Lululemon Athletica Inc. quarterly report, Q3 FY2015

Lululemon Athletica Inc. Form 10-Q Summary

Reporting period: The filing covers the thirteen and thirty-nine weeks ended November 1, 2015, compared with the corresponding periods ended November 2, 2014. Although the request identifies “2014 Q3,” the filing itself is the fiscal 2015 third-quarter report. Fiscal 2015 is a 52-week year ending January 31, 2016.

Business Context

Lululemon designs, distributes, and retails athletic apparel and accessories through company-operated stores, e-commerce, showrooms, outlets, wholesale accounts, and warehouse sales. The company operated 354 stores at November 1, 2015, compared with 302 at February 1, 2015, including expansion across the United States and several international markets.

Financial Performance

Metric	Q3 FY2015	Q3 FY2014	First 39 Weeks FY2015	First 39 Weeks FY2014
Net revenue	$479.7 million	$419.4 million	$1,356.2 million	$1,194.7 million
Gross profit	$224.8 million	$211.1 million	$642.7 million	$604.1 million
Gross margin	46.9%	50.3%	47.4%	50.6%
Income from operations	$68.2 million	$81.2 million	$202.8 million	$218.8 million
Operating margin	14.2%	19.4%	15.0%	18.4%
Net income	$53.2 million	$60.5 million	$148.6 million	$128.2 million
Diluted EPS	$0.38	$0.42	$1.05	$0.88

Q3 revenue increased 14%; total comparable sales increased 3%, or 9% on a constant-dollar basis.
Direct-to-consumer revenue increased 16% reported and 21% on a constant-dollar basis in Q3. It represented 18.6% of revenue, compared with 18.4% in the prior-year quarter.
Q3 gross profit increased 7%, but gross margin contracted 340 basis points because of higher product costs, occupancy and depreciation, unfavorable foreign exchange, and greater markdowns and discounts.
Q3 selling, general and administrative expense increased 21% to $156.6 million, exceeding revenue growth and rising to 32.7% of revenue from 30.9%.
First-nine-month revenue increased 14%, while operating income declined 7% because of margin pressure and higher operating expenses.

Cash Flow, Liquidity, Debt, and Capital Allocation

Cash and cash equivalents were $403.4 million at November 1, 2015, down from $664.5 million at February 1, 2015.
Working capital excluding cash was $316.7 million.
Operating cash flow was $25.9 million for the first 39 weeks, down from $166.8 million in the comparable period, primarily because of increased inventory purchases and prepaid income taxes.
Capital expenditures were $108.1 million, principally for new and renovated stores, information technology, and business systems.
Financing cash outflows were $167.5 million, including $170.0 million to repurchase 2.9 million shares.
The company had no borrowings outstanding under its $15.0 million revolving credit facilities, apart from letters of credit. Letters of credit totaling $2.7 million were issued.
Management stated that cash, operating cash flow, and available credit were expected to meet liquidity and capital expenditure needs for at least the next 12 months.

Material Changes and Unusual Items

The company recorded a net income tax recovery of $7.7 million in Q3 related to transfer-pricing arrangements, expected repatriation of foreign earnings, and foreign tax credit calculations. Related net interest expense was $3.6 million.
Q3 effective tax rate was 18.6%, compared with 27.1% in the prior-year quarter. Excluding the tax and related interest adjustments, the rate was 28.8% versus 27.1%.
Q3 diluted EPS excluding the tax and related interest adjustments was $0.35; the filing reports $0.38 on a GAAP basis.
The company was finalizing a bilateral Advance Pricing Arrangement with the IRS and Canada Revenue Agency. Depending on the final terms, additional income tax adjustments of up to approximately $10.0 million could be recorded.
The company expects to distribute up to $156.0 million to the U.S. parent to finance an intercompany obligation and recorded $7.8 million of tax expense for the expected distribution.
Inventory increased to $357.8 million from $208.1 million at February 1, 2015, reflecting new-store growth, higher e-commerce and store inventory requirements, and delivery timing.
The company repurchased an additional 832,000 shares for $40.8 million between November 1 and December 3, 2015.

Outlook, Risks, and Contingencies

The filing does not provide a clear numerical revenue or EPS guidance range in the supplied text.
Management highlighted retail seasonality: a substantial portion of annual operating profit is typically generated in the fourth quarter, with approximately 42% generated in Q4 FY2014.
Key operating risks include foreign exchange volatility, product and raw-material costs, inventory forecasting, markdowns, supply-chain concentration, international expansion, store execution, competition, consumer discretionary spending, information-system disruptions, and brand or product-quality damage.
Foreign currency translation increased accumulated other comprehensive loss by $17.3 million during the first 39 weeks. Management stated that it has not historically hedged foreign currency exposure.
Pending matters include a shareholder derivative lawsuit involving current and former directors and a New York wage-and-hour class action seeking unspecified damages. The company intends to defend the wage-and-hour matter vigorously, but potential legal expenses and outcomes cannot be predicted.
Management concluded that disclosure controls and procedures were effective as of November 1, 2015, with no material change in internal control over financial reporting during the quarter.

Facts Investors Should Verify

Confirm the reporting-period discrepancy: the supplied request says “2014 Q3,” while the filing is for Q3 FY2015 ended November 1, 2015.
Assess whether margin pressure from product costs, foreign exchange, occupancy, depreciation, and markdowns is temporary or structural.
Monitor inventory growth and operating cash conversion, particularly after operating cash flow fell sharply despite higher net income.
Review the final Advance Pricing Arrangement and any resulting tax payments, liabilities, or additional adjustments.
Evaluate the effect of continued store expansion and share repurchases on liquidity and future returns.
Track the pending derivative and wage-and-hour litigation, including any settlements, judgments, or insurance limitations.