Lululemon Athletica Inc. — Form 10-Q Summary
Business context and reporting period
The filing covers the thirteen and twenty-six weeks ended August 4, 2013, compared with the corresponding periods ended July 29, 2012. Although the request metadata identifies “2012 Q2,” the filing itself is the fiscal 2013 second-quarter Form 10-Q. Lululemon designs, manufactures and distributes technical athletic apparel through 226 corporate-owned stores, e-commerce, wholesale accounts, showrooms and outlets. Fiscal 2013 is a 52-week year ending February 2, 2014.
- Stores at August 4, 2013: 147 in the United States, 53 in Canada, 24 in Australia and 2 in New Zealand.
- Primary reportable segments: corporate-owned stores, direct to consumer and other.
Key financial metrics
| Metric | 13 weeks ended August 4, 2013 | 13 weeks ended July 29, 2012 | 26 weeks ended August 4, 2013 | 26 weeks ended July 29, 2012 |
|---|---|---|---|---|
| Net revenue | $344.5 million | $282.6 million | $690.3 million | $568.3 million |
| Gross profit | $186.0 million | $155.8 million | $356.7 million | $313.0 million |
| Gross margin | 54.0% | 55.1% | 51.7% | 55.1% |
| Income from operations | $79.0 million | $70.2 million | $144.9 million | $143.3 million |
| Operating margin | 22.9% | 24.8% | 21.0% | 25.2% |
| Net income attributable to lululemon | $56.5 million | $57.2 million | $103.7 million | $103.9 million |
| Diluted earnings per share | $0.39 | $0.39 | $0.71 | $0.71 |
| Cash flow from operations | — | — | $70.9 million | $63.5 million |
Cash and cash equivalents were $610.3 million at August 4, 2013, compared with $590.2 million at February 3, 2013. Working capital excluding cash was $126.9 million. Inventory was $163.0 million, including a $24.3 million provision reducing inventory to market value. Property and equipment, net, was $228.8 million.
The company had no borrowings outstanding under its CDN$20.0 million uncommitted revolving credit facility, other than approximately $1.0 million of letters of credit and guarantees. It reported no other debt, derivative contracts, synthetic leases or undisclosed borrowings.
Material changes versus the prior comparable period
- Second-quarter revenue increased 22% to $344.5 million; comparable-store sales increased 7%, or 8% excluding foreign currency effects.
- First-half revenue increased 22% to $690.3 million. Corporate-owned store revenue rose 18%, direct-to-consumer revenue rose 40%, and other revenue rose 28%.
- Direct-to-consumer sales represented 14.3% of second-quarter revenue and 15.0% of first-half revenue, up from 12.5% and 13.0%, respectively.
- Second-quarter gross margin declined 110 basis points, while first-half gross margin declined 340 basis points. The first-half decline primarily reflected the black Luon pants product pull-back, lower product margin, higher markdowns and increased inventory provisions.
- First-half selling, general and administrative expense increased 25% to $211.8 million and rose to 30.7% of revenue from 29.9%.
- First-half operating income increased only 1.1% despite 22% revenue growth, reflecting margin pressure and higher operating expenses. First-half net income attributable to lululemon was essentially flat year over year.
- Capital expenditures increased to $44.0 million from $39.0 million, primarily for new stores, store refurbishment, headquarters projects and technology investments.
- Operating cash flow increased to $70.9 million from $63.5 million, while cash used in investing activities increased to $44.0 million from $39.0 million. Foreign exchange movements reduced cash by $13.1 million.
Guidance, outlook, commentary, risks and unusual items
Management did not provide a specific quantitative earnings or revenue outlook in the filing. Management stated that cash from operations and available revolver capacity should be adequate for liquidity and capital expenditure needs for at least the next 24 months. The company plans continued investment in new stores, e-commerce, international expansion, information technology and its vertical retail strategy.
- Product-quality event: The company pulled affected women’s black Luon bottoms that failed to meet specifications. A $17.5 million inventory provision was recorded in the first half, and lost sales and related costs negatively affected first-half results. Management emphasized that quality control and brand reputation remain priorities.
- Leadership transition: CEO Christine Day announced her intention to step down when a successor is named. The filing identifies the CEO search and possible delay in appointing a successor as a business risk.
- Litigation: The company faces a putative shareholder class action, two shareholder derivative actions and a books-and-records action related principally to the Luon issue, CEO transition and certain insider stock trades. Management considers the claims meritless and intends to defend them. A California former-employee wage-and-hour class action had a tentative settlement pending court approval.
- Foreign exchange: A 10% depreciation of the Canadian dollar against the U.S. dollar was estimated to reduce first-half operating income by approximately $1.7 million; the comparable Australian-dollar sensitivity was less than $0.1 million. The company does not currently hedge currency exposure.
- Seasonality: Retail results are weighted toward the fourth quarter, which historically generates a significant portion of annual gross profit and operating income.
- Principal risks: Brand and product-quality risks, consumer discretionary spending, inventory forecasting, supplier concentration and quality, raw-material and labor costs, international expansion, competition, information-system and distribution disruptions, foreign exchange, long-term store leases, trade restrictions and dependence on key personnel.
- Disclosure controls and procedures were assessed as effective at August 4, 2013, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm the financial impact and any subsequent developments related to the black Luon product pull-back, including additional returns, replacement costs, markdowns or litigation exposure.
- Monitor gross margin recovery and determine whether first-half margin pressure was primarily non-recurring or reflects continuing product-mix, sourcing or cost issues.
- Track the CEO succession process and any effects on strategy, management continuity or investor confidence.
- Review the status and potential financial exposure of the shareholder, derivative, books-and-records and California labor litigation.
- Evaluate inventory growth, the adequacy of inventory provisions and the ability to convert rapid revenue growth into operating and free cash flow.
- Assess the pace and returns of new store openings, e-commerce growth and international expansion, including foreign-currency sensitivity.