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Lululemon CEO: We Can ‘Sell Our Product at Regular Price, Not React’

Lululemon’s high-growth rates rage on despite slowing consumer demand and ongoing supply chain headwinds, with the athleticwear giant’s third-quarter net revenue soaring 28 percent to $1.86 billion on net income of $255.5 million.

Despite the company’s continued growth, Lululemon’s stock reacted poorly, sliding more than 12 percent after the earnings report as analysts raised concerns about fourth-quarter guidance.

In a Nutshell: Lululemon is still taking market share in the adult active apparel market, gaining 1.5 percentage points in the U.S. since last year, said CEO Calvin McDonald in an earnings call.

Citing NPD Group’s Consumer Tracking Service data, McDonald pointed out that the industry’s U.S. revenue fell by 4 percent in the fiscal 2022 third quarter. Lululemon’s share increase reflected the most of any brand in the market, McDonald said.

Inventory at Lululemon soared 85 percent to $1.74 billion from $966.4 million in the year-ago period. McDonald said that the third quarter will represent the high point for Lululemon inventory on a one-year dollar basis.

On a unit basis, inventory increased 80 percent. Units were up 38 percent on a three-year compound annual growth rate (CAGR) basis.

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“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,” McDonald said.

Core styles account for approximately 45 percent of total inventory at the athletic apparel brand, with McDonald highlighting that this merchandise carries limited seasonal markdown risk.

According to McDonald, Lululemon’s factories have now returned to pre-pandemic levels of production efficiency. In addition, ocean delivery times are continuing to improve from the 70 days experienced in the second quarter. Meghan Frank, chief financial officer at Lululemon, also highlighted the easing of costs across both containers and air freight.

“We’re seeing them improve modestly,” Frank said during the earnings call. “I’d say they’re still not back to historical levels there, but we are also seeing some positive movements on the cost per unit front. And so, we continue to view that as an opportunity as we move into next year.”

To support demand in western Canada, Lululemon also recently opened a new distribution center in Tilbury, British Columbia, near Vancouver.

Elsewhere, the company recently rolled out ship-from-store and enhanced endless aisle capabilities in the U.K. and Australia. It also opened a flagship store in Paris, marking the fourth standalone location in the city and the company’s first flagship in continental Europe.

Globally, Lululemon now projects to open 79 net new company-operated stores before 2022 is over, up modestly from the prior guidance of 75. Forty-five to 50 of these stores will open in international markets. In the fourth quarter, the yoga pants purveyor expects to open approximately 30 net new company-operated stores.

Gross profit increased 25 percent to $1 billion and gross margin decreased 130 basis points (1.3 percentage points) to 55.9 percent, down from the prior-year period’s 57.2 percent margin.

The margin hit was driven primarily by deleveraging from foreign exchange rates, as well as some higher markdowns and inventory provisions relative to low levels last year. This was partially offset by lower air freight expenses and deleverage on fixed costs, driven primarily by investments in the product teams and distribution centers.

Versus 2019, markdowns were relatively flat and in line with the company’s expectations, Frank said.

Capital expenditures were $176 million for the quarter, compared to $123 million in the third quarter last year. Third-quarter spend relates primarily to investments including the multi-year distribution center project; store capital for new locations, relocations and renovations; and technology investments.

For the fourth quarter of 2022, the company expects net revenue to be in the range of $2.605 billion to $2.655 billion, a 22 percent to 25 percent jump from the 2021 quarter. Diluted earnings per share are expected to be in the range of $4.20 to $4.30 for the final quarter. Fourth-quarter gross margin is expected to increase 10 to 20 basis points (0.1 to 0.2 percentage points) relative to the year-ago period.

Despite the strong guidance, Wall Street had higher expectations. A survey of analysts polled by Refinitiv projected Lululemon would offer revenue guidance of $2.649 billion and earnings per share guidance of $4.30, both of which represent the high end of the retailer’s outlook.

Lululemon expects full-year net revenue to be in the range of $7.944 billion to $7.994 billion, an increase from prior forecasts of $7.865 billion to $7.94 billion and an expected 27 percent to 28 percent revenue improvement over 2021.

Diluted earnings per share are expected to be in the range of $9.94 to $10.04 for the year, also a bump from the previous range of $9.82 to $9.97 per share. Excluding the gain on the sale of an administrative office building, adjusted diluted earnings per share are expected to be in the range of $9.87 to $9.97.

The company ended the third quarter with $352.6 million in cash and cash equivalents and the capacity under its committed revolving credit facility was $394.8 million.

Net Revenue: Net revenue at Lululemon increased 28 percent to $1.86 billion, or 31 percent on a constant dollar basis, from $1.45 billion in the year-ago third quarter.

Third-quarter net revenue increased 26 percent in North America, and increased 41 percent internationally. Revenue in Mainland China has grown nearly 70 percent on a three-year CAGR basis.

Total comparable sales increased 22 percent compared to the prior-year period, or 25 percent on a constant dollar basis, while comparable store sales increased 14 percent, or 17 percent on a constant dollar basis. Store traffic increased 25 percent, according to Frank.

Direct-to-consumer net revenue increased 31 percent year over year, or 34 percent on a constant dollar basis. Direct-to-consumer net revenue represented 41 percent of total net revenue compared to 40 percent for the third quarter of 2021.

On a three-year CAGR basis across merchandise categories, men’s revenue has grown 28 percent, while women’s revenue has expanded 23 percent. Accessories has held the fastest growth at a 52 percent pace.

Net Earnings: Lululemon’s third-quarter net income was $255.5 million, a 36 percent jump from the $187.8 million in income generated in the year-ago period. Diluted earnings per share were $2.00 compared to $1.44 in the third quarter of 2021.

Income from operations increased 37 percent to $352.4 million, up from $257.9 million in the 2021 quarter. Adjusted income from operations increased 25 percent.

Operating margin increased 120 basis points (1.2 percentage points) to 19 percent. Adjusted operating margin decreased 40 basis points (0.4 percentage points).

CEO’s Take: McDonald said that Lululemon only increased prices on roughly 10 percent of its assortment mix in 2022, reflecting the brand’s pricing power.

“What we don’t want to do is react too aggressively, and create any impact on the demand of our product. And we’re going to continue to take that approach. We’re comfortable on the inflationary pressures we’re seeing on cost of goods and how we’re priced in,” McDonald said. “As we’ve seen through the three quarters of this year, the decision so far has been the right decision. Others that priced up are now heavily discounting and giving away any of that perceived gain and having to mark goods down, where we’re able to continue to sell our product at regular price, not react.”