Business Context and Reporting Period
Lululemon designs, distributes, and retails healthy-lifestyle athletic apparel and accessories through company-operated stores, e-commerce, outlets, wholesale, and licensing channels. This filing is a Form 10-Q for the quarter ended July 29, 2018, and the two quarters then ended, compared with July 30, 2017. The request metadata identifies “2017 Q2,” but the filing itself is for fiscal 2018 second quarter. Fiscal 2018 is a 53-week year ending February 3, 2019.
The company operated 415 stores at July 29, 2018, versus 404 at January 28, 2018, across North America, Asia, Europe, and Australia/New Zealand.
Key Financial Metrics
| Metric | Quarter Ended July 29, 2018 | Year-over-Year Change | Two Quarters Ended July 29, 2018 |
|---|---|---|---|
| Net revenue | $723.5 million | 25% | $1.373 billion, up 25% |
| Gross profit | $396.2 million | 33% | $740.9 million, up 34% |
| Gross margin | 54.8% | Up 360 basis points | 54.0%, up 370 basis points |
| Income from operations | $134.2 million | 95% | $238.5 million, up 109% |
| Operating margin | 18.5% | Up 670 basis points | 17.4%, up 700 basis points |
| Net income | $95.8 million | 97% | $170.9 million, up 114% |
| Diluted EPS | $0.71 | Compared with $0.36 | $1.26, compared with $0.58 |
| Operating cash flow | Not separately provided for the quarter | — | $210.0 million, compared with $102.0 million |
Second-quarter revenue growth was driven by company-operated stores revenue of $486.4 million, direct-to-consumer revenue of $167.4 million, and other revenue of $69.7 million. Direct-to-consumer revenue increased 48%, while comparable store sales increased 10% and total comparable sales increased 20%. On a constant-dollar basis, revenue increased 24%, direct-to-consumer revenue increased 47%, comparable store sales increased 10%, and total comparable sales increased 19%.
Gross-margin expansion reflected lower product costs, favorable product mix, lower markdowns, lower occupancy and depreciation costs as a percentage of revenue, and favorable foreign exchange. Selling, general and administrative expenses increased 16% in the quarter but declined to 36.2% of revenue from 38.8%.
Cash and cash equivalents were $777.8 million at July 29, 2018, compared with $990.5 million at January 28, 2018. Inventories increased to $392.7 million from $329.6 million. Working capital excluding cash and cash equivalents was $81.0 million.
Capital expenditures were $84.0 million for the first two quarters, compared with $49.9 million in the prior-year period. Financing cash outflows were $300.2 million, primarily reflecting $406.2 million of share repurchases, partially offset by $100.0 million of revolving-credit borrowings. The company repurchased 3.4 million shares during the period.
Debt, Liquidity, and Material Changes
- On June 6, 2018, the company amended its unsecured revolving credit facility, increasing commitments from $150.0 million to $400.0 million, with an option to increase commitments to $600.0 million subject to conditions. Maturity was extended to June 6, 2023.
- At July 29, 2018, $100.0 million was outstanding under the facility at a weighted-average interest rate of 3.32%, and $1.3 million of letters of credit had been issued. Available capacity was $298.7 million.
- The company repaid the $100.0 million revolving-credit balance on August 13, 2018, after the balance-sheet date.
- The board increased the share-repurchase authorization to $600.0 million in June 2018. Remaining authorization was $192.8 million at July 29, 2018, and the program was expected to be completed by November 2019.
- Accumulated other comprehensive loss increased to $204.1 million from $142.9 million, primarily due to foreign-currency translation effects.
- The company adopted ASC 606 revenue guidance on January 29, 2018, with no material change to the timing or amount of revenue recognition. ASC 842 lease guidance is expected to produce a significant increase in reported assets and liabilities upon adoption in fiscal 2019.
Material Changes Versus the Prior Comparable Period
- Profitability improved substantially, partly because the prior-year period included $5.4 million of second-quarter and $23.2 million of first-half pre-tax ivivva restructuring costs. No such costs were recorded in fiscal 2018.
- The company closed 48 of 55 ivivva company-operated stores in August 2017. These closures reduced second-quarter fiscal 2018 company-operated-store revenue by $13.8 million and first-half revenue by $25.4 million versus the prior periods.
- The company opened 42 net new lululemon-branded stores since the second quarter of fiscal 2017, contributing $50.6 million to second-quarter store revenue growth and $93.2 million to first-half growth.
- Share repurchases increased materially to $406.2 million from $90.8 million in the prior-year first half, contributing to lower weighted-average shares outstanding.
- Foreign-exchange and derivative revaluation effects shifted from a $4.1 million net gain in the prior-year first half to a $3.0 million net loss in fiscal 2018.
Guidance, Outlook, Risks, and Unusual Items
The filing does not provide a clear numerical revenue or earnings guidance update. Management expects cash balances, operating cash flow, and available revolver capacity to fund liquidity and capital requirements for at least the next 12 months. Management also emphasizes that retail seasonality causes a disproportionate share of annual operating profit to be generated in the fourth quarter; approximately 56% of fiscal 2017 operating profit was generated in that quarter.
Key risks include consumer discretionary spending, intense athletic-apparel competition, product quality and brand reputation, inventory forecasting and markdown exposure, reliance on concentrated suppliers and manufacturers, raw-material and labor-cost inflation, tariffs and trade restrictions, international expansion, store leases, information-technology and cybersecurity disruptions, foreign-exchange volatility, tax-law changes, and litigation.
The company continues to assess the effects of the U.S. Tax Cuts and Jobs Act, including GILTI and the potential tax consequences of repatriating foreign earnings. Provisional tax amounts may be adjusted during the permitted measurement period. Reported comprehensive income was reduced by foreign-currency translation losses of $18.2 million in the quarter and $61.2 million for the first half.
Pending legal matters include a wage-and-hour class action and a lawsuit alleging sexual assault, harassment, retaliation, and related claims seeking $3.0 million plus non-monetary relief. Management states that it intends to defend the matters vigorously and does not expect current proceedings to have a material adverse effect, although outcomes remain uncertain.
Investor Verification Items
- Confirm that the applicable filing period is fiscal 2018 second quarter ended July 29, 2018, rather than 2017 Q2.
- Assess whether margin expansion is sustainable after the benefit of lower markdowns, favorable product mix, foreign exchange, and the absence of ivivva restructuring charges.
- Monitor inventory growth, inventory provisions, markdown levels, and the effect of new-store expansion on future cash flow.
- Reconcile the $406.2 million share repurchase outflow with the reduced share count and remaining $192.8 million authorization.
- Verify the post-period repayment of the $100.0 million revolver balance and the company’s compliance with credit-facility covenants.
- Evaluate the balance-sheet impact of ASC 842 lease adoption and any future adjustments related to U.S. tax reform and GILTI.
- Review foreign-exchange exposure, derivative maturities, supplier concentration, tariffs, cybersecurity controls, and the status of disclosed litigation.