When Lululemon Athletica Inc. (NASDAQ:LULU) released mixed fiscal first-quarter 2016 results earlier this week, investors were right to celebrate. Shares of the yoga-apparel company closed up 5% on Tuesday after it revealed quarterly revenue rose a healthy 17% year over year, to $495.5 million, helped by a 6% increase in total comparable sales, and well above analysts' estimates that called for 15% growth, .
The metrics would have risen an even better 19% and 8%, respectively, had it not been for the negative effects of foreign-currency exchange. Lululemon's burgeoning men's category increased revenue 21%, marking its sixth-straight quarter of at least 15% growth. And its core women's bottoms business continued to achieve comparable-store sales growth in the double digits.
At the same time, lululemon's bottom line looked less impressive. Gross margin declined 30 basis points from the same year-ago period, to 48.3%, net income fell 5.2%, to $45.3 million, and adjusted earnings of $0.30 per share technically fell $0.01-per-share short of expectations. So why was the market so pleased?
First, lululemon's gross margin pressure began to manifest late last year when the company decided to sacrifice near-term profits in favor of making investments to improve its supply chain and quality assurance platforms -- or, as CEO Laurent Potdevin put it at the time, to build a "scalable, complex platform at a time when we are growing internationally and we have added resources to the team."
Despite the market's initial negative reaction to the move, I subsequently applauded lululemon for its long-term focus, especially as the company promised its gross margin pressure would only be a short-term issue, and ultimately recover as its quality assurance and supply-chain investments begin to yield fruit.
With lulumon's quarterly report in March, we saw more evidence that the company's turnaround was on track when gross margin came in above expectations, at 50.3%. But even more important is the fact that, in that report, lululemon told investors to expect fiscal Q1 gross margin to fall to roughly 47% as it continued to reduce inventories, then reach an inflection point beginning in the fiscal second quarter of this year. This means that, even as gross margin declined on a year-over-year basis this quarter, lululemon's actual 48.3% result was, once again, well ahead of expectations.
"As we look to the rest of 2016 and beyond," Potdevin stated during this week's conference call, "I am inspired by the progress we are making -- in particular, the return to earnings growth, driven by gross margin expansion -- that we see taking shape in Q2." Lululemon CFO Stuart Haselden elaborated, "We delivered accelerated progress in recovering our gross margins, and completed our work to rebalance our inventory levels in an orderly and disciplined manner."
Put another way, Lululemon is sitting on the cusp of reclaiming the enviable profitability that had investors so enamored with the stock before its quality-control issues and subsequent PR headaches effectively decimated both investor sentiment and consumers' perception of its premium brand. For opportunistic investors willing to buy now before that recovery is painfully obvious, I see no reason lululemon stock won't continue to drive market-beating returns going forward.