We are very pleased with our first quarter results, as our momentum from the fourth quarter continued into 2010. Our comparable store sales were 35% for the quarter on a constant dollar basis and we delivered $0.27 in diluted earnings per share. This was our company’s best ever first quarter, as we were able to generate very strong same store sales growth in both the U.S. and Canada. In the first quarter, we saw our trailing 12-month average sales per square foot reach $1,428, an improvement from last quarter’s $1,318.
All age classes are comping positively with our 2008 U.S. age class leading the way. We also added incremental profits from our e-commerce business, leveraged our strategic investments in infrastructure and managed our inventory and our margins for a strong flow-through of earnings.
We believe we took the right amount of inventory risk to drive sales and used our rapid response strategies to respond to incremental sales opportunities. Our inventory levels now match sales trends with opportunities to continue to refine channel allocation to e-commerce and to chase smaller sizes to meet market demand. Our yoga and run lines continue to lead sales demand as well as strong growth in equipment and accessories.
The flow-through this quarter was very strong due to a combination of market factors, such as strong demand for our product, leverage on sourcing, limited markdowns and timing of investments towards the back half of the year, as well as, leverage on stronger sales. Looking forward, we do see some sourcing pressure from materials and labor costs and reductions in out of stock.
Turning to revenue growth, our first priority remains growing existing stores. Our second is e-commerce and our third is new store openings.
We continue to be very excited about our e-commerce opportunity. Our direct-to-consumer business is now 6.6% of our revenue and a key growth vehicle for the company. We are investing an additional site performance and online community web strategies in the second half of the year, as well as, additions to our merchant and planning team to ensure better inventory flow to this channel.
We are on track to achieve our stated objective of 10% to 12% of sales. Our new distribution center in Sumner, Washington, is up and running in parallel and will begin deliveries to our U.S. stores next week. It will support all of our channels of business in the U.S., retail, e-commerce and strategic sales. [Does this mean the website won't get shipped from CA anymore? I'm spoiled, I get my stuff the day after I order it if I order before noon. Waaaaaa.]
So while it was a great quarter, we were not perfect. Going forward, we can do an even better job flowing product to a multi-channel business especially our e-commerce channel. We also delayed showroom openings to divert product to our retail stores and to secure the right locations. And while we have made strong progress in our system and people capacity, we are still at the early stages of building the infrastructure for a multi-channel business that is responsive and nimble as we need to be to outperform in today’s macro-environment.
Finance Guy Stuff:
For gross margin, we expect margin compression compared to Q1. For the full year, productivity leverage and efficiency in distribution and logistics will be partially offset by higher markdowns as we have returned to more balanced inventory levels, further investment in the product teams that support growth and execution, and in the latter part of the year, higher product costs due to inflationary pressures on fabric, labor and transportation.
Q&A:
Q: Could you guys give us a little more color on what you’re seeing for product costing? We heard about cotton prices increasing. How much of your product is cotton and what’s happening with prices for synthetic fabrics and what are you seeing with our cut made cost and labor and such?
A: We are seeing an increase in cotton pricing. We’re seeing an increase in nylon and there’s also Chinese labor which has gone up a bit. There have been, prior to these mitigation strategies that we’ve been employing to really minimize the impact on the margins there. So everything from further leveraging and smart planning of our raw materials to actually diversification of our supply base, so that we are manufacturing in some lower cost countries at this point.
Q: I have question on your e-commerce business. I was wondering how the performance of the business has been different in different geographies and do you find it’s performing best in areas where you have a store or you just opened a showroom or where you don’t have a store? And has it helped you determine future locations for stores? Thanks.
A: And basically, yeah, to all of the above. So we do see our sales populated definitely around our brick and mortar. And when we open up a showroom, again we see our sales pop up in that area. So our brick and mortar and e-commerce are working together exactly how we expected.
Q: Isn’t it helping you in locating future stores?
A: Yeah. Definitely, so -- yeah, definitely. We watch it every week and in -- what am I going to say, piece of the pie, along with the showrooms. So they are both giving us an indication as to where we should head with our real estate strategies.
Q: Can you talk a little bit about -- you indicated that inventory was -- you’re more comfortable with our current in stock levels. At this point going forward, should we expect inventory to increase at the same rate of sales and then secondarily in terms of the gross margin impact from not doing -- not chasing inventory, what kind of lift does that give you?
A: I think answering the first question, as I said, we’re comfortable with our inventory level at the end of Q1, being -- closer to being in line with our expected sales for Q2. So the answer to your question is yeah. Increases in sales would match increases in revenue or in inventory ideally going forward.
In terms of gross margin, you’re right. Being more in stock does mean that we’re more likely to have more markdowns, [Music to my ears!] as I said. There is a partial offset because we won’t be employing chase strategies to the same extent. It will be too granular to give you precise guidance on that but I would say the markdown impact is greater than the savings from not chasing. So net-net, there’s some deleverage on gross margin.
Q: just one follow-up question on inventory. Having the online business, is it giving you any better visibility as to where you need to be in terms of stock-outs because I would imagine you get better data as to where you’re not in stock?
A: [Christine Day] Yeah. What we found is it, there is a difference between what guests buy online and what they buy in the stores. And I think there’s a combination of factors in there. We have guests that shop both and then we do see some of what they’re really looking for and we do see what the hot items are. Actually, we learn more about that on Facebook and through social media [Really, what about the much-touted 'feedback' on your website? WTH? Are the handful of Facebook nuts who go crazy for harem pants with crotches around the knees going to determine the new designs? Not the customers who actually bought the item at full price, wore it, and then took the time to fill out the on-line Feedback form or send an email?], what are the guests really screaming for. And so we actually use that I think to get a little bit more indication. [haven't people been screaming for the Deep V to come back for at least 6 months now?]
As we talked about and I think it was in the last call, what we’ve really seen by the addition of the run line is it’s really shifted our guest size profile down to the smaller sizes because we’re attracting a more athletic fit guest, which is perfectly in line with our target and we’ve now adjusted a lot of our buys. [This is why I am finding fewer 12s in crops my local stores on the latest batch of crops. Hmmmm. I find it hard to believe that their customer is now smaller. The trophy wives in Newport Beach have alway been pretty slender whether they were buying yoga clothes or running clothes.]
And in terms of allocating to the stores, you can have an aggregate number right or even to e-commerce but be wrong between the two markets of Canada and U.S. on product or allocating source to many of our buys are fully allocated so the work that Sheree and her team are doing is much more sophisticated getting right size profiles at right stores and that’s -- even if we have the right product in the warehouse in the original buy, it’s getting it down to the stores at the right mix. [Aha, there *is* a difference between the typical Candian customer and the typical US one as we've observed] And that’s really been our focus and what will continue to be our focus through, I’m sure on the rest of this year and into next year.
[Re: Innovations] ...In terms of new product innovations or introductions, so for first quarter you saw more hot yoga and we had the introduction of the Matt and as part of our equipment and then for summer, we’d introduced UV sun protection in running which has been a run-away hit [really? I was rather underwhelmed by the Sunblocker stuff, especially in the fit and the feel of the fabric], no pun intended, along with lightweight running swift fabric in our running shorts, our tops and our running skirts. And then you will see a great introduction at the early part of Q3 which will be reflective running fabric where we actually have the reflective yarns woven into the fabric and of course, there’s more but we can’t tell you that just yet. We’ll have to surprise you later.
Q: Just a quick question about the performance that you saw in the U.S. versus Canada. Did you see any notable differences in traffic or buying patterns, any kind of difference in the consumer between the U.S. and Canada?
A: I think it’s still very much for us an age class story as we’ve been saying all along. It’s just driven by the ramp in new stores. Overall, we see healthy markets across the board, but some really strong growth of brand awareness like in the DC market has been really exciting for us to see.
And I think it was, a lot of the work we did on things like the Cherry Blossom Festival, where we had 1700 people show up and yoga at the White House which we anticipated in and then the Florida market as we increased our store penetration and community there, markets we used to worry about like, Texas, no longer worries whatsoever. That team down there has done an amazing job and that combined with our real estate strategy, opening in NorthPark, so we feel -- the really good news is there isn’t a weak spot. [I read this as hedge, hedge, hedge, our US customer hasn't changed (yet) much from the original 30-something professional woman with a six-figure income]
Q: Thanks very much. Now that you have or about to have your DC [distribution center] fully operational, is there a thought of bringing e-commerce in-house to take greater control of that piece of the business, not only the distribution and planning but the functionality of the site and to make it a wholly owned and totally controlled enterprise?
A: I don’t think we’ll go to wholly owned. We are working on a new really kind of online strategy, the very, very formative stages, really leveraging where we’re going in the social media and online presence.
And then we are working on increasing the web, the creative design and the speed of the system and a more scalable backside, but that would still be outsourced even though we will do did the distribution piece on our self in the U.S. as we do in Canada already. So I think you’ll see a lot of improvements in the site, but we also want to focus really on the creative and social side and I think from an IT complexity right now, I don’t see us in the short-term taking on the commercial side of that site for another few years.
[I think this is a big mistake and EXTREMELY shortsighted. Their website B-L-O-W-S. Why focus on Facebook? It's the same bunch of people chattering amongst themselves getting the same BS, canned answers (95% of the time) about bleeding or pilling from the GEC. If Lululemon wants to join the big leagues and go against Athleta they have to have a big league website. Right now, their website is bush league. You should bring the website back to North America and hire Canadian and US programmers. Argghhh! They must have hired the cheapest Indian programmers they could find because the website is probably the crudest, most error prone I've ever shopped on when compared to other major companies.]
Q: Thanks. Just a – what are your thoughts on warehouse sales maybe during the summertime frame and maybe in the winter. Are those a thing in the past or could we expect them to pop up again as you’re building your inventories a little bit.
A: We’ve typically only done them in Canada and one or two a year, so we do see probably doing one, coming up, but we haven’t quite agreed on the site or timing of that. So it could either be the end of second quarter, beginning of third. And we’re still pulling together what inventory we have for that, so we haven’t made the final decision.
But I think definitely as we go through the balance of the year, we do expect to return to kind of a more normal accumulation. I mean our outlet stores have been underperforming, because we haven’t been shipping a lot of merchandise to those. I’m not really that worried about that underperformance, frankly. So I think you’ll see some additional revenue generate from those as we return to fuller product lines.
Q: We were just wondering, how and if weather variability has any impact on your business, given the large amount of outdoor and street type locations that you have. We heard California had unseasonably cool weather in April and May. I’m just trying to get a sense if you saw any changes in buying patterns as a function of that volatility?
A: e didn’t really – Frankly, the thing that really drives our guest to our store is her passion for the brand. So if you know much about our guest, she’s willing to go to any lengths to experience our brand and to buy her components, to live a healthier life. [Oh yeah, I've driven through driving rain to the store]
So I think that there’s really fun stories in our stores, where we even have guests that come in that they can’t wait to see the educators, so they’re part of their network. So we’re very lucky in that way and frankly, there was minimal impact with weather.
Q: And then lastly, looks like you made some progress on the smaller size issue. Any thoughts would be great? Thank you.
A: As we introduced -- as Christine was mentioning before the run line, we’re seeing a more athletic, more slender body as one of our adding to our guest mix. So we’re now actually looking at that further and breaking that down to the – not just the style level but the style, color level. So we’re getting traction there and have made improvements for each buy that we do so.
And I think you’ll see the continued improvement in the core and black assortment but in the seasonal, in some of the seasonal styles, color waves, our strategy is a scarcity model. So if you like that size 6 or 4 in one of the color waves or seasonal styles, it’s never our strategy to be fully at demand level there, so there will always be a certain amount of noise that we expect but that helps keep the product and the brand strong which is also part of our strategy.
