Lululemon Athletica Inc. easily beat its own sales forecast for the fiscal first quarter ended May 3 even as late product deliveries caused a huge jump in inventories that will take two quarters to correct.

The Canadian fitness apparel company reported sales grew 10.1 percent to $423.5 million, well above the company's $413-to-$418 million guidance. The growth was driven by a net increase of 53 stores compared with a year earlier, including 35 in the United States, two in Canada, and 13 Ivivva stores. LULU grew its retail square footage 21.8 percent in the 12 months ended May 3. Direct to consumer net revenue increased 27 percent to $83.6 million, or 19.7 percent of total company revenue, up from 17.2 percent in the first quarter of fiscal 2014.

Comparable store sales declined 1 percent In currency-neutral (c-n) terms, at the 240 bricks-and-mortar stores in the company's comps base, but  increased 31 percent in its direct-to-consumer channels, resulting in a total  comps rate increase of 6 percent.  The high direct-to-sales growth reflected, in part, the company's ability to flow late deliveries more quickly to its e-commerce store.

Comps rising with improving inventory

More timely product deliveries since the mid-February resolution of the labor dispute at West Coast ports helped improve conversion rates and accelerate comps growth toward the end of the quarter and through the first five weeks of the current fiscal quarter. 

“We have seen an acceleration in our business in the latter part of the quarter, as our inventory positions began to improve, validating our new product flow and assortment,” said CEO Laurent Potdevin.

Men's comped up 19 percent, while Women's comp were driven upward an unspecified amount by higher sales of bottoms, including the company's flagship Wunder Under stretch yoga pants. At Ivivva, which caters to young girls, total comps rose 29 percent.

The new store and e-commerce sales growth  more than offset the impacts of late deliveries and a decline in  the Australian dollar, which decreased reported revenues by $15.2 million or 3.6 percent.  LULU operates 27 stores in the country.

Aging product, air freight charges hurt margins

The sales growth were not enough to sustain gross margin, which fell 230 basis points to 48.6 percent, falling short of LULU's guidance. Foreign currency exchange rates, strategic investments in product and supply chain functions and higher occupancy and depreciation expenses dragged down gross margin by 70, 30 and 130 basis points respectively.

Air freight costs  incurred to mitigate West Coast port delays cost another 100 basis points of gross margin. CFO Stuart Haselden noted that air freight rates and surcharges increased significantly towards the end of the quarter as companies competed for capacity. The lack of full-margin spring product, meanwhile, shifted the sales mix toward marked down winter product.

LULU countered some of the declines by trimming SG&A expenses to 32.5 percent of net revenues, down 20 basis points from a year earlier.

Income from operations decreased by 3 percent to $68.0 million, or 16.1 percent of net revenue, compared to 18.2 percent in the first quarter of fiscal 2014. Diluted earnings per share were 34 cents on net income of $47.8 million; about flat with a year earlier after excluding a surge in tax expense LULU incurred in the year earlier quarter when it repatriated U.S. profits.

Inventory stacks up
The company ended the first quarter with nearly $100 million less cash and cash equivalents and 31 percent more inventory compared with a year earlier as first quarter deliveries delayed by disruption at West Coast ports combined with on-time deliveries  to elevate inventory on hand and in transit at the end of the quarter.  Haselden said that while he expects inventory levels to remain elevated for the next few quarters, the company has devised strategies to sell it that minimize markdown risk.

“We have identified opportunities to reflow approximately two-thirds of this late arriving inventory into our second-half assortments at full price with little incremental markdown risk,” said Haselden. “The remaining third of these late arrivals will be sold down through our normal exit channels, which include our outlet stores, online warehouse sales and physical warehouse sales.”

For instance, the company is moving up its online warehouse sale from October to the second quarter.
Clearance sales expected to boost fiscal Q2 growth

Clearance sales expected to boost Q2 sales
As a result, LULU issued guidance for the current fiscal quarter that calls for total comparable stores sales to accelerate to the high-single digits in the current fiscal quarter, compared with flat growth in the year earlier quarter. That is expected to result in sales of $440-to-$445 million and diluted earnings per share of 31-to-33 cents, compared with $390.7 million and 33 cents in the fiscal second quarter of 2014.

LULU will ship new tanks in second quarter feature higher support constructions, more diverse coverage and expanded sizes.

“We look forward to seeing how our guests respond in Q2 and through the second half of the year when our product assortments are properly balanced by season and quantity,” Potdevin said.

LULU also upgraded its fiscal 2015 guidance, which now calls for net revenue to grow in the 11-to-13.8 percent range to $2.00-to-$2.05 billion. Guidance issued by the company March 26 forecast revenue growth of 9.4-to-12.2 percent.  The new forecast still assumes total comparable sales will grow in the mid-single digits on a currency-neutral basis. Diluted earnings per share are now expected to be in the range of $1.86 to $1.91 for the full year, up a penny from the march forecast, and still about flat with the $1.89  reported for fiscal 2014 after excluding the tax on repatriated profits. 

New stores in major Europe and Asian retail destinations, where Lululemon stores have so far been exceeding expectations, will also increasingly drive growth.

“They're rivaling some of the best stores in North America from a sales standpoint,  from a sales-per-square-foot standpoint” said Haselden. “These stores are very profitable. And on a four wall basis, very attractive.”