Lululemon Athletica Inc. Form 10-Q Summary
Reporting period: The filing covers the thirteen weeks ended May 4, 2014, compared with the thirteen weeks ended May 5, 2013. Although the request identifies “2013 Q1,” the filing is for fiscal 2014 first quarter. Lululemon designs, manufactures, and distributes athletic apparel through corporate-owned stores, e-commerce, showrooms, wholesale accounts, outlets, and warehouse sales. The company operated 263 corporate-owned stores at May 4, 2014, up from 254 at February 2, 2014.
Financial Highlights
| Metric | Q1 Fiscal 2014 | Q1 Fiscal 2013 | Change |
|---|---|---|---|
| Net revenue | $384.6 million | $345.8 million | Up 11% |
| Gross profit | $195.7 million | $170.7 million | Up 15% |
| Gross margin | 50.9% | 49.4% | Up 150 basis points |
| SG&A expense | $125.9 million | $104.8 million | Up 20% |
| Operating income | $69.8 million | $65.9 million | Up 6% |
| Operating margin | 18.2% | 19.1% | Down 90 basis points |
| Income before taxes | $71.4 million | $67.4 million | Up 6% |
| Income tax provision | $52.5 million | $20.1 million | Up 161% |
| Effective tax rate | 73.4% | 29.8% | Up 33.6 percentage points |
| Net income | $19.0 million | $47.3 million | Down 60% |
| Diluted EPS | $0.13 | $0.32 | Down $0.19 |
Revenue and Operating Performance
- Corporate-owned store revenue increased 7% to $288.1 million, driven by new stores, but comparable store sales declined 7%, or 4% excluding foreign exchange effects. Management attributed the comparable-store decline primarily to lower traffic.
- Direct-to-consumer revenue increased 22% to $66.0 million and represented 17.2% of revenue, compared with 15.6% in the prior-year quarter. Growth was primarily attributed to higher e-commerce traffic.
- Other revenue increased 36% to $30.5 million, reflecting new outlets, higher showroom revenue, and the timing of warehouse sales.
- Total comparable sales declined 2%; excluding foreign currency effects, comparable sales increased 1%.
- Gross margin benefited from lower inventory provisions related to the prior-year black Luon pants pull-back and lower markdowns and discounts. These benefits were partly offset by lower product margin, higher seasonal-item mix, higher product and supply-chain costs, unfavorable foreign exchange effects, and increased air freight.
- SG&A increased $21.1 million, reflecting higher store labor and variable costs, increased head-office staffing and strategic investment, direct-to-consumer costs, and a $1.5 million foreign exchange loss.
Cash Flow, Balance Sheet, Debt, and Liquidity
- Cash provided by operating activities increased to $71.0 million from $25.1 million, primarily due to lower income taxes paid and lower inventory purchases.
- Capital expenditures were $25.4 million, compared with $21.0 million in the prior-year quarter, primarily for stores and corporate infrastructure.
- Cash and cash equivalents increased to $752.0 million at May 4, 2014, from $698.6 million at February 2, 2014. The company reported working capital excluding cash of $123.9 million.
- The company had no borrowings outstanding under its $15.0 million aggregate unsecured revolving credit facilities, other than letters of credit and guarantees. Issued letters of credit and guarantees totaled $0.6 million.
- Management stated that cash from operations and available borrowing capacity should meet liquidity and capital expenditure requirements for at least the next 24 months, subject to demand and other risks.
- Total assets were $1.291 billion and total liabilities were $162.6 million at May 4, 2014.
Material Changes Versus the Prior Comparable Period
- Revenue grew 11%, but comparable-store performance weakened and total comparable sales declined 2%.
- Direct-to-consumer revenue continued to grow substantially faster than store revenue, increasing its share of total revenue.
- Gross margin expanded 150 basis points, but operating margin contracted 90 basis points because SG&A grew faster than revenue.
- Net income declined $28.3 million primarily because of a $30.9 million one-time deferred tax liability and higher operating expenses.
- The $30.9 million tax charge relates to U.S. income and foreign withholding taxes on previously undistributed foreign-subsidiary earnings intended to fund a share repurchase program.
- Foreign currency translation produced a $12.4 million gain in comprehensive income, compared with a $4.4 million loss in the prior-year quarter.
Guidance, Outlook, Risks, and Unusual Items
- Management characterized fiscal 2014 as an “investment year,” focused on product quality, supply-chain improvements, brand experience, community engagement, men's and ivivva categories, e-commerce, and domestic and international expansion.
- No specific numerical revenue, earnings, or margin guidance is provided in the filing.
- On June 11, 2014, the board approved a share repurchase program of up to $450.0 million, funded with available cash. The company intended to distribute up to $500.0 million of foreign-subsidiary earnings to the U.S. parent to fund repurchases and related taxes.
- Key risks include product-quality failures, reliance on third-party suppliers and specialized fabrics, supply-chain disruption, foreign exchange volatility, economic weakness affecting discretionary spending, competition, inventory forecasting, information-system and cybersecurity failures, international expansion, trade restrictions, labor and raw-material cost inflation, long-term store leases, and management turnover.
- Significant shareholder and derivative litigation relates to product-quality disclosures, the March 2013 sheer Luon issue, former executive leadership changes, and certain insider stock trades. Several claims were dismissed, but appeals remained pending. The company cannot estimate potential legal expenses, settlements, or damages and warns that adverse outcomes could affect liquidity and earnings.
- A 10% appreciation of the Canadian dollar relative to the U.S. dollar was estimated to reduce first-quarter operating income by approximately $1.5 million; a 10% depreciation of the Australian dollar was estimated to reduce operating income by approximately $0.1 million. The company does not currently hedge these exposures.
- The company adopted revised discontinued-operations guidance in the quarter with no material impact. Management concluded that disclosure controls and procedures were effective as of May 4, 2014.
Investor Verification Checklist
- Verify the effect of the $30.9 million one-time tax charge and distinguish reported earnings from underlying operating performance.
- Monitor whether comparable-store sales and traffic recover after the reported declines.
- Assess whether e-commerce growth can offset store productivity pressure without disproportionately increasing fulfillment and marketing costs.
- Review gross-margin sustainability in light of product costs, seasonal mix, air freight, markdowns, and foreign exchange movements.
- Confirm the timing, funding, and execution of the authorized $450.0 million share repurchase program.
- Track the appeals and potential financial exposure associated with the product-quality and insider-trading-related litigation.
- Evaluate liquidity after planned repurchases, international expansion, store openings, and capital expenditures.
- Consider the company’s exposure to supplier concentration, fabric quality, foreign manufacturing, trade restrictions, and cybersecurity risks.