It was a sunny yet slightly chilly late April day.
After a series of emails, I was to meet Lululemon (LULU) founder Chip Wilson at a Starbucks on Broadway in New York. To be honest, I had no idea what to expect. Over the many years of being an analyst, I was highly critical of Lululemon, never truly believing it deserved the valuation the market was assigning to the company.
In my view, while the company from day one made high-quality workout wear, so did its much larger competitors in Nike (NKE), Under Armour (UA) and Adidas. Due to the size of these competitors, they were able to charge way less than Lululemon for their high-quality clothes (though not as high quality as Lululemon, to be fair). It was only a matter of time before Lululemon's competitive position was eroded and the stock went up in flames. I hated how fellow analysts gushed at the company's prospects; it almost seemed at times they were on the company's payroll. (Under Armour is part of TheStreet's Growth Seeker portfolio.)
So suffice to say, I was a touch nervous meeting a founder who I am sure watched my critical videos and 800-word pieces ahead of our chat. Per the usual, I prepped a ton -- learning all I could about Wilson's new venture Kit & Ace (I dig the model and the product quality is best in class), while also brushing up on Lululemon history (hey, this is a company that I grew up in the business following -- unlike, say, Pepsi) and Wilson personally. Wilson, who is a stickler for being on time (as am I), sent me a text message 30 minutes before the meeting to say I could come earlier if I wanted. Note this is the first text I have ever gotten from a CEO in all the years of interviewing high-profile types. I quickly replied back I was in a bit of traffic, but would be there shortly come hell or high water -- if I had to run 10 blocks to get there 15 minutes early, I would have.
I hop out of the cab, take five seconds to ponder what I want to order (I like to be prepared) and ensure my debit card is in my pocket to quickly pay for the drink. I open the door, and immediately see Wilson -- who frankly is pretty jacked and tall -- decked out in some casual Kit & Ace clothes and wearing a backpack. We shake hands, make some small talk, and he compliments me on my new North Face backpack. So far, so good. Then, with coffees in hand, we proceed to speed-walk around the block three times discussing Lululemon and his plans with Kit & Ace. Toward the end, he brings up my prior work, I acknowledge it and shift the chat onto what the rest of the year looks like for him.
Unfortunately, the contents of the discussion were off the record. But I will offer several observations. First, the Lululemon of today is likely cutting some corners on product quality compared to when it was founded by Wilson. That isn't a surprise seeing as Lululemon now must answer to shareholders. To regain lost market share, Lululemon will likely have to try to redefine the market by taking its quality up a notch. Not too sure that is what investors would want to hear.
Second, I don't know if Wilson is the type to have a Steve Jobs moment, return to the company he founded and rattle off years upon years of success. He strikes me as someone who needs a good operating team around him that could execute his vision and push back on certain ideas -- the thing is, I am not sure such a godlike team exists. And finally, although he clearly still loves Lululemon, he feels betrayed by the company, which goes a long way in perhaps partially explaining his recent scathing open letter to shareholders.
In light of our encounter, and Lululemon's decent first-quarter results, I have been thinking hard on what the company must do to gain back long-term believers in the brand. Most of what I think needs to happen can't go down overnight, but it would be nice to start to see progress on these fronts.
Flagship stores: The company opened its largest flagship store in New York City's Flatiron district last November. At a whopping 11,500 square feet, the store has space for yoga classes, dinner events and obviously an area to sell pricey workout clothing. The problem is that Lululemon is not moving fast enough with flagship stores and hasn't really detailed its plans on the subject. I think in order for the brand to regain lasting interest with investors, it has to open flagship stores in major tourist locations to drive awareness of its premium products. As it does that, it has to show it's actually making money from these stores. Nike and Under Armour are successful global brands with well-positioned flagship stores, and it wasn't too long ago when Lululemon shares were being bought on a view it could dominate globally using the same model.
Wholesale: Why Lululemon is not selling exclusive capsule collections at Nordstrom (JWN), Saks and top Macy's (M) stores is beyond my understanding. The visitors to these stores are the ones buying Lululemon product, and would likely plunk down $200 on a limited-time-only pair of Lululemon's stretchy pants (a premium to the ones sold in its stores) in collaboration with a hot designer. I think Lululemon is limiting its market by staying out of high-end department stores and not doing collaborations. No plans that I know to get into them any time soon, either.
Ivivva: It's time for Lululemon to disclose the results for its kid-centric Ivivva division, which operates over 40 stores in the U.S. and Canada. Is it making money? What is the timeline to it making money if it's not making money right now? I think the brand is unnecessary -- Nike and Under Armour have the kids athleticwear market cornered likely forever. Nevertheless, time for clarity and a possible shuttering of the concept (like we saw with Aeropostale's now-defunct kids chain called P.S. From Aeropostale) if it's not working. Would rather see the money saved and reinvested into product quality or opening men's stores (note, men's must prove to be scalable, too).
Gross margin: Lululemon's gross profit margin has been in a long-term free-fall for years. According to Bloomberg data, the company's gross margin reached a peak of 56.89% in 2011 -- it plunged to 48.39% last year. The decline reflects inefficiencies in the company's supply chain and increased competition, as well as investments in product quality (that may not be paying off). For one to get excited about Lululemon's future, the company has to start stabilizing its gross margin by selling its premium clothing at even higher prices. It will no doubt be tough given the dynamic market conditions -- but if the company gets its act together it could start to creep back toward 50% or so.