Lululemon Athletica Inc. reported a rather blasé fourth quarter, with almost flat year-on-year profit on a comparable-store sales decline of 2 percent, its first quarterly drop since 2009. Its first-quarter and full year outlook also called for basically flat earnings, lower than analysts had expected.
But shares still rose $2.97 – or 6.2 percent on the report last Thursday as the chain’s new CEO, Laurent Potdevin, reassured investors about the yoga-themed chain’s long-term prospects. Representing his first earnings call since taking over from Christine Day in January, Potdevin revealed plans to accelerate international expansion, bring in more seasonal product, expand its “voice,” and redouble its commitment to “great product” and innovation.
“As we move into 2014, we are reflecting on our learnings with humility, and are entirely focused on our future,” said Potdevin. “2014 is an investment year, with an emphasis on strengthening our foundation, reigniting our product engine and accelerating sustainable and controlled global expansion.”
In the fourth quarter, earnings earned $109.7 million, or 75 cents a share, about even with $109.4 million, or 75 cents, a year ago. Results were slightly ahead of a forecast of 71 to 73 cents a share given on mid-January. Before the update, the retailer had expected earnings in the range of 78 to 80 cents a share.
Net revenue for the quarter increased 7.3 percent to $521.0 million due to the addition of 43 net new corporate-owned stores since Q4 of 2012. Of those, 33 new stores opened in the US, two in Canada, four in Australia and New Zealand with four Ivivva locations. E-commerce sales grew 24.9 percent. On a combined basis, including both physical stores and e-commerce, total comps increased 4 percent.
Gross margins decreased to 53.5 percent for the quarter from 56.5 percent a year ago. The decline was largely due to a product margin decline of 270 basis points attributable to a variety of factors, including a shift in product selling mix to seasonal lower-margin items; increased air freight usage; higher inventory provisions; and foreign exchange due to the weaker Canadian and Australian dollar.
SG&A expenses declined to 23.9 percent of sales from 25.1 percent. The overall SG&A spend increased 2.2 percent due to an increase in store compensation and operating expenses associated with new stores, showrooms and outlets; increased variable operating costs associated with e-commerce; and increases in expenses at its store support center, including salaries, administrative expenses and professional fees.
In the full year, earnings rose 3.3 percent to $279.5 million, or $1.91 a share. Sales climbed 16.1 percent to $1.59 billion with same-store sales rising 4 percent on a currency-neutral basis.
Discussing his plans for Lululemon, Potdevin, most recently president of trendy footwear brand TOMS Shoes after a long stint at Burton, said Lululemon will accelerate its global expansion. He added, “We see clear evidence of demand, both in Asia and Europe, with several countries ready for store.”
The retailer will shift its international strategy away from a pattern of first opening showrooms – smaller locations with limited selections and shorter hours – before finding the right staff and locations for full, permanent stores. The company will now run those processes at the same time, Potdevin said on the call.
A general manager for Asia has been hired to pursue growth in that region. Potdevin also said the retailer has “opportunities to build partnerships to increase speed to market and accelerate our international expansion in regions that are either too complex or don't have enough scale for us to have a direct presence in.”
In Europe, the first London store is opening this week. As an example of the local demand, Potdevin noted that 700 people on March 9 lined up outside the Royal Opera House for a yoga clinic. A second store is London will open later this year. Lululemon also opened showrooms in Germany, Singapore, the Netherlands and China in fiscal 2013.
The accelerated expansion will be more evident in 2015 and 2016. Store openings this year will closely match 2013’s rate, with the planned opening of 42 corporate-owned stores, including Australia and the UK, and up to 10 new Ivivva stores
On the product side, Lululemon is refocusing the organization on being design-led. Said Potdevin, “It's about getting back to our roots of inventing the future and we are doing that by fostering and promoting the healthy tension between technical innovation, style, function and beauty.”
The chain recently beefed up its in-house capabilities with the opening of a White Space workshop but will is also closely partnering with vendors to capitalize on their expertise in raw materials, development and construction. A focus will continue to be on bringing in ‘capsule,’ or limited-quantity, collections, with its Lab Colab and Handbook capsules both offering premium athletic styling recently selling well.
Investments will continue in building its supply chain and sourcing organization, which now include a Taiwan and Hong Kong office. Potdevin said the chain is seeing a “constantly increasing level of our product meeting our very high quality standards.”
In early 2012, Lululemon faced an embarrassing recall of its trademark yoga pants that were deemed too see-through. Even after problem was said to be fixed, new complaints emerged about the quality and durability of the pricey workout gear. Said Potdevin of the chain’s sourcing efforts, “There will be continued focus and investment in this area to ensure we're building a product development platform that will allow us to unlock our full global potential.”
In North America as the business matures, Lululemon is seeing increased demand for seasonal product with guests responding to seasonal offerings at a rate 4 times greater than anticipated. More seasonal offerings will be showcased in stores in the second half of the year. Said Potdevin, “Our guests are clearly speaking for more freshness and more or better product in our line.”
Relatedly, Potdevin said the while the focus will continue to be on a “scarcity model” to support demand, Lululemon will be putting more emphasis on quick-turn efforts to fill depleted stock. Said Potdevin, “While we don't mind our guests being hungry for our product we don't want them to starve for it.”
On the outreach front, Potdevin said “now is the time to amplify our voice” to complement its successful grassroots communication strategies. He noted Lululemon had “stumbled a couple times and we had to be defensive” in 2013, alluding to not on the recall but Founder Chip Wilson’s comments on Bloomberg TV last November that Lululemon's yoga pants didn't fit well on some women that caused an uproar. He later issued an videotaped apology, and in January indicated he would step down as chairman before the annual meeting in June.
“We need to take control of the discussion around Lululemon, and really share more proudly and with humility who we are and what we stand for, which really differentiate us from everybody else,” said Potdevin.
Potdevin said he doesn’t expect the retailer to roll out any “large marketing investments,” but will amplify “what we do really well at the grassroots level” through PR, in-store marketing, and further empowering store associates and ambassadors to speak out.
He pointed to a “treasure chest of amazing stories” that tell the story of Lululemon. This includes its SeaWheeze half marathon race, which sold over 10,000 spots in 56 minutes, with 45 percent of the guests registering from outside of Canada. It also includes its support of more than 100 Olympians through yoga and goal setting, as well as its over 900 local ambassadors that all demonstrate how Lululemon connects with communities.
“We've been voiceless for too long,” said Potdevin. “And I'm anxious to have all of us share more broadly who we are, what we stand for, with confidence and humility.”
Another related strategic focus will be on how Lululemon is engaging with guests across all touch points, both in stores and online. Potdevin said that while Lululemon’s customers are “passionate and loyal,” the competitive level has heightened.
“Unlike a few years ago we are not the only game in town,” he said. “And while we've created this category and continue to lead it, we understand that our guests have choice, and sustaining that loyal relationship is a priority. I believe this will come from ensuring that we really focus on creating a best-in-class guest experience.”
Potdevin still said while near term priorities include building its infrastructure internationally and investing in its design and sourcing capabilities, Lululemon still has a long-term goal of maintaining an operating margin in the mid-20s.
For the first quarter, Lululemon expects revenue to be in the range of $377 million to $382 million based on flat combined comparable sales on a constant dollar basis. The quarter is expected to be hurt by a lack of seasonal product given that buys were placed six to nine months. EPS is projected to range between 31 to 33 cents, which compares with 32 cents last year.
For fiscal 2014, Lululemon expects net revenue to be in the range of $1.770 billion to $1.820 billion based on a total combined comp increase in the low to mid-single digits on a constant dollar basis. EPS is expected to be in the range of $1.80 to $1.90 for the full year, slightly down from the $1.91 just reported.