Shares of Lululemon were plunging around 23 percent in afternoon trading after the company warned that its first-quarter results would arrive well below Wall Street targets.

Shares were down about $15 to $51 in over-the-counter trading.

The drop came despite the retailer reporting healthy fourth-quarter results marked by 7 percent constant-dollar comp and gross margin improvement of 390 basis points. For 2017, the company marked positive operating earnings growth for the first time since 2013. On a conference call with analysts, officials also predicted strong improvement in the back half of the year.

But the first-quarter slowdown was sudden. For the current quarter, earnings are expected in the range of 25 to 27 cents per share on revenue of $510 million to $515 million. Analysts had been looking for earnings of 39 cents on revenue of $552 million. Earnings will be down 18 to 24 percent versus year-ago results of 33 cents a share.

Total comparable sales on a constant-currency basis in the first quarter are projected to decrease in the low single digits, which would mark Lululemon’s first same-store sales decline in 28 quarters, or since 2009.

On the call, Stuart Haselden, CFO, blamed the downspin on softer traffic at its stores combined with lower conversion on its e-commerce site. Said Haselden, “Within our stores, we’ve seen conversion, AUR and UPT all remain solid with traffic the primary headwind.”

Laurent Potdevin, CEO, said the slowing sales trend in early Q1 has “most acutely impacted” e-commerce.

“We have clearly identified the issues, an assortment lacking depth and color for spring compounded with visual merchandising that did not powerfully translate our design vision,” stated Potdevin. “With focused urgency our teams have been cross correcting the issues, with early indications reflecting an immediate and positive impact on performance. We will see more color in selected style as early as next week.”

From a visual merchandising standpoint, Potdevin said its Loud And Clear Jacket “is the perfect example of what happens when we capture both design and function infused with energy and movement into our e-com images. Since delivering these results the performance of that jacket has significantly increased.”

Haselden likewise said that the launch of a number of guest acquisitions and retention programs beginning this week and ramping into Q2 should revive growth. The programs include next week’s launch of the Fast & Free Nulux collection. The expansion of omnichannel programs are also expected to lift sales. Ship-from-store is being expanded from 85 to 145 stores by the end of Q2, while also being added to its outlet stores beginning in the first quarter. The pilot of its buy-online-pickup-in-store (BOPIS) capability will begin in Q2.

“Within e-commerce, the online conversion trend has also been a particular focus and we’ve taken aggressive actions to improve site performance,” added Haselden. “Our initial reads indicate these efforts are gaining traction.”

From a margin standpoint, the company said that while product margins are continuing to improve at a similar rate as that seen in the second half of 2016, the sales decline will impact leverage in the first quarter. As a result, gross margin in the quarter is expected to increase only 50 basis points versus Q1 2016. SG&A is also expected to decline as a percent of sales by 150 basis points, again due to eroding leverage with the sales shortfall.

The first-quarter shortfall marred a fourth-quarter performance that was among the best at retail.

Fourth Quarter Boosted By 7 Percent Comp Gain
Earnings in the quarter ended January 29 climbed 15.9 percent to $136.1 million, or 99 cents a share. Revenues rose 12.2 percent to $789.9 million. Results came in largely in line with update at the start of the year.

On January 9, Lululemon said it anticipated revenue in the quarter in the range of $775 million to $785 million, based on a total comparable sales increase in the mid-single digits on a constant-dollar basis. That compared to previous guidance of revenue in the range of $765 million to $785 million. The company at the time raised its EPS guidance to the range of 99 cents to $1.01, up from 96 cents to $1.01 previously.

The 7 percent comp gain on a constant-dollar basis was comprised of a bricks-and-mortar comp increase of 6 percent and an e-commerce comp of 12 percent.

The top line benefited from an increase in square footage of 11 percent versus last year, driven by the addition of 43 net new company-operated stores since Q4 2015, including 16 in the U.S., three in Canada, 1 in Australia and New Zealand, 7 in Asia, 4 in Europe and 12 Ivivva stores.

At the close of the year, Lululemon had 406 total stores versus 363 a year ago, as well as a total of a 51 showrooms in operation. Company-operated stores represented 72.3 percent of total revenue in the quarter. Revenues from its digital channel totaled $164.3 million or 20.8 percent of total revenue, a consistent rate with the fourth quarter of last year. Revenues from our digital channel totaled $164.3 million or 20.8 percent of total revenue, a consistent rate with the fourth quarter of last year.

Other revenue, which includes strategic sales, showrooms, pop-up stores, warehouse sales and outlets, totaled $54.9 million versus $48.9 million in the fourth quarter of last year.

By product category, women’s bottoms jumped 14 percent in the quarter on top of a “very strong” Q4 last year, according to Potdevin. The gains were driven by the depth of its assortment in key franchises such Align and Wunder Under and complemented by special editions such as Tech Mesh. Bras saw a 10 comp, again driven by a breadth of assortment and “reflecting Lululemon’s strengthening position as a destination for active bras.”

Men’s jumped 20 percent in the quarter, boosted by the popularity of core styles as well as new additions with the Metal Vent Tech wall and the License-To-Train capsule “both performing very well.”

The 390-basis point improvement in gross margins reflects 410 basis points of gains in overall product margin, primarily due to lower average unit costs and improved AUR. The gains followed as similar strong pickup in the third quarter.

Markdowns had only a 20 basis points impact on product margin. Ten basis points of leverage in product and supply chain overhead costs was offset by 20 basis points of deleverage from occupancy and depreciation, and 10 basis points of decline due to the foreign exchange impact of a stronger U.S. dollar.

SG&A expenses increased to 29.3 percent of revenue from 26.7 percent in the same period a year ago. The expense rate was 110 basis points above prior guidance with nearly half of the shortfall due to FX-related reevaluation of U.S. dollar cash balances with the Canadian dollar strengthening significantly in the final weeks of the quarter. Operating income climbed 18.2 percent to $196.6 million.

For the full year, Lululemon marked progress in its goal to recover its product margins and reestablishing its growth momentum.

Net earnings rose 14 percent to $303.4 million, or $2.21 a share. Revenues climbed 13.8 percent to $2.34 billion, marked by a 7 percent gain in same-store sales. Gross margins improved 280 basis points to 51.2 percent.

Inventories were management well, up 5.1 percent overall, reflecting a 5.7 percent decrease in inventory per square foot. Said Haselden, “This was slightly lower than expected due to the timing of in-transit inventory. As we head into 2017, we expect our inventory growth going forward to normalize and be more in line with our forward sales trend.”

Discussing some priorities for 2017 and its progress on its goal to double revenues to $4 billion and more than double our earnings by 2020, Potdevin said the company will launch its first global brand campaign beginning in early Q2. He added, “Through these disruptive and innovative campaigns, we will strengthen our guest loyalty, while also inspiring millions of new guests to join our growing collective.”

“Unprecedented Cadence Of Innovation” Expected To Boost 2017 Sales
On the product side, Potdevin predicted its core business this year “will be powerfully augmented with an unprecedented cadence of innovation between now and the end of the year.”

Women’s remains on track to become a $3 billion business by 2020 with a focus on delivering innovative fabrics and styles and building on the popularity of its bottoms and bras.

A major launch next week will be the Fast & Free collection, which builds on its highly-successful Align Pant franchise and marks the first time its top-performing Nulux fabric will be featured in a tight, crop and bra. Said Potdevin, “Validated by Nulux’s recent attention as one of our guest’s favorite technical fabrics, we know this launch will deliver substantial revenue for 2017 and beyond.”

In early May, Lululemon will launch a “bold new concept that will disrupt the bra category.” Also in women’s, “substantial opportunities” in outerwear and accessories are expected to be tapped in the second half of the year.

Men’s is on track to become a $1 billion-plus business by 2020 and is expected to see “accelerated results beginning to take shape” in the second half of the year. Said Potdevin, “I’m excited by our men’s performance, particularly within our co-located formats where, for example, in our Mall of America store, by doubling our dedicated men’s square footage, we saw a 70 percent lift in the business with no increase in inventory. In 2017, we will open further co-located and local stores, while optimizing our men’s expense online to capture the significant runway ahead of us.”

Regarding digital, also projected to reach $1 billion by 2020, the focus is on fully leveraging its CRM platform and expanding and integrating omnichannel strategies.

North America retail still has “substantial upside as we continue to ramp up our most established business” with the success attributed to its “disciplined store expansion,” store teams, new store formats and market optimization strategies, according to Potdevin. The region will see 10 percent square footage growth with 28 new stores and 12 remodels.

Internationally, targeted to reach over $1 billion by 2020, the focus for 2017 will be on China. Its first three stores were opened in the fourth quarter in Shanghai and Beijing. The expansion focus will be on Tier 1 cities, including Shanghai, Beijing, Guangzhou and Chengdu.

“With China’s activewear market valued at $28 billion and growing, the world’s largest middle class and over 450 million millennials living an increasingly active lifestyle, the magnitude of our opportunity in China is unparalleled,” said Potdevin. “And the strong performance we’ve seen out of our store openings thus far give us confidence in the market readiness as we accelerate our expansion.”

For the current year, Lululemon expects revenue to arrive in the range of $2.55 billion to $2.60 billion based on a comp percentage increase of low-single digits. The full-year guidance reflects strengthening trends in both e-commerce and stores due to strategies around product assortment improvements, website enhancements and acceleration of its omni-channel model. Added Haselden, “We are starting to see evidence of these strategies now materializing.”

The company expects to open up to 50 company-operated stores, including an acceleration in its international store openings to 15, to add approximately 12 percent in square footage for the year.

Gross margin for the year is expected to be flat versus 2016. The benefits from the product margin improvements will have the “most meaningful impact” in the first half of the year and then moderate into the second half. Offsetting this is a modest level of deleverage in product and supply chain SG&A and an occupancy and depreciation primarily due to the accelerated international store openings, which carry a higher occupancy rate.

The SG&A rate is also projected to be flat versus 2016 with improvement seen in the second half. EPS is expected in the range of $2.26 per share to $2.36 per share, up from $2.21.

Photo courtesy Lululemon