Lulu 3Q13 Review

8/13/2019 Lulu 3Q13 Review

1/11

Lululemon: 3Q13 Review & Roadmap12/13/2013

Companies mentioned:

Lululemon (LULU) - $60.39

Why Read?

Growth has been king and yoga has been HOT! Specialty retailer Lululmeon has been riding this trend,growing store count, sales, and earnings. In turn, the concept has garnered premium valuation. Webelieve that investor optimism has become overblown citing leadership concerns, execution hurdles and

increasing competition."""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""

! Comparable store sales trending down:Yesterday morning LULU reported 3Q13 results,including a +5.0% increase comparable store sales (+2.0% constant currency), inline withtheir +MSD guidance from the 2Q13 call. Alarmingly, management lowered 4Q13 guidance,implying a flat comparable store sales result vs. a previously implied +7.0% increase. Thiswould be LULUs first flat comparable store sales result since the recession and we seegreater downside to guidance/next years estimate as the quarter continues. We are currentlyforecasting a -1.0% comp in 4Q13 and +2.0% in FY14.

! Supply chain issues adding to gross margin pressure:Current CEO Christine Day has beennice enough to leave LULU while the supply chain is still on shaky feet. Lululemon has beenswitching some key suppliers and shifting their production regions. Expect further GPM%deleverage from increased air freight expenses as LULU rushes product to stores. Luckily,Christine Day was nice enough to get on the 3Q13 conference call, her last as CEO, and offerinvestors some contrived excusesor not. Another day in retail land.

! Long-term fundamentals eroding:Investors have been drawn to growing retailers with hotconcepts. Lululemon was the first to corner the yoga wear trend/market but we have seenmargins erode as other retailers such as Athelta, Aerie, etc. enter the space. We also believeLululemon has become complacent in the newness of product offering and has been late tooffer more color in its mix. Despite the strong runway still remaining for store growth, we

expect investor expectations will continue to fall back in line with reality. At the end of theday, Lululemon is a decent growth company, but not necessarily a great stock. We give it afair value of $55.00, 25x FY14 earnings.

! Laurent Potdevin Review:Lululemon is ~$10bn company looking to make the next step inits growth cycle to become a mature large-carp retailer worth 2-3x todays cap. Whats a greatway to get there? Hire someone with no brick & mortar retail experience; whose mainexperience is giving away TOMs shoes and Burton Snowboards in the niche snowboardmarket. Were not impressed.


2/11 #

"#$%&'&()* +,#'* +&)*- .'*/01/2 3#4/5

Over the last few years, comparable store sales growth at Lululemon has slowed as the comparable storebase matures. The real disappointment comes when seeing the deceleration in the trend as we movefrom one-year results to the two and three-year comparable store stacks.

LULU Comparable Store Sales

Q1

2012

Q2

2012

Q3

2012

Q4

2012

Q1

2013

Q2

2013

Q3

2013

LULU - 1 Year 25.0% 15.0% 18.0% 10.0% 7.0% 8.0% 5.0%LULU - 2 Year Stack 41.0% 35.0% 34.0% 36.0% 32.0% 23.0% 23.0%

LULU - 3 Year Stack 76.0% 66.0% 63.0% 64.0% 48.0% 43.0% 39.0%

+6%%)7 "8&1/ 9--6*-5

Over the last few quarters, LULU has been plagued by supply chain issues and quality control. FromLuon-gate in 1Q13, mobile POS systems, political unrest, new suppliers and new supply chain teamhires, the Lululemon supply chain has seen it all in 2013.

Lululemon Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2 Year Stack Q1 Q2 Q3

Gross Profit Margin 2011 2011 2011 2011 2011 2012 2012 2012 2012 2012 2012 2013 2013 2013

LULU Gross Profit Breakdown

Product Costs and Markdowns 150 210 (20) (310) (20) (340) (310) (60) 10 (200) (220) (90) (220) (220)

Supply Chain Costs 40 (60) 10 (30) (30) (20) 40 30Air Freight 70 50 60 neg neg

Fixed Costs 130 120 70 50 80 120 (10) 40 50 130 40 70 40

Other - One Time Tax Adjustments 140 (140) (510)

Weakening Dollar 70 100 80 40 70 (20) neg

MD&A BREAKDOWN TOTAL 490 470 70 (220) 140 (360) (240) (40) 20 (120) 20 (560) (110) (150)


3/11 $

For a brand that is supposed to be protecting its competitive moat through higher price points and brandcache, we find LULUs gross product margin results disheartening. As you can see the margin erosionstory began long before the Luon issues arose in 1Q13, throwing off the supply chain timing.

We expect to see some reversal in gross margins as we lap the negative impacts from this years productand markdown impacts though we expect pressure to remain heavy as LULU relies on greater airfreightto rush core inventory and new Luon products to store for the second half of 4Q13. We expect somesequential benefit from supply chain spend was pulled forward from Q4 into Q3.

Overall the only consistent gross margin sub-metric LULU has been able to hit on is fixed cost leverage,which is a function of sales growth. We would like to see greater visibility (and results) in FY14 nowthat the supply chain and commercial process has had managements focus for an entire year.

To see how we got here lets take a quick blast through the past and highlight LULUs committedsupply chain transformation efforts in 2013. (Warning: This gets lengthy)

Without further adieu, Ladies and Gentleman

1Q13 Call

LULU hires a consultant to improve supply chain logistics.

We now have Jennifer Battersby formerly of Mast working with us on a consulting basis for

five months to enhance and improve our product processes and to get strong round of

candidates for a senior supply chain and logistic position. Were also well into the process of

interviewing candidates for the EVP product role. CEO Christine Day, 1Q13 Conference Call

Great. Well be out of our supply shortage hole and get our pants back in stores.

However, we are getting back into stock gradually as production and delivery of these styles

ramps up and will not be fully back in stock until the end of Q2. CFO John Currie, 1Q13Conference Call

In fact, we are going to see timing improve and regional buys/shipping implemented (retail 101, thisshould have happened a long, long, time ago.)

So by next February what you will see us doing is there will be an actually time to release our

product thats appropriate for the market, so we will start lighter colors sooner in the south and

hot climate, well start the transition to crop sooner in those markets. And then well move

into more of a localized even more localized buy strategy as we move forward and a much more

fuller integration of e-commerce and stores. CFO John Currie, 1Q13 Conference Call

But wait, you just said those pant styles were going to be fully back in stock by the end of Q2?!?

I mean I wouldnt say we would be completely back to our ideal inventory level by the end of Q2

thats a little bit too quick. But certainly by Q3, well clear that again this isnt a huge backlog

and we have the outlets to handle it andI think well be back in a balanced inventory position

by Q3. CFO John Currie, 1Q13 Conference Call

Fine, as long as its all hunky-dory by Q3.


4/11 %

So we bought in a master pattern grader and weve sent, every single factory has all the same

patterns now and we also reduced our tolerances from a inch to half an inch, which takes more to

sell, which is part of the reason why it took us a little longer to get back in stock because the

factories had to show to a new technology level.- CEO Christine Day, 1Q13 Conference Call

2Q13 Call

Time flies and LULU has been hard a work for 3 months on their supply chain, lets see what theyve

come up with!

Step 1: Hire the consultant who has already been working with you! This makes sense as LULU movesproduction away from China to South East Asia (49%/41% in 2011 to 34%/54% in 2012).

As part of that strategy, we named Jennifer Battersby, as our new Senior Vice President of

Sourcing, Quality and CommercializationHer last role with Mast was SVP, Victoria Secret

production, Asia, where she led the production and sourcing, product development, raw

materials and fit teams in Hong Kong, Sri Lanka and Korea. CEO Christine Day, 2Q13

Conference Call

More supply chain timing issues? Are the factories still sewing slow because of quality demands?

While the fall product was later to arrive in our store, we have seen good response to the fallcolor palette and the texture and print we have brought into our core. We are excited about the

innovation you will be seeing in functional outerwear and textured softshell fabrics, puffy jackets

and belts and versatile silhouettes. CEO Christine Day, 2Q13 Conference Call

And some moreOver the past several months weve focused on quality and getting Luon back into our stores.

While this is clearly what was important for our future, it resulted in some short-term pain.

Weve experienced a weak start to this quarter, driven primarily by late deliveries of fall

products, leaving us with the summer product on the floor through August. CFO John

Currie, 2Q13 Conference Call

Ugh. This hangover never ends, lets start focusing blame on our commercialization department! No oneknows who they are /ever asks about them! And wait, product timing issues through the balance of theyear!?! But you said everything was going to be okay by 3Q

These late deliveries are a hangover from the disruption caused early in the year with the Luon

issue. While we were successful in getting back in stores with Luon, the effort required to get

there had a lingering impact on our commercialization and sourcing teams ability to be ready to

hand-off to our vendors the current season. We anticipate this knock-on effect to continue to

impact timing of product deliveries in Q3 and through the balance of the year.- CFO John

Currie, 2Q13 Conference Call

Good thing we are going to have better product flow in the second half of Q3, cant wait to see theresults!

Yes, the Q3 guidance is based on a mid-single digit comp assumption and a slight improvement.

As I said product flow is better as we head into the second half of this quarter.So a slight

increase, but still within that mid-single digit range. CFO John Currie, 2Q13 Conference Call

Just in case you wanted to know how the commercialization process works, here is how they areteaching factory workers in Asia to sew accurately. Showing off how they did such a great job at pickingbest in class suppliers the first time around, since this is a high quality product and all


5/11 &

Great. Our main bottleneck right now is our commercialization department. Every time we

change a manufacturer or every time we change a pattern or fabric for the pant...plus as we

correct for quality and making sure that in every step weve done additional inspections, which

just slows it down and weve increased or decreased would be the correct word, our selling

tolerances, which slowed the factories down a little bit to make sure that at every step in the way

we were getting the quality that we wantedThen you add on just time constraints with the

amount of quantity of product were trying to catch up on with Luon and kind of the seasons

collapsing. If we are late with one, then it affects the start day of the next and so we are incurring

a little bit more airfreight and slowdown in the shipping processSo that commercialization

impact and bringing on the third factory is still at play and we are working back through all of

our other fabrics to make sure that were hitting the quality standard we want. So the

commercialization workload will affect us for a period of time. CEO Christine Day, 2Q13

Conference Call

But no set of excuses is complete without blaming an act of God, the weather, or in this case, Egyptianpolitical unrest. Expect a mix increase in magic carpet yoga mats going forward (I kid, I kid).

We did experience some additional late deliveries and shortages due to political unrest, one of

our key tops is manufactured in Egyptand so its mainly late shipping from that that we are

working through. But we do expect that from a Luon impact that at the beginning of next year weshould be caught up. CEO Christine Day, 2Q13 Conference Call

Okay, we got it, everything is back on plan, sure hope we dont see anymore issues going forward!I would say that because of some of the delays, we havent had as much new product in the end

of the quarter, that as we would have liked and so with the fall drop, were pretty much back on

track with our historical percentages in probably the overall buy, the timing of when things

arrive, the top that matches the bottom and some of the challenges weve had with that in holding

certain items.- CEO Christine Day, 2Q13 Conference Call

Hmm, good thing we now know your historical percentages for your buying pace includes inconsistentproduct flow, keep setting the bar high!

Were using more air freight than we have historically and thats already factored in and thepoint were making is, we still have inconsistent product flows and that will carry on through

Q4.- CFO John Currie, 2Q13 Conference Call

Okay, lets wrap up the Q2 call with the reassurance that LULUs late Fall sets were not only their supplychains fault from a quality/product flow issue but also because they cant get communication flowingproperly to forecast. Excellent.

We just set this last week and normally we would have set in the second or third week of August,

usually actually the second week we do a transitional pod. So yes, that definitely was about

three, three and a half week delay and we are still waiting for confirmation for deliveries for

October and November, so thats affecting our ability to forecast.- CEO Christine Day, 2Q13

Conference Call

3Q13 Call

Finally, the 3Q call. Lets start out with some good news; we finally got the POS systems ready thatweve been talking about all year, hurray!

We came into the holiday season better equipped to handle high traffic volumes during peak

periods, with handheld POS units for line busting. In our high volume stores, we rolled out


6/11 '

mobile ecommerce devices to draw on ecommerce inventory when the store is out of a guests size

or color.- CFO John Currie, 3Q13 Conference Call

But wait, you have to be kidding me, you didnt get everything fixed by Q3?!? Shocker.

The late product deliveries that impacted Q3 have also continued, resulting in uneven product

flow, and in some cases cancellation of purchase orders. CFO John Currie, 3Q13

Conference Call

You mean the product issues, traffic has been weak all year

The combination of traffic and product issues resulted in a lower expectation for fourth

quarter guidance. CFO John Currie, 3Q13 Conference Call

Dont worry though, the product and supply chain issues from the last year are just a symptom. We canget excited, because now we are going on a supply chain journey!

As we get into Q1 and beyond, the improvements that are really underway with the new team

on the supply chain side are a journey. CFO John Currie, 3Q13 Conference Call

And now for some complete BS. Lets just place most of the blame on traffic for guiding down, no focus

on sequentially declining AURs/product mix. Nothing to see here.Roughly Id say its about one third the product issues, and two thirds the traffic discussion.

CFO John Currie, 3Q13 Conference Call

And lower adoption from new customers do to mix shift away from core.

We are finding, as I said, the seasonal items, the unique items, are selling So that may

indicate less new guests, but again, its really too early in the holiday season to do that

diagnostic. CFO John Currie, 3Q13 Conference Call

To wrap things and up and put us all at rest, find solace that the bar has been set low for supply chainissues well into next year. Congratulations Potdevin, blank check. Cha-ching.

So again, as 2014 progresses, well get progressively better, and by 2015 Were not holdingback on investment, etc., in hiring, and by 2015, we should be seeing a much, much smoother

supply chain operation. - CFO John Currie, 3Q13 Conference Call

Needless to say the excuses and expectations have been continually pushed forward and out, are wereally surprised Christine Day is choosing to leave now? Cant wait to see what happens when they turnthe European supply chain on

(Cont. Next Page)


7/11 (

Long Term Expectations:

As fundamentals deteriorate, what can we really expect from LULU, now that they reaching amore mature point in their store rollout plan? Currently, the comparable store sales runway fornew stores is shorter than in the early years. New stores are producing around $1,100 sales persquare foot, just 10.5% below the company wide average.

If anyone thinks that the above chart reflects a company growing share and pricing power in theirmarket, it doesnt. LULU focuses on returning to historical ~55.0% gross margins. We ask whatabout ~ 57.0% gross margins? Yes we understand we are facing currency headwinds, but why isthe bar being lowered so far? On a 4-quarter trailing basis, gross margins did not cross below55.0% until after the Luon pant recall. Perhaps the opportunity for margin recapture is not asstrong as investors were initially led to believe.

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Almost all of the gross margin deleverage has trickled down to the bottom line. In fact, 3Q13was the first quarter where SG&A leveraged since 1Q2012 (+36 Bps). We expect to see furtherleverage in 4Q13 until FY14 where, once again, we expect further SG&A deleveraging(estimating -67 Bps impact in FY14).

Examining segment profitabilityfurther exposes the continuedprofitability erosion in LULUscore company-owned storesegment, which accounted for 80%of sales in 2012.

The erosion to the CompanyOwned Store segment has come ontop of a combined +130 Bps fixedcost and occupancy leveragebenefit in FY11/FY12 and +40Bps, +70 Bps, and +40 Bps, in 1Q,

2Q, and 3Q, respectively.

Conversely, weve seen a returnedpositive trend to the Direct ToConsumer segment as investmentspending has begun to leverage ontop of meaningful top-linesegment results.

We expect/dont care about declining profitability in the Other segment. Sales in this segmentare a dwindling portion of LULUs overall business and used to clear inventory.

Another deeper metric we like to look at is the spread between sales per average store and salesper average square foot. Ideally we would like to see sales per average square foot grow fasterthan sales per average store, indicating higher productively in incremental square footage.

As we can see, LULUs decline in sales per average square foot has been declining faster thansales per average store. Although this metric improved through FY12, the trend has reversed inFY13. We would like to see this trend reverse and spread tighten to reflect improvingincremental fundamentals on the store level.

Average Sales Spreads

Average Sales per Store

Sales per Average Square Feet

Spread

Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013

15.4% 3.1% 7.5% 6.4% -2.9% -1.6% -4.9%

11.1% -0.5% 5.8% 6.0% -4.0% -3.4% -6.6%

-4.3% -3.5% -1.7% -0.3% -1.2% -1.7% -1.7%

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9/11 *

Lululemon Guidance Analysis

Lululemons management has been very adept at hitting their quarterly guidance, their yearlyguidance not so much. We have included our guidance analysis sheet below to track the changes inguidance as the year progresses.

Notice the consistent EPS beats in 1Q-3Q. 3Q was even weaker than expected, missing both the high-end of the sales and gross margin ranges. Despite these misses LULU still reported 3Q EPS of $0.45,beating the high-end guide of $0.41. LULU was able to pull this off through SG&A leverage despiteguiding deleverage. We suspect LULU delayed certain variable expenses (marketing spend slush fundperhaps?) into 4Q13 to make the quarter.

LululemonG

uidanceAnalysis

Low-End

High-End

Low-End

High-End

Low-End

High-End

Low-End

High-End

Quarterly

Q12013G

Q12013G

Q12013A

Q22013G

Q22013G

Q22013A

Q32013G

Q32013G

Q32013A

Q42013G

Q42013G

Q42013E

Sales

333,000

$

343,000

$

345,782

$

340,000

$

345,000

$

344,513

$

370,000

$

375,000

$

379,900

$

535,000

$

540,000

$

545,151

$

0.81%

-0.14%

1.31%

0.95%

ComparableStoreSales

5%

8%

7.0%

5%

7%

8.0%

+MSD

+MS

D

5.0%

Flat

Flat

-1.0%

StoreOpenings

8

8

22

22

21

GrossMargin

48%

49%

49.37%

low

50s(51%)

low50s(52%)

53.98%

lowmid50s(53%)lowmid50

s(54%)

53.86%

55.04%

(567)

(113)

(152)

(150)

bps

bps

bps

bps

SG&A

delever

delever

(85)

delever

delever

(77)

delever

delev

er

36

78

OperatingMargin

implied

implied

19.06%

implied

implied

22.93%

implied

implied

24.31%

implied

implied

30.71%

(842)

(776)

(652)

(497)

(381)

(191)

(398)

(293)

(116)

(128)

(87)

(72)

ShareCount

146m

146m

145,849

146m

146m

145,916

146m

146m

146,014

146,320

EPS

0.28

$

0.30

$

0.32

$

0.33

$

0.35

$

0.39

$

0.39

$

0.41

$

0.45

$

0.78

$

0.80

$

0.81

$

Low-End

High-End

High-End

Low-End

High-End

High-End

Low-End

High-End

High-End

Low-End

High-End

High-End

A

nnual

FY2013G

FY2013G

Change

FY2013G

FY2013G

Change

FY2013G

FY2013G

Change

FY2013G

FY2013G

Change

FY2013E

Sales

1,615,000

$

1,640,000

$

1,645,000

$

1,665,000

$

1.5%

1,625,000

$

1,635,000

$

-1.8%

1,605,000

$

1,610,000

$

-1.5%

1,615,346

$

ImpliedGrowth

17.9%

19.7%

20.0%

21.5%

182

18.6%

19.3

%

(219)

17.1%

17.5%

(182)

17.9%

ComparableStoreSales

4.0%

StoreOpenings

43

43

43

43

43

43

showroomopenin

gs

10

15

15

15

GrossMargin

53.0%

54.0%

lo

w50s(53%)

lowmid50s(54%)

53.0%

54.0

%

5

3.32%

(

234)

SG&A

delever

delever

delever

delever

delever

delev

er

-2

8.27%

(8)

OperatingMargin

(

242)

Capex

90.0

$

95.0

$

95.0

$

100.0

$

5.3%

100.0

$

110.0

$

10.0%

100.0

$

105.0

$

-4.5%

10

5,945

ShareCount

146.2m

146.2m

146.2m

146.2m

146m

146m

14

6,000

EPS

1.95

$

1.99

$

1.96

$

2.01

$

1.0%

1.94

$

1.97

$

-2.0%

1.93

$

1.96

$

-0.5%

1.97

$


10/11 +,

New CEO Laurent Potdevin:

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11/11++

stock to a more terrestrial valuation is often hairy, volatile, and involves many cuts from all those fallingknives.

Consumer Fox doesnt like to lose money and definitely doesnt like to get cut. With shares down toaround $60, we see further downside and shares continuing to exchange hands, fleeing the ownership ofmomo growth owners in exchange for more reasonable GARP styled investors. Were waiting for theflush to end. That could be today, or it could be a month from now. Until then we are placing a $55.00PT based on 25x our 2014 estimate ($2.18). We can easily envision scenarios where we will take thisestimate down further and who really knows what multiple the market will get comfortable with. Withthat in mind, we wouldnt mind entering under $55.00 and below.

Disclaimer:The information contained herein reflects the views of Consumer Fox as of the date of publication. These views

are subject to change without notice at any time subsequent to the date of issue. All information provided in this presentationis for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sellthe securities mentioned or to invest in any specific security or investment product. While the information presented herein isbelieved to be reliable, no representation or warranty is made concerning the accuracy of any data presented. In addition,there can be no guarantee that any projection, forecast or opinion in this presentation will be realized. All trade names, trade-marks, service marks, and logos herein are the property of their respective owners who retain all proprietary rights over theiruse. This presentation is confidential and may not be reproduced without prior written permission from Consumer Fox. Itshould be noted that Consumer Fox has no position in any security of the company mentioned in the report/presentation.

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