UPDATE 5-Lululemon warns of weaker outlook after recall, gaffes

Thu Dec 12, 2013 5:50pm EST

(Adds comments from major shareholder, branding consultant)

By Solarina Ho

TORONTO Dec 12 (Reuters) - Lululemon Athletica Inc warned on Thursday that fewer customers visiting its stores will hit its sales in the crucial fourth quarter, acknowledging that negative press surrounding a product recall and comments by its founder had hurt sales of its trendy yogawear.

Lululemon, which was hit by an embarrassing recall in March when some of its signature black pants proved too see-through, said sales at established stores would be flat and lowered its full-year outlook, raising concerns that momentum at the once-hot retailer is fading.

The company also indicated that supply chain issues will last much longer than expected.

Shares of the Vancouver-based company, which has had public relations headaches all year, closed down 11.6 percent at $60.39.

Chief Financial Officer John Currie said the drop in the number of customers was responsible for about two-thirds of the flat same-store sales forecast, with supply also a factor.

"The traffic appeared to have fallen out of bed since the end of the third quarter," said Sterne Agee brokerage analyst Sam Poser.

"For me, that means this is about the PR and the brand. I think traffic is a reflection of these brand issues. That is a much more delicate situation (than the supply chain)."

The sales forecast is a big reversal for Lululemon, which not long ago was posting sales growth at mature stores well into double digits.

The saga of the semi-transparent trousers drew ridicule in media reports and on social networks, and the ripple effect caused supply chain snags and delivery delays.

Troubles were compounded by lingering complaints about product quality and comments from outgoing chairman and founder Chip Wilson. He said in early November that some women's body shapes "just actually don't work" for Lululemon's yoga pants, prompting a backlash from some customers.

"It is realistic to assume that when there is negative press that there is an impact on the business," said Currie, when asked about Wilson's comments. "I do think that has impacted us in November and early December."

Lisa Kane, strategy director with branding consultants Siegel+Gale, said Wilson's comments may have turned off customers by seeming to deflect blame for the quality issues.

"They're an athletic wear company, and basically insulted their customers' bodies," she said. "I think people will take a while to forgive that."

The company said this week that Wilson would be stepping down from his position as chairman next year, but remain on the board.

"Time heals a lot of wounds in this regard," said Charlie Wilson, an associate portfolio manager at Thornburg Investment Management, one of Lululemon's largest institutional investors.

He said he was unhappy with the ongoing operational problems, but more supportive of the company's long-term decisions. He said the departure of the chairman showed it was not being complacent.

QUALITY CONTROL ISSUES INTO NEXT YEAR

Lululemon ramped up its quality control measures after the recall. As a result, the company said some products have been rejected and not released to stores, causing uneven product flow, late deliveries and some cancellations of purchases.

Outgoing Chief Executive Christine Day, who was not on Thursday's call, had previously said the supply chain issues would likely last until the end of the year, but the company indicated it would be longer.

"By 2015 we should be seeing a much, much smoother supply chain operation," said Currie.

Lululemon announced on Tuesday that Day would be replaced by former TOMS Shoes executive Laurent Potdevin, who in addition to the product quality and delivery challenges, will have to shore up the company's reputation and fend off intensifying competition.

COMPETITION GROWS

Brands like Under Armour Inc, Nike Inc, and Gap Inc's Athleta retail banner, and smaller, trendy, niche rivals are all encroaching on Lululemon's turf.

Currie said no particular competitor was having a significant impact, but acknowledged that the "crowded landscape of course makes it more difficult to stand out."

He noted that the softer market trend was consistent in both Canada and the United States, even though competition was more intense south of the border.

Sterne Agee's Poser said the gap between Lulu and its competitors is narrowing, more due to Lulu's problems than rivals gaining ground.

Lululemon, which typically does not do promotional sales, said a weak retail environment and aggressive discounting also drew customers away.

For the current quarter, which includes the holiday shopping season, Lululemon forecast earnings between 78 and 80 cents a share, and revenue from $535 million to $540 million. Analysts had been expecting earnings of 84 cents a share on revenue of $571.8 million.

For fiscal 2013, which ends next year, the retailer now projects net revenue to be between $1.605 billion and $1.610 billion, down from an already lowered forecast of $1.625 billion to $1.635 billion. Diluted earnings per share are forecast to be between $1.94 and $1.96 for the year.

Net income for the third quarter rose to $66.1 million, or 45 cents per diluted share, from $57.3 million, or 39 cents, in the same period a year ago.

Revenue rose 20 percent to $379.9 million. Sales at established stores rose 5 percent.

Analysts, on average, had been expecting earnings of 41 cents a share on revenue of $376.2 million, according to Thomson Reuters I/B/E/S. (Additional reporting by Allison Martell; Editing by Jeffrey Hodgson, James Dalgleish, Grant McCool and Phil Berlowitz)

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