Lululemon said late on Monday it was pulling about 17 percent of the women's pants on its store shelves because the products - black pants made with its signature stretchy "Luon" fabric - fell short of technical specifications. It warned that the recall of the see-through pants would have a significant impact on its financial results.
The recall, the second quality issue disclosed in less than a year, could undermine Lululemon's reputation, analysts said, especially at a time when competition from lower-priced brands is heating up. Last July, the company acknowledged problems with dye-bleeding in some of its apparel.
"Those are two black eyes for a brand that is supposed to stand for quality in the marketplace," said Brian Sozzi, chief equities analyst at NBG Productions. "It's a window of opportunity for Lululemon competitors."
Sales growth in established stores is now expected to come in at 5 percent to 8 percent for the current quarter, compared with the 11 percent it had expected up to March 17. That's a far cry from the 25 percent growth it posted a year earlier.
The supplier, Taiwan's Eclat Textile Co Ltd, said it had followed Lulu's specs, and that the retailer had apparently misjudged customer tastes.
Lululemon, which is due to report earnings for its fiscal fourth quarter to February 3 on Thursday, had no immediate comment beyond its statement late Monday.
REPUTATION FOR QUALITY
Shares of Lululemon were down 4.4 percent at C$64.50 on the Toronto Stock Exchange on Tuesday as analysts trimmed their expectations.
With the recalled products off the market, Sozzi said, customers will be tempted to check out similar offerings from Nike Inc and Gap Inc's Athleta banner.
Sterne Agee analyst Sam Poser downgraded the stock to "neutral" from "buy," advising clients to "wait and see" while the problem is resolved. The company has not said when it would have the affected products in stock.
"The potential problem you have is that if the customer walks in and can't find that pant, and she can't find it for six weeks, she might end up saying: 'Oh, well, I'll try Under Armour, or I'll try Nike, or I'll try whomever,'" said Poser.
Lululemon has carved out a profitable niche selling fashionable, pricey workout gear to women. One of very few Canadian retailers to succeed in the United States, the chain is expanding in Europe and Asia over the next two years, and it has small but growing lines for men and girls.
Investors are split on whether Lulu's rapid growth can keep pace with lofty expectations as more competitors, such as Athleta, muscle into its territory, offering similar gear at lower prices.
"DO A COUPLE OF DOWN DOGS"
Customers may find that some Lululemon products still on sale are partially transparent as well.
"You may experience sheerness with some of our bright-colored bottoms because of the lightweight nature of the fabric," says a disclaimer on some product pages on the company's website.
"We recommend you do a couple of Down Dogs in your bright-colored bottoms to ensure you're happy with the fit and coverage," the page reads, referring to a basic yoga position.
Eclat, a longstanding Lululemon supplier that manufactures Luon, told Reuters that "a gap between Lululemon's expectations and reaction from the market" was the cause of the problem.
"We checked our orders this morning and indeed, we did follow their instructions to make the product," said Roger Lo, a spokesperson at Eclat. "Lulu has some new ideas every year, such as taking different approaches for fashion-related purposes."
Shares of Eclat fell 1.6 percent in Taipei on Tuesday, lagging a 0.4 percent gain in the benchmark TAIEX index.
In its annual report in March 2012, Lululemon said it was at risk of overly relying on a limited number of suppliers. The company said Luon was supplied by a single manufacturer in Taiwan.
Still, it was not immediately clear whether Eclat manufactured all of the fabric that prompted the recall, or if another manufacturer was also involved.
CUTS SALES FORECAST
Several analysts cut price targets and earnings expectations for the company.
Janney Capital Markets analyst Adrienne Tennant trimmed her price target to $71 from $80, and was cutting her earnings expectations to "give management breathing room to properly address and fix the issue."
Lululemon said it now expected to report fiscal first-quarter sales of $333 million to $343 million, down from its prior forecast of $350 million to $355 million.
The company is trying to determine the impact on first-quarter earnings, as well as the expected impact on results for the rest of 2013.
The warnings prompted price target cuts on Lululemon's stock from Wedbush Securities, KeyBanc, UBS, Sterne Agee, Canaccord Genuity and other brokerages on Tuesday.
International Strategy and Investment Group analyst Sam Lee said in a note to clients that Lululemon's woes are due to teething issues in an immature supply chain.
"We would really like to see the company more aggressively invest in and exercise greater control over its supply chain given the importance of quality and consistent fit to the Lulu brand promise," said Lee. He added that the pullback in Lulu's stock still presented a buying opportunity.
(Editing by Frank McGurty and Andrew Hay)
By Allison Martell and Yimou Lee