Business Context and Reporting Period
Company: Lululemon Athletica Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 4, 2008 (Thirteen weeks)
Comparison Period: Three months ended April 30, 2007
Lululemon is a designer and retailer of technical athletic apparel, primarily sold through corporate-owned stores, franchises, and wholesale accounts. As of May 4, 2008, the company operated 85 total locations (74 corporate-owned, 11 franchises) across Canada, the United States, Australia, and Japan. Management announced plans to discontinue operations in Japan in the second quarter of fiscal 2008 to refocus resources on U.S. growth and e-commerce development.
Key Financial Metrics
| Metric | Q1 2008 (13 weeks) | Q1 2007 (3 months) |
|---|---|---|
| Net Revenue | $78.17 million | $44.79 million |
| Gross Profit | $41.52 million | $22.61 million |
| Gross Margin | 53.1% | 50.5% |
| Operating Income | $11.72 million | $6.85 million |
| Net Income | $8.48 million | $3.54 million |
| Diluted EPS | $0.12 | $0.05 |
| Cash and Equivalents (End of Period) | $34.06 million | $4.39 million |
| Working Capital (excl. cash) | $32.6 million | N/A |
| Debt Outstanding | $0 | $0 |
Material Changes vs. Prior Period
- Revenue Growth: Net revenue increased 74.5% year-over-year, driven by an 85.7% increase in corporate-owned store revenue and a 63.7% increase in "Other" segment revenue (wholesale/phone). Franchise revenue declined 7.7% due to the conversion of three Calgary franchises to corporate-owned stores.
- Profitability: Net income more than doubled, increasing $4.9 million. Gross margin expanded 2.6 percentage points to 53.1%, aided by reduced product costs relative to revenue.
- Expense Growth: Selling, general, and administrative (SG&A) expenses rose 89.1% to $29.8 million, primarily due to increased employee compensation for new store openings and a one-time $0.8 million charge for accelerated vesting of performance options.
- Cash Flow: Operating cash flow was negative $10.3 million, compared to negative $5.3 million in the prior year. This was driven by a $17.6 million increase in inventory levels to prepare for the Spring selling season and higher prepaid expenses.
- Capital Expenditures: Investing cash outflows increased to $8.6 million, reflecting $5.3 million in purchases of property and equipment for new store openings and IT infrastructure.
Guidance, Outlook, and Risks
Outlook and Strategy: Management plans to open 35 new stores in the United States during fiscal 2008. The company intends to exit the Japanese market in Q2 2008 to prioritize U.S. expansion and e-commerce. Liquidity is expected to be sufficient for the next 24 months based on operating cash flows and the existing $20 million uncommitted revolving credit facility (currently with $0 outstanding).
Risks and Contingencies:
- Legal Proceedings: A former executive, James Jones, has filed a lawsuit alleging wrongful dismissal and breach of contract. The company believes the claim is without merit and is defending vigorously.
- Foreign Exchange: Approximately 69.1% of revenue is generated in Canada. A 10% appreciation of the U.S. dollar against the Canadian dollar would have reduced operating income by approximately $1.0 million in Q1 2008. The company does not currently hedge currency risk.
- Seasonality: The business is highly seasonal, with a significant portion of income recognized in the fourth fiscal quarter.
- Supply Chain: The company lacks long-term supplier contracts and exclusive intellectual property rights for its fabrics.
Investor Verification Checklist
- Inventory Build: Verify the necessity and sell-through rate of the $17.6 million inventory increase to ensure it does not lead to future write-downs.
- Japan Exit: Monitor the timeline and financial impact of discontinuing operations in Japan as planned for Q2 2008.
- Store Expansion: Track the execution of the plan to open 35 new U.S. stores and the associated capital expenditure requirements.
- Currency Exposure: Assess the impact of fluctuating CAD/USD exchange rates on future margins, given the lack of hedging.
- Legal Status: Monitor the status of the James Jones litigation for potential settlement costs or reputational impact.