Thank you for standing by. This is the conference operator. Welcome to the lululemon athletica inc. Third Quarter 2021 Earnings Conference Call. [Operator Instructions] And the conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Howard Tubin, Vice President, Investor Relations for lululemon athletica. Please go ahead.

Thank you, and good afternoon. Welcome to lululemon's Third Quarter Earnings Conference Call. Joining me to talk about our results are Calvin McDonald, CEO; and Meghan Frank, CFO. 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 lululemon'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 change. Actual results may differ materially from those contained in or implied by these forward-looking statements due to risks and uncertainties associated with our business, including those we have disclosed in our most recent 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 expressly disclaim any obligation or undertaking to update or revise any of 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 our quarterly report on Form 10-Q and in today's earnings press release. In addition, the comparable sales metrics given on today's call are on a constant dollar basis. The press release and accompanying quarterly report on Form 10-Q are available under the Investors section of our website at www.lululemon.com. Before we begin the call, I'd like to remind our investors to visit our investor site where you'll find a summary of our key financial and operating statistics for the third quarter as well as our quarterly info graph. Today's call is scheduled for 1 hour. [Operator Instructions] And now I'd like to turn the call over to Calvin.

Thank you, Howard, and welcome, everyone, to our third quarter conference call. I'm excited to be here to discuss our results and share highlights of our performance at the start of the holiday season. Our momentum remained strong in the quarter, reflecting the continued growth potential for lululemon in both the near term and the long term. I'm especially pleased with how our leaders and teams continue to successfully execute against our Power of Three growth plan while we navigate the supply chain issues within the industry. Relative to last year, revenue grew 30% and on a 2-year CAGR basis, increased 26%. Our strength continues to be broad-based and balanced across every facet of our business, including channel, category, activity, gender and geography. Before discussing more details about quarter 3, I would like to share some highlights on the 3 topics: our performance over the recent Thanksgiving holiday, inventory levels and the current labor market. Starting with Thanksgiving, we were pleased with our performance over the holiday weekend. For the 5 days spanning Thanksgiving through Cyber Monday, both our digital and brick-and-mortar channels performed well. E-commerce delivered record-breaking days in several key metrics, including sales, traffic and conversion. And I'm excited to share that this year, Thanksgiving Day was our highest-volume e-commerce day ever. The investments we have made over the last several years are enabling the acceleration we're seeing in the digital business and contributing to the growth this year on top of last year's outsized performance. While we still have several large volume weeks ahead of us, it was great to see our guests respond well to our merchandise offering as we kicked off the holiday season. Shifting to our supply chain. We continue to face the same issues as much of the industry, including port slowdowns and…

Thanks, Calvin. Our business remained strong in Q3. The trend in stores continued to improve with productivity above 2019, while our e-commerce business continues to comp positively over the growth we experienced last year. I will share our guidance outlook with you in a few minutes, but I think it's important for our investors to know that we are raising our guidance for the year despite increasing airfreight costs and a more conservative view on revenue for MIRROR. This is a testament to the underlying strength of our core business and to our teams around the globe who enable this impressive performance. Let me now share with you the details of our Q3 performance. I will also discuss specifics on our balance sheet, including our cash position, liquidity and inventories. Please note that the adjusted financial metrics I will share include the operating results of MIRROR, but exclude approximately $24 million of acquisition-related costs and our associated tax effect in Q3 2021, and $8.5 million of acquisition-related costs and their associated tax effect in Q3 2020. You can refer to our earnings release for more information and reconciliations to our GAAP metrics. For Q3, total net revenue increased 30% to $1.45 billion, above our expectations of $1.4 billion to $1.43 billion. This included a 28% increase in North America and a 40% increase in our international business. On a 2-year CAGR basis, total revenue increased 26%. This was better than our expectation of a 24% to 25% 2-year CAGR growth and continues to outpace our 3-year CAGR of 19%, leading up to the pandemic. Within North America, revenue increased 23% and within international, we saw a 42% increase, both on a 2-year CAGR basis. In our digital channel, revenues increased 54% on a 2-year CAGR basis and contributed $587 million…

Thank you, Meghan. I am very pleased with the high-level performance of lululemon across every major metric in category, which allows us to deliver such a strong quarter. We have begun the fourth quarter with the inventory, staffing and strategies in place to enable us to finish 2021 in a position of strength as we expect to pass the $6 billion annual revenue level for the first time. The way we continue to grow and expand is a testament to the commitment and passion of the people of lululemon. I am particularly proud of our agility throughout this year and over the course of the pandemic and how the leadership team continues to build upon the momentum in the business. And with that, we'll be happy to take your questions. Operator?

[Operator Instructions] Our first question comes from Adrienne Yih of Barclays.

And great job navigating what's a tremendously difficult environment. Calvin, I wanted to start by talking about average initial retails, what you think the pricing power there is? And most of retail didn't really touch their initial retails in 2021, but they are going to start touching the like-for-likes in 2022. So just wondering kind of how you're thinking about that and lululemon relative to that pricing? Meghan, given that 40% is core in the ongoing supply chain issues, is there an increase in weeks of supply scheduled for spring of 2022 as a safety stock?

Thanks, Adrienne. On pricing, we have no plans to change our pricing strategy at this time. As you know, we lead with technical innovation and price our garments accordingly. We're always studying the marketplace and make pricing adjustments as necessary based on the competitive dynamics and opportunities that exist, but we have no plans to make a change heading into 2022.

Adrienne, in terms of inventory, we do have an advantage in the proportion of our inventory that sits in core product. And while we aren't sharing details on our 2022 plans today, the team is actively looking at opportunities to capitalize on that core assortment and pull that forward where that makes sense for us.

Our next question comes from Matthew Boss of JPMorgan.

And congrats on another nice quarter. So Calvin, revenues year-to-date up 60% versus 2019, and you've mentioned demand exceeding supply now for the second straight quarter. Could you speak to new customer acquisition and drivers of the balance that you're seeing between stores and digital, which point in your view to sustainable strength of the brand?

Yes. Thanks, Matthew. There are a number of the overall driving metrics that point to that. The obvious one is the challenge we've seen in inventory. And even though we've been able to achieve these results, product drops, some of the product innovation and the way in which the design team's intended our activities and our categories to be launched for the guest just haven't materialized pretty much the entire and we've been chasing into that. So we know there's an upside to being able to represent and present the product the way in which it was designed and intended to. That said, when we look at our new guest acquisition, it remains very strong as before the pandemic during and post. We continue to see new guests come into the brand. We continue to have success migrating those new guests up through different categories and their spend journey and the retention of our high-spending loyal lululemon guest remain incredibly strong. What we alluded to during the early pandemic when stores were closed was that we -- we're seeing more of our store only shift into omni. We are seeing our omni-guest spend more. And because we have such a strong position with digital, that enabled them to engage in the brand and do purchasing. And we know there were some store-only guests that could not have access or chose not to. Now that the stores are up and operating, we're very pleased with seeing them return back to the brand as we continue to grow. We referenced stores being great acquirer of men's. Now that they're up and you've seen our men's business has come back incredibly strong, and we see new guests through that and having our stores perform above our 2019 numbers while maintaining our digital is really a factor of all those inputs, predominantly new guests, migration of guests and retention of gas, all very healthy. And we know our product positioning is only going to get stronger, and the team did a wonderful job chasing it, but it wasn't our best -- it was a good foot and it was -- we had a bigger intention even behind what we were able to get out.

That's great color. It's perfect lead into my second question on the product positioning. Could you elaborate on trends that you've seen so far in the fourth quarter? And given your inventory position, but then the proactive steps that you took to airfreight in product, what is your ability to chase demand if momentum exceeds plan? And to your point on product positioning, what do you wish you had more of or maybe changes that in an ideal world to meet that outsized demand?

Yes. No, thank you. Overall, on product, there haven't been any dramatic shifts to the trends that we saw coming in. We've seen great growth across men's and women's, very balanced growth across categories, top, second layer, bottom, short skirts and into the men's sweat categories and across our activities. So again, and as I've mentioned before, our growth remains very balanced across men's, women's, across each category, across all the activities we've identified and are innovating into and across every region that we are doing business in and across our channels, be it stores and digital. What would I have wanted more of, there are some products that we are light on. Outerwear is a category that has performed incredibly well for us this season. And we didn't have the depth there that we would have wanted. Some of our second layer categories, OTM leading into the holiday have been delayed, some of our early fall receipts. But overall, because of our balance in inventory core, we've been able to and we have learned in. We've made sure through airfreight to have those goods. And they are our fuel and drivers, and they continue to be and we're in a good position, but there are definitely certain items in areas where we've seen the delay as a result of the shutdown, but we have more than enough balance and key growth across our entire portfolio that is able to keep fueling the results that we achieved.

Matt, and I'd just add on there. We did with inventory up 22%, which was above our expectation of 15% to 20% growth and really reflective of the team's supply chain and product teams leveraging airfreight. We do make those decisions about 6 weeks out. Certainly don't have as much flexibility as a normal environment just with supply chain constraints, but it is something we're actively managing where we do have opportunity.

Our next question comes from Ike Boruchow of Wells Fargo.

I guess, Meghan, I just wanted to dig into the airfreight dynamic a bit more. Is there any way you could possibly share with us based on spring orders, what kind of pressure you guys should expect or we should expect you guys to see in the first half of next year? And then I guess if you don't want to get too specific, I guess for the full year, you're saying 200 to 250 basis points of pressure. How much of that based on what you know today is reasonable for us to expect for you guys to kind of recapture in 2022?

Thanks, Ike. I think a little soon to put a fine point on 2022, but we do expect that the supply chain pressures will be with us as we move into the first half of the year. That said, we think there'll be some puts and takes in our gross margin, and we are right now maintaining our commitment to modest margin expansion next year. Certainly, airfreight presents an opportunity over the long term, but there will be some normalization of historically high full-price sell-throughs and low markdowns as well as other investments in our business to maintain that modest margin expansion goal, and we'll share more in spring '22 on our next 5-year outlook.

Meghan, is it fair to say that this should be the peak of the airfreight pressure in Q4?

I believe so.

Our next question comes from Mark Altschwager of Baird.

So to start out, I mean, you sound very pleased with the start to the holiday season. Were there any changes to your approach to the Black Friday, Cyber Monday period this year versus prior years, especially in light of the supply chain disruption? And then relatedly, you've talked about how you may have left some sales on the table in the quarter given the inventory constraints, but you're also mindful of some potential pull-forward in sales that might be happening. So maybe just talk about your level of confidence of potentially building on the Q3 growth rates.

Thanks, Mark. In terms of our Thanksgiving shopping over Black Friday and Cyber Monday, there was really no change to our strategy and tactic. In that by, I mean, we didn't take further markdowns. We don't play promotionally, as you know. The teams definitely worked hard to get the stores and online in a good inventory position. To satisfy demand, we made sure that we were ready. We've been investing for months, quite frankly, going back to the beginning of the pandemic to get our digital channel ready to anticipate the sort of volume. And as I alluded to in my opening remarks, we had the largest volume day in the history of lululemon on Thursday, and the site performed incredibly well, as has our DCs and the full support. So there wasn't anything unique, there wasn't anything artificial to drive demand. Just all good work and hard work to get ready for the demand and getting our core product out there with traditional markdown activity. And we saw that the volume and we are anticipating a pull-forward. So we are continuing to monitor the weeks ahead. As Meghan mentioned, there are some big weeks ahead. We're pleased with our position. We're pleased coming out of November. We knew that we needed to have a strong start to the quarter, and we achieved that. And we're continuing to monitor and get ready for the coming weeks.

And Mark, I'd just add in terms of Q3 growth in next year, I think the guest metrics and growth that Calvin was pointing to in both new and existing engagement give us confidence in our ability to continue to grow on top of this baseline as well as our international and North America omni expansion strategies. And again, we'll share more in spring '22 on our next 5-year outlook.

And just a quick follow-up on MIRROR, if I could. Can you just give us some perspective on how you're thinking about balancing the growth and profitability for the platform for 2022? I guess, would you expect it to be net dilutive to EPS next year?

Sure. So in terms of MIRROR in 2022, we're not going to share specifics today, but I would offer that we -- the path to profitability is very much within our control. We'll remain prudent in our investments as we have been this year. And we do expect dilution to begin to decrease next year.

Our next question comes from Erinn Murphy of Piper Sandler.

I was hoping you could talk a little bit more about what you're seeing in the competitive landscape in China for the lulu brand. Just are you seeing any change in dynamic between global brands versus national brands there? And then relatedly, any early reads on 11/11 in that market?

Yes. Thanks, Erinn. We haven't seen any notable change from our brand perspective in the China market. As you heard in my opening remarks in terms of the performance, we continue to be very pleased with the results, 2-year CAGR of 70%. We continue to invest in China, opening stores, invest in our headquarters in Shanghai and creating in-country roles and jobs to really help support that business. Continue to connect with the community, which is our unique way of working with. And we see a real opportunity to continue and to push for the sweat life and the healthy initiatives that exist within that market and feel we play a very unique role in doing that. So from our perspective, we're pleased and pleased with the investments we're making in the connection with the community.

Yes. And I'd say in terms of 11/11, Erinn, generally in line with our expectations. We're not going to share specifics, but as Calvin mentioned, strong performance in China with approximately 70% to your CAGR in Q3, so we've been pleased.

Great. And then if I could just follow up on your footwear initiative. Is that still planned for next year? And how material are you thinking about the investment behind building that platform out?

Thanks, Erinn. Yes, we're still on track for a spring '22 launch. And just as a reminder, and consistent with how we've shared it, it's a test and learn for us. We're excited about it, excited about the opportunity and our unique position. But it's not required in the Power of Three growth commitments that we've shared and therefore, are taking a growth approach to this new initiative.

Our next question comes from Lorraine Hutchinson of Bank of America.

Just building on Erinn's question, can you give us an update on the margin performance of the international business? And how do you think about the path to parity with North America margins given the investments you're making there?

Lorraine, thanks. We are profitable in our international business overall. We are still on the path to profitability in Europe. We had pushed out that date to '22 just given the impact of store closures that we experienced throughout 2020 and then continuing into the first half of '21. And sorry, can you remind me the second half of your question?

Yes. Just looking at the path to parity overall, given all the investments you're planning to make in Asia.

Yes. We certainly see opportunity in the international margin. That said, we also see opportunity for expansion in our North America margin. So expect it to sit below, and there are some structural rent items that are a little bit more pressure, I would say, in our international region relative to North America.

Our next question comes from John Kernan of Cowen.

Nice job on the quarter. So what enabled you to outperform your expectations by this much given the reduction to MIRROR -- I guess in the core business, what outperformed your expectations from the last time you gave revenue guidance versus where we are now and what's a pretty difficult environment out there given the supply chain headwinds?

Yes. I'd say, John, it's really been broad-based. So we've -- our performance has come both from channels and e-comm as well as across women's, men's and accessories. And I think we've been particularly pleased, I'd say, with our store performance, so exceeding 2019 productivity in Q3 which was up from flat in Q2 and then 88% of 2019 in Q1. So we've seen some nice acceleration there. At the same time, e-commerce business has continued to be very strong. So we were up 22% year-over-year in Q3 and then 54% on a 2-year CAGR basis, so really pleased, I'd say, across the board.

Excellent. Quick follow-up, just on SG&A dollars. It looks like the expectations implied for SG&A expense are a little bit lower versus where they were last quarter. Can you talk to the drivers of that? Are you dialing back some of the investments in MIRROR and some of the acquisition costs there? Any comments on SG&A as obviously, the gross margin headwinds picked up a bit on airfreight.

Yes. So we did experience CAC for MIRROR in excess of our LTV to CAC ratio parameters in Q3 that continued into Q4. So we have made a strategic pullback there. And then there has been also some efficiencies identified on the lululemon side that are contributing to that SG&A line as well.

Our next question comes from Paul Lejuez of Citi.

Curious, can you just give us an update on the number of MIRROR shop-in-shops you have currently? Anything you could share in terms of what that does to the stores that they're in, connectivity to the customer and maybe just what your future plans are for shop-in-shops as you look out to next year?

Thanks, Paul. We did achieve our goal of 200 stores, that's both across the U.S. and in Canada. I think the Canadian number is around 48 is the final number. So call it 152 and 48. We have been and we're almost at the full MIRROR leads in each of those stores, which is a critical component to really activating the MIRROR and driving guest engagement and demonstrations. We saw -- we're very pleased with the results in Canada when we launched, which has only been the last few weeks. And we really wanted to test and learn and launch just through the lululemon channels and synergies, leveraging both online already guest relationships that we had in the store channel and very pleased with the start of the results of that initiative. And then I'd say across all very encouraging, and it's early in this, but we know it is one of our huge advantages of how we unlock synergies and tackle what remains the #1 opportunity, which is just general awareness behind this product in this category and the uniqueness of our proposition. One example is in-store demonstrations have a 6% conversion to sale, which is very encouraging. When you think of traditional retail conversion numbers of foot traffic in, our ability to convert 6% of those engaging in demonstrations with the MIRROR, it's a very encouraging number, which is why that MIRROR key lead is critical. In higher volume doors, having 2 key MIRROR leads to support the store in 7 days a week operation. And again, we're early. We see our unique point of view and the impact it's having on performances, and we're going to continue to invest where it makes sense and play our unique role and keep building this business forward.

And how has your thinking evolved just in terms of maybe using the existing customer base of the MIRROR to actually sell lulu product, if that's something on the horizon that you're going to be doing a little bit more on?

I think there's definitely the aspirational, which is we want everybody sweating on a MIRROR to be in lululemon, and we want everybody sweating with lululemon to be engaging and using a MIRROR. And that's an aspirational vision, but it's to say there's opportunity on both sides. As we continue to move forward, more and more of these guests are already or have shopped with lululemon, which is good because a big part of the role MIRROR plays with us is as a membership community that drives loyalty, retention and spend with our lululemon guests. We know the more they sweat with us, the more they spend with us. And our core business is our priority and will always remain our priority, and MIRROR is a way in which we drive that business forward. So we are seeing those dynamics play out. There is an opportunity. There are new guests we acquire and see come in to the family through MIRROR and we'll be able to convert them over. But the collective play is about retention, loyalty and increased spend, and we're pleased with those dynamics so far.

Our next question comes from Michael Binetti of Credit Suisse.

Meghan, would you -- could you guys give us some thoughts on what you think are some of the realistic scenarios for that store productivity number you referenced a few times as you look into 4Q? I know they get quite crowded as you get very close to the holiday. But maybe if there's a pull-forward, maybe that actually would have helped if there was any capacity issues in a normal season. But how should we think about what -- some of the scenarios you thought about as far as what the stores can do on a productivity basis fourth quarter? And then I guess, Calvin, if you can help us just back up if we think to the 2023 plan with the SG&A, I think if we look at the financial model from the Analyst Day, the thought was 13%, 14% type revenue growth and some SG&A leverage every year, maybe 10 basis points about. And I think you've delivered obviously, revenue growth has been much different than that because they're much higher than that because of the pandemic. But I know a lot of moving parts in there, but you mentioned a lot of times you pulled forward a lot of spend, particularly to fulfill on e-commerce. As we look out, excluding the MIRROR business, just at the core, is it -- or is the back end of that Analyst Day period a bigger SG&A leverage period because you got to those investments earlier and they generated bigger revenue returns than you thought? Or do you start looking at '24 and '25 investments and pulling those in as you look at '22 and '23?

Michael, thanks it's Meghan. So in terms of store productivity for Q4, we are managing our business from an omni perspective and really looking at multiple scenarios. I would say store productivity, I would say, flat to 2019 to up slightly. It's probably a good baseline scenario, though, again, we are planning for multiple scenarios to flex where the demand comes to us. And I'll also take the long-term question in terms of SG&A.

Sure.

So we did have modest SG&A expansion in our long-term plan. At this point, we remain on that commitment. And what we're really focused on is our operating income and growing our operating income in excess of sales growth. We have had some shift in dynamic of our business with more investment in e-comm to support the accelerated growth there, of which depreciation sits in SG&A and we've also had some lower occupancy and expenses, and so some more gross margin leverage come through. We'll continue to balance our investments to grow our operating income, and we'll share more on our next 5-year outlook again in spring of '22.

Our next question comes from Brooke Roach of Goldman Sachs.

You spoke in your prepared remarks earlier to strong new guest acquisition and retention. As you think about the profile of the guests that you're acquiring today, can you talk to how that incremental new guest might differ in terms of demographics or preferred activities versus the customer that you acquired in prior years? What is your outlook for new guest acquisition going forward?

Thanks, Brooke. From a general demographic perspective, we remain healthy across all the different demographic profiles from age, gender, and I will touch on the activity lens. But a lot of the initiatives we continue to deploy are resonating with younger consumers, very pleased with the health of new younger guest acquisition into the brand. And then as I mentioned, the migration and retention of the guests are very, very strong here at lululemon. So when we look at activity, 2 points: one, the versatility of our product is our -- one of our greatest strengths, and it allows for guests to find what they need for their sweat life across multiple categories, be it bottoms, tops, second layer, shorts. And as you know, we've defined a very clear activities that we want to own and have significant share of mind, share of wallet position in and that is Run, Train and Yoga. And then we've identified what we call play categories, be it golf, tennis, and hike. And these are businesses that equally, we're seeing our guests spend into and are helping to drive. But it's the versatility of the product and a very defined activity strategy linked to our product innovation that's helping to drive not just new guests, but spend with existing guests. And we are very early in those strategies. As you know, we just launched a brand-new yoga franchise for our female guest at the beginning of this quarter, the InStill Tight, which delivers a completely different feel sensation through our smooth cover material. And it's just one example of our approach of building franchises that deliver on feel states through these key core activities that are driving both new guest acquisition and spend with our existing guests.

Operator, we'll take one more question. Thanks.

Certainly. Our final question comes from Kimberly Greenberger of Morgan Stanley.

Okay. Great. Meghan, can I just start on a follow-up on gross margin. I think you indicated that you had 230 basis points of airfreight here in the third quarter and that really accounted for more than the 50 basis point decline in your product margin. If I back that inbound airfreight charge or cost out, am I right in doing so to get to, let's say, a gross merchandise margin increase in the quarter of 180 basis points? Is that an okay way for me to think about it?

Kimberly, I would think about also if you're looking for a baseline for future planning, just that we had historically high full-price sell-throughs and lower markdown rates. So when we look into the future, we will have some puts and takes within our gross margin rates. And right now, we're committed to that modest margin expansion as we outlined in our Power of Three growth plan.

Okay. Got it. So you'll hopefully get back a good chunk of that airfreight next year in the third quarter, but perhaps the 180 -- they'll be as well, maybe a small bit of get back on markdowns or the pure merchandise margin, okay. Understood. Did you quantify the potential airfreight costs for Q4 in basis points, Meghan, I'm not sure if I heard that.

Yes, we did. So 450 basis points of pressure in Q4 relative to 2019. And then also for the full year, 200 to 250 basis points relative to 2020.

Okay. Thanks so much. And my last question for Calvin. I heard you on the pricing philosophy, and that makes a ton of sense, Calvin, I think, to price for the performance that you're putting into the product year after year. We're starting to hear from some of our colleagues in supply chain that some of the OEMs in Asia are experiencing higher cost for either labor, utilities, raw materials. Would lululemon philosophically try to price for any actual increase in the cost of goods that your suppliers might be feeling? Would you think that, that would be an appropriate way to also raise price to the end consumer?

I mean, I think -- we really do price to market, and there are obviously a variety of inputs and considerations, and you've alluded to some. But as a business that is positioned as a premium brand that has much innovation built into the product. We look at a variety of factors to make our pricing decisions and it's just not -- we won't just do it unilaterally because of those pressures, we'll look at other ways to manage the overall mix and maintain our committed margins.

That is all the time we have for questions today. Thank you for joining the call, and have a nice day.