Lululemon Athletica Inc. Form 10-Q Summary
Reporting period: The filing covers the thirteen and twenty-six weeks ended July 31, 2011, compared with the periods ended August 1, 2010. Although the request identifies “2010 Q2,” the filing is for fiscal 2011 second quarter. The statements are unaudited and presented in U.S. dollars.
Business Context
Lululemon designs and distributes technical athletic apparel through corporate-owned stores, e-commerce, franchises, wholesale accounts, showrooms and outlets. Its primary markets are Canada, the United States and Australia. At July 31, 2011, the company operated 147 corporate-owned stores and had four franchise stores, compared with 133 and four, respectively, at January 30, 2011.
- Corporate-owned stores: 45 in Canada, 89 in the United States and 13 in Australia.
- Second-quarter revenue mix: approximately 45% Canada, 51% United States and 4% outside North America.
- The company opened 14 corporate-owned stores in the first half of fiscal 2011 and purchased its administrative-office building in March 2011.
Financial Performance
| Metric | Q2 FY2011 | Q2 FY2010 | Change |
|---|---|---|---|
| Net revenue | $212.3 million | $152.2 million | Up 39% |
| Gross profit | $122.1 million | $80.3 million | Up 52% |
| Gross margin | 57.5% | 52.8% | Up 470 basis points |
| Income from operations | $59.5 million | $34.2 million | Up 74% |
| Net income attributable to Lululemon | $38.4 million | $21.8 million | Up 76% |
| Diluted EPS | $0.26 | $0.15 | Up $0.11 |
Corporate-owned-store revenue increased 38% to $178.2 million. Comparable-store sales increased 25%, or 20% excluding foreign-exchange effects. Direct-to-consumer revenue increased 93% to $18.6 million, while other revenue increased 18% to $15.5 million.
Gross-margin expansion reflected strong sell-through with fewer markdowns, operating leverage, favorable foreign-exchange effects and lower relative product and supply-chain costs. SG&A increased 36% to $62.6 million but declined as a percentage of revenue to 29.5% from 30.3%. The effective tax rate declined to 35.7% from 40.3%, primarily because of revised plans for repatriating Canadian subsidiary earnings.
First-Half Results
| Metric | Twenty-six weeks FY2011 | Twenty-six weeks FY2010 | Change |
|---|---|---|---|
| Net revenue | $399.1 million | $290.5 million | Up 37% |
| Gross profit | $231.8 million | $154.7 million | Up 50% |
| Gross margin | 58.1% | 53.2% | Up 490 basis points |
| Income from operations | $111.2 million | $66.7 million | Up 67% |
| Net income attributable to Lululemon | $71.8 million | $41.4 million | Up 73% |
| Diluted EPS | $0.49 | $0.29 | Up $0.20 |
First-half comparable-store sales increased 23%, or 18% excluding foreign-exchange effects. Direct-to-consumer revenue rose 72% to $32.4 million. The direct-to-consumer channel was being brought in-house and its operating platform was being upgraded.
Cash Flow, Liquidity and Debt
- Cash and cash equivalents were $264.7 million at July 31, 2011, down from $316.3 million at January 30, 2011.
- First-half operating cash flow was $19.5 million, down from $34.6 million, primarily because of higher inventory purchases and income-tax payments.
- Investing cash outflow was $87.3 million, compared with $24.1 million, driven mainly by the $65.1 million purchase of the administrative-office building and increased store expansion.
- Financing cash inflow was $12.1 million, principally from stock-option exercises and related excess tax benefits.
- Inventory increased to $88.9 million from $57.5 million at year-end; the filing attributes the operating-cash-flow reduction primarily to inventory investment and taxes.
- The company reported no borrowings outstanding under its CDN$20.0 million uncommitted revolving credit facility. Letters of credit and guarantees totaled $1.5 million.
- Management stated that cash from operations and available revolving-credit borrowings should meet liquidity and capital-expenditure needs for at least the next 24 months, subject to business conditions and discretionary investments.
Material Changes and Unusual Items
- A two-for-one common-stock and exchangeable/special-voting-stock split was approved in June 2011 and reflected retrospectively in per-share data.
- Property and equipment increased substantially, primarily due to the administrative-office acquisition and ongoing store and infrastructure investment.
- Other income declined because the prior-year period included a gain from remeasuring the company’s 13% Australian non-controlling investment before obtaining control.
- First-half gross margin benefited by approximately 70 basis points from a non-recurring adjustment related to recognition of prior-period input tax credits.
- Stock-based compensation expense was $5.1 million in the first half, compared with $3.6 million in the prior-year period.
Outlook, Commentary and Risks
Management emphasized continued investment in stores, employees, e-commerce infrastructure, information systems and working capital while maintaining spending discipline. No specific numerical revenue or earnings guidance is provided in the filing.
The company noted significant retail seasonality, with a disproportionate share of annual sales and operating profit historically generated in the fourth quarter. Management also cautioned that results for interim periods may not indicate full-year performance.
- Consumer discretionary spending may weaken because of economic uncertainty, unemployment, consumer confidence or reduced access to credit.
- Raw-material, labor, sourcing and transportation costs may pressure margins, particularly because of petroleum-based synthetic fabrics, cotton and production in China and other Asian markets.
- The company relies on third-party suppliers, including concentrated sources for certain specialty fabrics, and generally has no long-term supplier contracts.
- Foreign-exchange exposure is material. A 10% depreciation of the Canadian dollar versus the U.S. dollar would have reduced first-half operating income by approximately $5.7 million; the comparable Australian-dollar sensitivity was approximately $0.2 million. The company did not hedge these exposures.
- Rapid growth creates execution risks involving store openings, inventory forecasting, distribution, information systems, staffing and maintaining brand reputation.
- The business is highly competitive, and the company’s technical fabrics and manufacturing processes are generally not protected by patents or exclusive intellectual-property rights.
- Management reported no legal proceeding expected to have a material adverse effect and concluded that disclosure controls were effective as of July 31, 2011.
Investor Verification Priorities
- Verify that the requested period is intended to be fiscal 2011 Q2, not fiscal 2010 Q2.
- Assess whether the 2011 gross-margin improvement is sustainable after favorable currency effects, lower markdowns and the non-recurring tax-credit adjustment.
- Monitor inventory growth, markdown risk and operating cash conversion as store expansion continues.
- Evaluate the return on the administrative-office purchase and the company’s elevated capital-expenditure program.
- Track e-commerce growth and the financial impact of bringing direct-to-consumer operations in-house.
- Review sensitivity to Canadian and Australian currency movements, raw-material inflation, supplier concentration and consumer discretionary spending.
- Confirm future store-opening plans, fourth-quarter seasonality and any subsequent numerical guidance, which this filing does not provide.