Lululemon Athletica Inc. Form 10-Q Summary
Filing period: The source filing is for the quarter ended May 3, 2020, the first quarter of fiscal 2020, compared with May 5, 2019. The request metadata identifies “2019 Q1,” but the filing itself clearly reports fiscal 2020 Q1.
Business context and reporting period
Lululemon designs, distributes, and sells athletic apparel and accessories through company-operated stores, e-commerce, outlets, wholesale accounts, and licensing arrangements. The company operated 489 stores at May 3, 2020, compared with 491 at February 2, 2020.
The quarter was materially affected by COVID-19. Most stores in North America, Europe, and certain Asia-Pacific markets were closed for a significant portion of the quarter. Distribution centers in Ohio and Washington also experienced temporary closures. By June 10, 2020, 295 company-operated stores and all distribution centers had reopened, subject to operating restrictions.
Key financial metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net revenue | $652.0 million | $782.3 million | Down 17% |
| Gross profit | $334.4 million | $421.7 million | Down 21% |
| Gross margin | 51.3% | 53.9% | Down 260 basis points |
| Income from operations | $32.8 million | $128.8 million | Down 75% |
| Operating margin | 5.0% | 16.5% | Down 1,150 basis points |
| Net income | $28.6 million | $96.6 million | Down 70% |
| Diluted earnings per share | $0.22 | $0.74 | Down 70% |
| Operating cash flow | $(121.2) million | $(62.8) million | Greater use of cash |
| Capital expenditures | $52.1 million | $68.4 million | Down 24% |
Direct-to-consumer revenue increased 68% to $352.0 million, or 70% on a constant-dollar basis, driven by higher website traffic and conversion. Company-operated store revenue fell 49% to $260.0 million. Other revenue declined 40% to $40.0 million.
Selling, general and administrative expense increased 3% to $301.7 million, despite $14.3 million of government payroll subsidies. The expense increase reflected higher depreciation, information technology, digital marketing, distribution, and other corporate costs. The company also incurred increased occupancy and distribution costs as a percentage of revenue.
Cash and cash equivalents were $823.0 million at May 3, 2020, down from $1.094 billion at February 2, 2020. Working capital excluding cash was $240.0 million. The company reported $398.2 million of available capacity under its committed North American revolving credit facility.
The company had no borrowings under the North American facility and only immaterial borrowings under the Mainland China facility. Letters of credit and guarantees totaled $1.8 million. The company was in compliance with applicable credit-facility covenants.
Material changes versus the prior comparable period
- COVID-19-related store closures shifted customer demand from physical stores to e-commerce, causing total revenue to decline while direct-to-consumer revenue grew substantially.
- Gross margin contracted primarily because occupancy and depreciation costs and distribution-center costs were spread over lower revenue. Product margin improved, partly offsetting these pressures.
- Company-operated stores generated an operating loss of $30.2 million versus operating income of $120.9 million in the prior-year quarter.
- Direct-to-consumer operating income increased to $156.9 million from $79.3 million, and its operating margin improved to 44.6% from 37.8%.
- Operating cash outflow increased, principally because of lower earnings, a $122.8 million inventory investment, and changes in prepaid assets and compensation liabilities.
- Capital expenditures declined as management reduced investments in information technology, store renovations, relocations, and other projects in response to COVID-19.
- Share repurchases declined to $63.7 million for 0.4 million shares from $163.5 million for 1.0 million shares. The repurchase program was paused effective March 31, 2020, with $263.6 million remaining authorized at May 3, 2020.
- Accumulated other comprehensive loss increased substantially, including a $60.6 million foreign-currency translation loss during the quarter.
Guidance, outlook, commentary, risks, and unusual items
The filing does not provide quantitative fiscal-year revenue or earnings guidance. Management stated that COVID-19 was expected to continue affecting results, financial position, and liquidity, but expressed confidence in long-term growth opportunities and the Power of Three growth plan.
Management believed existing cash, operating cash flows, and revolving-credit availability would satisfy liquidity and capital requirements for at least the next 12 months. The company deferred $56.8 million of Canadian corporate income tax payments from the first quarter to the third quarter of fiscal 2020.
The company recognized $14.3 million of payroll subsidies under the CARES Act, the Canada Emergency Wage Subsidy, and similar programs. It recognized an insignificant impairment charge for closed-store long-lived and right-of-use assets and no significant additional inventory provision related to COVID-19.
Key risks include renewed or prolonged store and distribution-center closures, changes in consumer behavior and discretionary spending, supply-chain and manufacturing disruptions, excess inventory and markdowns, lease obligations, foreign-exchange volatility, cybersecurity and e-commerce interruptions, competition, tariffs and trade restrictions, and potential litigation.
Reported legal matters include employment-related claims, a California PAGA action, and a trademark infringement lawsuit filed by Aliign Activation Wear, LLC. The company stated that it intends to vigorously defend the matters and does not expect routine proceedings to have a material adverse effect, although outcomes are uncertain.
Most important facts for investors to verify
- Whether store reopenings and customer traffic recover without a resurgence of COVID-19 or renewed restrictions.
- Whether the strong e-commerce performance is sustained and offsets continued weakness in physical-store revenue.
- Inventory levels, markdown activity, return allowances, and potential future inventory impairments.
- Operating cash flow, cash burn, and the effect of deferred taxes, lease payments, and working-capital changes on liquidity.
- Whether gross and operating margins recover as stores reopen and fixed occupancy and distribution costs are leveraged over higher revenue.
- Future use of the revolving credit facilities and compliance with their financial covenants.
- Potential effects of supply-chain disruption, tariffs, foreign-exchange movements, and litigation.
- The filing’s comparable-sales metrics, which management stated were not meaningful during the quarter because COVID-19 closures materially affected the comparable-store base.