Lululemon Athletica Inc.
Q4 2015 Earnings Call Transcript

Published: 30 Mar 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the lululemon athletica fourth quarter 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 be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Chris Tham, SVP of Finance. You may begin.

[Chris Tham:]

Thank you, and good morning. Welcome to lululemon’s fourth quarter 2015 earnings conference call. Joining me today to talk about our results are Laurent Potdevin, CEO; Stuart Haselden, CFO; and Lee Holman, EVP, Creative Director, will also 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 forecasts 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 annual report on Form 10-K will be available under the investors 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 will turn the call over to Laurent.

[Laurent Potdevin:]

Thank you, Chris, and good morning, everyone. It’s my pleasure today to share the results of a very solid fourth quarter. I will speak to some highlights of 2015, as well as our priorities into 2016 and beyond. Stuart will then walk you through our financials and guidance in more detail. 2015 was a transformative year for lululemon, one where we successfully reached key milestones that are positioning us for continued growth and improved profitability over the next five years. The strength that lululemon demonstrated in the fourth quarter exceeded our expectations as a result of continued top line momentum, focus on gross margin, and inventory levels. While we have room to improve, we’re well positioned to deliver solid earnings growth in 2016. From a top line perspective, the fourth quarter delivered 22% constant currency revenue growth, including exceptional full-price sellthrough during the key holiday week. We delivered a 11% global combined comp, the result of accelerating performance across all channels and regions. Our e-commerce revenues continued to outpace our overall growth posting a 33% increase in the quarter. While inventory levels are still elevated, they are significantly lower than our prior estimate. This reduction happened while delivering gross margin above the high end of our guidance. In looking more closely at the results in the quarter, we see exciting momentum by category, channel, and geography. Our women’s category continued its strong performance in Q4, with bottoms delivering double digit comps, reflecting the continued strength of our product assortment. The successful launch of Engineered Sensation with new technical fabrics and innovative construction techniques drove the business, led by the new Align Pants, designed to minimize distraction and maximize comfort. We also saw sequential improvement in women’s tops where comps turned positive in the quarter led by the success of our Seamless program. And I’m actually excited to see what will come next with the Align Pants as we launch the new Align Crop in the next couple of weeks. Our men’s category continued to outpace our overall growth, with another strong comp of 24%, driven by our sweat category. It’s been exciting to see the acceleration in men’s as we build on the continued success of franchise items such as our metal vent tee , our shorts program, and our ABC pants. With a total penetration to sales of just 16% and a renewed focus on creative direction, we’re only getting started in the men’s category. Our North American stores posted accelerating comps versus the highest prior year comparison, supported by strong full-price sales during the peak holiday sales period. The quality of sales speaks to our unrivaled product performance and to our educators who deliver exceptional experiences that are unique in the retail landscape today. Canada showed a strong trend in Q4 that continued into the first quarter. We are so proud of our Canadian business and the performance in our home market. It speaks to the loyalty of our guests and the strength and scalability of our brand globally. Within our North American footprint, we increased our square footage by 16% in 2015 through new store, store optimization, and expansion. We opened our new West Edmonton Mall which is now double its original size and is the most productive store in the world. We opened our Flatiron store in New York introducing Hub 17, our community space. We’ve now also brought our Lab concept to the United States, with our first location which opened yesterday on Bond Street in New York. lululemon labs are a hub of creativity for functional and experimental design that taps into the culture, trend, and technology of the people and places it celebrates. We are excited about what our teams can do in this new location and we’ll continue to look for the right opportunities to grow our footprint strategically in key markets. As I turn to our digital culture, we are building an ecosystem that will create unique experiences to our guests. As I mentioned earlier, our e-commerce revenue in Q4 grew [over] 30% to just over 20% of total sales in the quarter. This will only continue to increase as we expand our digital business model with the introduction of innovative digital experiences, leveraging CRM capabilities, and the expansion of more sophisticated digital marketing strategies. I’m thrilled to see what Miguel and his team are doing as we continue to build our channel agnostic strategies to our guests to engage with lululemon whenever, however, and wherever they want to. Internationally, we continued to make important progress in Q4 towards our expansion goal. In Europe, we remain focused on winning in London where we opened another great location in Q4 at Westfield Mall, and we are finalizing exciting new locations in capital cities around the world, including Seoul and Tokyo. Our success is based on the discipline and commitment to go to market when our communities are vibrant and pulling us in. It is a nimble, powerful, and unique strategy that further solidifies our footprint as we extend our global presence. 2015 was a pivotal year in which comp accelerated, margin stabilized, and critical infrastructure was established. Last month, we completed our management team with the arrival of Gina Warren, our Executive Vice President of talent and culture, to lead, nurture, and evolve our most important asset, our people. lululemon now has a full management team in place, a diverse group of global citizens incredibly talented and deeply ingrained in our culture. This team is more aligned than ever with our goal of building a highly profitable global brand. Our deliberate focus on being design led is fueling our growth and our focus on operational excellence is driving our earnings expansion. In addition to the highlights I’ve already mentioned, we also saw important progress in building key capabilities to support how we will scale the business in the coming year. First, we made traditional investments in our product design and innovation capabilities, reorganizing our Whitespace team as well as our design and merchandising team. We established the brand’s first ever Creative Director role and appointed Lee Holman to drive our design-led approach. This drive to unify men’s and women’s is creating great alignment and a strengthened brand vision. As a result, the role of Senior Vice President, Men’s, held by Felix del Toro has been eliminated. I want to personally thank Felix for his important contribution over the past couple of years. Second, our supply chain was and continues to be a major focus for us this year. We’ve made important steps towards building a reliable and scalable supply chain to bring to life our design vision, and I’m delighted to announce the hiring of [Ted] who has joined us in the role of Chief Supply Chain Officer. Ted is an industry veteran who will bring his leadership and experience to the tremendous amount of progress that was made this past couple of years. Looking forward to 2016 and the next five years, we’re excited and ready to leverage the capabilities we’ve built in 2015, as we resume earnings expansion and scale our business as originally planned. By 2020, our plan is to have doubled our revenue and more than doubled our earnings. We will achieve these through four distinct growth strategies. First, product innovation, it is central to how to continue to create transformational experiences for our guests who live and breathe the sweat life. Our products are rooted in function and our designers mandate it to be proud of every single product they create. Specifically, we will focus on two areas

[Stuart Haselden:]

Thank you, Laurent. I’ll begin today by reviewing the details of our fourth quarter of 2015 and highlights from the year. I’ll then provide details on our outlook for 2016 and the first quarter. I’ll also provide further details of our growth plans for the next five years as Laurent has described. The fourth quarter was an important period for us as we posted accelerating double digit comps against our highest prior period comparisons of the year. We also made improvements in our product margins and solid progress in realigning our inventories, which helped set the stage for the recovery in profitability in 2016 that we have been building towards this past year. Turning to the details, Q4 total net revenues rose 16.9% to $704.3 million, with the increase in revenue driven by several factors that include a total constant dollar comparable sales growth of 11%, comprised of a bricks and mortar comp store sales increase of 5% and an e-commerce comp of 33%. And also an increase in square footage of 20% versus last year, driven by the addition of 61 net new company-operated stores since Q4 of 2014; 30 net new stores in the United States; two stores in Canada; five in Europe; three in Asia; and 21 ivivva stores. And finally these factors were offset by the foreign exchange impact of a stronger US dollar which had the effect of decreasing reported revenues by $28.3 million or 4.7%. During the fourth quarter, we opened nine net new company-operated stores; six in the US; one in Europe and two ivivva. We ended the quarter with 363 total stores versus 302 a year ago. There are now 284 stores in our comp base; 41 of those in Canada, 188 in the United States, 31 in Australia and New Zealand, one in Europe, one in Asia and 22 ivivva. At the end of Q4, we also had a total of 84 showrooms in operation, 25 lululemon showrooms in North America, 21 internationally and 38 ivivva. Company-operated stores represented 72.3% of total revenue. Revenues from our digital channel totaled $146.3 million or 20.8% of total revenue compared to 19% of total revenue in the fourth quarter of last year. Other revenue which includes strategic sales, showrooms, pop up stores, warehouse sales and outlets totaled $48.9 million dollars versus $31.9 million in the fourth quarter of last year. Gross profit for the fourth quarter was $354.5 million or 50.3% of net revenue compared to $310 million or 51.5% of net revenue in Q4 2014. The factors which contributed to this 120 basis point decline in gross margin were

[Operator:]

[Operator Instructions] Our first question comes from the line of Oliver Chen of Cowen and Company.

[Oliver Chen:]

Congrats on a really awesome end to the great year. Regarding the unification of men’s and women’s, what do you think we should expect in terms of what may happen to men’s just because the momentum has been so strong there? And also as we look forward, you did mention that your inventories are a little bit more than you would have liked, which products is that related to? And, Laurent, if you could highlight anything we should expect with the women’s tops momentum and innovation there that would be helpful as we think about modeling the back half.

[Laurent Potdevin:]

I think that was four questions in a row. So I’ll pick up the men’s question. I want to remind everybody that we’ve got Lee in the room with us. But really the unification of men’s and women’s under one overarching vision is really just strengthening the brand. So when you think about telling global stories of functional raw materials or construction, now we have a platform that really is much larger than it was before. And I always talk about Ocean and Duke, our muses, being able to share a walk-in closet and we are one brand. So I’m very, very excited about the power of the unification and truly being design led as Lee builds his organization. So Lee, I will let you chime in on that. But it’s really the first time that, as an organization, we are design-led across men’s and women’s both from a functional and from a design standpoint.

[Lee Holman:]

Yes, I’m just really excited about 2016 and beyond, and it really starts from moving from a house of brands to a branded house. And what I mean is just aligning under one great vision, having a pipeline of innovation that taps into men’s and women’s, includes the Engineered Sensation, how you can take that platform and build it from a men’s and women’s point of view. So I’m just really excited about driving the men’s and women’s business forward and a constant stream of innovative product that we can bring to our guests.

[Stuart Haselden:]

On your question regarding inventory, and I think you’re asking any specific categories we would call out in terms of the current inventory balance, first I’ll say we’re pleased with the improvement that we saw in the quarter. I would offer that the inventory balances are very current, we’re not seeing any deterioration in ageing, there’s not a specific category, I’d say, we’re particularly heavy in. I think as we look forward for the year, we expect to see inventories by Q1 come in line with our forward sales trend. Inventories over the course of the year may even begin to look mean. I think on a two year basis versus our sales trend, it will look appropriate. But we’re pleased with the progress that we’ve made on the inventory balances as I said and no particular categories I’d call out. And Lee, do you want to touch real quick on the question around tops?

[Lee Holman:]

Yes. On the women’s tops business and we could look at the men’s as well, it’s really having a real heightened focus, an obsession, around how do we bring balanced assortment of newness. And also how do we make it easier to outfit within stores and on digital with our bottoms business, so really obsessing around how color and print work together. How different textures, one of the biggest callouts that we are hearing from our ambassadors and our athletes is technical on the bottom and natural on top and we’re really covering that with our new assortment.

[Operator:]

Our next question comes from the line of Adrienne Yih of Wolfe Research.

[Adrienne Yih:]

Let me add my congratulations. The stores look great. Lee, the question is for you. Can you talk about, before you got there, there was this push and pull and a balancing between core basics and the seasonal products, and I’m wondering how that strategic direction has changed under your vision. And then for Stuart, if you can talk about merch margin recovery over this long-range plan that you’ve laid out for us, where can it be merch margins returned back to over time?

[Lee Holman:]

I think coming in a year ago in October, I think, it’s really around how do we heighten up those functional seasonal stories with newness and new silhouettes that we are hearing from our ambassadors and our athletes, but also with a balanced offensive classification excellence, and we are proud of every product that we constantly put out. Core is constantly evolving. We always look at our fit, we look at how things are shifting really to more of a high-rise and the low-rise and these are some things we are hearing from our guests. I think what’s very unique about coming here in lululemon is just the constant feedback we are getting from our regional managers, our store managers, and our ambassadors that we can really react to shift in trends. And also what’s really exciting is just about how people are working out very differently, shifting to more of these hybrid classes that are combining high sweat activities and low sweat activities like yoga is moving and we are moving with yoga, which is really exciting and then tapping into training and run that Laurent talked about earlier with new innovative products, just so excited about – as we get through this year and beyond with the new innovative experiences that myself and Tom are bringing in.

[Adrienne Yih:]

And Stuart?

[Stuart Haselden:]

On merchandise margin, as you suggested, we’re looking forward in terms of the recovery. What I would say is we see in the second half of the year the anticipated recovery in product margins, in merchandise margin taking shape consistent with our prior expectations. We see this extending into the first half of next year as planned and beyond. And we think we can achieve the level of recovery that we had targeted previously and communicated with investors. That said, I would like to shift the focus here to gross margin in our discussions where we can provide more transparent guidance to investors and I think that’s likely what you intended with your question anyway. We’ll certainly provide details on the components of gross margin as we go forward, but ultimately that’s the metric we have to improve in order to drive recovery in our operating profit. And so specifically on your question of where we think we can get back to, I think we still feel like the low 50%s in aggregate for gross margin is where we can recover our gross margins. That will be the primary impetus for a recovery in our operating margins to the low 20%s. We don’t see that changing. We think over the next five years we should be able to get back to that level of performance. And we’ll continue to provide updates as we get to the year.

[Operator:]

Our next question comes from Paul Lejuez of Citi.

[Paul Lejuez:]

Can you talk about traffic versus ticket on that plus 5% store comp and what assumptions are built into your comp guidance for 2016 at the store level versus e-comm and then within that store assumption, again, traffic versus ticket? And then just bigger picture can you talk about pricing power you think you might have?

[Stuart Haselden:]

To make sure I hit this right, so I will give you some color on what we saw in traffic Q4 into Q1 and then just talk about how it connects to our comp outlook. We have seen positive store traffic in the first quarter both in-stores and online, for sure. And that’s really against the backdrop of a pretty challenging retail environment. That said, the traffic has not been as strong in the first quarter as we had experienced in the fourth quarter. And then thinking about how that connects to our comp guidance, we’ve planned comps for the year and for the first quarter at mid single digits. That’s how we are bought. And certainly if the guest votes above this, we can do better. But at this point, we feel like that guidance for our comps is appropriate. And that’s certainly reflective of the traffic trends that we’re seeing in the first quarter. As we think about – looking back at Q4, with the really strong traffic, the other factor that buoyed our comp results in the fourth quarter was just a very strong AUR outcome. So that connects I think to you ticket question. So certainly, traffic and AUR were the drivers of the comp performance in the fourth quarter. I would say that’s largely extended into the first quarter although as I just mentioned, you know, where it’s tempered by some moderation in the traffic trends in the first couple of months in the quarter.

[Laurent Potdevin:]

And as far as just to chime in real quick on pricing power, I think, first of all pricing power is dangerous because it’s chipping at the equity of the brand where we think we have tremendous power is in innovation and when we deliver innovation and value for our guests, we actually do have pricing power and that was very clearly validated when we re-launched our pant wall and also with our men’s business. So as long as we focus on innovation and as long as we deliver innovation across categories and across gender, we have tremendous pricing power.

[Operator:]

Our next question comes from the line of Ike Boruchow of Wells Fargo.

[Ike Boruchow:]

I guess, Stuart, I wanted to focus on the international side. So 11 openings this year from I think nine last year and then in the prepared remarks, you mentioned by 2020 getting to about 20% or 25% of sales, which is a pretty big jump from today. So I guess my question is can you help us understand how you get there in terms of new door growth versus productivity and then can you talk about the ramp in profitability there from what I guess is losses today to breakeven next year to what kind of contribution you’d expect by 2020?

[Stuart Haselden:]

So to be clear that 20% to 25% does include our Australia business which we have about 30 stores today in Australia and New Zealand. But certainly the bigger part of the story is with the acceleration of our growth in Asia and Europe. And so certainly we’re building a pipeline of showrooms in each of those geographies that we believe will support acceleration in store openings in the coming years. And then as we think about just those two geographies, particularly excited about the results that we’re seeing in Asia. We’ve seen strong results, strong performance in the new stores we have opened in Singapore and Hong Kong. We’re targeting other capital cities in the region, Seoul, Tokyo, Shanghai and Beijing in the near future for new stores that we’re just – we think will be particularly successful both in terms of profit and the total volume the stores will generate. We’re also pleased with the traction that we’re getting in London. We have had some important openings in London. We’ve got three or four more teed up for this year, really focusing on building our brand awareness in this pretty critical capital city for that region to help drive the brand awareness. The strategy is such that we’re balancing, executing our proven showroom strategy that helps us de-risk these new store openings, seed brand awareness, seed demand in those markets with developing a stronger brand awareness regionally through opening these high profile stores in these capital cities. So certainly if you think about the profitability, we think we’ll reach a point by the end of next year where we will have a critical scale, particularly in Asia and Europe where we believe we can begin to leverage our overhead and that should accelerate beyond 2017 as we achieve greater and greater scale. I wouldn’t look at the number of openings that we’ve had in 2015 and 2016 as a straight line. We will expect that we’ll be able to increase the store opening cadence as we get deeper into the five-year plan that we have outlined.

[Laurent Potdevin:]

And remember that we’ve got a very focused strategy on key capital cities to raise brand awareness. So later this year, we will actually be announcing a couple of different go to market strategies to really increase that. We’re being very innovative and curious in how we can accelerate, how quickly we raise brand awareness in those capital cities.

[Operator:]

Our next question comes from the line of Matt Boss of JPMorgan.

[Matthew Boss:]

As we think about same-store sales by category, can you talk about comp performance of tops versus bottoms in the fourth quarter, specific initiatives just to expect this year in tops and really the best way to think about bottoms in the back half just lapping the pant wall? And then finally on the first quarter, what have you seen in February and March versus the mid-single digit comp guide? I think any color would be really helpful.

[Stuart Haselden:]

Maybe I’ll speak to your latter question on Q1 trends, which really is sort of along the same lines of what Paul asked a few minutes ago. Then, I’ll turn it over to Lee to talk about the plans we have and the trends we’ve seen in women’s tops and bottoms. So in Q1, as we mentioned, we set the comp guidance at mid single digit and we have seen traffic while positive in the first quarter, not quite as strong as it had been in Q4. So we feel like the mid single digit guidance is appropriate. That said, as I mentioned, if our guests vote above this, there’s potential to do better than that. But at this point, we feel like this is – that guidance is appropriate. And really as we think about the KPIs that underlie that comp guidance, it’s really the same story from the fourth quarter where we’re seeing improvements in AUR and modest positive traffic in the first quarter that get us to that comp outlook. So hopefully that answers your questions regarding Q1. And Lee can speak to tops.

[Lee Holman:]

I think on our tops business, we’re really excited how we are getting to the back end of the quarter is around bringing newness into our tops business if it’s from a natural point of view from a fabrication and more technical. And we already are looking about how we are layering a system of dress, which is really around harmonies in tops, so how is your first layer, your second layer work for your outerwear so that when you’re going to storytelling in the stores or when the guests come in, it’s really easy to outfit. And then what I’m really excited about the bottoms business, it’s really extended Engineered Sensation platforms that we did in Q4 and then add in new fabrications that really heighten out those sensations. So you are going to see a lot more new fabrications, new execution on printing techniques within our pant wall as well and more obsession around craftsmanship as well, really driving this notion around engineering rather than veneering. That’s really engineering the fabric, really getting back to the design principles around fit, fabrication, silhouette and finish and really going back [indiscernible] fabrication around Luon and unique properties around that and also it made look amazing, so how do we get back into that and drive innovation for a lot product that we’re driving and I’m really excited about how we’re bringing these innovation products for the next year and beyond.

[Operator:]

And our next question comes from the line of Brian Tunick of Royal Bank of Canada.

[Brian Tunick:]

Just on the supply chain and your design calendar and leadtimes, just maybe give us an idea of what’s happened over the last year or two, how long does it take to get product in the store, what kind of testing are you doing, just an overall viewpoint there. And then the second question is on omnichannel, your new DTC launch. Can you maybe talk about timing? Where are you on some of the projects there?

[Stuart Haselden:]

On your first question in terms of the supply chain and the product calendar, fundamentally the time table for how we bring products to market is unchanged. And we’re really operating on essentially a nine-month seasonal calendar where we’re making financial commitments probably for four to five months out and the balance of that nine months is related to design and development. So that’s largely unchanged. Certainly, we’re always looking for ways to improve that timing and create flexibility. Our fast turn strategy is really the most prominent way we’ve tried to do that in terms of leveraging fabric that we own into trends that we see emerging in stores on a shorter leadtime. And that’s I think a well understood strategy we’ve had. We’re always looking to try to grow that where it makes sense to again create a greater degree of flexibility to respond closer to market. So I hope that answers your question there. On the omnichannel and direct to consumer, as we mentioned in our prepared remarks, a lot going on, Miguel is rapidly building an impressive team, we’re making a lot of important technological investments. We had mentioned, I think, previously that we are building towards a new launch for our website that is definitely still the case. That website is now live internally. We’re testing and looking at a launch externally to our guests in early Q2. So plans there are on track as we had previously described. Additionally from an omnichannel standpoint, it’s important to mention the work that we’re doing in CRM. So we’re building new customer analytic capabilities that the company has never had that will enable us to better tailor, better craft our communication with guests in a sophisticated way that we just have never done. It will give us better understanding of our customer segments, how they’re performing, how they’re trending, what’s working, what’s not, so that we can just become a stronger more customer centric business. And then connecting that with the technological improvements in RFID, how we’re connecting our pools of inventory across channels so that we can meet our guests – as Laurent described – in a channel agnostic manner so that we’re able to connect those experiences between stores and online more seamlessly. That’s a big part of the growth strategies over the next four years. That was one of the four that Laurent had mentioned and it’s certainly something we’re investing aggressively behind,

[Chris Tham:]

Operator, we have time for one more question.

[Operator:]

Our next question comes from the line of Paul Alexander of BB&T.

[Paul Alexander:]

Any learnings from the New York Flatiron store so far? And then just a broader question about flagship stores, it sounds like the international strategy will rely heavily on capital cities. Will North America get anymore flagship stores?

[Laurent Potdevin:]

I think we talked about that on the last call. I want to be really clear when we talk about flagship store and what we’ve guided that we’ve got a very proven powerful formula with our 3,000 square foot stores and we’re experiencing with more formats. So whether it’s a larger format or a smaller format in a resort, beach/mountain location, but it’s not a flagship – we don’t build flagship from a branding standpoint that are losing money. So we look for the [same profitability] we just did larger format when we wanted to show a broader assortment of the product where we’ve got much better, much stronger traffic. So it’s not so much [about] flagship, it’s a question of really having the right assortment where we needed and provide global assortment with digital air cover. So you will see larger format where it makes sense, but you won’t see us build flagship as marketing or branding exercise.

[Chris Tham:]

Thank you, everyone, for joining us today. We’ll talk again soon.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. That does conclude today’s program. You may disconnect. Have a great day, everyone.