Lululemon Athletica Inc. — Form 10-Q Summary
Reporting period: The supplied filing covers the thirteen and twenty-six weeks ended July 29, 2012, compared with July 31, 2011. Although the request metadata identifies “2011 Q2,” the filing is the fiscal 2012 second-quarter Form 10-Q. Fiscal 2012 is a 53-week year ending February 3, 2013.
Business context
Lululemon designs, manufactures and distributes athletic apparel through corporate-owned stores, e-commerce and wholesale, franchise, showroom and outlet channels. At July 29, 2012, the company operated 189 corporate-owned stores: 119 in the United States, 49 in Canada, 19 in Australia and 2 in New Zealand.
Key financial metrics
| Metric | Q2 FY2012 | Q2 FY2011 | Change |
|---|---|---|---|
| Net revenue | $282.6 million | $212.3 million | +33% |
| Gross profit | $155.8 million | $122.1 million | +28% |
| Gross margin | 55.1% | 57.5% | -240 bps |
| Income from operations | $70.2 million | $59.5 million | +18% |
| Operating margin | 24.8% | 28.0% | -320 bps |
| Net income attributable to lululemon | $57.2 million | $38.4 million | +49% |
| Diluted EPS | $0.39 | $0.26 | +$0.13 |
| Metric | First 26 weeks FY2012 | First 26 weeks FY2011 | Change |
|---|---|---|---|
| Net revenue | $568.3 million | $399.1 million | +42% |
| Gross profit | $313.0 million | $231.8 million | +35% |
| Gross margin | 55.1% | 58.1% | -300 bps |
| Income from operations | $143.3 million | $111.2 million | +29% |
| Net income attributable to lululemon | $103.9 million | $71.8 million | +45% |
| Diluted EPS | $0.71 | $0.49 | +$0.22 |
Revenue and operating trends
- Q2 comparable-store sales increased 13%, or 15% excluding foreign currency effects. First-half comparable-store sales increased 18%, or 20% on a constant-dollar basis.
- Corporate-owned store revenue increased 30% in Q2 and 38% for the first half, supported by comparable-store growth and new stores.
- Direct-to-consumer revenue increased 91% in Q2 and 128% for the first half. E-commerce represented 13.0% of first-half revenue, versus 8.1% in the prior-year period.
- Q2 gross margin declined because of higher labor and raw-material costs, greater product complexity, seasonal merchandise mix, and increased markdowns and discounts. Lower air freight costs partially offset the pressure.
- Q2 SG&A increased 37% and rose to 30.3% of revenue from 29.5%, reflecting store growth, e-commerce investment, higher head-office costs, compensation and strategic initiatives.
- The Q2 effective tax rate was 19.1%, compared with 35.7%, including a $7.2 million tax adjustment related to the finalization of intercompany pricing arrangements. The first-half effective tax rate was 28.0%, compared with 36.0%.
Cash flow, liquidity and capital structure
- Cash and cash equivalents were $444.3 million at July 29, 2012, compared with $409.4 million at January 29, 2012.
- First-half operating cash flow was $63.5 million, compared with $19.5 million in the prior-year period.
- Capital expenditures were $39.0 million, compared with $87.3 million, which included the prior-year purchase of the company’s principal executive and administrative offices.
- Cash increased by $34.8 million during the first half, compared with a $51.6 million decrease in the prior-year period.
- The company had no borrowings outstanding under its CDN$20.0 million uncommitted revolving credit facility, excluding letters of credit and guarantees. Letters of credit and guarantees totaled $1.4 million.
- Management stated that operating cash flow and available revolver capacity should meet liquidity and capital expenditure requirements for at least the next 24 months.
- Inventory increased to $125.4 million from $104.1 million at January 29, 2012. Working capital excluding cash was $84.2 million.
Material changes, outlook and unusual items
- Management planned continued investment in e-commerce, information technology, international expansion, country-specific websites and additional showrooms.
- The company opened 15 corporate-owned stores during the first half and added 26 U.S. stores, four reacquired U.S. franchised stores, four Canadian ivivva stores, six Australian stores and two New Zealand stores since the prior-year second quarter.
- In August 2012, the company purchased the remaining 20% non-controlling interest in lululemon athletica Australia Pty Ltd for $26.1 million. The $5.6 million non-controlling interest was eliminated, with the excess purchase price charged to additional paid-in capital.
- The filing does not provide a clear quantitative revenue or earnings guidance range. Management emphasized growth opportunities but cautioned that retail seasonality makes fourth-quarter results particularly important; fiscal 2012 results are not necessarily indicative of future periods.
- Foreign currency remains material. Management estimated that a 10% depreciation of the Canadian dollar versus the U.S. dollar would have reduced first-half operating income by approximately $10.2 million; the comparable Australian-dollar sensitivity was approximately $0.5 million. The company did not hedge foreign currency exposure.
- Key risks include brand and product quality, changing consumer preferences, inventory forecasting, inflation and raw-material costs, reliance on offshore suppliers, supply-chain and distribution disruptions, competition, information-system failures, long-term store leases, international expansion, seasonality and foreign exchange.
- Management concluded that disclosure controls were effective and reported no material change in internal control over financial reporting. No legal proceeding was identified as likely to have a material adverse effect.
Investor verification points
- Reconcile the request’s “2011 Q2” designation with the filing’s actual July 29, 2012 fiscal 2012 second-quarter period.
- Assess whether gross-margin pressure from product costs, markdowns, seasonal mix and inflation is temporary or structural.
- Monitor e-commerce growth and profitability as the channel becomes a larger share of revenue.
- Review inventory growth and future markdown risk, particularly given the company’s rapid store expansion and seasonal business.
- Verify the effect of the August 2012 Australian subsidiary acquisition on equity, cash and future earnings attribution.
- Evaluate Canadian- and Australian-dollar exposure and the absence of foreign-exchange hedging.
- Consider the dependence on fourth-quarter holiday sales when extrapolating first-half performance.