Lululemon Athletica Inc. — Form 10-Q Summary
Reporting-period note: The request identifies “2015 Q3,” but the supplied filing is for the thirteen and thirty-nine weeks ended October 30, 2016, compared with October 30, 2015 and November 1, 2015, respectively. Fiscal 2016 ends January 29, 2017.
Business Context and Reporting Period
Lululemon designs, distributes, and sells athletic apparel and accessories through company-operated stores, e-commerce, outlets, wholesale and other channels under the lululemon and ivivva brands. The company operated 389 stores at October 30, 2016, compared with 363 at January 31, 2016. Its business is seasonal, with a substantial portion of annual operating profit historically generated in the fourth quarter.
Financial Performance and Position
| Metric | Q3 Fiscal 2016 | Q3 Fiscal 2015 | Change |
|---|---|---|---|
| Net revenue | $544.4 million | $479.7 million | 13% |
| Gross profit | $278.4 million | $224.8 million | 24% |
| Gross margin | 51.1% | 46.9% | +420 basis points |
| Income from operations | $93.0 million | $68.2 million | 36% |
| Operating margin | 17.1% | 14.2% | +290 basis points |
| Net income | $68.3 million | $53.2 million | 28% |
| Diluted EPS | $0.50 | $0.38 | 32% |
| Metric | First 39 Weeks Fiscal 2016 | First 39 Weeks Fiscal 2015 | Change |
|---|---|---|---|
| Net revenue | $1.554 billion | $1.356 billion | 15% |
| Gross profit | $771.7 million | $642.7 million | 20% |
| Gross margin | 49.6% | 47.4% | +220 basis points |
| Income from operations | $224.5 million | $202.8 million | 11% |
| Net income | $167.2 million | $148.6 million | 13% |
| Diluted EPS | $1.22 | $1.05 | 16% |
Q3 comparable sales increased 7%, including a 4% increase in comparable store sales. Direct-to-consumer revenue increased 16% to $104.0 million, while company-operated store revenue increased 11% to $393.5 million. Growth reflected new stores, higher transaction values, improved conversion rates, and increased e-commerce traffic.
Q3 selling, general and administrative expense increased 18% to $185.5 million and rose to 34.1% of revenue from 32.7%. The increase reflected higher store and head-office labor, professional fees, technology, marketing, and other operating costs, partially offset by favorable foreign-exchange gains.
For the first 39 weeks, cash provided by operating activities was $97.3 million, compared with $25.9 million in the prior-year period. Capital expenditures were $106.2 million, resulting in negative operating cash flow after capital expenditures of approximately $8.8 million. Financing activities used $24.0 million, including $28.6 million for repurchases of 0.4 million shares.
Cash and cash equivalents were $480.4 million at October 30, 2016, versus $501.5 million at January 31, 2016. Inventory increased to $364.5 million from $284.0 million. The company reported working capital excluding cash of $329.8 million. No borrowings were outstanding under its aggregate $15.0 million unsecured revolving credit facilities, aside from letters of credit. Letters of credit and guarantees totaled $1.5 million.
Material Changes and Unusual Items
- The company completed a bilateral advance pricing arrangement with the IRS and CRA during the third quarter. Related tax adjustments produced a $4.0 million tax recovery in Q3 and an $11.6 million recovery for the first 39 weeks.
- A Canadian subsidiary distributed $156.0 million to the U.S. parent to finance settlement of an intercompany debt arising from the arrangement.
- Related net interest expense was $0.2 million in Q3 2016, compared with $3.6 million in Q3 2015. Excluding tax and related interest adjustments, Q3 diluted EPS was $0.47 versus $0.35, and the effective tax rate was 31.3% versus 28.8%.
- Foreign-currency translation produced a $24.7 million other comprehensive loss in Q3, while the first 39 weeks included a $20.8 million translation gain. The company does not historically hedge foreign-currency exposure.
- The prior $450.0 million share-repurchase program was completed during the second quarter of fiscal 2016. On December 1, 2016, the board approved a new program to repurchase up to $100 million of common shares over two years.
Guidance, Outlook, Risks, and Contingencies
The filing does not provide a clear numerical revenue or earnings outlook. Management stated that available cash, operating cash flow, and borrowing capacity are expected to meet liquidity and capital expenditure needs for at least the next 12 months, subject to business conditions.
- Key operating risks include consumer discretionary demand, intense competition, brand and product quality, inventory forecasting, product costs, and the ability to open and operate new stores successfully.
- The company relies on third-party suppliers and manufacturers, with significant production concentrated among its largest suppliers and in Asia. Supply disruptions, labor issues, tariffs, transportation problems, or raw-material inflation could pressure sales and margins.
- Foreign-exchange movements, particularly involving the Canadian dollar, affect reported revenue, expenses, equity, and operating results. A 10% appreciation of the U.S. dollar against the Canadian dollar was estimated to increase first-39-week operating income by approximately $2.6 million, based on the filing’s assumptions.
- Seasonality makes fourth-quarter results particularly important and limits the usefulness of sequential quarterly comparisons.
- Pending matters include an appeal of a dismissed derivative lawsuit concerning historical insider-trading allegations and a wage-and-hour class action in New York seeking unspecified damages. Management does not expect current proceedings to have a material adverse effect, although outcomes remain uncertain.
- The company is evaluating upcoming accounting changes, including revenue recognition, leases, inventory measurement, and stock-compensation guidance. The new lease standard is expected to materially increase reported assets and liabilities when adopted.
Investor Verification Checklist
- Confirm the requested period: the supplied filing is Q3 fiscal 2016, not Q3 fiscal 2015.
- Assess whether improved gross margin is sustainable after the effects of lower product costs, pricing, foreign exchange, and seasonal sales.
- Monitor inventory growth, markdown exposure, and working-capital conversion relative to revenue growth.
- Separate recurring earnings from the unusual APA-related tax recovery and related interest adjustments.
- Evaluate fourth-quarter execution because of the company’s significant retail seasonality.
- Review store productivity, comparable-store sales, e-commerce growth, and the profitability impact of continued international expansion.
- Track foreign-exchange sensitivity, supplier concentration, product quality, litigation developments, and the new $100 million repurchase authorization.