Lulu's Fashion Company Update

Lulu’s Fashion Lounge has gotten off to a very impressive start as a public company since their $92M IPO in November 2021. Last year we reported on their highly differentiated business that their CEO describes as a “data driven digitally native” model that currently only ships to US-based customers. Our last piece focused on their impressive returns on acquisition spending. Things have gotten even better for the company this year as the return of weddings and other post-pandemic events have driven impressive gains in Revenue, AOV, and Gross Margins in the most recent quarter.

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Their stock has been on an impressive run, outperforming the S&P 500 YTD by 30 percentage points and almost tripling from peak to trough since reporting earnings on May 17th. We will also look at their most recent comments on the challenges other retailers are seeing on excess inventory, consumer demand, and logistics challenges. (Hint: They aren’t seeing any of these issues)

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Stats from the most recent quarter were unambiguously good. Sales of $111M grew 62% YoY, gross margin of 47.3% was up 220 bps YoY and Adj EBITDA margin expanded to 8.9% vs 7.8% in Q1 of 2021. Management also very modestly raised the FY22 sales guidance by 2.1% to 490M-500M. Annualized inventory turns stand at an extremely impressive 8x, meaning they full turn every 45 days. Luckily Lulu’s executive team has been very busy hitting the Street with interviews and commentary over the last six weeks with their earnings call and attending Retail & Internet conferences with Cowen, Jefferies, and Baird. Their major talking points and initiatives have centered around their data driven buying model, financial flexibility since paying off long-term debt, and substantial supply chain investments.

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Data Driven Buying Model

Lulu’s leadership team consistently attributes their success to their “low fashion risk” approach that is primarily supported by a process of buying small batches of products and testing consumer reactions. Their design team launches hundreds of SKUs per week and can sell 94% of their “winners” at full price. Non-winners are dropped from the catalog, leading to 70% of revenue coming from reorders recommended by their proprietary algorithm. Lulu’s CFO calls this a “great ability to flex up and down, as we are heavy on variable costs.” Lulu’s doesn’t try to predict the next trend, they will introduce 200 to 250 SKUs across product classes and measure performance by product attributes. This allows them to always know what attributes are trending and then work closely and quickly with their vendors to increase those attributes in the catalog. They key on the term “fresh fashion,” offering longer shelf life, less seasonal risk, and better quality than fast fashion competitors.

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Balance Sheet Flexibility

Lulu’s has smartly used their IPO funding to reduce their long-term debt on the balance sheet. Their $12.8M interest expense in 2021 will decline to 700K in FY22. The CEO told Cowen’s Oliver Chen that months ago they had a “difficult balance sheet.” Before the IPO liquidity event, they had to monitor their cash flow weekly, but their newly gained debt freedom allows them to test new categories and invest in fulfillment center robotics and expansion.

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Their CEO spoke about using this opportunity to expand their top of funnel brand marketing. They typically have not spent much in that area, choosing to focus on transactional/performance online advertising primarily “due to balance sheet constraints and the ownership structure.” He called out their relatively low brand awareness, and his interest in driving more awareness from brand spending. This is intended to support what has been a primarily word of mouth driven brand discovery.

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The Lulu’s team also chose to invest in a transition to a reward-based discounting program as opposed to coupon-based offers. In March 2022 they relaunched LUV Rewards. The program is intended to provide Lulu with first party data as points are rewarded to customers based on engagement. The flexibility of this new program (relative to coupons) will drive higher customer lifetime value. While customer engagement has increased “right off the bat,” there is no disclosed financial modeling or ROI analysis around this initiative. Leadership told analysts on their earnings call that they are still in test and learn mode.

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Supply Chain Investments

In Q1 2022 Lulu’s also transitioned inbound receiving and product quality control from a 3PL to in house facilities and staff. Their in-house fulfillment centers are in Southern California, Northern California, and Eastern Pennsylvania. In March 2022 they rolled out robotics use in the Eastern Pennsylvania FDC. These decisions have already shown increased efficiencies and lower cost per unit than the third-party provider.

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The company also has a full slate of follow-on investments in logistics, including expanding their Southern California center in coming quarters to meet demand in California, AZ, and NV and rolling out robotics in the Northern California facility (included in Capex forecast). The CEO trumpeted their successful robotics rollout that occurred during the peak Spring season, adding that these automation efforts significantly improved employee turnover vs Q1 2021.

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Conclusion

Lulu’s management has a clearly differentiated business model that has obviously excited many equity investors that have been downbeat on retail recently. Management plays up balance sheet strength, cash flow, and fast turn of inventory. They offered positive comments on consumer health, seeing more activity from both new and repeat customers while there is little to no reaction from price increases. We will be continuing to follow their story and see how their performance develops as post-quarantine events diminish into year end.