Business Context and Reporting Period
Lululemon designs, distributes, and sells athletic apparel and accessories through company-operated stores, e-commerce, showrooms, wholesale accounts, outlets, and warehouse sales. The filing is a Form 10-Q for the thirteen and twenty-six weeks ended August 2, 2015, compared with the periods ended August 3, 2014. The request metadata identifies “2014 Q2,” but the filing itself clearly reports fiscal 2015 second-quarter results. The company operated 336 stores at August 2, 2015, compared with 302 at February 1, 2015.
Financial Performance and Liquidity
| Metric | 13 weeks ended August 2, 2015 | 13 weeks ended August 3, 2014 | 26 weeks ended August 2, 2015 | 26 weeks ended August 3, 2014 |
|---|---|---|---|---|
| Net revenue | $453.0 million | $390.7 million | $876.6 million | $775.3 million |
| Gross profit | $212.0 million | $197.3 million | $417.9 million | $393.1 million |
| Gross margin | 46.8% | 50.5% | 47.7% | 50.7% |
| Income from operations | $66.6 million | $67.9 million | $134.6 million | $137.7 million |
| Operating margin | 14.7% | 17.4% | 15.4% | 17.8% |
| Net income | $47.7 million | $48.7 million | $95.5 million | $67.7 million |
| Diluted EPS | $0.34 | $0.33 | $0.67 | $0.46 |
Second-quarter revenue increased 16%, driven by 66 new company-operated stores and strong direct-to-consumer growth. Total comparable sales increased 6%, or 11% on a constant-dollar basis. Direct-to-consumer revenue increased 30% reported and 35% on a constant-dollar basis.
Gross margin declined 370 basis points in the quarter and 300 basis points year to date. Management attributed the deterioration primarily to lower product margin, higher occupancy and depreciation costs, unfavorable foreign exchange, increased air freight, and higher markdowns. Selling, general and administrative expense increased 12% in the quarter and 11% year to date, although it declined as a percentage of revenue.
Year-to-date net income increased 41% despite a 2% decline in operating income, primarily because the effective tax rate fell to 29.8% from 52.0%. The prior-year tax rate included a $31.3 million provision for U.S. income and withholding taxes related to dividends distributed from foreign subsidiaries to fund share repurchases.
Cash and cash equivalents were $541.3 million at August 2, 2015, down from $664.5 million at February 1, 2015. Working capital excluding cash was $228.9 million. The company generated $32.2 million of operating cash flow year to date, used $65.1 million for capital expenditures, and used $78.8 million in financing activities. No borrowings were outstanding under the $15.0 million revolving credit facilities, aside from letters of credit; issued letters of credit totaled $3.1 million.
Material Changes Versus the Prior Comparable Period
- Revenue increased 16% in the quarter and 13% year to date; constant-dollar revenue growth was 21% and 18%, respectively.
- Company-operated store revenue increased 16% in the quarter, supported by new stores, while reported comparable-store sales increased 1% in the quarter and decreased 2% year to date. Constant-dollar comparable-store sales increased 6% and 2%, respectively.
- Direct-to-consumer revenue increased 30% in the quarter and 28% year to date, representing 18.2% and 18.9% of revenue, respectively.
- Operating income decreased 2% in both the quarter and year-to-date periods as margin pressure and higher operating expenses offset revenue growth.
- Operating cash flow declined from $124.0 million to $32.2 million year to date, primarily because inventory increased by $74.0 million and prepaid taxes increased.
- The company repurchased $82.0 million of stock, or approximately 1.3 million shares, year to date, compared with $55.8 million and approximately 1.4 million shares in the prior-year period. The remaining authorization was approximately $220.7 million at August 2, 2015.
- Accumulated other comprehensive loss increased to $190.2 million, principally reflecting foreign currency translation effects.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide a clear numerical earnings or revenue guidance update. Management stated that cash balances, operating cash flow, and available borrowings were expected to meet liquidity and capital expenditure needs for at least the next 12 months. Results are seasonal, with a substantial portion of annual operating profit historically generated in the fourth quarter.
Key risks include foreign exchange volatility, pressure on product costs and margins, inventory forecasting and markdown risk, dependence on international suppliers and limited-source fabrics, transportation and port disruptions, competition, consumer discretionary demand, international expansion, long-term store leases, information-system and cybersecurity disruptions, intellectual-property matters, and regulatory compliance.
A derivative lawsuit was filed in Delaware concerning alleged fiduciary-duty violations related to 2013 stock trades by a former director. The company and individual defendants filed motions to dismiss. The company stated that it cannot predict related legal expenses or any settlement or damages, which could exceed insurance coverage and materially affect liquidity if adverse.
The previously filed shareholder class action was dismissed, and the plaintiff's appeal was dismissed on May 15, 2015. Management stated that routine legal matters were not expected to have a material adverse effect, but litigation could still be costly and divert management resources.
Recently issued accounting standards, including revenue recognition, stock compensation, cloud computing arrangements, and inventory measurement guidance, had not yet been adopted. The company was evaluating their potential effects.
Important Facts for Investors to Verify
- Confirm that the intended period is fiscal 2015 second quarter, despite the request metadata referring to 2014 Q2.
- Assess whether gross-margin pressure from product costs, occupancy, foreign exchange, air freight, and markdowns persists.
- Monitor inventory growth, cash conversion, and the effect of continued store expansion on operating cash flow.
- Evaluate the sustainability and profitability of direct-to-consumer growth relative to company-operated stores.
- Review the remaining share-repurchase authorization and its effect on liquidity and diluted share count.
- Track foreign exchange exposure, particularly the Canadian dollar, and the lack of historical hedging activity.
- Follow the Delaware derivative litigation and potential indemnification, settlement, or insurance exposure.
- Verify future management guidance and the impact of pending accounting standards when subsequently disclosed.