SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________
Form 10-K
_______________________________________
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended January 28, 2018
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 001-33608
_______________________________________
lululemon athletica inc.
(Exact name of registrant as specified in its charter)
_______________________________________
Delaware | 20-3842867 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
1818 Cornwall Avenue Vancouver, British Columbia | V6J 1C7 | |
(Address of principal executive offices) | (Zip Code) | |
Registrant's telephone number, including area code: (604) 732-6124
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Each Exchange on Which Registered | |
Common Stock, par value $0.005 per share | Nasdaq Global Select Market | |
_______________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | þ | Accelerated filer | o | |||
Non-accelerated filer | o (Do not check if a smaller reporting company) | Smaller reporting company | o | |||
Emerging growth company | o | |||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Act). Yes o No þ
The aggregate market value of the voting stock held by non-affiliates of the registrant on July 28, 2017 was approximately $4,703,000,000. Such aggregate market value was computed by reference to the closing price of the common stock as reported on the Nasdaq Global Select Market on July 28, 2017. For purposes of determining this amount only, the registrant has defined affiliates as including the executive officers, directors, and owners of 10% or more of the outstanding voting stock of the registrant on July 28, 2017.
Common Stock:
At March 21, 2018 there were 125,679,588 shares of the registrant's common stock, par value $0.005 per share, outstanding.
Exchangeable and Special Voting Shares:
At March 21, 2018, there were outstanding 9,776,421 exchangeable shares of Lulu Canadian Holding, Inc., a wholly-owned subsidiary of the registrant. Exchangeable shares are exchangeable for an equal number of shares of the registrant's common stock.
In addition, at March 21, 2018, the registrant had outstanding 9,776,421 shares of special voting stock, through which the holders of exchangeable shares of Lulu Canadian Holding, Inc. may exercise their voting rights with respect to the registrant. The special voting stock and the registrant's common stock generally vote together as a single class on all matters on which the common stock is entitled to vote.
_______________________________________
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2018 Annual Meeting of Stockholders have been incorporated by reference into Part III of this Annual Report on Form 10-K.
TABLE OF CONTENTS
Page | ||
Item 1. | ||
Item 1A. | ||
Item 2. | ||
Item 3. | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Item 7A. | ||
Item 8. | ||
Item 9A. | ||
Item 10. | ||
Item 11. | ||
Item 12. | ||
Item 13. | ||
Item 14. | ||
Item 15. | ||
PART I
Special Note Regarding Forward-Looking Statements
This report and some documents incorporated herein by reference include estimates, projections, statements relating to our business plans, objectives, and expected operating results that are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We use words such as "anticipates," "believes," "estimates," "may," "intends," "expects," and similar expressions to identify forward-looking statements. Discussions containing forward-looking statements may be found in the material set forth under "Business", "Management's Discussion and Analysis of Financial Condition and Results of Operations", and in other sections of the report. All forward-looking statements are inherently uncertain as they are based on our expectations and assumptions concerning future events. Any or all of our forward-looking statements in this report may turn out to be inaccurate. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, and financial needs. They may be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties, including the risks, uncertainties and assumptions described in the section entitled "Item 1A. Risk Factors" and elsewhere in this report. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur as contemplated, and our actual results could differ materially from those anticipated or implied by the forward-looking statements. All forward-looking statements in this report are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward-looking statement.
ITEM 1. BUSINESS
General
lululemon athletica inc. is principally a designer, distributor, and retailer of healthy lifestyle inspired athletic apparel and accessories. We have a mission to create transformational products and experiences which enable people to live a life they love, and have developed a brand for those pursuing an active, mindful lifestyle. Since our inception, we have fostered a distinctive corporate culture; we promote a set of core values in our business which include taking personal responsibility, nurturing entrepreneurial spirit, acting with honesty and courage, valuing connection, and choosing to have fun. These core values attract passionate and motivated employees who are driven to achieve personal and professional goals, and share our purpose of "elevating the world through the power of practice."
In this Annual Report on Form 10-K ("10-K" or "Report") for the fiscal year ended January 28, 2018 ("fiscal 2017"), lululemon athletica inc. (together with its subsidiaries) is referred to as "lululemon," "the Company," "we," "us" or "our."
Our Products
Our healthy lifestyle inspired athletic apparel and accessories are marketed under the lululemon and ivivva brand names. We offer a comprehensive line of apparel and accessories for women, men and female youth. Our apparel assortment includes items such as pants, shorts, tops, and jackets designed for a healthy lifestyle and athletic activities such as yoga, running, training, and most other sweaty pursuits. We also offer fitness-related accessories, including items such as bags, socks, underwear, yoga mats and equipment, and water bottles.
Our design and development team continues to source technically advanced fabrics, with new feel and fit, and craft innovative functional features for our products. Through our vertical retail strategy and direct connection with our guests, we are able to collect feedback and incorporate unique performance and fashion needs into our design process. In this way, we believe we solve problems for our guests, helping us advance our product lines and differentiate us from the competition.
Although we benefit from the growing number of people that participate in yoga, we believe the percentage of our products sold for other activities will continue to increase as we broaden our product range.
Our Market
Our guests seek a combination of performance, style, and sensation in their athletic apparel, choosing products that allow them to feel great however they exercise. Since consumer purchase decisions are driven by both an actual need for functional products and a desire to live a particular lifestyle, we believe the credibility of our brand and the authentic community experiences we offer expand our potential market beyond just athletes to those who pursue an active, mindful, and balanced life.
1
Although our primary and largest customer group is made up of women, we also design a comprehensive men's line and have a targeted strategy in place to serve our male guests. Our business is growing as more men discover the technical rigor and premium quality of our products, and are attracted by our distinctive brand.
North America is our largest market by geographical split, offering a mature health and wellness industry and sophisticated consumer. Additionally, we are expanding internationally across Europe (including the United Kingdom and Germany) and Asia Pacific (including China, South Korea, and Japan). We are expanding in these regions via a decentralized model, allowing for local community insight and consumer preference to inform our strategic expansion.
Our Segments
We primarily conduct our business through two channels: company-operated stores and direct to consumer.
We also generate net revenue from outlets, sales from temporary locations, sales to wholesale accounts, showrooms, warehouse sales, and license and supply arrangements. The net revenue we generate from these sources is combined in our other segment.
We operate in both the physical and digital space to better cater to the shopping desires of our guest. At the end of fiscal 2017, we had 404 stores in 12 countries across the globe. In addition to being a venue to sell product, our stores give us a direct connection to our guest, which we view as a valuable tool in helping us build our brand and product line.
Our direct to consumer segment includes the net revenue which we generate from our e-commerce website www.lululemon.com, other country and region specific websites, and mobile apps, including mobile apps on in-store devices that allow demand to be fulfilled via our distribution centers.
Segment information is included in Note 19 to our audited consolidated financial statements included in Item 8 of Part II of this report.
Company-Operated Stores
As of January 28, 2018, our retail footprint included 404 company-operated stores. While most of our company-operated stores are branded lululemon, seven of our company-operated stores are branded ivivva and specialize in athletic wear for female youth. Our retail stores are located primarily on street locations, in lifestyle centers, and in malls.
2
Our company-operated stores by brand, and by country, as of January 28, 2018 and January 29, 2017, are summarized in the table below:
January 28, 2018 | January 29, 2017 | |||||
lululemon | ||||||
United States(1) | 270 | 246 | ||||
Canada | 57 | 51 | ||||
Australia | 28 | 27 | ||||
China(2) | 15 | 6 | ||||
United Kingdom | 9 | 9 | ||||
New Zealand | 6 | 5 | ||||
Singapore | 3 | 3 | ||||
South Korea | 3 | 2 | ||||
Germany | 2 | 1 | ||||
Japan | 2 | — | ||||
Ireland | 1 | — | ||||
Switzerland | 1 | 1 | ||||
397 | 351 | |||||
ivivva | ||||||
United States | 4 | 42 | ||||
Canada | 3 | 13 | ||||
7 | 55 | |||||
Total | 404 | 406 | ||||
__________
(1) | Included within the United States as of January 28, 2018 and January 29, 2017, was one company-operated store in the Commonwealth of Puerto Rico. |
(2) | Included within China as of January 28, 2018, were three company-operated stores in the Hong Kong Special Administrative Region and one company-operated store in the Taiwan Province. As of January 29, 2017, there were three company-operated stores in the Hong Kong Special Administrative Region and no company-operated stores in the Taiwan Province. |
We opened 46 net new lululemon branded company-operated stores in fiscal 2017, including 16 net new stores outside of North America.
We perform ongoing evaluations of our portfolio of company-operated store locations. In fiscal 2017, we closed three of our lululemon branded company-operated stores, and on August 20, 2017, as part of the restructuring of our ivivva operations, we closed 48 of our 55 ivivva branded company-operated stores. The seven remaining ivivva branded stores remain in operation and are not expected to close. As we continue our evaluation we may, in future periods, close or relocate additional company-operated stores.
In fiscal 2018, our new store growth will come primarily from new company-operated stores in the United States and an acceleration in our company-operated store openings in Asia. Our real estate strategy over the next several years will not only consist of opening new company-operated stores, but also in overall square footage growth through store expansions and relocations.
We believe that our innovative retail concept and guest experience contribute to the success of our stores. During fiscal 2017, our company-operated stores open at least one year, which average approximately 3,012 square feet, averaged sales of $1,554 per square foot. The square footage of our company-operated stores excludes space used for non-retail activities such as yoga studios and office space.
Direct to Consumer
Direct to consumer is a substantial part of our business, representing approximately 21.8% of our net revenue in fiscal 2017. We believe that e-commerce is convenient for our core customer and enhances the image of our brand. Our direct to consumer channel makes our product accessible to more markets than our company-operated store channel alone. We believe this channel is effective in building brand awareness, especially in new markets.
3
We continue to evolve and integrate our digital and physical channels in order to enrich our interactions with our guests, and to provide an enhanced omni-channel experience.
Other Channels
Other net revenue accounted for 8.9% of total net revenue in fiscal 2017, compared to 8.0% in fiscal 2016, and 6.9% of total net revenue in fiscal 2015. Other net revenue includes sales made through the following channels:
• | Outlets and warehouse sales - We utilize outlets as well as physical warehouse sales, which are held from time to time, to sell slow moving inventory and inventory from prior seasons to retail customers at discounted prices. |
• | Temporary locations - Our temporary locations, including seasonal stores, are typically opened for a short period of time in markets in which we may not already have a presence. |
• | Wholesale - Our wholesale accounts include premium yoga studios, health clubs, and fitness centers. We believe these premium wholesale locations offer an alternative distribution channel that is convenient for our core consumer and enhances the image of our brand. We do not intend wholesale to be a significant contributor to overall sales. Instead, we use the channel to build brand awareness, especially in new markets, including those outside of North America. |
• | Showrooms - Our showrooms are typically small locations that we open when we enter new markets and feature a limited selection of our product offering. |
• | License and supply arrangements - We enter into license and supply arrangements from time to time when we believe that it will be to our advantage to partner with companies and individuals with significant experience and proven success in certain target markets. |
We have entered into license and supply arrangements with partners in the Middle East and Mexico which grant them the right to operate lululemon branded retail locations in the United Arab Emirates, Kuwait, Qatar, Oman, Bahrain, and Mexico. We retain the rights to sell lululemon products through our e-commerce websites in these countries. Under these arrangements we supply the partners with lululemon products, training and other support. The initial term of the agreement for the Middle East expires in January 2020, and the initial term of the agreement for Mexico expires in November 2026. As of January 28, 2018, there were three licensed retail locations in the United Arab Emirates, one in Qatar, and one in Mexico, which are not included in the above company-operated stores table.
Community-Based Marketing
We utilize a community-based approach to build brand awareness and customer loyalty. We pursue a multi-faceted strategy which leverages our local teams and ambassadors, digital marketing and social media, in-store community boards, and a variety of grassroots initiatives. Our first global marketing campaign launched in fiscal 2017, and we plan to continue to explore how we complement and amplify our community-based initiatives with global brand-building activity.
Product Design and Development
Our product design and development efforts are led by a team of researchers, scientists, engineers and designers based in Vancouver, British Columbia, partnering with international designers. Our team is comprised of athletes and users of our products who embody our design philosophy and dedication to premium quality. Our design and development team identifies trends based on market intelligence and research, proactively seeks the input of our guests and our ambassadors and broadly seeks inspiration consistent with our goals of function, style and technical superiority.
As we strive to continue to provide our guests with technically advanced fabrics, our team works closely with our suppliers to incorporate the latest in technical innovation, bringing particular specifications to our products. We partner with independent inspection, verification, and testing companies, who conduct a variety of tests on our fabrics, testing performance characteristics including pilling, shrinkage, abrasion resistance, and colorfastness. We develop proprietary fabrics and collaborate with leading fabric and trims suppliers to manufacture fabrics and trims that we ultimately protect through agreements, trademarks and trade-secrets.
Sourcing and Manufacturing
We do not own or operate any manufacturing facilities. We rely on a limited number of suppliers to provide fabrics for, and to produce, our products. We work with a group of approximately 65 suppliers to provide the fabrics for our products. We work with a group of approximately 47 vendors that manufacture our products, five of which produced approximately 64% of
4
our products in fiscal 2017. During fiscal 2017, no single manufacturer produced more than 25% of our product offerings. During fiscal 2017, approximately 53% of our products were manufactured in South East Asia, approximately 25% in South Asia, approximately 10% in China, approximately 8% in the Americas, and the remainder in other regions.
We have developed long-standing relationships with a number of our vendors and take great care to ensure that they share our commitment to quality and ethics. We do not, however, have any long-term term contracts with the majority of our suppliers or manufacturing sources for the production and supply of our fabrics and garments, and we compete with other companies for fabrics, raw materials, and production. We require that all of our manufacturers adhere to a vendor code of ethics regarding social and environmental sustainability practices. Our product quality and sustainability teams partner with leading inspection and verification firms to closely monitor each supplier's compliance with applicable laws and our vendor code of ethics.
Distribution Facilities
We operate and distribute finished products from our distribution facilities in the United States, Canada, and Australia. We own our distribution center in Columbus, Ohio, and lease our other distribution facilities. The approximate square footage of each facility is included in Item 2 of Part I of this report. We also utilize third-party logistics providers to warehouse and distribute finished products from their warehouse locations in Hong Kong, Rotterdam, and Shanghai.
Competition
Competition in the athletic apparel industry is based principally on brand image and recognition as well as product quality, innovation, style, distribution, and price. We believe that we successfully compete on the basis of our premium brand image and our technical product innovation. We also believe our ability to introduce new product innovations and combine function and fashion sets us apart from our competition. In addition, we believe our vertical retail distribution strategy and community-based marketing differentiates us further, allowing us to more effectively control our brand image and connect with our guest.
The market for athletic apparel is highly competitive. It includes increasing competition from established companies that are expanding their production and marketing of performance products, as well as from frequent new entrants to the market. We are in direct competition with wholesalers and direct sellers of athletic apparel, such as Nike, Inc., adidas AG, and Under Armour, Inc. We also compete with retailers specifically focused on women's athletic apparel including The Gap, Inc. (including the Athleta brand) and L Brands, Inc. (including the Victoria Sport assortment at Victoria's Secret).
Seasonality
Our business is affected by the general seasonal trends common to the retail apparel industry. Our annual net revenue is weighted more heavily toward our fourth fiscal quarter, reflecting our historical strength in sales during the holiday season, while our operating expenses are more equally distributed throughout the year. As a result, a substantial portion of our operating profits are generated in the fourth quarter of our fiscal year. For example, we generated approximately 56%, 47%, and 45% of our full year operating profit during the fourth quarters of fiscal 2017, fiscal 2016, and fiscal 2015, respectively. Excluding the costs we incurred in connection with the ivivva restructuring, we generated approximately 51% of our operating profit during the fourth quarter of fiscal 2017.
Our Employees
We believe that our people are key to the success of our business, and we strive to foster a distinctive corporate culture rooted in our core business values which attract passionate and motivated employees who are driven to achieve personal and professional goals.
As of January 28, 2018, we had approximately 13,400 employees, of which approximately 7,900 were employed in the United States, approximately 3,800 were employed in Canada, and approximately 1,700 were employed outside of North America. None of our employees are currently covered by a collective bargaining agreement. We have had no labor-related work stoppages by our employees and we believe our relations with our employees are excellent.
Intellectual Property
We have trademark rights on most of our products and believe having distinctive marks that are readily identifiable is an important factor in building our brand image and in distinguishing our products from the products of others. We consider our lululemon and wave design trademarks to be among our most valuable assets. In addition, we own many other trademarks for
5
names of several of our brands, slogans, fabrics and products. We own registered and pending U.S. and foreign utility and design patents, industrial designs in Canada, and registered community designs in Europe that protect our product innovations, distinctive apparel, and accessory designs.
Securities and Exchange Commission Filings
Our website address is www.lululemon.com. We provide free access to various reports that we file with, or furnish to, the United States Securities and Exchange Commission, or the SEC, through our website, as soon as reasonably practicable after they have been filed or furnished. These reports include, but are not limited to, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports. Our SEC reports can also be accessed through the SEC's website at www.sec.gov. The public may read and copy any materials filed by us with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also available on our website are printable versions of our Code of Business Conduct and Ethics and charters of the Audit, Compensation, and Nominating and Governance Committees of our board of directors. Information on our website does not constitute part of this annual report on Form 10-K or any other report we file or furnish with the SEC.
ITEM 1A. RISK FACTORS
In addition to the other information contained in this Form 10-K, the following risk factors should be considered carefully in evaluating our business. Our business, financial condition or results of operations could be materially adversely affected by any of these risks. Please note that additional risks not presently known to us or that we currently deem immaterial could also impair our business and operations.
Our success depends on our ability to maintain the value and reputation of our brand.
Our success depends on the value and reputation of the lululemon brand. The lululemon name is integral to our business as well as to the implementation of our strategies for expanding our business. Maintaining, promoting, and positioning our brand will depend largely on the success of our marketing and merchandising efforts and our ability to provide a consistent, high quality product, and guest experience. We rely on social media, as one of our marketing strategies, to have a positive impact on both our brand value and reputation. Our brand and reputation could be adversely affected if we fail to achieve these objectives, if our public image was to be tarnished by negative publicity, if we fail to deliver innovative and high quality products acceptable to our guests, or if we face a product recall. Negative publicity regarding the production methods of any of our suppliers or manufacturers could adversely affect our reputation and sales and force us to locate alternative suppliers or manufacturing sources. Additionally, while we devote considerable efforts and resources to protecting our intellectual property, if these efforts are not successful the value of our brand may be harmed. Any harm to our brand and reputation could have a material adverse effect on our financial condition.
If any of our products are unacceptable to us or our guests, our business could be harmed.
We have occasionally received, and may in the future receive, shipments of products that fail to comply with our technical specifications or that fail to conform to our quality control standards. We have also received, and may in the future receive, products that are otherwise unacceptable to us or our guests. Under these circumstances, unless we are able to obtain replacement products in a timely manner, we risk the loss of net revenue resulting from the inability to sell those products and related increased administrative and shipping costs. Additionally, if the unacceptability of our products is not discovered until after such products are purchased by our guests, our guests could lose confidence in our products or we could face a product recall and our results of operations could suffer and our business, reputation, and brand could be harmed.
We operate in a highly competitive market and the size and resources of some of our competitors may allow them to compete more effectively than we can, resulting in a loss of our market share and a decrease in our net revenue and profitability.
The market for technical athletic apparel is highly competitive. Competition may result in pricing pressures, reduced profit margins or lost market share, or a failure to grow or maintain our market share, any of which could substantially harm our business and results of operations. We compete directly against wholesalers and direct retailers of athletic apparel, including large, diversified apparel companies with substantial market share and established companies expanding their production and marketing of technical athletic apparel, as well as against retailers specifically focused on women's athletic apparel. We also face competition from wholesalers and direct retailers of traditional commodity athletic apparel, such as cotton T-shirts and sweatshirts. Many of our competitors are large apparel and sporting goods companies with strong worldwide brand recognition. Because of the fragmented nature of the industry, we also compete with other apparel sellers, including those
6
specializing in yoga apparel and other activewear. Many of our competitors have significant competitive advantages, including longer operating histories, larger and broader customer bases, more established relationships with a broader set of suppliers, greater brand recognition and greater financial, research and development, store development, marketing, distribution, and other resources than we do.
Our competitors may be able to achieve and maintain brand awareness and market share more quickly and effectively than we can. In contrast to our "grassroots" marketing approach, many of our competitors promote their brands through traditional forms of advertising, such as print media and television commercials, and through celebrity endorsements, and have substantial resources to devote to such efforts. Our competitors may also create and maintain brand awareness using traditional forms of advertising more quickly than we can. Our competitors may also be able to increase sales in their new and existing markets faster than we do by emphasizing different distribution channels than we do, such as catalog sales or an extensive franchise network.
In addition, because we hold limited patents and exclusive intellectual property rights in the technology, fabrics or processes underlying our products, our current and future competitors are able to manufacture and sell products with performance characteristics, fabrication techniques, and styling similar to our products.
Our reliance on suppliers to provide fabrics for and to produce our products could cause problems in our supply chain.
We do not manufacture our products or the raw materials for them and rely instead on suppliers. Many of the specialty fabrics used in our products are technically advanced textile products developed and manufactured by third parties and may be available, in the short-term, from only one or a very limited number of sources. We work with a group of approximately 65 suppliers to provide the fabrics for our products. In fiscal 2017, approximately 59% of our fabrics were produced by our top five fabric suppliers, and no single manufacturer produced more than 35% of raw materials used. We work with a group of approximately 47 vendors that manufacture our products, five of which produced approximately 64% of our products in fiscal 2017. During fiscal 2017, no single manufacturer produced more than 25% of our product offerings. We have no long-term contracts with any of our suppliers or manufacturing sources for the production and supply of our fabrics and garments, and we compete with other companies for fabrics, raw materials, and production.
We have experienced, and may in the future experience, a significant disruption in the supply of fabrics or raw materials from current sources and we may be unable to locate alternative materials suppliers of comparable quality at an acceptable price, or at all. In addition, if we experience significant increased demand, or if we need to replace an existing supplier or manufacturer, we may be unable to locate additional supplies of fabrics or raw materials or additional manufacturing capacity on terms that are acceptable to us, or at all, or we may be unable to locate any supplier or manufacturer with sufficient capacity to meet our requirements or to fill our orders in a timely manner. Identifying a suitable supplier is an involved process that requires us to become satisfied with its quality control, responsiveness and service, financial stability, and labor and other ethical practices. Even if we are able to expand existing or find new manufacturing or fabric sources, we may encounter delays in production and added costs as a result of the time it takes to train our suppliers and manufacturers in our methods, products, and quality control standards. Delays related to supplier changes could also arise due to an increase in shipping times if new suppliers are located farther away from our markets or from other participants in our supply chain. Any delays, interruption or increased costs in the supply of fabric or manufacture of our products could have an adverse effect on our ability to meet guest demand for our products and result in lower net revenue and income from operations both in the short and long term.
An economic downturn or economic uncertainty in our key markets may adversely affect consumer discretionary spending and demand for our products.
Many of our products may be considered discretionary items for consumers. Factors affecting the level of consumer spending for such discretionary items include general economic conditions, particularly those in North America, and other factors such as consumer confidence in future economic conditions, fears of recession, the availability and cost of consumer credit, levels of unemployment, and tax rates. As global economic conditions continue to be volatile or economic uncertainty remains, trends in consumer discretionary spending also remain unpredictable and subject to reductions due to credit constraints and uncertainties about the future. Unfavorable economic conditions may lead consumers to delay or reduce purchases of our products. Consumer demand for our products may not reach our targets, or may decline, when there is an economic downturn or economic uncertainty in our key markets, particularly in North America. Our sensitivity to economic cycles and any related fluctuation in consumer demand may have a material adverse effect on our financial condition.
Our sales and profitability may decline as a result of increasing product costs and decreasing selling prices.
Our business is subject to significant pressure on costs and pricing caused by many factors, including intense competition, constrained sourcing capacity and related inflationary pressure, pressure from consumers to reduce the prices we charge for our products, and changes in consumer demand. These factors may cause us to experience increased costs, reduce
7
our prices to consumers or experience reduced sales in response to increased prices, any of which could cause our operating margin to decline if we are unable to offset these factors with reductions in operating costs and could have a material adverse effect on our financial conditions, operating results and cash flows.
If we are unable to anticipate consumer preferences and successfully develop and introduce new, innovative and updated products, we may not be able to maintain or increase our sales and profitability.
Our success depends on our ability to identify and originate product trends as well as to anticipate and react to changing consumer demands in a timely manner. All of our products are subject to changing consumer preferences that cannot be predicted with certainty. If we are unable to introduce new products or novel technologies in a timely manner or our new products or technologies are not accepted by our guests, our competitors may introduce similar products in a more timely fashion, which could hurt our goal to be viewed as a leader in technical athletic apparel innovation. Our new products may not receive consumer acceptance as consumer preferences could shift rapidly to different types of athletic apparel or away from these types of products altogether, and our future success depends in part on our ability to anticipate and respond to these changes. Our failure to anticipate and respond in a timely manner to changing consumer preferences could lead to, among other things, lower sales and excess inventory levels. Even if we are successful in anticipating consumer preferences, our ability to adequately react to and address those preferences will in part depend upon our continued ability to develop and introduce innovative, high-quality products. Our failure to effectively introduce new products that are accepted by consumers could result in a decrease in net revenue and excess inventory levels, which could have a material adverse effect on our financial condition.
Our results of operations could be materially harmed if we are unable to accurately forecast guest demand for our products.
To ensure adequate inventory supply, we must forecast inventory needs and place orders with our manufacturers based on our estimates of future demand for particular products. Our ability to accurately forecast demand for our products could be affected by many factors, including an increase or decrease in guest demand for our products or for products of our competitors, our failure to accurately forecast guest acceptance of new products, product introductions by competitors, unanticipated changes in general market conditions, and weakening of economic conditions or consumer confidence in future economic conditions. If we fail to accurately forecast guest demand, we may experience excess inventory levels or a shortage of products available for sale in our stores or for delivery to guests.
Inventory levels in excess of guest demand may result in inventory write-downs or write-offs and the sale of excess inventory at discounted prices, which would cause our gross margin to suffer and could impair the strength and exclusivity of our brand. Conversely, if we underestimate guest demand for our products, our manufacturers may not be able to deliver products to meet our requirements, and this could result in damage to our reputation and guest relationships.
Our inability to safeguard against security breaches with respect to our information technology systems could disrupt our operations.
Our business employs systems and websites that allow for the storage and transmission of proprietary or confidential information regarding our business, guests and employees including credit card information. Security breaches could expose us to a risk of loss or misuse of this information and potential liability. We may not have the resources or technical sophistication to be able to anticipate or prevent rapidly evolving types of cyber-attacks. Actual or anticipated attacks may cause us to incur increasing costs including costs to deploy additional personnel and protection technologies, train employees and engage third party experts and consultants. Advances in computer capabilities, new technological discoveries or other developments may result in the technology used by us to protect transaction or other data being breached or compromised. Data and security breaches can also occur as a result of non-technical issues including intentional or inadvertent breach by employees or persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Any compromise or breach of our security could result in a violation of applicable privacy and other laws, significant litigation and potential liability and damage to our brand and reputation or other harm to our business.
Any material disruption of our information technology systems or unexpected network interruption could disrupt our business and reduce our sales.
We are increasingly dependent on information technology systems and third-parties to operate our e-commerce websites, process transactions, respond to guest inquiries, manage inventory, purchase, sell and ship goods on a timely basis, and maintain cost-efficient operations. The failure of our information technology systems to operate properly or effectively, problems with transitioning to upgraded or replacement systems, or difficulty in integrating new systems, could adversely affect our business. In addition, we have e-commerce websites in the United States, Canada, and internationally. Our information technology systems, websites, and operations of third parties on whom we rely, may encounter damage or disruption or slowdown caused by a failure to successfully upgrade systems, system failures, viruses, computer "hackers" or
8
other causes, could cause information, including data related to guest orders, to be lost or delayed which could, especially if the disruption or slowdown occurred during the holiday season, result in delays in the delivery of products to our stores and guests or lost sales, which could reduce demand for our products and cause our sales to decline. In addition, if changes in technology cause our information systems to become obsolete, or if our information systems are inadequate to handle our growth, we could lose guests. We have limited back-up systems and redundancies, and our information technology systems and websites have experienced system failures and electrical outages in the past which have disrupted our operations. Any significant disruption in our information technology systems or websites could harm our reputation and credibility, and could have a material adverse effect on our business, financial condition and results of operations.
If the technology-based systems that give our customers the ability to shop with us online do not function effectively, our operating results, as well as our ability to grow our e-commerce business globally, could be materially adversely affected.
Many of our customers shop with us through our e-commerce websites and mobile apps. Increasingly, customers are using tablets and smart phones to shop online with us and with our competitors and to do comparison shopping. We are increasingly using social media and proprietary mobile apps to interact with our customers and as a means to enhance their shopping experience. Any failure on our part to provide attractive, effective, reliable, user-friendly e-commerce platforms that offer a wide assortment of merchandise with rapid delivery options and that continually meet the changing expectations of online shoppers could place us at a competitive disadvantage, result in the loss of e-commerce and other sales, harm our reputation with customers, have a material adverse impact on the growth of our e-commerce business globally and could have a material adverse impact on our business and results of operations.
Risks specific to our e-commerce business also include diversion of sales from our company-operated stores, difficulty in recreating the in-store experience through direct channels and liability for online content. Our failure to successfully respond to these risks might adversely affect sales in our e-commerce business, as well as damage our reputation and brands.
The fluctuating cost of raw materials could increase our cost of goods sold and cause our results of operations and financial condition to suffer.
The fabrics used by our suppliers and manufacturers include synthetic fabrics whose raw materials include petroleum-based products. Our products also include silver and natural fibers, including cotton. Our costs for raw materials are affected by, among other things, weather, consumer demand, speculation on the commodities market, the relative valuations and fluctuations of the currencies of producer versus consumer countries, and other factors that are generally unpredictable and beyond our control. Increases in the cost of raw materials, including petroleum or the prices we pay for silver and our cotton yarn and cotton-based textiles, could have a material adverse effect on our cost of goods sold, results of operations, financial condition, and cash flows.
Our limited operating experience and limited brand recognition in new international markets may limit our expansion and cause our business and growth to suffer.
Our future growth depends in part on our expansion efforts outside of North America. We have limited experience with regulatory environments and market practices internationally, and we may not be able to penetrate or successfully operate in any new market. In connection with our expansion efforts we may encounter obstacles we did not face in North America, including cultural and linguistic differences, differences in regulatory environments, labor practices and market practices, difficulties in keeping abreast of market, business and technical developments, and foreign guests' tastes and preferences. We may also encounter difficulty expanding into new international markets because of limited brand recognition leading to delayed acceptance of our technical athletic apparel by guests in these new international markets. Our failure to develop our business in new international markets or disappointing growth outside of existing markets could harm our business and results of operations.
If we encounter problems with our distribution system, our ability to deliver our products to the market and to meet guest expectations could be harmed.
We rely on our distribution facilities for substantially all of our product distribution. Our distribution facilities include computer controlled and automated equipment, which means their operations may be subject to a number of risks related to security or computer viruses, the proper operation of software and hardware, electronic or power interruptions, or other system failures. In addition, because substantially all of our products are distributed from four locations, our operations could also be interrupted by labor difficulties, extreme or severe weather conditions or by floods, fires or other natural disasters near our distribution centers. If we encounter problems with our distribution system, our ability to meet guest expectations, manage inventory, complete sales, and achieve objectives for operating efficiencies could be harmed.
9
Our fabrics and manufacturing technology generally are not patented and can be imitated by our competitors.
The intellectual property rights in the technology, fabrics, and processes used to manufacture our products generally are owned or controlled by our suppliers and are generally not unique to us. Our ability to obtain intellectual property protection for our products is therefore limited and we do not generally own patents or hold exclusive intellectual property rights in the technology, fabrics or processes underlying our products. As a result, our current and future competitors are able to manufacture and sell products with performance characteristics, fabrics and styling similar to our products. Because many of our competitors have significantly greater financial, distribution, marketing, and other resources than we do, they may be able to manufacture and sell products based on our fabrics and manufacturing technology at lower prices than we can. If our competitors do sell similar products to ours at lower prices, our net revenue and profitability could suffer.
Our failure or inability to protect our intellectual property rights could diminish the value of our brand and weaken our competitive position.
We currently rely on a combination of copyright, trademark, trade dress, and unfair competition laws, as well as confidentiality procedures and licensing arrangements, to establish and protect our intellectual property rights. The steps we take to protect our intellectual property rights may not be adequate to prevent infringement of these rights by others, including imitation of our products and misappropriation of our brand. In addition, intellectual property protection may be unavailable or limited in some foreign countries where laws or law enforcement practices may not protect our intellectual property rights as fully as in the United States or Canada, and it may be more difficult for us to successfully challenge the use of our intellectual property rights by other parties in these countries. If we fail to protect and maintain our intellectual property rights, the value of our brand could be diminished and our competitive position may suffer.
Our future success is substantially dependent on the continued service of our senior management and identifying and attracting our next Chief Executive Officer.
On February 2, 2018, our Chief Executive Officer resigned. In addition to this change, a number of members of our senior management team have left the Company in the last several years. These changes, or the loss of services of any of our other key executive officers or other members of our senior management team, or any negative public perception with respect to these individuals, may be disruptive to, or cause uncertainty in, our business and could have a negative impact on our ability to manage and grow our business effectively. Such disruption could have a material adverse impact on our financial performance, financial condition, and the market price of our stock.
We may not be successful in identifying and attracting a highly qualified successor to our Chief Executive Officer, and our process to search for the successor may be time-consuming and divert management's attention and resources away from our business. The search for our next Chief Executive Officer may have a negative impact on our senior management team, business, and financial performance and condition.
We do not maintain a key person life insurance policy on any of the members of our senior management team. As a result, we would have no way to cover the financial loss if we were to lose the services of members of our senior management team.
Changes in tax laws or unanticipated tax liabilities could adversely affect our effective income tax rate and profitability.
We are subject to the income tax laws of the United States, Canada, and several other international jurisdictions. Our effective income tax rates could be unfavorably impacted by a number of factors, including changes in the mix of earnings amongst countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, the outcome of income tax audits in various jurisdictions around the world, and any repatriation of unremitted earnings for which we have not previously accrued applicable U.S. income taxes and foreign withholding taxes.
We and our subsidiaries engage in a number of intercompany transactions across multiple tax jurisdictions. Although we believe that these transactions reflect the accurate economic allocation of profit and that proper transfer pricing documentation is in place, the profit allocation and transfer pricing terms and conditions may be scrutinized by local tax authorities during an audit and any resulting changes may impact our mix of earnings in countries with differing statutory tax rates.
Current economic and political conditions make tax rules in any jurisdiction, including the United States and Canada, subject to significant change. Changes in applicable U.S., Canadian, or other or foreign tax laws and regulations, or their interpretation and application, including the possibility of retroactive effect, could affect our income tax expense and profitability, as they have in fiscal 2017 upon passage of the U.S. Tax Cuts and Jobs Act.
10
We have recorded provisional amounts in fiscal 2017 in relation to the U.S. Tax Cuts and Jobs Act. We may make adjustments to the provisional amounts as additional information is collected and analyzed, and as we complete our assessment of the impact that the U.S. Tax Cuts and Jobs Act has, if any, upon our reinvestment plans for the accumulated earnings of the Company's foreign subsidiaries. As the Company completes its analysis of the U.S. Tax Cuts and Jobs Act it may also make adjustments to incorporate any additional interpretations or guidance that may be issued. The Company may also identify additional effects of the U.S. Tax Cuts and Jobs Act that are not reflected as of January 28, 2018. Any such adjustments may materially impact the provision for income taxes and our effective income tax rate in the period in which the adjustments are made, and in future periods.
If we continue to grow at a rapid pace, we may not be able to effectively manage our growth and the increased complexity of our business and as a result our brand image and financial performance may suffer.
We have expanded our operations rapidly since our inception in 1998 and our net revenue has increased from $40.7 million in fiscal 2004 to $2.6 billion in fiscal 2017. If our operations continue to grow at a rapid pace, we may experience difficulties in obtaining sufficient raw materials and manufacturing capacity to produce our products, as well as delays in production and shipments, as our products are subject to risks associated with overseas sourcing and manufacturing. We could be required to continue to expand our sales and marketing, product development and distribution functions, to upgrade our management information systems and other processes and technology, and to obtain more space for our expanding workforce. This expansion could increase the strain on our resources, and we could experience operating difficulties, including difficulties in hiring, training and managing an increasing number of employees. These difficulties could result in the erosion of our brand image which could have a material adverse effect on our financial condition.
We are subject to risks associated with leasing retail and distribution space subject to long-term and non-cancelable leases.
We lease the majority of our stores under operating leases and our inability to secure appropriate real estate or lease terms could impact our ability to grow. Our leases generally have initial terms of between five and ten years, and generally can be extended in five-year increments if at all. We generally cannot cancel these leases at our option. If an existing or new store is not profitable, and we decide to close it, as we have done in the past and may do in the future, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. Similarly, we may be committed to perform our obligations under the applicable leases even if current locations of our stores become unattractive as demographic patterns change. In addition, as each of our leases expire, we may fail to negotiate renewals, either on commercially acceptable terms or at all, which could require us to close stores in desirable locations.
We also lease the majority of our distribution centers and our inability to secure appropriate real estate or lease terms could impact our ability to deliver our products to the market.
Our ability to source our merchandise profitably or at all could be hurt if new trade restrictions are imposed or existing trade restrictions become more burdensome.
The United States and the countries in which our products are produced or sold internationally have imposed and may impose additional quotas, duties, tariffs, or other restrictions or regulations, or may adversely adjust prevailing quota, duty or tariff levels. We have expanded our relationships with suppliers outside of China, which among other things has resulted in increased costs and shipping times for some products. Countries impose, modify and remove tariffs and other trade restrictions in response to a diverse array of factors, including global and national economic and political conditions, which make it impossible for us to predict future developments regarding tariffs and other trade restrictions. Trade restrictions, including tariffs, quotas, embargoes, safeguards, and customs restrictions, could increase the cost or reduce the supply of products available to us or may require us to modify our supply chain organization or other current business practices, any of which could harm our business, financial condition and results of operations.
We are dependent on international trade agreements and regulations. If the United States were to withdraw from or materially modify certain international trade agreements, our business could be adversely affected.
Increasing labor costs and other factors associated with the production of our products in South and South East Asia could increase the costs to produce our products.
A significant portion of our products are produced in South and South East Asia and increases in the costs of labor and other costs of doing business in the countries in this area could significantly increase our costs to produce our products and could have a negative impact on our operations, net revenue, and earnings. Factors that could negatively affect our business include a potential significant revaluation of the currencies used in these countries, which may result in an increase in the cost
11
of producing products, labor shortage and increases in labor costs, and difficulties in moving products manufactured out of the countries in which they are manufactured and through the ports on the western coast of North America, whether due to port congestion, labor disputes, product regulations and/or inspections or other factors, and natural disasters or health pandemics. A labor strike or other transportation disruption affecting these ports could significantly disrupt our business. Also, the imposition of trade sanctions or other regulations against products imported by us from, or the loss of "normal trade relations" status with any country in which our products are manufactured, could significantly increase our cost of products imported into North America and/or Australia and harm our business.
The operations of many of our suppliers are subject to additional risks that are beyond our control and that could harm our business, financial condition, and results of operations.
Almost all of our suppliers are located outside of North America. During fiscal 2017, approximately 53% of our products were manufactured in South East Asia, approximately 25% in South Asia, approximately 10% in China, approximately 8% in the Americas, and the remainder in other regions.
As a result of our international suppliers, we are subject to risks associated with doing business abroad, including:
• | political unrest, terrorism, labor disputes, and economic instability resulting in the disruption of trade from foreign countries in which our products are manufactured; |
• | the imposition of new laws and regulations, including those relating to labor conditions, quality and safety standards, imports, duties, taxes and other charges on imports, as well as trade restrictions and restrictions on currency exchange or the transfer of funds; |
• | reduced protection for intellectual property rights, including trademark protection, in some countries, particularly China; |
• | disruptions or delays in shipments; and |
• | changes in local economic conditions in countries where our manufacturers, suppliers, or guests are located. |
These and other factors beyond our control could interrupt our suppliers' production in offshore facilities, influence the ability of our suppliers to export our products cost-effectively or at all and inhibit our suppliers' ability to procure certain materials, any of which could harm our business, financial condition, and results of operations.
We may not be able to successfully open new store locations in a timely manner, if at all, which could harm our results of operations.
Our growth will largely depend on our ability to successfully open and operate new stores, which depends on many factors, including, among others, our ability to:
• | identify suitable store locations, the availability of which is outside of our control; |
• | negotiate acceptable lease terms, including desired tenant improvement allowances; |
• | hire, train and retain store personnel and field management; |
• | immerse new store personnel and field management into our corporate culture; |
• | source sufficient inventory levels; and |
• | successfully integrate new stores into our existing operations and information technology systems. |
Successful new store openings may also be affected by our ability to initiate our grassroots marketing efforts in advance of opening our first store in a new market. We typically rely on our grassroots marketing efforts to build awareness of our brand and demand for our products. Our grassroots marketing efforts are often lengthy and must be tailored to each new market based on our emerging understanding of the market. We may not be able to successfully implement our grassroots marketing efforts in a particular market in a timely manner, if at all. Additionally, we may be unsuccessful in identifying new markets where our technical athletic apparel and other products and brand image will be accepted or the performance of our stores will be considered successful.
12
Our failure to comply with trade and other regulations could lead to investigations or actions by government regulators and negative publicity.
The labeling, distribution, importation, marketing, and sale of our products are subject to extensive regulation by various federal agencies, including the Federal Trade Commission, Consumer Product Safety Commission and state attorneys general in the United States, the Competition Bureau and Health Canada in Canada, as well as by various other federal, state, provincial, local and international regulatory authorities in the countries in which our products are distributed or sold. If we fail to comply with any of these regulations, we could become subject to enforcement actions or the imposition of significant penalties or claims, which could harm our results of operations or our ability to conduct our business. In addition, the adoption of new regulations or changes in the interpretation of existing regulations may result in significant compliance costs or discontinuation of product sales and could impair the marketing of our products, resulting in significant loss of net revenue.
Our international operations are also subject to compliance with the U.S. Foreign Corrupt Practices Act, or FCPA, and other anti-bribery laws applicable to our operations. In many foreign countries, particularly in those with developing economies, it may be a local custom that businesses operating in such countries engage in business practices that are prohibited by the FCPA or other U.S. and foreign laws and regulations applicable to us. Although we have implemented procedures designed to ensure compliance with the FCPA and similar laws, some of our employees, agents, or other channel partners, as well as those companies to which we outsource certain of our business operations, could take actions in violation of our policies. Any such violation could have a material and adverse effect on our business.
Our business is affected by seasonality.
Our business is affected by the general seasonal trends common to the retail apparel industry. This seasonality may adversely affect our business and cause our results of operations to fluctuate, and, as a result, we believe that comparisons of our operating results between different quarters within a single fiscal year are not necessarily meaningful and that results of operations in any period should not be considered indicative of the results to be expected for any future period.
Because a significant portion of our net revenue and expenses are generated in countries other than the United States, fluctuations in foreign currency exchange rates have affected our results of operations and may continue to do so in the future.
The functional currency of our foreign subsidiaries is generally the applicable local currency. Our consolidated financial statements are presented in U.S. dollars. Therefore, the net revenue, expenses, assets, and liabilities of our foreign subsidiaries are translated from their functional currencies into U.S. dollars. Fluctuations in the value of the U.S. dollar affect the reported amounts of net revenue, expenses, assets, and liabilities. Foreign exchange differences which arise on translation of our foreign subsidiaries' balance sheets into U.S. dollars are recorded as a foreign currency translation adjustment in accumulated other comprehensive income or loss within stockholders' equity.
We also have exposure to changes in foreign exchange rates associated with transactions which are undertaken by our subsidiaries in currencies other than their functional currency. Such transactions include intercompany transactions and inventory purchases denominated in currencies other than the functional currency of the purchasing entity. As a result, we have been impacted by changes in exchange rates and may be impacted for the foreseeable future. The potential impact of currency fluctuation increases as our international expansion increases.
We have, and may continue to, enter into forward currency contracts, or other derivative instruments, in an effort to mitigate the foreign exchange risks which we are exposed to. This may include entering into forward currency contracts to hedge against the foreign exchange gains and losses which arise on translation of our foreign subsidiaries' balance sheets into U.S. dollars, or entering into forward currency contracts in an effort to reduce our exposure to foreign exchange revaluation gains and losses that arise on monetary assets and liabilities held by our subsidiaries in a currency other than their functional currency.
Although we use financial instruments to hedge certain foreign currency risks, these measures may not succeed in fully offsetting the negative impact of foreign currency rate movements.
We are exposed to credit-related losses in the event of nonperformance by the counterparties to the forward currency contracts.
Our trademarks and other proprietary rights could potentially conflict with the rights of others and we may be prevented from selling some of our products.
Our success depends in large part on our brand image. We believe that our trademarks and other proprietary rights have significant value and are important to identifying and differentiating our products from those of our competitors and creating
13
and sustaining demand for our products. We have obtained and applied for some United States and foreign trademark registrations, and will continue to evaluate the registration of additional trademarks as appropriate. However, some or all of these pending trademark applications may not be approved by the applicable governmental authorities. Moreover, even if the applications are approved, third parties may seek to oppose or otherwise challenge these registrations. Additionally, we may face obstacles as we expand our product line and the geographic scope of our sales and marketing. Third parties may assert intellectual property claims against us, particularly as we expand our business and the number of products we offer. Our defense of any claim, regardless of its merit, could be expensive and time consuming and could divert management resources. Successful infringement claims against us could result in significant monetary liability or prevent us from selling some of our products. In addition, resolution of claims may require us to redesign our products, license rights from third parties, or cease using those rights altogether. Any of these events could harm our business and cause our results of operations, liquidity, and financial condition to suffer.
We are subject to periodic claims and litigation that could result in unexpected expenses and could ultimately be resolved against us.
From time to time, we are involved in litigation and other proceedings, including matters related to product liability claims, stockholder class action and derivative claims, commercial disputes and intellectual property, as well as trade, regulatory, employment, and other claims related to our business. Any of these proceedings could result in significant settlement amounts, damages, fines or other penalties, divert financial and management resources, and result in significant legal fees. An unfavorable outcome of any particular proceeding could exceed the limits of our insurance policies or the carriers may decline to fund such final settlements and/or judgments and could have an adverse impact on our business, financial condition, and results of operations. In addition, any proceeding could negatively impact our reputation among our guests and our brand image.
Our business could be negatively affected as a result of actions of activist stockholders, and such activism could impact the trading value of our securities.
Responding to actions by activist stockholders can be costly and time-consuming, disrupting our operations and diverting the attention of management and our employees. Such activities could interfere with our ability to execute our strategic plan. In addition, a proxy contest for the election of directors at our annual meeting would require us to incur significant legal fees and proxy solicitation expenses and require significant time and attention by management and our board of directors. The perceived uncertainties as to our future direction also could affect the market price and volatility of our securities.
Anti-takeover provisions of Delaware law and our certificate of incorporation and bylaws could delay and discourage takeover attempts that stockholders may consider to be favorable.
Certain provisions of our certificate of incorporation and bylaws and applicable provisions of the Delaware General Corporation Law may make it more difficult or impossible for a third-party to acquire control of us or effect a change in our board of directors and management. These provisions include:
• | the classification of our board of directors into three classes, with one class elected each year; |
• | prohibiting cumulative voting in the election of directors; |
• | the ability of our board of directors to issue preferred stock without stockholder approval; |
• | the ability to remove a director only for cause and only with the vote of the holders of at least 66 2/3% of our voting stock; |
• | a special meeting of stockholders may only be called by our chairman or Chief Executive Officer, or upon a resolution adopted by an affirmative vote of a majority of the board of directors, and not by our stockholders; |
• | prohibiting stockholder action by written consent; and |
• | our stockholders must comply with advance notice procedures in order to nominate candidates for election to our board of directors or to place stockholder proposals on the agenda for consideration at any meeting of our stockholders. |
In addition, we are governed by Section 203 of the Delaware General Corporation Law which, subject to some specified exceptions, prohibits "business combinations" between a Delaware corporation and an "interested stockholder," which is generally defined as a stockholder who becomes a beneficial owner of 15% or more of a Delaware corporation's voting stock, for a three-year period following the date that the stockholder became an interested stockholder. Section 203 could have the effect of delaying, deferring or preventing a change in control that our stockholders might consider to be in their best interests.
14
ITEM 2. PROPERTIES
Our principal executive and administrative offices are located at 1818 Cornwall Avenue, Vancouver, British Columbia, Canada, V6J 1C7.
As of January 28, 2018, we operated four distribution centers located in the United States, Canada, and Australia. During fiscal 2017 we completed the relocation of our distribution center facilities in Vancouver, BC to a new 155,000 square foot leased premises in Vancouver, BC. In addition to those distribution centers, we hold inventory at warehouses managed by third-parties in Hong Kong, Rotterdam, and Shanghai. We regularly evaluate our distribution infrastructure and consolidate or expand our distribution capacity as we believe appropriate for our operations and to meet anticipated needs.
The general location, use and approximate size of our principal owned properties as of January 28, 2018, are set forth below:
Location | Use | Approximate Square Feet | |||
Columbus, OH | Distribution Center | 310,000 | |||
Vancouver, BC | Executive and Administrative Offices | 140,000 | |||
Vancouver, BC | Executive and Administrative Offices | 15,000 | |||
The general location, use, approximate size and lease renewal date of our principal non-retail leased properties as of January 28, 2018, are set forth below:
Location | Use | Approximate Square Feet | Lease Renewal Date | ||||
Sumner, WA | Distribution Center | 150,000 | May 2020 | ||||
Vancouver, BC | Distribution Center | 155,000 | January 2031 | ||||
Vancouver, BC | Executive and Administrative Offices | 60,000 | May 2020 | ||||
Vancouver, BC | Executive and Administrative Offices | 25,000 | June 2023 | ||||
Melbourne, VIC | Distribution Center | 50,000 | October 2022 | ||||
Melbourne, VIC | Executive and Administrative Offices | 25,000 | August 2019 | ||||
As of January 28, 2018, we leased approximately 1.3 million gross square feet relating to 402 of our 404 stores. Our store leases generally have initial terms of between five and 10 years, and generally can be extended in five-year increments, if at all. All of our leases require a fixed annual rent, and the majority require the payment of additional rent if store sales exceed a negotiated amount. Generally, our leases are "net" leases, which require us to pay all of the cost of insurance, taxes, maintenance and utilities. We generally cannot cancel these leases at our option.
ITEM 3. LEGAL PROCEEDINGS
In addition to the legal matters described in Note 16 to our audited consolidated financial statements included in Item 8 of Part II of this report, we are, from time to time, involved in routine legal matters incidental to the conduct of our business, including legal matters such as initiation and defense of proceedings to protect intellectual property rights, personal injury claims, product liability claims, employment claims, and similar matters. We believe the ultimate resolution of any such current proceeding will not have a material adverse effect on our continued financial position, results of operations or cash flows.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information and Dividends
Our common stock is quoted on the Nasdaq Global Select Market under the symbol "LULU." The following table sets forth, for the periods indicated, the high and low closing sale prices of our common stock reported by the Nasdaq Global Select Market for the last two fiscal years:
Common Stock Price (Nasdaq Global Select Market) | ||||||||
High | Low | |||||||
Fiscal Year Ended January 28, 2018 | ||||||||
Fourth Quarter | $ | 79.85 | $ | 60.24 | ||||
Third Quarter | 63.83 | 57.39 | ||||||
Second Quarter | 62.02 | 47.91 | ||||||
First Quarter | 67.76 | 49.43 | ||||||
Fiscal Year Ended January 29, 2017 | ||||||||
Fourth Quarter | $ | 69.90 | $ | 54.61 | ||||
Third Quarter | 80.65 | 54.88 | ||||||
Second Quarter | 77.80 | 60.07 | ||||||
First Quarter | 68.69 | 56.88 | ||||||
As of March 21, 2018, there were approximately 800 holders of record of our common stock. This does not include persons whose stock is in nominee or "street name" accounts through brokers.
We have never declared or paid any cash dividends on our common stock and do not anticipate paying any cash dividends on our common stock. Any future determination as to the payment of cash dividends will be at the discretion of our board of directors and will depend on our financial condition, operating results, current and anticipated cash needs, plans for expansion, and other factors that our board of directors considers to be relevant. In addition, financial and other covenants in any instruments or agreements that we enter into in the future may restrict our ability to pay cash dividends on our common stock.
Stock Performance Graph
The graph set forth below compares the cumulative total stockholder return on our common stock between February 3, 2013 (the date of our fiscal year end five years ago) and January 28, 2018, with the cumulative total return of (i) the S&P 500 Index and (ii) S&P 500 Apparel, Accessories & Luxury Goods Index, over the same period. This graph assumes the investment of $100 on February 3, 2013 at the closing sale price our common stock, the S&P 500 Index and the S&P Apparel, Accessories & Luxury Goods Index and assumes the reinvestment of dividends, if any.
The comparisons shown in the graph below are based on historical data. We caution that the stock price performance showing in the graph below is not necessarily indicative of, nor is it intended to forecast, the potential future performance of our common stock. Information used in the graph was obtained from Bloomberg, a source believed to be reliable, but we are not responsible for any errors or omissions in such information.
16
03-Feb-13 | 02-Feb-14 | 01-Feb-15 | 31-Jan-16 | 29-Jan-17 | 28-Jan-18 | |||||||||||||||||||
lululemon athletica inc. | $ | 100.00 | $ | 67.33 | $ | 97.61 | $ | 91.47 | $ | 98.47 | $ | 116.53 | ||||||||||||
S&P 500 Index | $ | 100.00 | $ | 117.81 | $ | 131.84 | $ | 128.22 | $ | 151.65 | $ | 189.86 | ||||||||||||
S&P 500 Apparel, Accessories & Luxury Goods Index | $ | 100.00 | $ | 114.44 | $ | 117.40 | $ | 97.15 | $ | 81.50 | $ | 106.09 | ||||||||||||
Issuer Purchase of Equity Securities
The following table provides information regarding our purchases of shares of our common stock during the thirteen weeks ended January 28, 2018 related to our stock repurchase program:
Period(1) | Total Number of Shares Purchased(2) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2) | Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs(2) | ||||||||||
October 30, 2017 - November 26, 2017 | — | $ | — | — | $ | — | ||||||||
November 27, 2017 - December 31, 2017 | 13,317 | 74.56 | 13,317 | 199,007,128 | ||||||||||
January 1, 2018 - January 28, 2018 | — | — | — | 199,007,128 | ||||||||||
Total | 13,317 | 13,317 | ||||||||||||
__________
(1) | Monthly information is presented by reference to our fiscal periods during our fourth quarter of fiscal 2017. |
(2) | Our stock repurchase program was approved by our board of directors in November 2017. Common shares generally are repurchased in the open market at prevailing market prices, including under plans complying with the provisions of Rule 10b5-1 and Rule 10b-18 of the Securities Exchange Act of 1934, with the timing and actual number of common shares repurchased depending upon market conditions, eligibility to trade, and other factors. The repurchases are expected to be completed by November 2019, and the maximum dollar value of shares to be repurchased is $200 million. |
17
The following table provides information regarding our purchases of shares of our common stock during the thirteen weeks ended January 28, 2018 related to our Employee Share Purchase Plan:
Period(1) | Total Number of Shares Purchased(2) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2) | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs(2) | |||||||||
October 30, 2017 - November 26, 2017 | 10,476 | $ | 63.56 | 10,476 | 4,918,281 | ||||||||
November 27, 2017 - December 31, 2017 | 13,974 | 73.70 | 13,974 | 4,904,307 | |||||||||
January 1, 2018 - January 28, 2018 | 8,276 | 78.95 | 8,276 | 4,896,031 | |||||||||
Total | 32,726 | 32,726 | |||||||||||
___________
(1) | Monthly information is presented by reference to our fiscal periods during our fourth quarter of fiscal 2017. |
(2) | Our Employee Share Purchase Plan (ESPP) was approved by our board of directors and stockholders in September 2007. All shares purchased under the ESPP are purchased on the Nasdaq Global Select Market (or such other stock exchange as we may designate from time to time). Unless our board of directors terminates the ESPP earlier, the ESPP will continue until all shares authorized for purchase under the ESPP have been purchased. The maximum number of shares authorized to be purchased under the ESPP is 6,000,000. |
Excluded from this disclosure are shares repurchased to settle statutory employee tax withholding related to the vesting of stock-based compensation awards.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below is derived from our consolidated financial statements and should be read in conjunction with our consolidated financial statements for the years ended January 28, 2018, January 29, 2017, January 31, 2016, February 1, 2015 and February 2, 2014. The consolidated statement of operations and comprehensive income data for each of the years ended January 28, 2018, January 29, 2017 and January 31, 2016 and the consolidated balance sheet data as of January 28, 2018 and January 29, 2017 is derived from, and qualified by reference to, our audited consolidated financial statements and related notes appearing elsewhere in this Annual Report.
Fiscal Year Ended | ||||||||||||||||||||
January 28, 2018 | January 29, 2017 | January 31, 2016 | February 1, 2015 | February 2, 2014 | ||||||||||||||||
(In thousands, except per share data) | ||||||||||||||||||||
Consolidated statement of operations and comprehensive income data: | ||||||||||||||||||||
Net revenue | $ | 2,649,181 | $ | 2,344,392 | $ | 2,060,523 | $ | 1,797,213 | $ | 1,591,188 | ||||||||||
Cost of goods sold | 1,250,391 | 1,144,775 | 1,063,357 | 883,033 | 751,112 | |||||||||||||||
Gross profit | 1,398,790 | 1,199,617 | 997,166 | 914,180 | 840,076 | |||||||||||||||
Selling, general and administrative expenses | 904,264 | 778,465 | 628,090 | 538,147 | 448,718 | |||||||||||||||
Asset impairment and restructuring costs | 38,525 | — | — | — | — | |||||||||||||||
Income from operations | 456,001 | 421,152 | 369,076 | 376,033 | 391,358 | |||||||||||||||
Other income (expense), net | 3,997 | 1,577 | (581 | ) | 7,102 | 5,768 | ||||||||||||||
Income before income tax expense | 459,998 | 422,729 | 368,495 | 383,135 | 397,126 | |||||||||||||||
Income tax expense | 201,336 | 119,348 | 102,448 | 144,102 | 117,579 | |||||||||||||||
Net income | $ | 258,662 | $ | 303,381 | $ | 266,047 | $ | 239,033 | $ | 279,547 | ||||||||||
Other comprehensive income (loss), net of tax: | ||||||||||||||||||||
Foreign currency translation adjustment | 58,577 | 36,703 | (64,796 | ) | (105,339 | ) | (89,158 | ) | ||||||||||||
Comprehensive income | $ | 317,239 | $ | 340,084 | $ | 201,251 | $ | 133,694 | $ | 190,389 | ||||||||||
Basic earnings per share | $ | 1.90 | $ | 2.21 | $ | 1.90 | $ | 1.66 | $ | 1.93 | ||||||||||
Diluted earnings per share | $ | 1.90 | $ | 2.21 | $ | 1.89 | $ | 1.66 | $ | 1.91 | ||||||||||
Basic weighted-average number of shares outstanding | 135,988 | 137,086 | 140,365 | 143,935 | 144,913 | |||||||||||||||
Diluted weighted-average number of shares outstanding | 136,198 | 137,302 | 140,610 | 144,298 | 146,043 | |||||||||||||||
18
As of | ||||||||||||||||||||
January 28, 2018 | January 29, 2017 | January 31, 2016 | February 1, 2015 | February 2, 2014 | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Consolidated balance sheet data: | ||||||||||||||||||||
Cash and cash equivalents | $ | 990,501 | $ | 734,846 | $ | 501,482 | $ | 664,479 | $ | 698,649 | ||||||||||
Inventories | 329,562 | 298,432 | 284,009 | 208,116 | 188,790 | |||||||||||||||
Total assets | 1,998,483 | 1,657,541 | 1,314,077 | 1,296,213 | 1,252,388 | |||||||||||||||
Total stockholders' equity | 1,596,960 | 1,359,973 | 1,027,482 | 1,089,568 | 1,096,682 | |||||||||||||||
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our fiscal year ends on the Sunday closest to January 31 of the following year, typically resulting in a 52 week year, but occasionally giving rise to an additional week, resulting in a 53 week year.
Fiscal 2017, fiscal 2016, and fiscal 2015 were 52 week years. The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K.
This discussion and analysis contains forward-looking statements based on current expectations that involve risks, uncertainties and assumptions, such as our plans, objectives, expectations, and intentions set forth in the "Special Note Regarding Forward-Looking Statements." Our actual results and the timing of events may differ materially from those anticipated in these forward looking statements as a result of various factors, including those set forth in the "Item 1A. Risk Factors" section and elsewhere in this Annual Report on Form 10-K.
Overview
Fiscal 2017 was a strong year for our company. New stores and new store formats, product innovations, and an enhanced e-commerce offering, combined with successful community and brand initiatives helped drive a 13% increase in net revenue. We had a 7% increase in total comparable sales.
Our product design and development teams launched a number of new category innovations this year. For women, our newest fabric Everlux was created for high intensity, indoor workouts and the Enlite bra offers guests proprietary technology for running and high impact training. For men, we expanded our popular ABC pant franchise to include slim and jogger styles, and all of our men's fixed waist bottoms now feature our ABC construction. We look forward to delivering on a strong pipeline of innovation and product rollouts in fiscal 2018.
During the year, we opened 46 net new lululemon branded company-operated stores, including 30 in North America, 14 in Asia Pacific, and two in Europe. Our multiple formats now include standard, co-located, local, and select flagship locations, which allow us to cater to our guests where they live, work, and sweat.
As of January 28, 2018, we had 57 stores in Asia Pacific and 13 stores in Europe, including our European flagship on London's Regent Street which showcases the fullest expression of our brand to both local and travelling guests. We expanded in Germany in fiscal 2017 with a new location in Munich. In Asia, we opened nine new stores in China during fiscal 2017, in addition to growing our local e-commerce presence via Tmall, and opening company-operated stores in Japan.
We relaunched our websites at the end of the third quarter of fiscal 2017, improving the online experience through upgraded visuals, added video content, more intuitive navigation, enhanced storytelling, and the integration of ivivva. The sales performance of our e-commerce business, which accelerated throughout the year, culminated in a 44% increase in direct to consumer net revenue in the fourth quarter of fiscal 2017 compared to the fourth quarter of fiscal 2016. In fiscal 2018 we plan to continue to develop our omni-channel experience to serve guests wherever and however they choose to shop, including launching a WeChat store in China.
Our grassroots approach to brand-building - locally led by stores and store associates, who we call educators - enables us to connect with and uniquely understand our guest. We hosted several events during the year, including our annual SeaWheeze half marathon in Vancouver, The Ghost Race in 15 cities in North America, the Sweatlife Festival in London, and Unroll China across multiple cities. We complemented our local efforts with our first global marketing campaign "This Is Yoga", followed by men's focused "Strength To Be" and finally, for holiday, "Breathe It All In".
We look forward to continuing this strong momentum into fiscal 2018, focusing on our four key strategic growth pillars: Digital, Men's, North America, and International, underpinned by innovations in product, our distinctive brand and community approach, and our vertically-integrated model.
Financial Highlights
The summary below provides both GAAP and non-GAAP financial measures. In connection with the restructuring of our ivivva operations, we recognized pre-tax costs totaling $47.2 million in fiscal 2017, and a related income tax recovery of $12.7 million. We recognized a provisional income tax expense of $59.3 million in fiscal 2017 related to the U.S. Tax Cuts and Jobs Act. The adjusted financial measures exclude these items, and also exclude certain discrete items related to our transfer pricing arrangements and taxes on repatriation of foreign earnings which were recognized during the fiscal 2016.
For the fiscal year ended January 28, 2018, compared to the fiscal year ended January 29, 2017:
• | Net revenue increased 13% to $2.6 billion. On a constant dollar basis, net revenue increased 12%. |
20
• | Total comparable sales, which includes comparable store sales and direct to consumer, increased 7%. On a constant dollar basis, total comparable sales increased 7%. |
– | Comparable store sales increased 1%, or increased 1% on a constant dollar basis. |
– | Direct to consumer net revenue increased 27%, or increased 27% on a constant dollar basis. |
• | Gross profit increased 17% to $1.4 billion. Adjusted gross profit increased 17% to $1.4 billion. |
• | Gross margin increased 160 basis points to 52.8%. Adjusted gross margin increased 190 basis points to 53.1%. |
• | Income from operations increased 8% to $456.0 million. Adjusted income from operations increased 19% to $503.2 million. |
• | Operating margin decreased 80 basis points to 17.2%. Adjusted operating margin increased 100 basis points to 19.0%. |
• | Income tax expense increased 69% to $201.3 million. Our effective tax rate for fiscal 2017 was 43.8% compared to 28.2% for fiscal 2016. The adjusted effective tax rate was 30.5% for fiscal 2017 compared to 30.7% for fiscal 2016. |
• | Diluted earnings per share were $1.90 for fiscal 2017 compared to $2.21 in fiscal 2016. Adjusted diluted earnings per share were $2.59 for fiscal 2017 compared to $2.14 for fiscal 2016. |
Refer to the non-GAAP reconciliation tables contained in the "Non-GAAP Financial Measures" section of this "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for reconciliations between constant dollar changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue, and adjusted gross profit, gross margin, income from operations, operating margin, income tax expense, effective tax rates, and diluted earnings per share, and the most directly comparable measures calculated in accordance with GAAP.
General
Net revenue is comprised of company-operated store sales, direct to consumer sales through www.lululemon.com, other country and region specific websites, and mobile apps, including mobile apps on in-store devices that allow demand to be fulfilled via our distribution centers, and other net revenue, which includes outlet sales, sales from temporary locations, sales to wholesale accounts, showroom sales, warehouse sales, and license and supply arrangement net revenue, which consists of royalties as well as sales of our products to licensees.
Cost of goods sold includes the cost of purchased merchandise, including freight, duty, and nonrefundable taxes incurred in delivering the goods to our distribution centers. It also includes occupancy costs and depreciation expense for our company-operated store locations, all costs incurred in operating our distribution centers and production, design, distribution, and merchandise departments, hemming, shrink, and inventory provision expense. The primary drivers of the costs of individual products are the costs of raw materials and labor in the countries where we source our merchandise.
Selling, general and administrative expenses consist of all operating costs not otherwise included in cost of goods sold or asset impairment and restructuring costs. We expect selling, general and administrative expenses to increase in fiscal 2018 as we incur additional operating expenses to support our store and direct to consumer growth, while also making strategic investments to support the long term growth of the business.
Asset impairment and restructuring costs consist of the lease termination, impairment of property and equipment, employee related costs, and other restructuring costs recognized in connection with the restructuring of our ivivva operations.
Income tax expense depends on the statutory tax rates in the countries where we sell our products and the proportion of taxable income earned in those jurisdictions. To the extent the relative proportion of taxable income in the jurisdictions fluctuates, or the tax legislation in the respective jurisdictions changes, so will our effective tax rate. We also anticipate that, in the future, we may start to sell our products through retail locations in countries in which we have not yet operated, in which case, we would become subject to taxation based on the foreign statutory rates in the countries where these sales take place and our effective tax rate could fluctuate accordingly.
21
Results of Operations
The following tables summarize key components of our results of operations for the periods indicated, both in dollars and as a percentage of net revenue:
Fiscal Year Ended | ||||||||||||
January 28, 2018 | January 29, 2017 | January 31, 2016 | ||||||||||
(In thousands) | ||||||||||||
Net revenue | $ | 2,649,181 | $ | 2,344,392 | $ | 2,060,523 | ||||||
Cost of goods sold | 1,250,391 | 1,144,775 | 1,063,357 | |||||||||
Gross profit | 1,398,790 | 1,199,617 | 997,166 | |||||||||
Selling, general and administrative expenses | 904,264 | 778,465 | 628,090 | |||||||||
Asset impairment and restructuring costs | 38,525 | — | — | |||||||||
Income from operations | 456,001 | 421,152 | 369,076 | |||||||||
Other income (expense), net | 3,997 | 1,577 | (581 | ) | ||||||||
Income before income tax expense | 459,998 | 422,729 | 368,495 | |||||||||
Income tax expense | 201,336 | 119,348 | 102,448 | |||||||||
Net income | $ | 258,662 | $ | 303,381 | $ | 266,047 | ||||||
Fiscal Year Ended | |||||||||
January 28, 2018 | January 29, 2017 | January 31, 2016 | |||||||
(Percentages) | |||||||||
Net revenue | 100.0 | % | 100.0 | % | 100.0 | % | |||
Cost of goods sold | 47.2 | 48.8 | 51.6 | ||||||
Gross profit | 52.8 | 51.2 | 48.4 | ||||||
Selling, general and administrative expenses | 34.1 | 33.2 | 30.5 | ||||||
Asset impairment and restructuring costs | 1.5 | — | — | ||||||
Income from operations | 17.2 | 18.0 | 17.9 | ||||||
Other income (expense), net | 0.2 | — | — | ||||||
Income before income tax expense | 17.4 | 18.0 | 17.9 | ||||||
Income tax expense | 7.6 | 5.1 | 5.0 | ||||||
Net income | 9.8 | % | 12.9 | % | 12.9 | % | |||
Comparison of Fiscal 2017 to Fiscal 2016
Net Revenue
Net revenue increased $304.8 million, or 13%, to $2.6 billion in fiscal 2017 from $2.3 billion in fiscal 2016. On a constant dollar basis, assuming the average exchange rates in fiscal 2017 remained constant with the average exchange rates in fiscal 2016, net revenue increased $290.6 million, or 12%.
The increase in net revenue was primarily due to net revenue generated by new company-operated stores as well as increased direct to consumer net revenue. Total comparable sales, which includes comparable store sales and direct to consumer, increased 7% in fiscal 2017 compared to fiscal 2016. Total comparable sales increased 7% on a constant dollar basis.
22
Our net revenue on a segment basis for fiscal 2017 and fiscal 2016 is summarized below. Net revenue is expressed in dollar amounts. The percentages are presented as a percentage of total net revenue.
Fiscal Years Ended January 28, 2018 and January 29, 2017 | ||||||||||||||
2017 | 2016 | 2017 | 2016 | |||||||||||
(In thousands) | (Percentages) | |||||||||||||
Company-operated stores | $ | 1,837,065 | $ | 1,704,357 | 69.3 | % | 72.7 | % | ||||||
Direct to consumer | 577,590 | 453,287 | 21.8 | 19.3 | ||||||||||
Other | 234,526 | 186,748 | 8.9 | 8.0 | ||||||||||
Net revenue | $ | 2,649,181 | $ | 2,344,392 | 100.0 | % | 100.0 | % | ||||||
Company-Operated Stores. Net revenue from our company-operated stores segment increased $132.7 million, or 8%, to $1.8 billion in fiscal 2017 from $1.7 billion in fiscal 2016. The following contributed to the increase in net revenue from our company-operated stores segment:
• | Net revenue from company-operated stores we opened or significantly expanded subsequent to January 29, 2017, and are therefore not included in comparable store sales, increased net revenue by $146.5 million. During fiscal 2017 we opened 46 net new lululemon branded company-operated stores, including 30 stores in North America, 14 stores in Asia Pacific, and two stores in Europe. |
• | A comparable store sales increase of 1% in fiscal 2017 compared to fiscal 2016 resulted in a $12.8 million increase to net revenue. Comparable store sales increased 1%, or $5.4 million on a constant dollar basis. The increase in comparable store sales was primarily a result of improved conversion rates and increased dollar value per transaction. This was partially offset by a decrease in store traffic, due in part to shifting retail traffic trends from in-store to online. |
These increases in net revenue were partially offset by the closure of 48 of our ivivva branded company-operated stores as part of the restructuring of our ivivva operations. These closures reduced our fiscal 2017 net revenue from company-operated stores by $26.6 million compared to fiscal 2016.
Direct to Consumer. Net revenue from our direct to consumer segment increased $124.3 million, or 27%, to $577.6 million in fiscal 2017 from $453.3 million in fiscal 2016. Direct to consumer net revenue increased 27% on a constant dollar basis. The increase in net revenue from our direct to consumer segment was primarily the result of increased traffic on our e-commerce websites, improved conversion rates, and increased dollar value per transaction. During the second quarter of fiscal 2017, we held online warehouse sales in the United States and Canada which generated net revenue of $12.3 million. We did not hold any online warehouse sales during fiscal 2016. Excluding the impact of the online warehouse sales, direct to consumer net revenue increased 25%.
Other. Net revenue from our other segment increased $47.8 million, or 26%, to $234.5 million in fiscal 2017 from $186.7 million in fiscal 2016. This increase was primarily the result of an increase in the number of outlets, increased net revenue at existing outlets, and an increase in the number of temporary locations. The increase in net revenue from our other segment was partially offset by lower net revenue from showrooms, primarily due a decrease in the number of showrooms open during fiscal 2017 compared to fiscal 2016.
Gross Profit
Gross profit increased $199.2 million, or 17%, to $1.4 billion in fiscal 2017 from $1.2 billion in fiscal 2016.
Gross profit as a percentage of net revenue, or gross margin, increased 160 basis points, to 52.8% in fiscal 2017 from 51.2% in fiscal 2016. The increase in gross margin was primarily the result of:
• | an increase in product margin of 200 basis points which was primarily due to lower product costs and a favorable mix of higher margin product, partially offset by higher markdowns, and higher shrink and damages; and |
• | a favorable impact of foreign exchange rates of 10 basis points. |
This was partially offset by an increase in fixed costs related to our product and supply chain departments of 20 basis points, and costs incurred in connection with the restructuring of our ivivva operations of 30 basis points.
During fiscal 2017, as a result of the restructuring of our ivivva operations, we recognized costs totaling $8.7 million within costs of goods sold, as outlined in Note 13 to the audited consolidated financial statements included in Item 8 of Part II
23
of this report. Excluding these charges, adjusted gross profit increased 17.3% to $1.4 billion and adjusted gross margin increased 190 basis points to 53.1% compared to fiscal 2016.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $125.8 million, or 16%, to $904.3 million in fiscal 2017 from $778.5 million in fiscal 2016. The increase in selling, general and administrative expenses was primarily due to:
• | an increase in costs related to our operating channels of $91.4 million, comprised of: |
– | an increase in employee costs of $32.8 million primarily from a growth in labor hours and benefits, mainly associated with new company-operated stores and other new operating locations; |
– | an increase in variable costs such as distribution costs and credit card fees of $16.4 million primarily as a result of increased net revenue; and |
– | an increase in other costs of $42.2 million primarily due to an increase in digital marketing expenses, website related costs including photography costs, brand and community costs, information technology related costs, and other costs associated with our operating locations; |
• | an increase in head office costs of $50.0 million, comprised of: |
– | an increase in employee costs of $19.3 million primarily due to additional employees to support the growth in our business; and |
– | an increase in other costs of $30.7 million primarily due to increases in information technology related costs, brand and community costs, and professional fees. |
The increase in selling, general, and administrative expenses was partially offset by an increase in net foreign exchange and derivative gains of $15.6 million. There were net foreign exchange and derivative gains of $7.3 million in fiscal 2017 compared to net foreign exchange losses of $8.3 million in fiscal 2016. The net foreign exchange gains and losses primarily relate to the revaluation of U.S. dollar denominated monetary assets and liabilities held by Canadian subsidiaries. During fiscal 2017, we began entering into forward currency contracts designed to economically hedge these foreign exchange revaluation gains and losses. We have not applied hedge accounting to these instruments and the change in fair value of these derivatives is recorded within selling, general and administrative expenses.
As a percentage of net revenue, selling, general and administrative expenses increased 90 basis points, to 34.1% in fiscal 2017 from 33.2% in fiscal 2016.
Asset Impairment and Restructuring Costs
As a result of the restructuring of our ivivva operations, we recognized asset impairment and restructuring costs of $38.5 million in fiscal 2017. This includes lease termination costs of $21.1 million, long-lived asset impairment charges of $11.6 million, employee related costs of $4.2 million, and other restructuring costs of $1.6 million. We did not have any asset impairment and restructuring costs in fiscal 2016. Please refer to Note 13 to the audited consolidated financial statements included in Item 8 of Part II of this report for further information on these adjustments.
Income from Operations
Income from operations increased $34.8 million, or 8%, to $456.0 million in fiscal 2017 from $421.2 million in fiscal 2016. Operating margin decreased 80 basis points to 17.2% compared to 18.0% in fiscal 2016.
In connection with the restructuring of our ivivva operations, we recognized pre-tax costs totaling $47.2 million in fiscal 2017. This includes asset impairment and restructuring costs of $38.5 million and costs recognized in cost of goods sold totaling $8.7 million. Excluding these charges, adjusted income from operations increased 19% to $503.2 million and adjusted operating margin increased 100 basis points to 19.0%.
On a segment basis, we determine income from operations without taking into account our general corporate expenses and the costs we incur in connection with the restructuring of our ivivva operations.
24
Income from operations before general corporate expenses and restructuring related costs for fiscal 2017 and fiscal 2016 is summarized below and is expressed in dollar amounts. The percentages are presented as a percentage of net revenue of the respective operating segments.
Fiscal Years Ended January 28, 2018 and January 29, 2017 | ||||||||||||||
2017 | 2016 | 2017 | 2016 | |||||||||||
(In thousands) | (Percentages) | |||||||||||||
Company-operated stores | $ | 464,321 | $ | 415,635 | 25.3 | % | 24.4 | % | ||||||
Direct to consumer | 231,295 | 186,178 | 40.0 | 41.1 | ||||||||||
Other | 35,580 | 22,312 | 15.2 | 11.9 | ||||||||||
Income from operations before general corporate expenses | 731,196 | 624,125 | ||||||||||||
General corporate expenses | 227,972 | 202,973 | ||||||||||||
Restructuring and related costs | 47,223 | — | ||||||||||||
Income from operations | $ | 456,001 | $ | 421,152 | ||||||||||
Company-Operated Stores. Income from operations from our company-operated stores segment increased $48.7 million, or 12%, to $464.3 million for fiscal 2017 from $415.6 million for fiscal 2016. The increase was primarily the result of an increase in gross profit of $89.4 million, which was primarily due to increased net revenue and higher gross margin. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses, including increased store employee costs, increased brand and community costs, and increased operating expenses associated with higher net revenues and new stores. Income from operations as a percentage of company-operated stores net revenue increased by 90 basis points primarily due to increased gross margin, partially offset by deleverage of selling, general and administrative expenses.
Direct to Consumer. Income from operations from our direct to consumer segment increased $45.1 million, or 24%, to $231.3 million in fiscal 2017 from $186.2 million in fiscal 2016. The increase was primarily the result of an increase in gross profit of $88.7 million, which was primarily due to increased net revenue and higher gross margin. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses including higher digital marketing expenses, website related costs, and higher variable costs such as packaging, distribution and credit card fees as a result of higher net revenue. Income from operations as a percentage of direct to consumer net revenue has decreased by 110 basis points primarily due to deleverage of selling, general and administrative expenses, partially offset by an increase in gross margin.
Other. Income from operations from our other segment increased $13.3 million, or 59%, to $35.6 million in fiscal 2017 from $22.3 million in fiscal 2016. The increase was primarily the result of increased gross profit of $29.8 million, which was primarily due to increased net revenue and higher gross margin. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses, including increased employee costs, increased brand and community costs, and increased operating expenses associated with new locations and higher net revenues. Income from operations as a percentage of other net revenue increased 330 basis points primarily due to an increase in gross margin partially offset by deleverage of selling, general and administrative expenses as a percentage of other net revenue.
General Corporate Expenses. General corporate expenses increased $25.0 million, or 12%, to $228.0 million in fiscal 2017 from $203.0 million in fiscal 2016. This increase was primarily due to increased head office employee costs, a global brand campaign, increases in other brand and community costs, professional fees, depreciation, and information technology related costs. These increases were partially offset by an increase in net foreign exchange and derivative gains of $15.6 million. There were net foreign exchange and derivative gains of $7.3 million in fiscal 2017 compared to net foreign exchange losses of $8.3 million in fiscal 2016. We expect general corporate expenses to continue to increase in future years as we grow our overall business and require increased efforts at our head office to support our company-operated stores, direct to consumer and other segments.
Other Income (Expense), Net
There was net other income of $4.0 million in fiscal 2017 compared to $1.6 million in fiscal 2016. The increase was primarily due to increased net interest income in fiscal 2017 compared to fiscal 2016. The increase in net interest income was primarily due to a net interest expense of $1.7 million which was recorded in fiscal 2016 in relation to certain tax adjustments that are outlined in Note 14 to the audited consolidated financial statements included in Item 8 of Part II of this report, as well as interest earned on our increased cash and cash equivalents in fiscal 2017 compared to fiscal 2016.
25
Income Tax Expense
Income tax expense increased $82.0 million, or 69%, to $201.3 million in fiscal 2017 from $119.3 million in fiscal 2016.
In fiscal 2017 we recorded certain discrete tax adjustments which resulted in a net $46.6 million increase in income tax expense. These adjustments related to the U.S. Tax Cuts and Jobs Act and to the ivivva restructuring. In fiscal 2016 we recorded certain separate tax adjustments related to the Company's transfer pricing arrangements between Canada and the U.S. The adjustments in fiscal 2016 resulted in an income tax recovery of $10.7 million.
On December 22, 2017, legislation commonly referred to as the U.S. Tax Cuts and Jobs Act ("U.S. tax reform") was enacted. The U.S. tax reform made significant changes to corporate income tax in the United States, including reducing the federal income tax rate from 35% to 21% and imposing a mandatory transition tax on accumulated foreign subsidiary earnings which have not previously been subject to U.S. income tax. As a result of these tax legislation changes we have recognized a provisional income tax expense of $58.9 million for the mandatory transition tax and we have remeasured our deferred income assets and liabilities, resulting in a provisional deferred income tax expense of $0.4 million. In fiscal 2017 we also recognized an income tax recovery of $12.7 million related to the tax effect of the costs recognized in connection with the ivivva restructuring.
In fiscal 2016 we recognized an income tax recovery of $10.7 million as a result of the finalization of an Advance Pricing Arrangement with the Internal Revenue Service and the Canada Revenue Agency. This agreement determines the amount of income which is taxable in each respective jurisdiction, and the final terms of the arrangement resulted in an increased amount of income tax recoverable in the United States.
Further information on the adjustments recognized in both fiscal 2017 and fiscal 2016 is outlined in Notes 13 and 14 to the audited consolidated financial statements included in Item 8 of Part II of this report.
Our effective tax rate for fiscal 2017 was 43.8% compared to 28.2% for fiscal 2016. Our effective tax rate excluding the above tax and related interest adjustments was 30.5% for fiscal 2017 compared to 30.7% for fiscal 2016. The decrease in our adjusted effective tax rate was primarily due to the lower U.S. federal income tax rate which was effective January 1, 2018, a decrease in state taxes, and certain other adjustments.
Net Income
Net income decreased $44.7 million, or 15%, to $258.7 million in fiscal 2017 from $303.4 million in fiscal 2016. The decrease in net income in fiscal 2017 was primarily due to an increase of $125.8 million in selling, general and administrative expenses, an increase of $82.0 million in income tax expense, and asset impairment and restructuring costs of $38.5 million recognized in fiscal 2017, partially offset by a $199.2 million increase in gross profit and an increase in other income (expense), net of $2.4 million.
Comparison of Fiscal 2016 to Fiscal 2015
Net Revenue
Net revenue increased $283.9 million, or 14%, to $2.3 billion in fiscal 2016 from $2.1 billion in fiscal 2015. On a constant dollar basis, assuming the average exchange rates in fiscal 2016 remained constant with the average exchange rates in fiscal 2015, net revenue increased $292.9 million, or 14%.
Net revenue increased across all segments. The increase in net revenue was primarily due to the addition of 43 net new company-operated stores during fiscal 2016, as well as increased comparable store sales and the growth of our direct to consumer segment. Total comparable sales, which includes comparable store sales and direct to consumer, increased 6% in fiscal 2016 compared to fiscal 2015. Total comparable sales increased 7% on a constant dollar basis.
Our net revenue on a segment basis for fiscal 2016 and fiscal 2015 is summarized below. Net revenue is expressed in dollar amounts. The percentages are presented as a percentage of total net revenue.
Fiscal Years Ended January 29, 2017 and January 31, 2016 | ||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||
(In thousands) | (Percentages) | |||||||||||||
Company-operated stores | $ | 1,704,357 | $ | 1,516,323 | 72.7 | % | 73.6 | % | ||||||
Direct to consumer | 453,287 | 401,525 | 19.3 | 19.5 | ||||||||||
Other | 186,748 | 142,675 | 8.0 | 6.9 | ||||||||||
Net revenue | $ | 2,344,392 | $ | 2,060,523 | 100.0 | % | 100.0 | % | ||||||
26
Company-Operated Stores. Net revenue from our company-operated stores segment increased $188.0 million, or 12%, to $1.7 billion in fiscal 2016 from $1.5 billion in fiscal 2015. The following contributed to the increase in net revenue from our company-operated stores segment:
• | Net revenue from company-operated stores we opened or significantly expanded subsequent to January 31, 2016, and therefore not included in comparable store sales, contributed $126.7 million to the increase. During fiscal 2016 we opened 43 net new company-operated stores, including 31 stores in North America, eight stores in Asia Pacific, and four stores in Europe. |
• | A comparable store sales increase of 4% in fiscal 2016 compared to fiscal 2015 resulted in a $61.3 million increase to net revenue. Comparable store sales increased 5%, or $66.4 million on a constant dollar basis. The increase in comparable store sales was primarily as a result of increased dollar value per transaction and improved conversion rates. |
Direct to Consumer. Net revenue from our direct to consumer segment increased $51.8 million, or 13%, to $453.3 million in fiscal 2016 from $401.5 million in fiscal 2015. Direct to consumer net revenue increased 13% on a constant dollar basis. The increase in net revenue from our direct to consumer segment was primarily the result of increased traffic on our e-commerce websites, increased dollar value per transaction and improved conversion rates.
Other. Net revenue from our other segment increased $44.1 million, or 31%, to $186.7 million in fiscal 2016 from $142.7 million in fiscal 2015. This increase was primarily the result of an increased number of outlets which were open for the full year in fiscal 2016, increased net revenue at other existing outlets, and an increase in the number of temporary locations.
Gross Profit
Gross profit increased $202.5 million, or 20%, to $1.2 billion in fiscal 2016 from $997.2 million in fiscal 2015.
Gross profit as a percentage of net revenue, or gross margin, increased 280 basis points, to 51.2% in fiscal 2016 from 48.4% in fiscal 2015. The increase in gross margin was primarily the result of an increase in product margin of 330 basis points, primarily due to lower product costs, improved average retail prices, and lower costs related to our raw material commitments.
The increase in gross margin was partially offset by an increase in expenses related to our product and supply chain departments of 20 basis points, an increase in occupancy costs and depreciation of 20 basis points, and an unfavorable impact of foreign exchange rates of 10 basis points.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $150.4 million, or 24%, to $778.5 million in fiscal 2016 from $628.1 million in fiscal 2015. The increase in selling, general and administrative expenses was principally comprised of:
• | an increase in employee costs for our operating locations of $47.0 million, primarily from a growth in labor hours and bonuses, mainly associated with new company-operated stores; |
• | an increase in head office employee costs of $35.4 million to support the growth in our business; |
• | an increase in head office costs other than employee costs of $21.2 million primarily as a result of increased brand and community costs, increased depreciation, and increased information technology costs; |
• | an increase in net foreign exchange losses of $20.3 million, primarily related to the revaluation of U.S. dollar cash and receivables held in Canadian subsidiaries. There were net foreign exchange losses of $8.3 million in fiscal 2016 compared to net foreign exchange gains of $12.0 million in fiscal 2015; |
• | an increase in other costs of $18.5 million for our operating channels such as digital marketing expenses, repairs and maintenance costs, and increased depreciation; and |
• | an increase in variable costs such as credit card fees and distribution costs of $8.1 million primarily as a result of increased sales. |
As a percentage of net revenue, selling, general and administrative expenses increased 270 basis points, to 33.2% in fiscal 2016 from 30.5% in fiscal 2015.
27
Income from Operations
Income from operations increased $52.1 million, or 14%, to $421.2 million in fiscal 2016 from $369.1 million in fiscal 2015. The increase was a result of increased gross profit of $202.5 million, partially offset by increased selling, general and administrative costs of $150.4 million.
On a segment basis, we determine income from operations without taking into account our general corporate expenses.
Income from operations before general corporate expenses for fiscal 2016 and fiscal 2015 is summarized below and is expressed in dollar amounts. The percentages are presented as a percentage of net revenue of the respective operating segments.
Fiscal Years Ended January 29, 2017 and January 31, 2016 | ||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||
(In thousands) | (Percentages) | |||||||||||||
Company-operated stores | $ | 415,635 | $ | 346,802 | 24.4 | % | 22.9 | % | ||||||
Direct to consumer | 186,178 | 166,418 | 41.1 | 41.4 | ||||||||||
Other | 22,312 | 5,826 | 11.9 | 4.1 | ||||||||||
Income from operations before general corporate expenses | 624,125 | 519,046 | ||||||||||||
General corporate expenses | 202,973 | 149,970 | ||||||||||||
Income from operations | $ | 421,152 | $ | 369,076 | ||||||||||
Company-Operated Stores. Income from operations from our company-operated stores segment increased $68.8 million, or 20%, to $415.6 million for fiscal 2016 from $346.8 million for fiscal 2015. The increase was primarily the result of an increase in gross profit of $132.8 million, which was primarily due to increased net revenue and higher gross margin. Net revenue increased as a result of new stores as well as increased comparable store sales, which was primarily a result of increased dollar value per transaction and improved conversion rates. This was partially offset by an increase in selling, general and administrative expenses, including increased store employee costs and increased operating expenses associated with new stores and increased net revenue at existing stores. Income from operations as a percentage of company-operated stores net revenue increased by 150 basis points primarily due to increased gross margin, partially offset by deleverage of selling, general and administrative expenses.
Direct to Consumer. Income from operations from our direct to consumer segment increased $19.8 million, or 12%, to $186.2 million in fiscal 2016 from $166.4 million in fiscal 2015. The increase was primarily the result of increased gross profit of $43.2 million primarily due to increased net revenue resulting from an increase in traffic on our e-commerce websites, increased dollar value per transaction, and improved conversion rates. This was partially offset by an increase in selling, general and administrative expenses including higher digital marketing expenses and higher variable costs such as distribution costs and credit card fees as a result of increased net revenue. Income from operations as a percentage of direct to consumer net revenue has decreased by 30 basis points primarily due to deleverage of selling, general and administrative expenses, partially offset by an increase in gross margin.
Other. Income from operations from our other segment increased $16.5 million, or 283%, to $22.3 million in fiscal 2016 from $5.8 million in fiscal 2015. The increase was primarily the result of increased gross profit of $26.4 million, partially offset by increased selling, general and administrative expenses primarily due to increased employee costs. Income from operations as a percentage of other net revenue increased by 780 basis points primarily due to an increase in gross margin and decreased selling, general and administrative expenses as a percentage of other net revenue.
General Corporate Expenses. General corporate expenses increased $53.0 million, or 35%, to $203.0 million in fiscal 2016 from $150.0 million in fiscal 2015. This increase was primarily due to increased head office employee costs, brand and community costs, depreciation, and information technology costs. There was also a $20.3 million increase in foreign exchange losses. We expect general corporate expenses to continue to increase in future years as we grow our overall business and require increased efforts at our head office to support our company-operated stores, direct to consumer and other segments.
Other Income (Expense), Net
There was net other income of $1.6 million in fiscal 2016 compared to net other expense of $0.6 million in fiscal 2015. This was primarily the result of a $1.8 million reduction in net interest expense related to certain tax adjustments that are outlined in Note 14 to the audited consolidated financial statements included in Item 8 of Part II of this report, as well as interest earned on our increased cash and cash equivalents in fiscal 2016 compared to fiscal 2015.
28
Income Tax Expense
Income tax expense increased $16.9 million, or 16%, to $119.3 million in fiscal 2016 from $102.4 million in fiscal 2015. Fiscal 2016 and fiscal 2015 included certain tax adjustments which resulted in net income tax recoveries of $10.7 million and $7.4 million, respectively, as outlined in Note 14 to the audited consolidated financial statements included in Item 8 of Part II of this report.
Our effective tax rate for fiscal 2016 was 28.2% compared to 27.8% for fiscal 2015. Our effective tax rate excluding the above tax and related interest adjustments was 30.7% for fiscal 2016 compared to 29.5% for fiscal 2015.
Net Income
Net income increased $37.4 million, or 14%, to $303.4 million in fiscal 2016 from $266.0 million in fiscal 2015. The increase in net income in fiscal 2016 was primarily due to a $202.5 million increase in gross profit and an increase in other income (expense), net of $2.2 million, partially offset by an increase of $150.4 million in selling, general and administrative expenses and an increase of $16.9 million in income tax expense.
Comparable Sales
We separately track comparable store sales, which reflect net revenue from company-operated stores that have been open for at least 12 months, or open for at least 12 months after being significantly expanded. Net revenue from a store is included in comparable store sales beginning with the first month for which the store has a full month of sales in the prior year. Comparable store sales exclude sales from new stores that have not been open for at least 12 months, from stores which have not been in their significantly expanded space for at least 12 months, and from stores which have been temporarily relocated for renovations. Comparable store sales also exclude sales from direct to consumer, outlets, temporary locations, wholesale accounts, showrooms, warehouse sales, license and supply arrangements, and sales from company-operated stores that we have closed.
Total comparable sales combines comparable store sales and direct to consumer sales. We are evolving towards an omni-channel approach to support the shopping behavior of our guests. This involves country and region specific websites, mobile apps, including mobile apps on in-store devices that allow demand to be fulfilled via our distribution centers, social media, product notification emails, and online order fulfillment through stores. We therefore believe that reporting total comparable sales with comparable store sales and direct to consumer sales combined provides a relevant performance metric.
Various factors affect comparable sales, including:
• | the location of new stores relative to existing stores; |
• | consumer preferences, buying trends, and overall economic trends; |
• | our ability to anticipate and respond effectively to customer preferences for technical athletic apparel; |
• | competition; |
• | changes in our merchandise mix; |
• | pricing; |
• | the timing of our releases of new merchandise and promotional events; |
• | the effectiveness of our marketing efforts; |
• | the design and ease of use of our websites and mobile apps; |
• | the level of customer service that we provide in our stores and on our websites and mobile apps; |
• | our ability to source and distribute products efficiently; and |
• | the number of stores we open, close (including for temporary renovations), and expand in any period. |
Opening new stores is an important part of our growth strategy. Accordingly, total comparable sales has limited utility for assessing the success of our growth strategy insofar as comparable sales do not reflect the performance of stores open less than 12 months. The comparable sales measures we report may not be equivalent to similarly titled measures reported by other companies.
29
Non-GAAP Financial Measures
Constant dollar changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue, and the adjusted financial results are non-GAAP financial measures.
A constant dollar basis assumes the average foreign exchange rates for the period remained constant with the average foreign exchange rates for the same period of the prior year. We provide constant dollar changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue because we use these measures to understand the underlying growth rate of net revenue excluding the impact of changes in foreign exchange rates. We believe that disclosing these measures on a constant dollar basis is useful to investors because it enables them to better understand the level of growth of our business.
Adjusted gross profit, gross margin, income from operations, operating margin, income tax expense, effective tax rates, and diluted earnings per share exclude the costs recognized in connection with the restructuring of our ivivva operations and its related tax effects, the amounts recognized in connection with the U.S. tax reform, and certain discrete items related to our transfer pricing arrangements and taxes on repatriation of foreign earnings. We believe these adjusted financial measures are useful to investors as the adjustments do not directly relate to our ongoing business operations and therefore do not contribute to a meaningful evaluation of the trend in our operating performance. Furthermore, we do not believe the adjustments are reflective of our expectations of our future operating performance and believe these non-GAAP measures are useful to investors because of their comparability to our historical information.
The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or with greater prominence to, the financial information prepared and presented in accordance with GAAP. A reconciliation of the non-GAAP financial measures follows, which includes more detail on the GAAP financial measure that is most directly comparable to each non-GAAP financial measure, and the related reconciliations between these financial measures.
The below changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue show the change compared to the corresponding period in the prior year.
30
Constant dollar changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue
Fiscal Year Ended January 28, 2018 | Fiscal Year Ended January 29, 2017 | |||||||||||||
(In thousands) | (Percentages) | (In thousands) | (Percentages) | |||||||||||
Change in net revenue | $ | 304,789 | 13 | % | $ | 283,869 | 14 | % | ||||||
Adjustments due to foreign exchange rate changes | (14,221 | ) | (1 | ) | 8,983 | — | ||||||||
Change in net revenue in constant dollars | $ | 290,568 | 12 | % | $ | 292,852 | 14 | % | ||||||
Fiscal Year Ended | ||||||
January 28, 2018 | January 29, 2017 | |||||
Change in total comparable sales(1),(2) | 7 | % | 6 | % | ||
Adjustments due to foreign exchange rate changes | — | 1 | ||||
Change in total comparable sales in constant dollars(1),(2) | 7 | % | 7 | % | ||
Fiscal Year Ended January 28, 2018 | Fiscal Year Ended January 29, 2017 | |||||||||||||
(In thousands) | (Percentages) | (In thousands) | (Percentages) | |||||||||||
Change in comparable store sales(2) | $ | 12,820 | 1 | % | $ | 61,341 | 4 | % | ||||||
Adjustments due to foreign exchange rate changes | (7,395 | ) | — | 5,036 | 1 | |||||||||
Change in comparable store sales in constant dollars(2) | $ | 5,425 | 1 | % | $ | 66,377 | 5 | % | ||||||
Fiscal Year Ended | ||||||
January 28, 2018 | January 29, 2017 | |||||
Change in direct to consumer net revenue | 27 | % | 13 | % | ||
Adjustments due to foreign exchange rate changes | — | — | ||||
Change in direct to consumer net revenue in constant dollars | 27 | % | 13 | % | ||
__________
(1) | Total comparable sales includes comparable store sales and direct to consumer sales. |
(2) | Comparable store sales reflects net revenue from company-operated stores that have been open for at least 12 months, or open for at least 12 months after being significantly expanded. |
31
Adjusted financial measures
The following tables reconcile adjusted financial measures with the most directly comparable measures calculated in accordance with GAAP. The adjustments relate to the restructuring of our ivivva operations and its related tax effects, the amounts recognized in connection with the U.S. tax reform, and certain discrete items related to our transfer pricing arrangements and taxes on repatriation of foreign earnings. Please refer to Notes 13 and 14 to the audited consolidated financial statements included in Item 8 of Part II of this report for further information on these adjustments.
Fiscal Year Ended January 28, 2018 | ||||||||||||||||
GAAP Results | Adjustments | Adjusted Results (Non-GAAP) | ||||||||||||||
Restructuring of ivivva Operations | U.S. Tax Reform | |||||||||||||||
(In thousands, except per share amounts) | ||||||||||||||||
Gross profit | $ | 1,398,790 | $ | 8,698 | $ | — | $ | 1,407,488 | ||||||||
Gross margin | 52.8 | % | 0.3 | % | — | % | 53.1 | % | ||||||||
Income from operations | 456,001 | 47,223 | — | 503,224 | ||||||||||||
Operating margin | 17.2 | % | 1.8 | % | — | % | 19.0 | % | ||||||||
Income before income tax expense | 459,998 | 47,223 | — | 507,221 | ||||||||||||
Income tax expense | 201,336 | 12,741 | (59,294 | ) | 154,783 | |||||||||||
Effective tax rate | 43.8 | % | (0.4 | )% | (12.9 | )% | 30.5 | % | ||||||||
Diluted earnings per share | $ | 1.90 | $ | 0.25 | $ | 0.44 | $ | 2.59 | ||||||||
Fiscal Year Ended January 29, 2017 | ||||||||||||
GAAP Results | Transfer Pricing and Repatriation Tax Adjustments | Adjusted Results (Non-GAAP) | ||||||||||
(In thousands, except per share amounts) | ||||||||||||
Income before income tax expense | $ | 422,729 | $ | 1,695 | $ | 424,424 | ||||||
Income tax expense | 119,348 | 10,744 | 130,092 | |||||||||
Effective tax rate | 28.2 | % | 2.5 | % | 30.7 | % | ||||||
Diluted earnings per share | $ | 2.21 | $ | (0.07 | ) | $ | 2.14 | |||||
Fiscal Year Ended January 31, 2016 | ||||||||||||
GAAP Results | Transfer Pricing and Repatriation Tax Adjustments | Adjusted Results (Non-GAAP) | ||||||||||
(In thousands, except per share amounts) | ||||||||||||
Income before income tax expense | $ | 368,495 | $ | 3,467 | $ | 371,962 | ||||||
Income tax expense | 102,448 | 7,443 | 109,891 | |||||||||
Effective tax rate | 27.8 | % | 1.7 | % | 29.5 | % | ||||||
Diluted earnings per share | $ | 1.89 | $ | (0.03 | ) | $ | 1.86 | |||||
Liquidity and Capital Resources
Our primary sources of liquidity are our current balances of cash and cash equivalents, cash flows from operations, and capacity under our revolving credit facility. Our primary cash needs are capital expenditures for opening new stores and remodeling or relocating existing stores, making information technology system enhancements, funding working capital requirements, and making other strategic capital investments both in North America and internationally. We may also use cash to repurchase shares of our common stock. Cash and cash equivalents in excess of our needs are held in interest bearing accounts with financial institutions.
32
As of January 28, 2018, our working capital (excluding cash and cash equivalents) was $153.2 million, our cash and cash equivalents were $990.5 million and our capacity under our revolving credit facility was $148.8 million.
The following table summarizes our net cash flows provided by and used in operating, investing and financing activities for the periods indicated:
Fiscal Year Ended | ||||||||||||
January 28, 2018 | January 29, 2017 | January 31, 2016 | ||||||||||
(In thousands) | ||||||||||||
Total cash provided by (used in): | ||||||||||||
Operating activities | $ | 489,337 | $ | 386,392 | $ | 297,538 | ||||||
Investing activities | (173,392 | ) | (149,511 | ) | (143,487 | ) | ||||||
Financing activities | (97,862 | ) | (26,611 | ) | (272,491 | ) | ||||||
Effect of exchange rate changes on cash | 37,572 | 23,094 | (44,557 | ) | ||||||||
Increase (decrease) in cash and cash equivalents | $ | 255,655 | $ | 233,364 | $ | (162,997 | ) | |||||
Operating Activities
Cash flows provided by operating activities consist primarily of net income adjusted for certain items including depreciation and amortization, asset impairments costs relating to the restructuring of our ivivva operations, stock-based compensation expense, and the effect of changes in operating assets and liabilities.
Net cash provided by operating activities increased $102.9 million in fiscal 2017 compared to fiscal 2016, primarily as a result of the following:
Changes in operating assets and liabilities
• | an increase of $104.0 million in the change in operating assets and liabilities, primarily due to the following: |
– | $62.5 million related to income taxes, primarily due to income taxes payable in relation to the U.S. tax reform; |
– | $31.8 million related to other accrued and non-current liabilities, primarily due to changes in accrued operating expenses, forward currency contract liabilities, and tenant inducements. |
Net income and non-cash items
• | a decrease of $44.7 million in net income, partially offset by an increase of $43.6 million in non-cash expenses primarily related to asset impairment costs related to the restructuring of our ivivva operations, and an increase in depreciation. |
In fiscal 2016, cash provided by operating activities increased $88.9 million, to $386.4 million compared to cash provided by operating activities of $297.5 million in fiscal 2015. The increase was primarily a result of a decrease in inventory purchases, a decrease in the change in prepaid and receivable income taxes, and an increase in net income. This was partially offset by a decrease in the change in income taxes payable, deferred income taxes, and accrued inventory liabilities. Inventory purchases decreased during fiscal 2016 primarily as a result of actions taken to align inventory levels with forward sales trends.
Investing Activities
Cash flows used in investing activities relate to capital expenditures, the settlement of net investment hedges, and other investing activities. Cash used in investing activities increased $23.9 million, to $173.4 million in fiscal 2017 from $149.5 million in fiscal 2016. Cash used in investing activities increased $6.0 million, to $149.5 million in fiscal 2016 from $143.5 million in fiscal 2015.
Capital expenditures for our company-operated stores segment were $80.2 million, $75.3 million, $85.8 million in fiscal 2017, fiscal 2016, and fiscal 2015, respectively. The capital expenditures for our company-operated stores segment in each period were primarily for the remodeling or relocation of certain stores, and ongoing store refurbishment. The capital expenditures for our company-operated stores segment also included $29.3 million to open 49 company-operated stores, $30.6 million to open 46 company-operated stores, and $49.2 million to open 62 new company-operated stores, in fiscal 2017, fiscal 2016, and fiscal 2015, respectively.
Capital expenditures for our direct to consumer segment were $19.9 million, $11.5 million, and $8.3 million in fiscal 2017, fiscal 2016, and fiscal 2015, respectively. The capital expenditures for our direct to consumer segment were primarily related to our global and region specific websites as well as mobile apps.
33
Capital expenditures related to corporate activities and other were $57.7 million, $62.7 million, and $49.4 million in fiscal 2017, fiscal 2016, and fiscal 2015, respectively. The capital expenditures in each fiscal year were primarily related to investments in information technology and business systems, improvements at our head office and other corporate buildings, and for capital expenditures related to opening retail locations other than company-operated stores.
In fiscal 2017 we redeveloped and relaunched our enhanced website. We also undertook various information technology infrastructure and corporate system initiatives and continued with the development of our new enterprise resource planning system that will help improve our merchandising, costing, allocation, and inventory platforms.
The increase in corporate capital expenditures in fiscal 2016 compared to fiscal 2015 was primarily related to a parcel of land that we purchased in Vancouver, BC for general corporate purposes for $19.7 million.
Capital expenditures are expected to range between $240 million and $250 million in fiscal 2018.
Financing Activities
Cash flows used in or provided by financing activities consist primarily of cash used to repurchase shares of our common stock and certain cash flows related to stock-based compensation.
Cash used in financing activities increased $71.3 million, to $97.9 million in fiscal 2017 from $26.6 million in fiscal 2016. Cash used in financing activities decreased $245.9 million, to $26.6 million in fiscal 2016 from $272.5 million in fiscal 2015. The primary cause of these changes in cash used in financing activities was our stock repurchase programs.
On June 11, 2014, our board of directors approved a program to repurchase shares of our common stock up to an aggregate value of $450.0 million. This stock repurchase program was completed during the second quarter of fiscal 2016. On December 1, 2016, our board of directors approved a program to repurchase shares of our common stock up to an aggregate value of $100.0 million. This stock repurchase program was completed during the third quarter of fiscal 2017. On November 29, 2017, our board of directors approved a program to repurchase shares of our common stock up to an aggregate value of $200.0 million.
During the fiscal years ended January 28, 2018, January 29, 2017, and January 31, 2016, 1.9 million, 0.5 million, and 5.0 million shares, respectively, were repurchased under the programs at a total cost of $100.3 million, $29.3 million, and $274.2 million, respectively. The common stock was repurchased in the open market at prevailing market prices, including under plans complying with the provisions of Rule 10b5-1 and Rule 10b-18 of the Securities Exchange Act of 1934, with the timing and actual number of shares repurchased depending upon market conditions, eligibility to trade, and other factors.
We believe that our cash and cash equivalent balances, cash generated from operations, and borrowings available to us under our revolving credit facility will be adequate to meet our liquidity needs and capital expenditure requirements for at least the next 12 months. Our cash from operations may be negatively impacted by a decrease in demand for our products as well as the other factors described in "Item 1A. Risk Factors". In addition, we may make discretionary capital improvements with respect to our stores, distribution facilities, headquarters, or systems, or we may repurchase shares under an approved stock repurchase program, which we would expect to fund through the use of cash, issuance of debt or equity securities or other external financing sources to the extent we were unable to fund such capital expenditures out of our cash and cash equivalents and cash generated from operations.
Revolving Credit Facility
On December 15, 2016, we entered into a credit agreement for $150.0 million under an unsecured five-year revolving credit facility. Bank of America, N.A., is administrative agent and HSBC Bank Canada is the syndication agent and letter of credit issuer, and the lenders party thereto. Borrowings under the revolving credit facility may be made, in U.S. Dollars, Euros, Canadian Dollars, and in other currencies, subject to the approval of the administrative agent and the lenders. Up to $35.0 million of the revolving credit facility is available for the issuance of letters of credit and up to $25.0 million is available for the issuance of swing line loans. Commitments under the revolving credit facility may be increased by up to $200.0 million, subject to certain conditions, including the approval of the lenders. Borrowings under the agreement may be prepaid and commitments may be reduced or terminated without premium or penalty (other than customary breakage costs). The principal amount outstanding under the credit agreement, if any, will be due and payable in full on December 15, 2021, subject to provisions that permit us to request a limited number of one year extensions annually.
Borrowings made under the revolving credit facility bear interest at a rate per annum equal to, at our option, either (a) a rate based on the rates applicable for deposits on the interbank market for U.S. Dollars or the applicable currency in which the borrowings are made ("LIBOR") or (b) an alternate base rate, plus, in each case, an applicable margin. The applicable margin is determined by reference to a pricing grid, based on the ratio of indebtedness to earnings before interest, tax depreciation, amortization and rent ("EBITDAR") and ranges between 1.00%-1.75% for LIBOR loans and 0.00%-0.75% for alternate base
34
rate loans. Additionally, a commitment fee of between 0.125%-0.200%, also determined by reference to the pricing grid, is payable on the average daily unused amounts under the revolving credit facility.
The credit agreement contains negative covenants that, among other things and subject to certain exceptions, limit the ability of our subsidiaries to incur indebtedness, incur liens, undergo fundamental changes, make dispositions of all or substantially all of their assets, alter their businesses and enter into agreements limiting subsidiary dividends and distributions.
We are also required to maintain a consolidated rent-adjusted leverage ratio of not greater than 3.50:1.00 and we are not permitted to allow the ratio of consolidated EBITDAR to consolidated interest charges (plus rent) to be less than 2.00:1.00. The credit agreement also contains certain customary representations, warranties, affirmative covenants, and events of default (including, among others, an event of default upon the occurrence of a change of control). If an event of default occurs, the credit agreement may be terminated and the maturity of any outstanding amounts may be accelerated.
As of January 28, 2018, aside from letters of credit of $1.2 million, we had no other borrowings outstanding under this credit facility.
Contractual Obligations and Commitments
Leases. We lease certain store and other retail locations, distribution centers, offices, and equipment under non-cancelable operating leases. Our leases generally have initial terms of between five and 10 years, and generally can be extended in five-year increments, if at all. A substantial number of our leases include renewal options and certain of our leases include rent escalation clauses, rent holidays and leasehold rental incentives, none of which are reflected in the table below. The majority of our leases for store premises also include contingent rental payments based on sales, the impact of which also are not reflected in the table below.
Product purchase obligations. The amounts listed for product purchase obligations in the table below represent agreements (including open purchase orders) to purchase products in the ordinary course of business that are enforceable and legally binding and that specify all significant terms. In some cases, prices are subject to change throughout the production process. The reported amounts exclude product purchase liabilities included in accounts payable and accrued inventory liabilities as of January 28, 2018.
One-time transition tax. As outlined in Note 14 to our audited consolidated financial statements included in Item 8 of Part II of this report, the U.S. tax reform imposed a mandatory transition tax on accumulated foreign subsidiary earnings which have not previously been subject to U.S. income tax. The one-time transition tax is payable over eight years. We recognized a provisional income tax expense of $58.9 million in fiscal 2017 for the mandatory transition tax. The one-time transition tax payable is net of foreign tax credits, and the table below outlines the expected payments due by fiscal year.
The following table summarizes our contractual arrangements as of January 28, 2018, and the timing and effect that such commitments are expected to have on our liquidity and cash flows in future periods:
Payments Due by Fiscal Year | ||||||||||||||||||||||||||||
Total | 2018 | 2019 | 2020 | 2021 | 2022 | Thereafter | ||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||
Operating leases (minimum rent) | $ | 611,817 | $ | 143,428 | $ | 127,641 | $ | 105,720 | $ | 81,595 | $ | 59,058 | $ | 94,375 | ||||||||||||||
Product purchase obligations | 159,679 | 159,679 | — | — | — | — | — | |||||||||||||||||||||
One-time transition tax payable | 56,969 | 8,701 | 4,197 | 4,197 | 4,197 | 4,197 | 31,480 | |||||||||||||||||||||
Off-Balance Sheet Arrangements
We enter into standby letters of credit to secure certain of our obligations, including leases, taxes and duties. As of January 28, 2018, letters of credit totaling $1.2 million had been issued.
We have not entered into any transactions, agreements or other contractual arrangements to which an entity unconsolidated with us is a party and under which we have (i) any obligation under a guarantee, (ii) any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity, (iii) any obligation under derivative instruments that are indexed to our shares and classified as equity in our consolidated balance sheets, or (iv) any obligation arising out of a variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
35
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions. Predicting future events is inherently an imprecise activity and, as such, requires the use of judgment. Actual results may vary from our estimates in amounts that may be material to the financial statements. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact our consolidated financial statements.
We believe that the following critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements:
Revenue Recognition. Net revenue is recognized net of sales taxes, discounts, and an estimated allowance for sales returns. Sales to customers through company-operated stores and other retail locations are recognized at the point of sale, net of an estimated allowance for sales returns. Direct to consumer sales are recognized once delivery has occurred and collection is reasonably assured, net of an estimated allowance for sales returns. Other net revenue includes outlet sales, sales from temporary locations, sales to wholesale accounts, showroom sales, warehouse sales, and license and supply arrangement net revenue, which consists of royalties as well as sales of our product to licensees. Revenue is recognized when these sales occur. Employee discounts are classified as a reduction of net revenue.
Our estimated allowance for sales returns is a subjective critical estimate that has a direct impact on reported net revenue. This allowance is calculated based on a history of actual returns, estimated future returns and any significant future known or anticipated events. Consideration of these factors results in an estimated allowance for sales returns. Our standard terms for retail sales limit returns to approximately 30 days after the sale of the merchandise, however we accept returns after 30 days where the product fails to meet our guests' quality expectations.
Revenue from our gift cards is recognized when tendered for payment. Outstanding customer balances are included in "Unredeemed gift card liability" on the consolidated balance sheets. There are no expiration dates on our gift cards, and we do not charge any service fees that cause a decrement to customer balances.
While we will continue to honor all gift cards presented for payment, we may determine the likelihood of redemption to be remote for certain card balances due to, among other things, long periods of inactivity. In these circumstances, to the extent we determine there is no requirement for remitting card balances to government agencies under unclaimed property laws, the portion of card balances not expected to be redeemed are recognized in net revenue in proportion to the gift cards which have been redeemed.
Inventory. Inventory is valued at the lower of cost and net realizable value. We periodically review our inventories and make provisions as necessary to appropriately value goods that are obsolete, have quality issues, or are damaged. The amount of the provision is equal to the difference between the cost of the inventory and its net realizable value based upon assumptions about future demand, selling prices, and market conditions. If changes in market conditions result in reductions in the estimated net realizable value of our inventory below our previous estimate, we would increase our reserve in the period in which we made such a determination. In addition, we provide for inventory shrinkage as a percentage of sales, based on historical trends from actual physical inventories. Inventory shrinkage estimates are made to reduce the inventory value for lost or stolen items. We perform physical inventory counts and cycle counts throughout the year and adjust the shrink provision accordingly.
Property and Equipment. Property and equipment are recorded at cost less accumulated depreciation. Buildings are depreciated on a straight-line basis over the expected useful life of the asset, which is individually assessed, and estimated to be up to 20 years. Leasehold improvements are depreciated on a straight-line basis over the lesser of the length of the lease and the estimated useful life of the assets, up to a maximum of five years. All other property and equipment is depreciated using the declining balance method as follows:
Furniture and fixtures | 20% | |
Computer hardware and software | 20% - 30% | |
Equipment and vehicles | 30% | |
Changes in circumstances, such as technological advances, can result in differences between the actual and estimated useful lives. In those cases where we determine that the useful life of a long-lived asset should be shortened, we increase depreciation expense over the remaining useful life to depreciate the asset's net book value to its estimated salvage value.
36
Long-Lived Assets. Long-lived assets, including intangible assets with finite useful lives are evaluated for impairment when the occurrence of events or changes in circumstances indicates that the carrying value of the assets may not be recoverable as measured by comparing their net book value to the undiscounted estimated future cash flows generated by their use and eventual disposition. Impaired assets are recorded at fair value, determined principally by the present value of the estimated future cash flows expected from their use and eventual disposition.
Income Taxes. The U.S. tax reform enacted on December 22, 2017 introduces significant changes to the U.S. income tax laws. The accounting for the income tax effects of the U.S. tax reform is complex and requires significant judgement and estimates in the interpretation and calculations of its provisions.
We have recognized a provisional amount of $59.3 million in income tax expense in fiscal 2017 in relation to the U.S. tax reform. This includes a provisional current income tax expense of $58.9 million for the mandatory one-time transition tax on the deemed repatriation of accumulated undistributed earnings of foreign subsidiaries, and a provisional deferred income tax expense of $0.4 million to reflect the reduced U.S. tax rate and other effects of the U.S. tax reform.
Further analysis will be required with respect to the method of computation and components of the foreign subsidiaries' earnings and profits, the definition of foreign cash positions, the computation and limitation of the use of foreign tax credits, the conformity of each state to the U.S. federal income tax laws on the mandatory deemed repatriation income inclusion for state income tax purposes, the impact that the U.S. tax reform has, if any, upon our reinvestment plans for the accumulated earnings of the Company's foreign subsidiaries, and the amount of tax that would apply in the event of any change in our reinvestment plans. We may make adjustments to the provisional amounts and those adjustments may materially impact our provision for income taxes and effective income tax rates in the period in which the adjustments are made, and in future periods.
Deferred income tax assets and liabilities are determined based on the temporary differences between the carrying amounts and the tax basis of assets and liabilities, and for tax losses, tax credit carryforwards, and other tax attributes, using the enacted tax rates that are to be in effect when these differences are expected to reverse. Our deferred income tax balances and income tax rates are significantly affected by the tax rates on our global operations and the extent to which the undistributed earnings of our foreign subsidiaries are indefinitely reinvested outside the U.S. Deferred income tax liabilities are recognized for U.S. federal and state income taxes and foreign withholding taxes on the undistributed earnings of foreign subsidiaries, unless those earnings are indefinitely reinvested outside of the U.S. Indefinite reinvestment is determined by management's judgment about, and intentions concerning, the future operations of the Company.
As of January 28, 2018, we have not changed our indefinite reinvestment plans as a result of the U.S. tax reform. Accordingly, no deferred income tax liabilities have been recognized on any of the undistributed earnings of the Company's foreign subsidiaries. We are continuing to evaluate the impact that the U.S. tax reform has upon the taxes which may become payable upon repatriation, our reinvestment plans, and the most efficient means of deploying our capital resources globally. As this analysis has not yet been completed, it is possible that amounts determined to be indefinitely reinvested outside of the U.S. may ultimately be repatriated, resulting in additional tax liabilities being recognized.
The cumulative undistributed earnings of our foreign subsidiaries as of January 28, 2018 were $1.24 billion, including $1.21 billion of accumulated undistributed earnings of a Canadian subsidiary. In the event we determine that all or a portion of such Canadian earnings will no longer be indefinitely reinvested outside of the United States, Canadian withholding taxes of 5% and U.S. state income taxes could apply to some portion of any distribution made. This is in addition to the one-time transition tax that is payable as a result of the U.S. tax reform. The amount of tax that would be payable upon repatriation is dependent on the elections available to us under Canadian withholding tax legislation, the extent to which such withholding tax would be recoverable through U.S. foreign tax credits, and the interaction between state and U.S. federal income tax laws as a result of the U.S. tax reform.
We evaluate our tax filing positions and recognize the largest amount of tax benefit that is considered more likely than not to be sustained upon examination by the relevant taxing authorities based on the technical merits of the position. This determination requires the use of significant judgment. Income tax expense is adjusted in the period in which an uncertain tax position is effectively settled, the statute of limitations expires, facts or circumstances change, tax laws change, or new information becomes available. Our tax positions include intercompany transfer pricing policies and the associated taxable income and deductions arising from intercompany charges between subsidiaries within the consolidated group. Although we believe that our intercompany transfer pricing policies and tax positions are reasonable, the final outcomes of tax audits or potential tax disputes may be materially different from that which is reflected in our income tax provisions and accruals.
Goodwill and Intangible Assets. Intangible assets are recorded at cost. Reacquired franchise rights are amortized on a straight-line basis over their estimated useful lives of 10 years. Goodwill represents the excess of the purchase price over the fair market value of identifiable net assets acquired and is not amortized. Goodwill is tested for impairment annually or more frequently when an event or circumstance indicates that goodwill might be impaired. Goodwill impairment testing requires us
37
to estimate the fair value of our reporting units. We generally base our measurement of the fair value on the present value of future cash flows. Our significant estimates in the discounted cash flows model include the discount rate and long-term rates of growth. We use our best estimates and judgment based on available evidence in conducting the impairment testing.
Stock-Based Compensation. We account for stock-based compensation using the fair value method. The fair value of awards granted is estimated at the date of grant and is recognized as employee compensation expense on a straight-line basis over the requisite service period. For awards with service and/or performance conditions, the amount of compensation expense recognized is based on the number of awards that are expected to vest.
The estimation of the number of stock awards that will ultimately vest requires judgment, and to the extent actual results differ from our estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider several factors when estimating the number of awards which are expected to vest, including, future profit forecasts, types of awards, size of option holder group, and anticipated employee retention and estimated expected forfeitures. Actual results may differ substantially from these estimates.
The calculation of the grant-date fair value of stock options requires us to make certain estimates and assumptions, including, stock price volatility, and the expected life of the options. We evaluate and revise these estimates and assumptions as necessary, to reflect market conditions and our historical experience. The expected term of the options is based upon historical experience of similar awards, giving consideration to expectations of future employee behavior. Expected volatility is based upon the historical volatility of our common stock for the period corresponding with the expected term of the options. In the future, the expected volatility and expected term may change which could substantially change the grant-date fair value of future awards of stock options and, ultimately, the expense we record.
Contingencies. In the ordinary course of business, we are involved in legal proceedings regarding contractual and employment relationships and a variety of other matters. We record contingent liabilities resulting from claims against us, when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third-party claimants and courts.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Risk. The functional currency of our foreign subsidiaries is generally the applicable local currency. Our consolidated financial statements are presented in U.S. dollars. Therefore, the net revenue, expenses, assets, and liabilities of our foreign subsidiaries are translated from their functional currencies into U.S. dollars. Fluctuations in the value of the U.S. dollar affect the reported amounts of net revenue, expenses, assets, and liabilities. Foreign exchange differences which arise on translation of our foreign subsidiaries' balance sheets into U.S. dollars are recorded as a foreign currency translation adjustment in accumulated other comprehensive income or loss within stockholders' equity.
We also have exposure to changes in foreign exchange rates associated with transactions which are undertaken by our subsidiaries in currencies other than their functional currency. Such transactions include intercompany transactions and inventory purchases denominated in currencies other than the functional currency of the purchasing entity. As a result, we have been impacted by changes in exchange rates and may be impacted for the foreseeable future. The potential impact of currency fluctuation increases as our international expansion increases.
As of January 28, 2018, we had certain forward currency contracts outstanding in order to hedge a portion of the foreign currency exposure that arises on translation of a Canadian subsidiary into U.S. dollars. We also had certain forward currency contracts outstanding in an effort to reduce our exposure to the foreign exchange revaluation gains and losses that are recognized by our Canadian subsidiaries on U.S. dollar denominated monetary assets and liabilities. Please refer to Note 12 to our audited consolidated financial statements included in Item 8 of Part II of this report for further information, including details of the notional amounts outstanding.
In the future, in an effort to reduce foreign exchange risks, we may enter into further derivative financial instruments including hedging additional currency pairs. We do not, and do not intend to, engage in the practice of trading derivative securities for profit.
38
We currently generate a significant portion of our net revenue and incur a significant portion of our expenses in Canada. We also hold a significant portion of our net assets in Canada. The reporting currency for our consolidated financial statements is the U.S. dollar. A weakening of the U.S. dollar against the Canadian dollar results in:
• | the following impacts to the consolidated statements of operations: |
– | an increase in our net revenue upon translation of the sales made by our Canadian subsidiaries into U.S. dollars for the purposes of consolidation; |
– | an increase in our selling, general and administrative expenses incurred by our Canadian subsidiaries upon translation into U.S. dollars for the purposes of consolidation; |
– | foreign exchange revaluation losses by our Canadian subsidiaries on U.S. dollar denominated monetary assets; and |
– | derivative valuation gains on forward currency contracts not designated in a hedging relationship; |
• | the following impacts to the consolidated balance sheets: |
– | an increase in the foreign currency translation adjustment which arises on the translation of our Canadian subsidiaries' balance sheets into U.S. dollars; and |
– | a decrease in the foreign currency translation adjustment from derivative valuation losses on forward currency contracts, entered into as net investment hedges of a Canadian subsidiary. |
During fiscal 2017, the change in the relative value of the U.S. dollar against the Canadian dollar resulted in a $44.4 million reduction in accumulated other comprehensive loss within stockholders' equity. During fiscal 2016, the change in the relative value of the U.S. dollar against the Canadian dollar resulted in a $41.7 million reduction in accumulated other comprehensive loss within stockholders' equity.
A 10% depreciation in the relative value of the U.S. dollar against the Canadian dollar compared to the exchange rates in effect for fiscal 2017 would have resulted in additional income from operations of approximately $1.0 million in fiscal 2017. This assumes a consistent 10% depreciation in the U.S. dollar against the Canadian dollar throughout the fiscal year. The timing of changes in the relative value of the U.S. dollar combined with the seasonal nature of our business, can affect the magnitude of the impact that fluctuations in foreign exchange rates have on our income from operations.
Interest Rate Risk. Our revolving credit facility provides us with available borrowings in an amount up to $150.0 million in the aggregate. Because our revolving credit facility bears interest at a variable rate, we will be exposed to market risks relating to changes in interest rates, if we have a meaningful outstanding balance. As of January 28, 2018, aside from letters of credit of $1.2 million, we had no other borrowings outstanding under this credit facility. We currently do not engage in any interest rate hedging activity and currently have no intention to do so. However, in the future, if we have a meaningful outstanding balance under our revolving facility, in an effort to mitigate losses associated with these risks, we may at times enter into derivative financial instruments, although we have not historically done so. These may take the form of forward contracts, option contracts, or interest rate swaps. We do not, and do not intend to, engage in the practice of trading derivative securities for profit.
Our cash and cash equivalent balances are held in the form of cash on hand, bank balances, and short-term deposits with original maturities of three months or less. We do not believe these balances are subject to material interest rate risk.
Credit Risk. We have cash and cash equivalents on deposit with various large, reputable financial institutions. The amount of cash and cash equivalents held with certain financial institutions exceeds government-insured limits. We are also exposed to credit-related losses in the event of nonperformance by the financial institutions that are counterparties to our forward currency contracts. The credit risk amount is our unrealized gains on our derivative instruments, based on foreign currency rates at the time of nonperformance. We have not experienced any losses related to these items, and we believe credit risk to be minimal. We seek to minimize our credit risk by entering into transactions with credit worthy and reputable financial institutions and by monitoring the credit standing of the financial institutions with whom we transact. We seek to limit the amount exposure with any one counterparty.
Inflation
Inflationary factors such as increases in the cost of our product and overhead costs may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net revenue if the selling prices of our products do not increase with these increased costs.
39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
lululemon athletica inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
40
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of lululemon athletica inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of lululemon athletica inc. and its subsidiaries, (together, the Company) as of January 28, 2018 and January 29, 2017, and the related consolidated statements of operations and comprehensive income, stockholders' equity and cash flows for each of the 52 week periods ended January 28, 2018, January 29, 2017 and January 31, 2016, including the related notes and the financial statement schedule listed in the index appearing under Item 15(a)(2) (collectively referred to as the "consolidated financial statements"). We also have audited the Company's internal control over financial reporting as of January 28, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of January 28, 2018 and January 29, 2017, and their results of operations and their cash flows for each of the 52 week periods ended January 28, 2018, January 29, 2017, and January 31, 2016 in conformity with accounting principles generally accepted in the United States of America (US GAAP). Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control over Financial Reporting, appearing under item 9A. Our responsibility is to express opinions on the Company's consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
41
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP |
Chartered Professional Accountants |
Vancouver, Canada |
March 26, 2018 |
We have served as the Company's auditor since 2006.
42
lululemon athletica inc.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except per share amounts)
January 28, 2018 | January 29, 2017 | |||||||
ASSETS | ||||||||
Current assets | ||||||||
Cash and cash equivalents | $ | 990,501 | $ | 734,846 | ||||
Accounts receivable | 19,173 | 9,200 | ||||||
Inventories | 329,562 | 298,432 | ||||||
Prepaid and receivable income taxes | 48,948 | 81,190 | ||||||
Other prepaid expenses and other current assets | 48,098 | 39,069 | ||||||
1,436,282 | 1,162,737 | |||||||
Property and equipment, net | 473,642 | 423,499 | ||||||
Goodwill and intangible assets, net | 24,679 | 24,557 | ||||||
Deferred income tax assets | 32,491 | 26,256 | ||||||
Other non-current assets | 31,389 | 20,492 | ||||||
$ | 1,998,483 | $ | 1,657,541 | |||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
Current liabilities | ||||||||
Accounts payable | $ | 24,646 | $ | 24,846 | ||||
Accrued inventory liabilities | 13,027 | 8,601 | ||||||
Accrued compensation and related expenses | 70,141 | 55,238 | ||||||
Current income taxes payable | 15,700 | 30,290 | ||||||
Unredeemed gift card liability | 82,668 | 70,454 | ||||||
Lease termination liabilities | 6,427 | — | ||||||
Other current liabilities | 79,989 | 52,561 | ||||||
292,598 | 241,990 | |||||||
Non-current income taxes payable | 48,268 | — | ||||||
Deferred income tax liabilities | 1,336 | 7,262 | ||||||
Other non-current liabilities | 59,321 | 48,316 | ||||||
401,523 | 297,568 | |||||||
Stockholders' equity | ||||||||
Undesignated preferred stock, $0.01 par value: 5,000 shares authorized; none issued and outstanding | — | — | ||||||
Exchangeable stock, no par value: 60,000 shares authorized; 9,781 and 9,781 issued and outstanding | — | — | ||||||
Special voting stock, $0.000005 par value: 60,000 shares authorized; 9,781 and 9,781 issued and outstanding | — | — | ||||||
Common stock, $0.005 par value: 400,000 shares authorized; 125,650 and 127,304 issued and outstanding | 628 | 637 | ||||||
Additional paid-in capital | 284,253 | 266,622 | ||||||
Retained earnings | 1,455,002 | 1,294,214 | ||||||
Accumulated other comprehensive loss | (142,923 | ) | (201,500 | ) | ||||
1,596,960 | 1,359,973 | |||||||
$ | 1,998,483 | $ | 1,657,541 | |||||
See accompanying notes to the consolidated financial statements
43
lululemon athletica inc.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Amounts in thousands, except per share amounts)
Fiscal Year Ended | ||||||||||||
January 28, 2018 | January 29, 2017 | January 31, 2016 | ||||||||||
Net revenue | $ | 2,649,181 | $ | 2,344,392 | $ | 2,060,523 | ||||||
Cost of goods sold | 1,250,391 | 1,144,775 | 1,063,357 | |||||||||
Gross profit | 1,398,790 | 1,199,617 | 997,166 | |||||||||
Selling, general and administrative expenses | 904,264 | 778,465 | 628,090 | |||||||||
Asset impairment and restructuring costs | 38,525 | — | — | |||||||||
Income from operations | 456,001 | 421,152 | 369,076 | |||||||||
Other income (expense), net | 3,997 | 1,577 | (581 | ) | ||||||||
Income before income tax expense | 459,998 | 422,729 | 368,495 | |||||||||
Income tax expense | 201,336 | 119,348 | 102,448 | |||||||||
Net income | $ | 258,662 | $ | 303,381 | $ | 266,047 | ||||||
Other comprehensive income (loss), net of tax: | ||||||||||||
Foreign currency translation adjustment | 58,577 | 36,703 | (64,796 | ) | ||||||||
Comprehensive income | $ | 317,239 | $ | 340,084 | $ | 201,251 | ||||||
Basic earnings per share | $ | 1.90 | $ | 2.21 | $ | 1.90 | ||||||
Diluted earnings per share | $ | 1.90 | $ | 2.21 | $ | 1.89 | ||||||
Basic weighted-average number of shares outstanding | 135,988 | 137,086 | 140,365 | |||||||||
Diluted weighted-average number of shares outstanding | 136,198 | 137,302 | ||||||||||