Lululemon Athletica Inc. — Form 10-Q Summary
Reporting period: The filing covers the 13 weeks ended May 1, 2016, compared with the 13 weeks ended May 3, 2015. The request identifies “2015 Q1,” but the filing is for fiscal first quarter 2016. Fiscal 2016 will end January 29, 2017. Lululemon designs, distributes, and sells athletic apparel through company-operated stores, e-commerce, outlets, wholesale, and other channels. The company operated 373 stores at May 1, 2016, compared with 363 at January 31, 2016.
Financial Performance and Position
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Net revenue | $495.5 million | $423.5 million | Up 17% |
| Gross profit | $239.1 million | $205.9 million | Up 16% |
| Gross margin | 48.3% | 48.6% | Down 30 bps |
| Income from operations | $57.6 million | $68.0 million | Down 15% |
| Operating margin | 11.6% | 16.1% | Down 450 bps |
| Net income | $45.3 million | $47.8 million | Down 5% |
| Diluted EPS | $0.33 | $0.34 | Down $0.01 |
| Operating cash flow | $39.7 million | $20.9 million | Up $18.8 million |
| Capital expenditures | $26.6 million | $27.9 million | Down $1.3 million |
Revenue growth was driven by 57 net new company-operated stores opened since the comparable period, higher comparable store sales, and e-commerce growth. Total comparable sales increased 6%, or 8% on a constant-dollar basis. Comparable store sales increased 3%, or 5% on a constant-dollar basis. Direct-to-consumer revenue increased 17% to $97.6 million, or 18% on a constant-dollar basis.
Selling, general and administrative expense increased 32% to $181.5 million, rising to 36.6% of revenue from 32.5%. The increase reflected higher store labor and bonuses, head-office costs, professional and technology expenses, distribution and payment costs, digital marketing, and foreign-exchange losses.
Cash and cash equivalents were $550.0 million at May 1, 2016, compared with $501.5 million at January 31, 2016. Working capital excluding cash was $218.7 million. The company had no borrowings outstanding under its aggregate $15.0 million revolving credit facilities, excluding letters of credit. Letters of credit and guarantees totaled $1.6 million. The filing states that available cash, operating cash flow, and credit availability are expected to meet liquidity and capital requirements for at least the next 12 months.
Material Changes Versus the Prior Comparable Period
- Revenue increased 17%, but operating income declined 15% because SG&A growth substantially exceeded gross-profit growth.
- Gross margin declined 30 basis points due primarily to unfavorable foreign exchange and higher fixed costs, partly offset by improved product margin.
- Net foreign-exchange losses included in SG&A increased to $13.5 million from $4.5 million, primarily from revaluation of U.S.-dollar cash and receivables held in Canada.
- General corporate expense increased 52% to $56.3 million, reflecting additional personnel, professional fees, strategic initiatives, and foreign-exchange losses.
- The effective tax rate declined to 20.6% from 30.3%, including a $5.6 million tax recovery related to transfer-pricing arrangements and planned repatriation of foreign earnings. Excluding related tax and interest adjustments, the effective tax rate was 29.8% and adjusted diluted EPS was $0.30.
- Operating cash flow increased primarily because of lower inventory purchases and changes in tax-related liabilities.
- The company repurchased approximately 0.2 million shares for $15.8 million during the quarter. The remaining authorization was approximately $12.8 million at May 1, 2016.
- Accumulated other comprehensive loss improved by $73.6 million, including a $68.1 million reduction in accumulated currency translation loss from changes in the U.S.-dollar/Canadian-dollar relationship.
Outlook, Commentary, Risks, and Unusual Items
The filing does not provide a clear quantitative full-year revenue, earnings, or margin guidance figure. Management describes continued expansion of company-operated stores, direct-to-consumer growth, international expansion, technology investment, and strategic initiatives as important growth priorities. Results are seasonal, with a substantial portion of annual revenue and operating profit historically generated in the fourth quarter.
The company is finalizing a bilateral Advance Pricing Arrangement with the IRS and Canada Revenue Agency. Management expects completion within nine months of the filing. The arrangement is expected to produce a U.S. tax recovery and a Canadian tax payment for fiscal years 2011 through 2015, with associated plans to repatriate $156.0 million of foreign earnings. The first quarter included a $5.6 million net tax recovery and $1.2 million of related net interest expense. The ultimate tax outcome remains subject to additional information and finalization.
Key risks include foreign-currency volatility, which could materially affect reported revenue, expenses, cash, and margins; supply-chain concentration and reliance on overseas manufacturers; product-quality and recall risks; competition and pricing pressure; consumer discretionary spending; inventory forecasting; technology and cybersecurity disruptions; international expansion; labor and trade restrictions; long-term retail leases; tax audits and transfer-pricing matters; and litigation.
Pending matters include a shareholder derivative action concerning alleged fiduciary-duty breaches related to 2013 stock sales and a New York wage-and-hour class action seeking unspecified damages. Management intends to defend the matters and states that current proceedings are not expected to have a material adverse effect, although outcomes are uncertain.
The company estimates that a 10% depreciation of the U.S. dollar against the Canadian dollar, sustained throughout the quarter, would have reduced first-quarter operating income by approximately $8.2 million. The company has not historically hedged foreign-currency exposure.
Investor Verification Items
- Confirm that the relevant filing period is Q1 fiscal 2016, not Q1 fiscal 2015, and reconcile all comparisons to the May 3, 2015 period.
- Assess whether store expansion and e-commerce growth can continue without further SG&A deleverage and operating-margin deterioration.
- Separate recurring earnings from the $5.6 million tax recovery, $1.2 million related interest expense, and significant foreign-exchange effects.
- Monitor the final outcome, cash consequences, and timing of the IRS/CRA Advance Pricing Arrangement.
- Evaluate foreign-exchange sensitivity, particularly the company’s Canadian exposure and lack of historical hedging.
- Review inventory levels, markdowns, product margins, supplier concentration, and potential supply-chain disruption.
- Track liquidity after capital expenditures, store openings, share repurchases, and any future tax payments.
- Follow the shareholder derivative and wage-and-hour litigation for potential financial or reputational effects.