Lululemon Athletica, Inc. raised its full-year outlook on robust third-quarter results that surpassed plans, but soft guidance for the fourth quarter sent the stock down about 12 percent Friday in mid-day trading. Speaking to analysts, CEO Calvin McDonald acknowledged a “challenging” environment for sales. The tempered guidance came despite Black Friday ranking as LULU’s most profitable for revenue and traffic, driven by worldwide sales.

McDonald said, “Our performance across markets and geographies shows that consumers are seeking brands like Lululemon that offer innovative, versatile products and a strong community connection that they can’t find anywhere else. We also recognize that the external environment remains challenging with several high-volume weeks still in front of us. That being said, I’m encouraged with the beginning of our holiday season, and I am confident in how our brand is positioned in the near and long term.”

Shares of LULU in early afternoon trading were off $44.57, or 11.9 percent, to $329.94. The stock is now down about 16 percent since starting the year at $391.45, although it’s been a winner over the last three years as the company’s sales gains accelerated during the pandemic. The stock started 2020 at $231.67. 

Third-Quarter Sales Climb 28 Percent
Sales in the third quarter ended October 30 jumped 28.0 percent to $1.86 billion. Sales exceeded Lululemon’s guidance in the range of $1.780 billion to $1.805 billion and Wall Street’s consensus estimate of $1.81 billion. On a three-year CAGR basis that removes the impact of the pandemic, total revenue increased 27 percent.

Comparable sales increased 25 percent, with a 17 percent increase in stores and a 34 percent increase in digital. By store channels, sales increased 28 percent on a one-year basis and 16 percent on a three-year CAGR basis. Lululemon ended the quarter with a total of 623 stores worldwide, with 99 percent open. In the last week of November, twenty-two stores in mainland China were closed. Square footage increased 19 percent versus last year, driven by the addition of 71 stores since Q321.

Digital revenues jumped 46 percent on a three-year CAGR basis and accounted for 41 percent of total revenue.

By region, revenue climbed 24 percent in North America and 42 percent internationally, both on a three-year CAGR basis. Revenue growth in mainland China was strong for the quarter but below expectations due to COVID-19 impacts. On a three-year basis, revenue in China grew nearly 70 percent, with men’s up 28 percent, women’s ahead 23 percent and accessories growing 52 percent.

By category, globally, on a three-year CAGR basis, men’s revenue increased 28 percent, women’s gained 23 percent and accessories grew 52 percent.

Traffic year-over-year increased by nearly 25 percent at the store level and nearly 50 percent to its e-commerce sites and apps globally. On a three-year CAGR basis, traffic was up 9 percent in stores and over 41 percent in e-commerce. 

Gross Margins Erode 130 Basis Points
Gross profit increased 25 percent to $1.0 billion but declined as a percent of sales by 130 basis points to 55.9 percent. 

The margin decline was driven primarily by 60 basis points of deleverage from foreign exchange within gross margin, which was offset by a 20 basis point FX benefit with SG&A; a 40 basis point decrease in product margin, driven by higher markdowns and inventory provisions relative to low levels last year, partially offset by lower airfreight expense; and 30 basis points of deleverage on fixed costs, driven primarily by investments in product teams and distribution centers.

Meghan Frank, CFO, said that when compared to 2019, markdowns were relatively flat and in line with expectations. The decline in gross margin was larger than the guidance of 50-to-70 basis points, driven predominantly by FX and regional revenue mix.

Due to sales leverage, SG&A expenses were reduced to 36.8 percent of revenue from 37.6 percent.

Operating income improved 24.9 percent to $352.4 million from adjusted operating income of $282.1 million a year ago, although the operating margin declined 40 basis points to 19.0 percent.

Net earnings reached $255.5 million, or $2.00 a share, up 20.9 percent from adjusted earnings of $211.3 million, or $1.62, a year ago. Non-recurring costs related to its acquisition of Mirror brought down year-ago net income to $187.8 million, or $1.44.

The $2.00 per share logged in the latest quarter topped guidance in the range of $1.90 to $1.95 and Wall Street’s consensus target of $1.97. Adjusted EPS increased 28 percent on a three-year CAGR basis. 

Inventories Surge 85 Percent
Inventories at the end of the quarter were up 85 percent year-over-year. On a unit basis, inventory increased 80 percent, representing a three-year compound annual growth rate of 38 percent, which includes three-percentage points for in-transit inventories.

McDonald said supply-chain disruption continues to ease, with factory production returning to pre-pandemic levels and ocean delivery times improving from the 70 days experienced in the second quarter. Inventory levels are in line with expectations.

“As we discussed, our inventory levels were too lean last year, and we made the strategic decision to build inventories this year, which enabled the strong top-line growth we have delivered,” said McDonald. “And we remain comfortable with both the quality and quantity of our inventory. We continue to leverage our core styles, which account for approximately 45 percent of our total inventory and carry limited seasonal markdown risk.”

McDonald also noted that the third quarter should represent the high point for inventory on a one-year dollar basis. 

Third-Quarter Highlights
McDonald noted that market share gains continue for LULU. While the adult active apparel industry decreased its U.S. revenue by 4 percent in the third quarter year-over-year, the company gained 1.5 points of market share in the U.S., according to the NPD Group.

The CEO attributed Lululemon’s strong results compared to the challenges other apparel specialty chains face to the brand’s focus on providing “technical solutions” for working out, its versatile product offering for non-workouts and its emphasis on community through new membership programs and events.

He also believes Lululemon’s decisions regarding pricing, air freight use and inventories have helped the chain “continue to sell at regular price, not forced into unnecessary markdowns or course correcting with a promotional play like we’re seeing happen in the marketplace.”

Highlighting key growth initiatives, McDonald said LULU is “encouraged” by the response to the brand’s fourth footwear style, Strongfeel, a training shoe for women. McDonald said, “As I’ve mentioned before, footwear is a test-and-learn category for us, and it represents a small portion of the growth we anticipate over the next five years. This allows us to build into the potential at an appropriate pace as we learn and make adjustments.”

Among its franchises, the Wunder Puff has expanded from a single women’s jacket to eleven outerwear styles. McDonald said, “While last year we were constrained in terms of inventory, particularly in outerwear, we are well-positioned with Wunder Puffs for the holiday season and expect to meet guest demand.”

LULU has also found success in extending its Align Scuba and Define franchises. McDonald said, “We will continue to introduce, expand and grow our franchise business into the future.”

From an engagement perspective, Lululemon, in early October, successfully launched its two-tier membership program in North America and also hosted 10K races in Atlanta and Houston to mark its first race sponsorships since the pandemic began. In October, the company orchestrated a major activation in China around World Mental Health Day. Said McDonald, “This enduring strength of Lululemon demonstrates our ability to be globally strong and regionally relevant as we foster a deeper relationship with Lululemon for existing and, importantly, new guests. All of this increases brand awareness, drives traffic to our stores and websites and ultimately results in higher purchase consideration engagement with Lululemon.”

McDonald also said he was more confident in Lululemon achieving its goal of quadrupling international revenue over five years, from 2021 to 2026, after his recent tours of the UK and Australia, the brand’s strong entry into Spain and opening the first LULU store on the Champs-Elysees in Paris. Said McDonald, “In the heart of one of the city’s main shopping districts, this store will enable us to grow brand awareness, both in France and across Europe, given this is such a popular tourist destination. While our growth prospects are balanced across geographies, international represents a key piece of our Power of Three x2 growth plan.”

For the full year, sales are expected in the range of $7.944 billion to $7.994 billion, representing a three-year compound annual growth rate of approximately 26 percent. Adjusted EPS is expected to be in the range of $9.87 to $9.97. Under its prior guidance, sales were expected in the range of $7.865 billion to $7.940 billion and adjusted EPS between $9.75 to $9.90.

Fourth quarter EPS is expected in the range of $4.20 to $4.30, on the low side given Wall Street’s consensus estimate of $4.30. Revenue is projected between $2.605 billion to $2.655 billion, versus Wall Street’s projection of $2.649 billion.

Gross margin in Q4 is expected to increase 10-to-20 basis points year-over-year as the benefits of lower airfreight expense offset FX pressure and the timing of expenses related to supply chain investments. Markdowns are expected to be in line with 2019 levels.

Frank said, “We’re pleased with the start of the holiday season; however, the environment remains dynamic, and we still have approximately two-thirds of the quarter ahead of us.”

Photo courtesy Lululemon