Lululemon Athletica Inc. Form 10-Q Summary
Reporting period: The filing is for the quarter and first two quarters ended July 30, 2017, compared with July 31, 2016. The request metadata identifies “2016 Q2,” but the filing itself clearly reports fiscal 2017 second-quarter results. The company designs, distributes, and sells athletic apparel and accessories through company-operated stores, e-commerce, outlets, wholesale, and other channels. It operated 421 company-operated stores at quarter-end, compared with 406 at January 29, 2017.
Financial performance and position
| Metric | Q2 FY2017 | Q2 FY2016 | First two quarters FY2017 | First two quarters FY2016 |
|---|---|---|---|---|
| Net revenue | $581.1 million | $514.5 million | $1.101 billion | $1.010 billion |
| Gross profit | $297.4 million | $254.2 million | $554.3 million | $493.3 million |
| Gross margin | 51.2% | 49.4% | 50.3% | 48.8% |
| Income from operations | $68.7 million | $74.0 million | $114.1 million | $131.5 million |
| Operating margin | 11.8% | 14.4% | 10.4% | 13.0% |
| Net income | $48.7 million | $53.6 million | $80.0 million | $99.0 million |
| Diluted EPS | $0.36 | $0.39 | $0.58 | $0.72 |
Revenue drivers: Q2 revenue increased 13%, including 9% growth from company-operated stores, 29% growth in direct-to-consumer revenue, and 18% growth in other channels. Total comparable sales increased 7%; comparable store sales increased 2%, while direct-to-consumer revenue increased 29%. Direct-to-consumer growth was 15% excluding a $12.3 million online warehouse sale.
Cash flow and liquidity: Cash provided by operating activities was $102.0 million for the first two quarters, compared with $101.2 million in the prior-year period. Capital expenditures were $49.9 million, and financing cash outflows were $91.9 million, primarily reflecting share repurchases. Cash and cash equivalents were $721.2 million at July 30, 2017, compared with $734.8 million at January 29, 2017. Working capital excluding cash was $225.5 million. The company had $148.9 million of available capacity under its revolving facility.
Debt and commitments: The company had no borrowings outstanding under its $150.0 million unsecured five-year revolving credit facility, other than $1.1 million of letters of credit. The facility matures December 15, 2021 and includes leverage and interest-coverage covenants. The company also had $1.1 million of letters of credit and letters of guarantee outstanding.
Balance sheet: Inventories were $316.4 million at July 30, 2017, up from $298.4 million at fiscal year-end. Total assets were $1.687 billion and stockholders’ equity was $1.398 billion. Accumulated other comprehensive loss improved to $160.4 million from $201.5 million, substantially reflecting foreign currency translation effects.
Material changes versus the prior comparable period
- Q2 net income declined 9% and first-half net income declined 19%, despite revenue growth, primarily because of higher selling, general and administrative expenses and ivivva restructuring charges.
- Gross margin expanded 180 basis points in Q2 and 150 basis points for the first half, driven mainly by favorable product mix and lower product costs, partly offset by markdowns, occupancy costs, foreign exchange, and restructuring-related charges.
- Q2 SG&A increased 25% to $225.5 million, rising to 38.8% of revenue from 35.0%. The increase reflected channel costs, head-office expenses, marketing, technology, employee costs, and a $6.8 million unfavorable year-over-year change in foreign exchange and derivative revaluation results.
- Q2 company-operated store revenue increased 9%, helped by 42 net new stores opened since the prior-year second quarter. First-half comparable store sales decreased by less than 1%, primarily because of lower traffic.
- Share repurchases increased to $90.8 million for the first half, covering 1.7 million shares, compared with $28.6 million for 0.4 million shares in the prior-year period. $8.5 million remained available under the repurchase authorization at July 30, 2017.
Outlook, unusual items, risks, and contingencies
ivivva restructuring: The company announced a plan to shift ivivva to a primarily e-commerce-focused business. It subsequently closed 47 of 55 ivivva stores on August 20, 2017; seven of the eight remaining stores were expected to continue operating and one was expected to convert to a lululemon store. The company expects the restructuring to be substantially complete by the end of Q3 FY2017.
The company estimated aggregate fiscal 2017 pre-tax restructuring charges of $50 million to $60 million, including $23.2 million recognized through the first two quarters. Remaining costs were expected to be recognized substantially in Q3 and primarily related to lease terminations and employee costs. The estimate depends on significant assumptions and could change materially. First-half charges included $11.6 million of asset impairment, $7.7 million in cost of goods sold, $3.2 million of employee costs, and $0.7 million of lease termination and other costs.
Adjusted results: Excluding ivivva-related charges and certain prior-year tax and transfer-pricing items, Q2 adjusted diluted EPS was $0.39 versus $0.38 in the prior-year quarter. First-half adjusted diluted EPS was $0.71 versus $0.68. These are non-GAAP measures and should not replace GAAP results.
Seasonality: Retail apparel results are seasonal, with a substantial portion of operating profit historically generated in the fourth quarter. Interim results may not be indicative of full-year performance.
Foreign exchange: The company is exposed to translation and transaction risk, particularly involving the Canadian dollar. It had forward contracts with $78.0 million of notional amount designated as net investment hedges and $65.0 million not designated as hedges. Management estimated that a 10% depreciation in the U.S. dollar against the Canadian dollar would have reduced first-half operating income by approximately $7.6 million.
Legal matter: A class action filed by current and former hourly employees alleges violations of New York labor laws, including unpaid wages and overtime. Damages sought were unspecified, and the company intends to defend the matter. Management stated that routine legal matters are not expected to have a material adverse effect, although outcomes can be uncertain.
Accounting and controls: The company expects to adopt ASC 606 in the first quarter of fiscal 2018 and does not expect a material impact on the amount or timing of revenue recognition. ASC 842 lease accounting will be adopted in fiscal 2019 and is expected to significantly increase reported assets and liabilities. Management concluded that disclosure controls were effective as of July 30, 2017.
Key ongoing risks include brand and product quality, competition, supplier concentration and overseas sourcing, inventory forecasting, e-commerce and information technology disruptions, raw-material and labor costs, international expansion, tariffs and trade restrictions, foreign exchange, lease obligations, tax matters, litigation, and execution of the ivivva restructuring.
Facts investors should verify
- Reconcile the requested “2016 Q2” period with the filing’s actual July 30, 2017 reporting period.
- Track whether the ivivva restructuring remains within the estimated $50 million to $60 million pre-tax cost range and whether expected benefits materialize.
- Assess whether SG&A growth, corporate spending, and foreign exchange volatility continue to pressure operating margins.
- Evaluate inventory growth, markdown exposure, and the $2.9 million ivivva inventory valuation provision and $2.5 million committed-purchase liability.
- Separate reported revenue growth from the impact of new stores, the $12.3 million online warehouse sale, and comparable-store performance.
- Monitor cash usage from share repurchases, capital expenditures, and seasonal working-capital requirements.
- Review foreign exchange derivative positions, counterparty exposure, and the sensitivity of operating income to currency movements.
- Follow the New York wage-and-hour litigation and any material developments in other legal or regulatory matters.