Shares of lululemon athletica inc. (LULU 3.13%) are down 18% since the yoga apparel specialist reported fiscal second-quarter results earlier this month. But contrary to what that plunge might seem to imply, you might be surprised to know Lululemon actually exceeded analysts' expectations on both revenue and earnings for the quarter.
So what happened? While Lululemon told investors to expect current-quarter revenue of $477 million to $482 million -- the mid-point of which was also above expectations -- it anticipates earnings per share will be $0.35 to $0.37, significantly below average estimates for earnings of $0.43 per share.
To be fair, those numbers in isolation don't provide clarity on what exactly is driving Lululemon's results. Luckily for investors, Lululemon management spends some time each quarter providing color on its performance and future prospects in a conference call with analysts. Here are five key points discussed during this quarter's call:
1. Why margins are under pressure -- for now
It's really, really important for everybody to understand that the short-term gross margin pressure that we're experiencing is not the result of higher markdown of quality issues. We're building a very scalable, complex platform at a time when we're growing internationally. And we've added resources to team, and we've validated that not only we will see the margin expansion that we've committed to, but still see it in 2016 and beyond as we have stated before. -- Lululemon CEO Laurent Potdevin
Though Potdevin also touched on this topic early in the call, this comment came in response to a question on the expected long-term recovery of Lululemon's gross margin, which largely explains its guidance shortfall on the bottom line. To be sure, some analysts had wrongly worried this was a result of either higher markdowns or ongoing quality issues that plagued the company up until last year. Instead, Potdevin argues the gross margin pressure is the result of Lululemon's ongoing expansion of products and its geographic footprint -- both positive factors for investors over the long term.
2. Elevated inventories are no surprise
It is important to note that our outlook on inventory levels remains the same and we're on track with the strategy outlined during our last call. As a reminder, we identified opportunities to reflow approximately two-thirds of the late arriving inventory into our second half assortments at full price with little incremental markdown risk. The remaining third will be sold down through our normal exit channels which includes our outlet stores, online warehouse sales, and physical warehouse sales. -- Lululemon CFO Stuart Haselden
Relatedly, Lululemon's inventory skyrocketed 55% year over year to $280.6 million, far outpacing actual sales growth of 16%. Again, this stoked fears that Lululemon will be forced to incur significant markdowns in order to right-size inventory in the coming quarters. But while inventory is obviously higher than Lululemon would like, investors should be reassured by Haselden's comments that Lululemon is still on track to meet its inventory goals as outlined in the last conference call three months ago.
3. Why Lululemon is pushing back the new website launch
With Miguel [Almeida] coming on-board, and as we prioritize our digital initiative for the remainder of the year, we have decided to launch our new website in Q1 of 2016. This shift in timing allows us to free-up some bandwidth to focus on optimizing traffic and conversion on our current platform at a critical time of the year. It also creates more runway to fully leverage the new site design when we launch early next year. -- Laurent Potdevin
Potdevin first outlined the planned redesign of Lululemon's website during last quarter's call, stating it would include an improved checkout process, targeted recommendations, and optimization across all web-enabled devices. At the time, he also suggested the first phase of that redesign would be launched in the second half of 2015, just in time for the holidays. In late June, however, Lululemon hired industry veteran Miguel Almeida to effectively spearhead its digital transformation. Keeping in the mind the move didn't affect Lululemon's guidance, Potdevin later elaborated, "it just felt like the right decision" to hold off on the broad website launch until after the crucial holiday season.
4. The men's business is accelerating
The solid 31% comp in our men's business was driven by strong sales in the 'sweat' category which is the anchor of our men's business. Along with further improvements to our metal vent franchise, we continue to introduce new fabric such as Intersec and PrimaTech to support our male guests' training pursuits. That said, all men's categories -- including our 'no-sweat' and 'post-sweat' offerings -- performed well, and these results continue to validate our goal of building a billion dollar men's business globally. -- Laurent Potdevin
That 31% boost is a solid acceleration from the 19% comparable-store sales growth Lululemon's men's business posted last quarter. According to Lululemon CPO Tara Poseley during the Q&A portion of the call, they're particularly excited about the "sweat" category because they view it as "really the foundation of our men's athletic business." As I suggested early last year, I believe the single biggest challenge Lululemon faces on a global basis is convincing consumers and investors it's not "just" a female-centric yoga brand. With these impressive results, I think Lululemon is doing a great job of overcoming this challenge so far.
5. International development is going strong
As we build a global, iconic brand, we are extending our footprint globally. International expansion is a key growth driver and we continue to increase our brand presence in major cities both in Europe and Asia.
Speaking of global growth, keep in mind the United States and Canada still collectively accounted for 298 of Lululemon's 336 total company-operated stores at the end of last quarter. In addition, only 17 of Lululemon's 82 showrooms in operation are located internationally. Let it suffice to say, then, that Luluemon should enjoy a massive runway for international growth going forward.
That said, management has also stated international locations generally come with a higher cost structure than North American locations, namely in the form of higher occupancy costs. Nonetheless, Lululemon would be crazy not to seize the global stage, has not only seen strong positive consumer reactions to its brand so far in key European markets and Asia, but is also looking forward to its first opening in Dubai by the end of this month. Over time, if Lululemon can continue this momentum, extend its reach, and keep growing the value of its brand, shares of this promising athletic apparel company should follow suit.
