Today was the Q1 2012 earnings call and it was definitely one of the more interesting ones I’ve listened to in the last 2 years. The initial headlines are that the first quarter of the year is better than expected (based on the prepared comments by Christine Day, particularily ecomm has done really well (but that is compared with last year when they were transitioning ecomm to in house, also the product drops are now occurring first on ecomm before the stores). And while that is true there were some very interesting concerns brought up by investors in the question period that really reflect the concerns I have been speaking about (over here) in regards to the brand getting diluted with too much ‘innovated’ product that falls flat, and hardly any of the tried and true designs that we consumers come back to over and over again. It’s so interesting that the investors seem to really be hearing our feedback and concerns yet Lululemon seems deaf to it all. You really learn so much more based on the questions that are being asked rather than the projections. Please also note that I am just summarizing and making my own  observations of what was discussed based on a cursory glance, this is not a transcript of the call. For a full version of the call please listen to the webcast.

Virtually every single caller asked about this strong focus on capsules and if that is driving price increases while the capsules are performing poorly.  Christine confirmed that indeed there were more capsules this year at 8 when the norm was about 2-3 per year before. She also confirmed that the swim line and commuter capsule did not perform well. Commenting that with the swim line ‘we learned a lot about tech manufacturing and about fit and function and fabric. We had a great response (nope, no you didn’t. That is why the capsule was not a success and why all local stores have full inventory still) but we learned something about the technical aspect. We don’t make big buys in new categories and take big risks so there aren’t huge markdowns. As for the commuter capsule there were some issues with the buy there and we went a little deeper than we should have.’ ‘These capsules will compress our margin over short term but will help with product development over long term. We had great learning about bike.’ 

Another caller asked ‘Talk about the strategy on product innovation vs. inventory chase. What opportunities are you seeing in product innovation side in terms of resources. It seems like there has been a shift of focus from last quarter’ 

There has been a shift from last year where we were so heavily in chase vs. what the consumer needs. There is a brand cost to that.  (Flash?????) If we chase an extra amount of pink (flash!!!!!) when yellow is what’s needed we create future markdowns and just destroy the brand. Are we doing no chase? no. Just not as much chase as last year. We are committed to quality. Innovation is not just capsules and pods, it’s blending fabrics on garments and that requires more complexity and more construction and we make sure that quality is what we are are doing well. Our ability to execute the brand that we know the consumer wants us to be.  

Are the risks you are taking with innovation and specific capsules hurting you?And the response was that ‘hits and misses are already built into the growth model’. 

Elaborate on the innovation comment. It sounds like it may constrain the comps on the core business. And Sherry please talk about the capsules. 6 this year? 

Sherry: June/Aug/Oct – cycling commute and spin. November – Bar (Bar Method) Capsule, December – Deeper into warm wear, puffies and running luon. January – Gym and Crossfit

And half of the year are there lower product costs opportunities or is innovation going to continue to raise prices of costs to good sold? 

lower product cost later in the year…certainly after q2, any inflation that we started to see a year ago is  going to be reflected in our cost. Continued innovation using new fabrics and construction is likely to offset any costs we may be seeing. 

How much inventory should we see dedicated to these innovation capsules? John, normalized markdowns – did that have something to do with some of the hit you took with the commuter line products? And also, how are some of your current products not meeting the needs of Crossfit and Bar Method. I already see lululemon being worn in these places.

The capsules effect are pretty insignificant (It’s what show rooms are to full stores). they are not meant for capital but meant as product testing. Sales of any one capsules impact was minor. 

Product costs. A lot of that is coming from the innovation that your doing so well. Are you able to do anything about controlling the cost of labour and materials? 

product costs and pressure are coming from inflation. That is already baked in. 

What is the breakdown John? Labour or raw material?

John: primarily raw materials

And my favorite question of the day (although they were all pretty awesome questions): Christine, prioritizing innovation vs. chasing product. Aren’t those two different functions? Design vs. planning? Just trying to get a sense of how chasing product would restrict the design process? 

Christine: Core product gets replenished. But where we color our new product innovation or ‘wow!’ products thats where it is done. When you look at say Paris Pink, our yarn is dyed. Not grade dipped which is what gives us the quality that gives us 5 years. (really? lets try grade dipped for color fastness). If I want to chase product and use grade dip that sacrifices quality. If we pre over order your yarn dyed, I haven’t created something special. then I have to get a designer to change a design or speed up ability to create incremental product don’t want to bulk buy. We had a couple of dyes (yeah…that Paris Pink you just mentioned) that didn’t work and we pulled those items (after they sold and customers kept complaining!) because we don’t want to put that product on the floor. So we leave room for that. 

Is there a change in philosophy from the past several years? 

I didn’t catch the first part of the response here but Christine ended by saying: I really don’t feel the need to apologize for the level of performance that we have. We do see some increase. Now, innovation is priced at a lower margin and when that does well we increase margin. We are always looking for high value, high margin products. Not quick turning tee shirts. 

So there you have it. Innovation of things like ‘A Muse Me Pants’ and the swim line that fits 2% of the target consumer, the commuter capsule that was priced so, so high – (that jacket at $300 which ended up at the outlets in bulk at around $89). Harem pants and  Flash galore, and none of the usual big summer sellers like the light weight hoodies and wraps, that is what this year has been all about and what investors, educators and consumers have noticed. 

Other things to note is that there is a plan to open a few more outlet stores in the US and to perhaps purchase a few stand alone stores rather than leasing. The possibility of the Crossfit capsule was interesting however the investor had a really good point in that a lot of the products already available function well for crossfit. I can’t imagine what the innovation would be there other than non garment items (gloves maybe? dead lift socks?). Also, the Seawheeze is 200 registrants away from being full capacity which is at a 7500 cap. 

Some articles discussing the results:
Lululemon’s First Quarter Better Than Expected, But Inventory Levels A Concern. Canada Press
Lululemon’s Q1 Better Than Expected But Stocks Fall on Slightly Soft Outlook. Huffington Post


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