Lululemon Athletica Inc. quarterly report, Q3 FY2012

Lululemon Athletica Inc. Form 10-Q Summary

Business context and reporting period

This filing reports results for the thirteen and thirty-nine weeks ended October 28, 2012, compared with the corresponding periods ended October 30, 2011. Although the request identifies “2011 Q3,” the filing is the fiscal 2012 third-quarter Form 10-Q. Fiscal 2012 is a 53-week year ending February 3, 2013.

Lululemon designs, manufactures and distributes premium athletic apparel through corporate-owned stores, e-commerce and other channels. At October 28, 2012, the company operated 201 corporate-owned stores: 127 in the United States, 50 in Canada, 22 in Australia and two in New Zealand.

Financial performance and liquidity

MetricQ3 2012Q3 2011Change
Net revenue$316.5 million$230.2 million+37%
Gross profit$175.3 million$128.5 million+36%
Gross margin55.4%55.8%-40 bps
Income from operations$80.6 million$59.7 million+35%
Operating margin25.5%25.9%-40 bps
Net income attributable to Lululemon$57.3 million$38.8 million+48%
Diluted EPS$0.39$0.27+44%
MetricThirty-nine weeks 2012Thirty-nine weeks 2011Change
Net revenue$884.9 million$629.3 million+41%
Gross profit$488.3 million$360.3 million+36%
Gross margin55.2%57.3%-210 bps
Income from operations$223.9 million$170.9 million+31%
Operating margin25.3%27.2%-190 bps
Net income attributable to Lululemon$161.2 million$110.5 million+46%
Diluted EPS$1.11$0.76+46%

Q3 revenue growth reflected an 18% comparable-store sales increase, new store openings and strong e-commerce performance. Direct-to-consumer revenue increased 89% to $45.1 million and represented 14.3% of quarterly revenue, versus 10.4% in the prior-year quarter. For the first 39 weeks, e-commerce revenue increased 112% to $119.0 million and represented 13.4% of revenue, versus 8.9% previously.

Gross-margin pressure reflected higher labor and raw-material costs, product innovation and complexity, increased markdowns and discounts, foreign-exchange effects and a prior-period tax-credit adjustment. Lower air-freight usage and operating-cost leverage partially offset these factors.

At October 28, 2012, cash and cash equivalents were $439.4 million, compared with $409.4 million at January 29, 2012. Working capital excluding cash was $110.4 million. Total liabilities were $121.0 million, and the company had no borrowings outstanding under its CDN$20.0 million uncommitted revolving credit facility. Letters of credit and guarantees totaled $1.4 million.

For the first 39 weeks, operating cash flow was $113.2 million, compared with $53.5 million in the prior-year period. Capital expenditures were $72.0 million, and cash used in financing activities was $11.9 million, including $26.0 million to acquire the remaining non-controlling interest in Lululemon Australia. Ending cash increased by $30.0 million to $439.4 million.

Material changes versus the prior comparable period

  • Revenue growth was driven by comparable-store sales, 27 new or acquired corporate-owned stores, and accelerated e-commerce traffic, conversion and average order value.
  • Corporate-owned store revenue increased 33% in Q3 and 36% for the first 39 weeks. The company added 21 U.S. stores, five Canadian ivivva stores, eight Australian stores and two New Zealand stores after the prior-year comparison date.
  • Direct-to-consumer operating income increased 102% in Q3 and 130% for the first 39 weeks, with margin expansion from fixed-cost leverage.
  • General corporate expense increased 37% in Q3 and 41% year to date, primarily from higher head-office compensation, stock-based compensation, incentive compensation and strategic investments.
  • The effective tax rate declined to 30.1% from 35.5% in Q3 and to 28.7% from 35.8% for the first 39 weeks, reflecting revised intercompany pricing agreements.
  • Inventory increased to $164.7 million from $104.1 million at January 29, 2012, while property and equipment increased to $204.1 million from $162.9 million, consistent with store and infrastructure expansion.
  • In August 2012, the company purchased the remaining 20% non-controlling interest in Lululemon Australia for $26.0 million. The transaction eliminated the $5.7 million non-controlling interest balance and reduced additional paid-in capital by $20.3 million.

Guidance, outlook, risks and unusual items

The filing does not provide a specific numerical earnings or revenue outlook. Management expects cash from operations and available revolver capacity to meet liquidity and capital-expenditure needs for at least the next 24 months, while noting that demand weakness or discretionary capital spending could require external financing.

Management plans to continue investing in e-commerce, international expansion, country-specific websites, showrooms, stores and information technology. The company expects e-commerce to become an increasingly substantial and higher-margin part of the business.

Results are seasonal, with a significant portion of annual sales and operating profit historically generated in the fourth quarter holiday period. The filing cautions that interim results may not be indicative of full-year performance.

  • Foreign-exchange exposure is significant. A 10% depreciation of the Canadian dollar versus the U.S. dollar was estimated to reduce first-three-quarter operating income by approximately $15.8 million; the comparable Australian-dollar sensitivity was approximately $0.6 million. The company did not hedge these exposures.
  • Product costs, raw-material and labor inflation, markdowns, inventory forecasting and supply-chain concentration could pressure margins and cash flow.
  • The company relies on third-party suppliers and manufacturers, including concentrated sources for certain technical fabrics. Fiscal 2011 production was approximately 49% in China and 67% through the five largest manufacturing suppliers.
  • Two California class-action lawsuits were disclosed: one alleging employment-law violations by former hourly employees and another alleging improper collection of customer ZIP-code information with credit-card transactions. Damages sought were unspecified, and management stated it intends to vigorously defend both matters.
  • The filing identifies competition, brand reputation, product quality, information systems, distribution disruptions, long-term store leases, international expansion and consumer discretionary spending as material risks.

Important facts for investors to verify

  • Confirm that the applicable period is fiscal Q3 2012, not 2011 Q3, and assess the impact of the 53-week fiscal year.
  • Monitor whether e-commerce growth and its higher operating margin continue to offset slowing store growth or margin pressure.
  • Evaluate the sustainability of gross-margin performance after the 210-basis-point year-to-date decline.
  • Review inventory growth, markdown activity and the adequacy of inventory provisions during the holiday quarter.
  • Assess sensitivity to Canadian- and Australian-dollar movements and the absence of foreign-currency hedging.
  • Track the disclosed California litigation and any changes in estimated exposure.
  • Verify capital-spending requirements, store expansion returns and cash-flow conversion following the Australian subsidiary buyout.