as a percent of the mix, I don’t see that changing dramatically overtime and while with our first place that we really tackled in March with new innovation but you will continue to see that in other categories within both men’s and women’s. So I am expecting our mix to relative stay the same between tops and bottoms and jackets, et cetera. And then on balance I think you said core versus basic really the balance, how we think about it is seasonal and core I think we struck a very nice balance that we have in the stores right know. We know it’s seasonal how important newness is to our guests, how important delivering new products every week and the excitement that that drives both online and guests coming into the store. So we feel really confident that we’ve got a nice balance as we go forward.

[Laurent Potdevin:]

And Oliver to Tara’s point I mean I think that’s -- we started with -- no we focused initially on the pant category and that’s really the anchor of our women’s business that’s what drives traffic and that’s what ultimately drives sort of more people to purchase in the in the store so I mean that’s where we really don’t see the mix changing, but actually driving higher sales in all of our categories.

[Chris Tham:]

And operator we have time for one last question, thanks.

[Operator:]

Okay. Our last question comes from Matthew Boss with JPMorgan.

[Matthew Boss:]

So as we think about SG&A, beyond this year what’s the best way to think about the total expense dollar growth in relation to sales growth, just any color around remaining investments? And do we need to consider the timing of the Web site shift into next year as maybe an additional build?

[Stuart Haselden:]

So I think as we look at the near to medium-term, we expect to be able to see modest SG&A leverage into next year. I am going to balance that with just the ongoing strategic investments that we’re going to continue to make in the business. We’ll have priority to enable us to continue to drive our growth initiative. So that will balance those two objectives for sure. But ensuring we have the resources and the capabilities to deliver on our growth goals is the primary factor to consider there. And looking at Q2 and Q3, the leverage that we saw in Q2 was affected by the FX translation, for the P&L overall FX is neutral as we’ve mentioned, but there was a benefit in the second quarter there. In Q3, the slight deleverage that we’re calling out is related to again those strategic investments and specifically in the third quarter we are anniversarying that comp that incentive comp reversal from last year, so that creates some comparative pressure this year. But again I think we’ll remain focused on making the investments we need and as well as working to deliver modest SG&A improvements.

[Operator:]

Thank you. This concludes the question-and-answer portion of today’s conference. I’d like to turn the call back over to Chris for closing remarks.

[Chris Tham:]

Thank you everyone for joining us today. We’ll talk to you again next quarter. Good-bye.

[Operator:]

Ladies and gentlemen that conclude today’s presentation. You may now disconnect and have a wonderful day.