Business Context and Reporting Period
Lululemon designs, distributes, and sells athletic apparel and accessories through company-operated stores, e-commerce, outlets, wholesale, licensing, and supply arrangements. This Form 10-Q covers the quarter and first two quarters ended August 2, 2020, compared with August 4, 2019. Although the request identifies “2019 Q2,” the filing itself is for fiscal 2020 second quarter.
The period was materially affected by COVID-19, including temporary store and distribution-center closures, reduced operating hours, occupancy restrictions, supply-chain disruption, and a significant shift toward e-commerce. As of August 2, 2020, 492 of 506 company-operated stores were open.
Key Financial Metrics
| Metric | Q2 FY2020 | Q2 FY2019 | First two quarters FY2020 | First two quarters FY2019 |
|---|---|---|---|---|
| Net revenue | $902.9 million | $883.4 million | $1.555 billion | $1.666 billion |
| Gross profit | $489.5 million | $485.8 million | $823.9 million | $907.5 million |
| Gross margin | 54.2% | 55.0% | 53.0% | 54.5% |
| Income from operations | $124.4 million | $168.0 million | $157.2 million | $296.8 million |
| Operating margin | 13.8% | 19.0% | 10.1% | 17.8% |
| Net income | $86.8 million | $125.0 million | $115.4 million | $221.6 million |
| Diluted EPS | $0.66 | $0.96 | $0.88 | $1.69 |
| Cash flow from operations | Not separately provided for the quarter | Not separately provided for the quarter | $60.1 million | $50.0 million |
Q2 revenue increased 2% year over year, or 3% on a constant-dollar basis. First-half revenue declined 7%, or 6% on a constant-dollar basis.
- Company-operated store revenue declined 51% in Q2 to $287.2 million and 50% year to date to $547.2 million.
- Direct-to-consumer revenue increased 155% in Q2 to $554.3 million and 112% year to date to $906.3 million. The Q2 online warehouse sale contributed $43.3 million.
- Q2 selling, general and administrative expense increased 11% to $352.9 million, or 39.1% of revenue, compared with 36.0%.
- Q2 income tax expense was $37.3 million, with a 30.0% effective tax rate versus 26.4% in the prior-year quarter.
- Government payroll subsidies totaled $35.5 million during the first two quarters and reduced selling, general and administrative expenses.
Financial Position, Cash Flow, Debt, and Liquidity
- Cash and cash equivalents were $523.0 million at August 2, 2020, compared with $1.094 billion at February 2, 2020.
- Inventories increased to $672.8 million from $518.5 million, including $700.0 million of finished goods before a $27.3 million net realizable-value provision.
- Operating cash flow was $60.1 million. Investing cash flow was negative $545.3 million, primarily because of the MIRROR acquisition and $104.7 million of capital expenditures. Financing cash flow was negative $82.2 million.
- The company paid $452.6 million, net of cash acquired, for MIRROR and repurchased $63.7 million of common stock during the first two quarters. The repurchase program was paused as of March 31, 2020.
- No borrowings were outstanding under the $400.0 million North America revolving facility, the Mainland China facility, or the new $300.0 million 364-day revolving facility. Letters of credit totaled $2.3 million.
- Management reported $697.7 million of capacity under committed revolving credit facilities and stated that available cash, operating cash flow, and borrowing capacity should meet liquidity and capital needs for at least the next 12 months.
- Total lease liabilities were $780.6 million, consisting of $147.9 million current and $632.6 million non-current liabilities.
Material Changes Versus the Prior Comparable Period
- COVID-19 shifted the revenue mix sharply from stores to digital channels. Direct-to-consumer revenue represented 61.4% of Q2 revenue versus 24.6% in the prior-year quarter, while company-operated stores represented 31.8% versus 66.1%.
- Q2 operating margin declined 520 basis points and first-half operating margin declined 770 basis points, reflecting store deleverage, higher distribution and digital costs, and acquisition-related expenses.
- First-half net income declined 48%, primarily because of lower gross profit, higher selling, general and administrative expenses, MIRROR acquisition expenses, and new intangible-asset amortization.
- On July 7, 2020, Lululemon acquired MIRROR, an in-home fitness platform, for approximately $464.7 million of gross consideration, including assumed debt and the fair value of an existing investment. The provisional purchase-price allocation included $362.5 million of goodwill and $85.0 million of intangible assets.
- MIRROR generated $13.5 million of acquisition-related expenses in the first two quarters and is expected to generate an additional $57.1 million of deferred consideration expense, subject to continuing employee service through vesting dates.
Guidance, Outlook, Commentary, and Risks
The filing does not provide a clear quantitative full-year revenue or earnings guidance figure. Management stated that COVID-19 is expected to continue affecting operations, financial position, and liquidity, but expressed confidence in long-term growth opportunities and the Power of Three plan.
- Potential future COVID-19 effects include renewed store or distribution-center closures, reduced consumer demand and store traffic, supply-chain interruptions, higher logistics costs, inventory provisions, and impairment charges.
- Management noted that comparable-store and total-comparable-sales metrics were not representative because widespread temporary closures removed a significant number of stores from the comparable base.
- MIRROR integration, subscriber growth, technology performance, content development, competition, and the ability to achieve expected synergies are significant execution risks.
- Additional risks include dependence on offshore suppliers, concentrated fabric and manufacturing sources, tariffs and trade restrictions, foreign-exchange volatility, cybersecurity and privacy obligations, lease commitments, product quality, competition, and discretionary consumer spending.
- The company was in compliance with credit-facility covenants at August 2, 2020. The filing identifies employment, trademark, labor, and other legal proceedings but states that management does not expect current matters to have a material adverse effect.
Important Facts for Investors to Verify
- Whether the rapid e-commerce growth persists after stores fully reopen and whether store productivity recovers without significant impairment charges.
- The pace and profitability of MIRROR revenue, subscriptions, hardware sales, integration, and cash consumption.
- Inventory aging, markdown exposure, and the adequacy of the $27.3 million inventory valuation provision.
- The duration and severity of COVID-19-related restrictions and their effects on liquidity, supply chains, margins, and consumer demand.
- Whether government payroll subsidies and deferred Canadian tax payments are nonrecurring and how their reversal affects future cash flow and expenses.
- Available borrowing capacity, covenant headroom, and the potential need to draw on the revolving facilities.
- Future acquisition-related compensation of up to $57.1 million and the provisional nature of MIRROR’s purchase-price allocation.