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High costs at Lululemon mean bad karma for profits

September 10, 2015

Lululemon Athletica Inc. Chief Executive Officer Laurent Potdevin At New Hong Kong StoreLululemon Athletica Inc. Chief Executive Officer Laurent Potdevin At New Hong Kong Store
Athletic apparel sits on display inside a Lululemon store.Photograph by Xaume Olleros — Bloomberg via Getty Images

High air freight costs, increased markdowns, and store renovations stretched Lululemon’s profits into a downward pose for the latest quarter, sending its stock down 15% Thursday.

Shares slumped after Lululemon (LULU) reported gross margins for its fiscal second quarter dropped to 46.8% from 50.5% the prior year. International expansion and high lease costs tied to store renovations and relocations hurt results, as did markdowns from an online warehouse sale held during the term.

Lululemon also warned that gross margins for the current quarter would remain pressured at around 47%. Margins stood at 50.3% during the same period last year and 53.9% two years ago.

“It’s really, really important for everyone to understand that the short-term growth in margin pressure that we are experiencing is not the result of higher markdowns or quality issues,” Lululemon CEO Laurent Potdevin assured investors as he responded to an analyst during a conference call Thursday morning.


However, markdowns were one of several factors pressuring margins listed by Potdevin during his prepared statement on the conference call, albeit not as meaningful of an impact as say, airfreight costs or weaker Canadian and Australian dollars.

Lululemon executives promised during the conference call that the retailer would remain at the “top end” of the pyramid it has created – the high-priced market for athletic gear that rivals like Athleta (GPS) have sought to replicate at more affordable price points. Potdevin said Lululemon doesn’t see itself limited by pricing “as long as we deliver the value to our guests both from a functional and from a design standpoint.”

Quality was a big issue a few years ago when Lululemon got caught up in a high-profile recall involving see-through yoga pants. Since then, the company has pushed to lift its image as an apparel maker that can promise high-quality garments. That message continues to succeed with consumers: Despite shrinking margins, Lululemon on Thursday reported strong top-line growth. Revenue jumped 16% to $453 million in the second quarter, better than what Wall Street analysts had anticipated.

Expansion has greatly boosted sales. Lululemon has increased its retail square footage by 24% since last year. A strong performance for its men’s business continues to fuel results, as comparable sales for the unit soared 31% from a year ago, bolstered by interest in Lululemon’s “sweat” gear, which is company lingo for shirts and pants meant to be worn while out for a run or in a yoga studio.