Lululemon Athletica Inc. Form 10-Q Summary
Business context and reporting period
This filing reports results for the thirteen and thirty-nine weeks ended October 28, 2012, compared with the corresponding periods ended October 30, 2011. Although the request identifies “2011 Q3,” the filing is the fiscal 2012 third-quarter Form 10-Q. Fiscal 2012 is a 53-week year ending February 3, 2013.
Lululemon designs, manufactures and distributes premium athletic apparel through corporate-owned stores, e-commerce and other channels. At October 28, 2012, the company operated 201 corporate-owned stores: 127 in the United States, 50 in Canada, 22 in Australia and two in New Zealand.
Financial performance and liquidity
| Metric | Q3 2012 | Q3 2011 | Change |
|---|---|---|---|
| Net revenue | $316.5 million | $230.2 million | +37% |
| Gross profit | $175.3 million | $128.5 million | +36% |
| Gross margin | 55.4% | 55.8% | -40 bps |
| Income from operations | $80.6 million | $59.7 million | +35% |
| Operating margin | 25.5% | 25.9% | -40 bps |
| Net income attributable to Lululemon | $57.3 million | $38.8 million | +48% |
| Diluted EPS | $0.39 | $0.27 | +44% |
| Metric | Thirty-nine weeks 2012 | Thirty-nine weeks 2011 | Change |
|---|---|---|---|
| Net revenue | $884.9 million | $629.3 million | +41% |
| Gross profit | $488.3 million | $360.3 million | +36% |
| Gross margin | 55.2% | 57.3% | -210 bps |
| Income from operations | $223.9 million | $170.9 million | +31% |
| Operating margin | 25.3% | 27.2% | -190 bps |
| Net income attributable to Lululemon | $161.2 million | $110.5 million | +46% |
| Diluted EPS | $1.11 | $0.76 | +46% |
Q3 revenue growth reflected an 18% comparable-store sales increase, new store openings and strong e-commerce performance. Direct-to-consumer revenue increased 89% to $45.1 million and represented 14.3% of quarterly revenue, versus 10.4% in the prior-year quarter. For the first 39 weeks, e-commerce revenue increased 112% to $119.0 million and represented 13.4% of revenue, versus 8.9% previously.
Gross-margin pressure reflected higher labor and raw-material costs, product innovation and complexity, increased markdowns and discounts, foreign-exchange effects and a prior-period tax-credit adjustment. Lower air-freight usage and operating-cost leverage partially offset these factors.
At October 28, 2012, cash and cash equivalents were $439.4 million, compared with $409.4 million at January 29, 2012. Working capital excluding cash was $110.4 million. Total liabilities were $121.0 million, and the company had no borrowings outstanding under its CDN$20.0 million uncommitted revolving credit facility. Letters of credit and guarantees totaled $1.4 million.
For the first 39 weeks, operating cash flow was $113.2 million, compared with $53.5 million in the prior-year period. Capital expenditures were $72.0 million, and cash used in financing activities was $11.9 million, including $26.0 million to acquire the remaining non-controlling interest in Lululemon Australia. Ending cash increased by $30.0 million to $439.4 million.
Material changes versus the prior comparable period
- Revenue growth was driven by comparable-store sales, 27 new or acquired corporate-owned stores, and accelerated e-commerce traffic, conversion and average order value.
- Corporate-owned store revenue increased 33% in Q3 and 36% for the first 39 weeks. The company added 21 U.S. stores, five Canadian ivivva stores, eight Australian stores and two New Zealand stores after the prior-year comparison date.
- Direct-to-consumer operating income increased 102% in Q3 and 130% for the first 39 weeks, with margin expansion from fixed-cost leverage.
- General corporate expense increased 37% in Q3 and 41% year to date, primarily from higher head-office compensation, stock-based compensation, incentive compensation and strategic investments.
- The effective tax rate declined to 30.1% from 35.5% in Q3 and to 28.7% from 35.8% for the first 39 weeks, reflecting revised intercompany pricing agreements.
- Inventory increased to $164.7 million from $104.1 million at January 29, 2012, while property and equipment increased to $204.1 million from $162.9 million, consistent with store and infrastructure expansion.
- In August 2012, the company purchased the remaining 20% non-controlling interest in Lululemon Australia for $26.0 million. The transaction eliminated the $5.7 million non-controlling interest balance and reduced additional paid-in capital by $20.3 million.
Guidance, outlook, risks and unusual items
The filing does not provide a specific numerical earnings or revenue outlook. Management expects cash from operations and available revolver capacity to meet liquidity and capital-expenditure needs for at least the next 24 months, while noting that demand weakness or discretionary capital spending could require external financing.
Management plans to continue investing in e-commerce, international expansion, country-specific websites, showrooms, stores and information technology. The company expects e-commerce to become an increasingly substantial and higher-margin part of the business.
Results are seasonal, with a significant portion of annual sales and operating profit historically generated in the fourth quarter holiday period. The filing cautions that interim results may not be indicative of full-year performance.
- Foreign-exchange exposure is significant. A 10% depreciation of the Canadian dollar versus the U.S. dollar was estimated to reduce first-three-quarter operating income by approximately $15.8 million; the comparable Australian-dollar sensitivity was approximately $0.6 million. The company did not hedge these exposures.
- Product costs, raw-material and labor inflation, markdowns, inventory forecasting and supply-chain concentration could pressure margins and cash flow.
- The company relies on third-party suppliers and manufacturers, including concentrated sources for certain technical fabrics. Fiscal 2011 production was approximately 49% in China and 67% through the five largest manufacturing suppliers.
- Two California class-action lawsuits were disclosed: one alleging employment-law violations by former hourly employees and another alleging improper collection of customer ZIP-code information with credit-card transactions. Damages sought were unspecified, and management stated it intends to vigorously defend both matters.
- The filing identifies competition, brand reputation, product quality, information systems, distribution disruptions, long-term store leases, international expansion and consumer discretionary spending as material risks.
Important facts for investors to verify
- Confirm that the applicable period is fiscal Q3 2012, not 2011 Q3, and assess the impact of the 53-week fiscal year.
- Monitor whether e-commerce growth and its higher operating margin continue to offset slowing store growth or margin pressure.
- Evaluate the sustainability of gross-margin performance after the 210-basis-point year-to-date decline.
- Review inventory growth, markdown activity and the adequacy of inventory provisions during the holiday quarter.
- Assess sensitivity to Canadian- and Australian-dollar movements and the absence of foreign-currency hedging.
- Track the disclosed California litigation and any changes in estimated exposure.
- Verify capital-spending requirements, store expansion returns and cash-flow conversion following the Australian subsidiary buyout.