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Lululemon Braces for Year-Long Supply Chain Delays

Lululemon Athletica beat its projected first-quarter revenue and earnings, it reported Thursday.

The strong performance prompted the activewear brand to raise its full-year forecast from between $7.49 billion and $7.615 billion in net revenue to between $7.61 billion and $7.71 billion. It also upped its diluted earnings per share outlook from between $9.15 and $9.35 to between $9.35 and $9.50.

In a Nutshell: At the same time, however, Lululemon has endured continued supply chain headwinds. “Overall,” CEO Calvin McDonald told investors Thursday, the global environment “remains challenging” with ocean lead times not improving and air freight costs remaining high.

“At this point in time, I think the supply chain pressures will be with us for the balance of 2022,” chief financial officer Meghan Frank said.

Air freight “related to macro supply chain challenges” produced a 340-basis point headwind in the first quarter, Frank said. The company had guided for 300 basis points of air freight impact, but came in over “due to increased usage relative to our initial plans,” she added. Overall, Lululemon’s gross margin fell 320 basis points in the first quarter. In the full year, it now expects air freight to have a 30-basis point negative impact on gross margin instead of its prior expectation of no impact.

Beyond air freight, Lululemon has also seen the current inflationary environment drive up costs on raw materials and labor. As it noted in March, the company is implementing “some select price increases” on about 10 percent of is assortment. So far, it has not seen a negative impact to sales volume, McDonald said.

“We are very intentional with our pricing strategies, and we monitor guest response accordingly,” he added. “That said, I remain cautious around increasing prices in this period of uncertainty, and we will continue to monitor and maintain a measured approach toward this strategy.”

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McDonald also addressed the situation in China, where Lululemon has seen “up to a third” of its 71 stores close at some point during the first and second quarters. “We are seeing modest impacts of the COVID-19-related lockdowns on our stores and with some of our vendors,” the CEO said. Despite the closures, revenue grew double digits against the prior year and more than 60 percent on a three-year compound annual growth rate (CAGR).

Just this week, eight of the company’s 10 Beijing stores reopened. In Shanghai, it is “starting to see restrictions ease,” McDonald said. Fifteen of Lululemon’s Chinese stores are currently closed. Its growth plans also remain on track, with the majority of the brand’s 40 international new store openings this year planned for Mainland China.

From a sourcing perspective, the country represents 4 percent to 6 percent of Lululemon’s total unit volume, McDonald said. When including trim and other components, “the volume increases,” he noted. The CEO said that though the “majority” of the company’s vendors are now up and running, it has experienced delays and expects “some level of impact” on future receipts.

“Having said all of this, we remain excited about our business in China, and we view the current situation as short term in nature,” McDonald said. “Our brand momentum remains strong, and we will continue to invest in the region, and we’re excited about what the future holds for lululemon in this important market.”

Lululemon’s inventories grew 74 percent year over year to $1.3 billion by the end of the first quarter. On a unit basis, inventory increased 56 percent for a three-year compound annual growth rate of 36 percent, inclusive of five percentage points for in-transit inventories.

“While our levels are higher than our historical norms, we are comfortable with the quality and composition of our inventory,” McDonald said. “This allows us to balance the momentum we’re seeing in the business with the challenges that remain within the global supply chain.”

Lululemon’s newly launched footwear category has been particularly short on inventory. Since launching its debut sneaker style, the Blissfeel, in March, “the response has been enthusiastic,” McDonald said, with demand “far” exceeding its sales forecast. The company expects to be in a better inventory position “in the coming weeks,” he added.

“We sort of went in knowing that demand would be in excess of supply and it far exceeded our expectations,” McDonald said. “And we definitely had a lot more demand than we anticipated. Encouraging, but definitely impacted supply quicker than we would have wanted in an ideal scenario, but it all points to an incredible product that was well received both in the industry and with the guest.”

Net Sales: Year over year, net revenue grew 32 percent to $1.6 billion in the quarter ended May 1, exceeding its forecast of between $1.525 billion $1.55 billion. Compared to the first quarter of 2019, sales improved 106 percent for a three-year compound annual growth rate of 27 percent.

Total comparable sales increased 28 percent, or 29 percent on a constant-dollar basis. Comparable store sales climbed 24 percent. Direct-to-consumer net revenue accounted for 45 percent of net revenue, up only slightly from 44 percent in the first quarter of last year. It grew 32 percent, or 33 percent on a constant-dollar basis.

Net Income: Though Lululemon’s gross profit increased 24 percent to $870.4 million, its gross margin dropped 320 basis points to 53.9 percent—putting it exactly in line with the first quarter of 2019. Income from operations grew 34 percent to $260.3 million, while adjusted income from operations increased at a slightly shallower 29 percent. Its operating margin inched up 30 basis points to 16.1 percent, but its adjusted operating margin slipped 30 basis points.

The company reported a net income of $190 million, or $1.48 per diluted share, up from $1.11 per share a year earlier—adjusted diluted earnings per share were $1.16—and $0.74 in the first quarter of 2019. In late March, its forecast called for diluted earnings per share in the range of $1.38 and $1.43.

CEO’s Take: McDonald called out several factors that he believes give Lululemon a “unique” competitive advantage, including cultural shifts toward active, versatile clothing, its direct-to-consumer model, its “balanced” growth approach and a mitigated need for markdowns.

“All of this positions us for continued growth and we will continue to take a balanced and holistic view of our business,” he said. “In fact, our business is in the early innings and all levers are contributing to our performance. This is unique, speaks to the strength of our brand and our opportunity to innovate, all while maintaining our momentum.”