Lululemon Athletica Inc. Form 10-Q Summary
Reporting period: The provided filing is for the 13 weeks and 39 weeks ended November 2, 2014, compared with the periods ended November 3, 2013. Although the request metadata states “2013 Q3,” the filing itself is a fiscal 2014 third-quarter Form 10-Q. Fiscal 2014 is a 52-week year ending February 1, 2015.
Business Context
Lululemon designs, manufactures and distributes athletic apparel through corporate-owned stores, e-commerce, showrooms, wholesale accounts, outlets and warehouse sales. It operated 289 corporate-owned stores at November 2, 2014, compared with 254 at February 2, 2014. The company identified fiscal 2014 as a transitional year focused on product quality, supply chain improvements, brand rebuilding, international expansion, men’s apparel and ivivva.
Financial Performance
| Metric | Q3 FY2014 | Q3 FY2013 | 39 Weeks FY2014 | 39 Weeks FY2013 |
|---|---|---|---|---|
| Net revenue | $419.4 million | $379.9 million | $1,194.7 million | $1,070.2 million |
| Gross profit | $211.1 million | $204.6 million | $604.1 million | $561.3 million |
| Gross margin | 50.3% | 53.9% | 50.6% | 52.4% |
| Income from operations | $81.2 million | $92.3 million | $218.8 million | $237.2 million |
| Operating margin | 19.4% | 24.3% | 18.4% | 22.2% |
| Net income | $60.5 million | $66.1 million | $128.2 million | $169.9 million |
| Diluted EPS | $0.42 | $0.45 | $0.88 | $1.16 |
Q3 revenue increased 10%, while revenue for the first 39 weeks increased 12%. Constant-currency revenue growth was 12% in Q3 and 14% for the first 39 weeks. Direct-to-consumer revenue grew 25% in both periods and represented 18.4% of Q3 revenue and 17.3% of year-to-date revenue.
Comparable sales increased 1% in Q3 and decreased 1% for the first 39 weeks. Excluding foreign exchange, comparable sales increased 3% in Q3 and 1% year to date. Comparable store sales declined 5% in Q3 and 6% year to date, reflecting lower conversion rates and fewer units per transaction despite increased traffic.
Cash Flow, Liquidity and Capital Structure
- Cash and cash equivalents were $633.6 million at November 2, 2014, compared with $698.6 million at February 2, 2014.
- Operating cash flow was $166.8 million for the first 39 weeks, up from $94.8 million in the prior-year period.
- Capital expenditures were $89.4 million, compared with $71.9 million, primarily for stores, distribution, e-commerce and corporate infrastructure.
- Financing cash outflow was $131.8 million, including $130.3 million used to repurchase 3.3 million shares.
- The company had no borrowings outstanding under its $15.0 million unsecured revolving credit facilities, other than letters of credit and guarantees. The facilities were renewed for one year in November 2014.
- Letters of credit and guarantees totaled $0.6 million. The filing reports no other material off-balance-sheet arrangements beyond operating leases and these commitments.
- Working capital excluding cash was $163.3 million. Management stated that operating cash flow and available borrowing capacity should meet liquidity and capital expenditure needs for at least the next 12 months.
Material Changes Versus Prior Comparable Period
- Revenue growth was driven by 35 net new corporate-owned stores, increased e-commerce traffic and outlet growth, while comparable store performance weakened.
- Gross margin declined 360 basis points in Q3 and 180 basis points year to date. Drivers included lower-margin seasonal product mix, higher product costs, supply-chain and product-related expenses, higher occupancy and depreciation, and unfavorable foreign exchange.
- SG&A increased 16% in Q3 and 19% year to date, primarily due to employee costs, new-store operating costs, head-office investments and direct-to-consumer infrastructure.
- Operating income declined 12% in Q3 and 8% year to date despite revenue growth.
- Year-to-date net income declined 25% because of higher SG&A and a $31.3 million non-recurring tax adjustment related to previously undistributed foreign subsidiary earnings used to fund the share repurchase program. The year-to-date effective tax rate rose to 42.8% from 29.7%.
- The company initiated a $450 million share repurchase program in June 2014, expected to run through June 2016. It repurchased 1.8 million shares for $74.5 million during Q3 and 3.3 million shares for $130.3 million year to date.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide a clear numerical quarterly or full-year earnings or revenue guidance figure. Management emphasized continued investment in product quality, supply chain capabilities, e-commerce, new stores, international markets and brand experience. The company expects seasonality to make the fourth quarter particularly important, historically generating a significant portion of annual gross profit during the holiday period.
- Key operating risks include declining store conversion and transaction size, product quality failures, excess inventory, rising product and labor costs, supply-chain concentration, international expansion, foreign currency volatility, competition and dependence on consumer discretionary spending.
- A 10% appreciation of the Canadian dollar relative to the U.S. dollar was estimated to reduce first-39-week operating income by approximately $3.4 million; the comparable Australian dollar sensitivity was approximately $0.1 million. The company does not currently hedge foreign currency exposure.
- Port labor negotiations were ongoing after expiration of the existing contract on July 1, 2014; a strike or transportation disruption could affect product availability and costs.
- Shareholder books-and-records, derivative and securities class-action matters related primarily to the 2013 sheer Luon product issue, former CEO succession and related stock trading remained outstanding in part. The company stated that it could not predict legal expenses, settlements or damages, and adverse outcomes could materially affect liquidity and financial condition.
- The company early adopted discontinued-operations and going-concern presentation amendments without financial statement impact. It had not yet determined the effect of the new revenue recognition standard or the amended stock-compensation guidance.
Investor Verification Checklist
- Verify that the intended reporting period is Q3 fiscal 2014, not Q3 fiscal 2013.
- Assess whether comparable store sales weakness, lower conversion and lower units per transaction persist beyond the quarter.
- Evaluate the sustainability of gross-margin pressure from product costs, seasonal mix, supply-chain investment and foreign exchange.
- Review the effect of the $31.3 million non-recurring tax adjustment when comparing year-to-date earnings.
- Monitor inventory growth, markdown exposure and holiday-season sell-through.
- Track remaining authorization and cash impact under the $450 million share repurchase program.
- Review developments in the pending shareholder litigation and potential indemnification, settlement and insurance exposure.
- Assess exposure to Canadian dollar movements, offshore sourcing, port disruptions and concentrated suppliers.