Business Context and Reporting Period
Lululemon Athletica Inc. designs, manufactures and distributes technical athletic apparel through corporate-owned stores, e-commerce, franchises and wholesale accounts, primarily in Canada, the United States and Australia. The filing covers the thirteen and thirty-nine weeks ended October 30, 2011, compared with October 31, 2010. The request labels the period “2010 Q3,” but the filing is for fiscal 2011 third quarter; fiscal 2011 ends January 29, 2012.
At October 30, 2011, the Company operated 165 corporate-owned stores: 45 in Canada, 106 in the United States and 14 in Australia, compared with 133 corporate-owned and four franchise stores at January 30, 2011.
Financial Highlights
| Metric | Q3 Fiscal 2011 | Q3 Fiscal 2010 | First 39 Weeks Fiscal 2011 | First 39 Weeks Fiscal 2010 |
|---|---|---|---|---|
| Net revenue | $230.2 million | $175.8 million | $629.3 million | $466.3 million |
| Gross profit | $128.5 million | $96.8 million | $360.3 million | $251.5 million |
| Gross margin | 55.8% | 55.1% | 57.2% | 53.9% |
| Income from operations | $59.7 million | $42.4 million | $170.9 million | $109.1 million |
| Net income attributable to Lululemon | $38.8 million | $25.7 million | $110.5 million | $67.1 million |
| Diluted earnings per share | $0.27 | $0.18 | $0.76 | $0.47 |
| Cash flow from operations | Not separately provided | Not separately provided | $53.5 million | $87.9 million |
Q3 revenue increased 31%, gross profit increased 33%, operating income increased 41% and diluted EPS increased from $0.18 to $0.27. For the first 39 weeks, revenue increased 35%, gross profit increased 43%, operating income increased 57% and diluted EPS increased from $0.47 to $0.76.
Q3 comparable-store sales increased 18%, or 16% excluding foreign currency effects. For the first 39 weeks, comparable-store sales increased 21%, or 18% excluding foreign currency effects. Direct-to-consumer revenue increased 71% in Q3 and 72% for the first 39 weeks, reaching 10.4% and 8.9% of total revenue, respectively.
Liquidity, Capital Spending and Debt
- Cash and cash equivalents were $276.9 million at October 30, 2011, compared with $316.3 million at January 30, 2011.
- Working capital excluding cash was $68.1 million.
- Cash provided by operating activities was $53.5 million, down from $87.9 million, primarily because of increased inventory purchases and higher income taxes paid.
- Cash used in investing activities was $106.3 million, compared with $34.4 million, including approximately $65.1 million for the purchase of the principal executive and administrative office building and $5.7 million for reacquired franchises.
- Cash provided by financing activities was $14.5 million, primarily from stock-option exercises and excess tax benefits.
- The Company had no borrowings outstanding under its CDN$20.0 million uncommitted revolving credit facility, other than issued letters of credit and guarantees. Letters of credit and guarantees totaled $1.5 million.
- Management stated that operating cash flow and available borrowings should meet liquidity and capital expenditure needs for at least the next 24 months.
Material Changes and Unusual Items
- Four franchised stores were reacquired for $5.7 million in cash plus $0.2 million of working-capital adjustments. The preliminary allocation included $5.2 million of goodwill and intangible assets.
- The Company opened or acquired 32 corporate-owned stores during the first 39 weeks and invested substantially in store expansion, infrastructure and its e-commerce platform.
- A two-for-one stock split became effective in July 2011; prior-period EPS and share data were retrospectively adjusted.
- The effective tax rate declined to 35.5% in Q3 and 35.8% for the first 39 weeks, compared with 38.9% and 39.7%, respectively, primarily because of revised plans for repatriating unremitted Canadian earnings.
- Foreign exchange benefited reported results, particularly through the strengthening Canadian and Australian dollars against the U.S. dollar. The Company does not currently hedge foreign currency exposure.
- Stock-based compensation expense was $7.7 million for the first 39 weeks, with $22.3 million of unrecognized compensation cost expected to be recognized over a weighted-average period of 2.4 years.
Outlook, Commentary and Risks
Management emphasized continued investment in stores, employees, infrastructure, e-commerce and working capital while maintaining control over discretionary spending. It views e-commerce as an important international growth channel and expects direct-to-consumer revenue to exceed 10% of total revenue in future fiscal years. The filing does not provide specific numerical revenue, earnings or margin guidance.
Results are seasonal, with a significant portion of annual sales and operating profit historically generated in the fourth fiscal quarter during the holiday period. Management cautioned that interim results are not necessarily indicative of full-year performance.
- Key risks include economic weakness and reduced discretionary consumer spending.
- Product cost inflation, raw-material and labor costs, pricing pressure and potential margin compression remain concerns.
- The Company relies on third-party suppliers, including concentrated sources for certain technical fabrics, and approximately 69% of fiscal 2010 production came from its five largest manufacturing suppliers.
- Approximately 60% of fiscal 2010 production occurred in China, exposing the Company to labor, currency, trade, tariff, shipping and geopolitical risks.
- Inventory increased to $129.2 million from $57.5 million at January 30, 2011; inaccurate demand forecasts could result in markdowns, write-downs or shortages.
- Foreign currency exposure is material: a 10% depreciation of the Canadian dollar versus the U.S. dollar would have reduced first-39-week operating income by approximately $8.4 million based on the filing’s sensitivity analysis.
- Additional risks include competition, dependence on successful new products and store openings, information-system and distribution disruptions, long-term store leases, intellectual-property limitations and brand-reputation risks.
Management reported no material legal proceeding, concluded that disclosure controls were effective, and reported no material change in internal control over financial reporting during the quarter.
Investor Verification Items
- Verify the period designation: this is a fiscal 2011 Q3 filing, despite the request metadata referring to 2010 Q3.
- Assess whether the sharp inventory increase is supported by holiday demand and future sales, and monitor markdowns and inventory provisions.
- Reconcile the decline in operating cash flow with strong earnings and determine whether working-capital investment normalizes.
- Evaluate the sustainability of the 57.2% year-to-date gross margin, including foreign exchange benefits, lower markdowns and raw-material cost pressures.
- Track performance and profitability of the rapidly expanding corporate-owned store base and the reacquired franchises.
- Monitor e-commerce growth, infrastructure spending and progress toward more than 10% of revenue from direct-to-consumer sales.
- Review foreign exchange sensitivity, supplier concentration and China-related sourcing risks.
- Confirm the impact of seasonality and fourth-quarter execution on full-year results, as no specific numerical guidance was provided.