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Yesterday, Lululemon Athletica Inc. (LULU - Analyst Report), a leading yoga-inspired athletic apparel and accessories retailer, posted better-than-expected second-quarter fiscal 2013 results on the back of robust sales growth. The quarterly earnings per share of 39 cents beat the Zacks Consensus Estimate of 35 cents but remained flat compared with the year-ago quarter.

The earnings of second-quarter fiscal 2012 included a benefit of 5 cents per share related to retroactive tax adjustment. Excluding that, Lululemon’s earnings for the quarter rose 14.7% on a year-over-year basis. However, a rise in input and operating costs, and higher tax rate were the negatives for the quarter.

Moreover, due to delay in receiving the deliveries of fall products at the beginning of third quarter this fiscal, Lululemon lowered its outlook for fiscal 2013. This gave rise to negative sentiment among investors, which was later reflected in the company’s share prices decreasing 5.4% to close at $65.29 per share from the previous day’s closing price of $69.02.

Quarter in Detail

In the reported quarter, Lululemon’s revenues of $344.5 million was up 21.9% from $282.6 million in the comparable year-ago quarter and came marginally ahead of the Zacks Consensus Estimate of $343.0 million. Revenue growth in the quarter was primarily driven by new store openings, an 8% upside in comparable-store sales and a 39.4% increase in Direct-to-Consumer revenues. Direct-to-Consumer revenues of $49.4 million in the quarter constituted about 14.3% of the total revenue.

Gross profit during the quarter rose 19.4% to $186.0 million from the prior-year quarter. However, gross margin contracted 110 basis points (bps) to 54.0% compared with 55.1% in the second quarter of fiscal 2012. This was primarily due to 220 bps fall in product margin arising from lower mix of high-margin Black Luon pants and increased inventory reserves. The negative impact on gross margin was partially offset by a 70 bps fall in occupancy and depreciation costs and a decline of 40 bps in product and supply chain costs.

Selling, general & administrative (SG&A) expenses increased 25.0% to $107.0 million compared with $85.6 million in the same period of fiscal 2012, while as a percentage of sales, it rose 80 bps to 31.1%.

The dollar increase in SG&A expenses was mainly due to higher compensation and operating costs related to new store openings, increased labor expenses at existing stores due to higher sales volumes, increased variable operating costs related to the e-Commerce business and higher expenses at the store support center, including salaries, administrative expenses, professional fees, management incentives and stock-based compensation pertaining to the company’s business expansion.

Income from operations rose 12.5% to $79.0 million while as a percentage of sales, it contracted 190 bps to 22.9%. The year-over-year contraction in operating margin was primarily due to lower gross margin and higher SG&A expenses as a percentage of sales.

During the quarter, the company’s tax expenses increased 74.4% to $23.8 million. The effective tax rate for the quarter was 29.7% compared with 19.1% in the comparable year-ago quarter.

Balance Sheet

Lululemon exited the second quarter with cash and cash equivalents of $610.3 million, up 37.4% from the year-ago quarter level. Inventories at the quarter-end totaled $163.0 million versus $125.4 million at the end of the year-ago quarter. Stockholders' equity came in at $979.3 million. In addition, the company is free from any long-term debts.

In the first two quarters of fiscal 2013, Lululemon generated about $70.9 million of cash flow from operating activities compared with $63.5 million during the same period in fiscal 2012. The company incurred capital expenditure of $44.0 million during the first half of the fiscal mainly on account of opening new stores, renovation costs as well as expenses related to IT and head office capital. Moreover, Lululemon intends to make a capital expenditure of $100.0–$110.0 million in fiscal 2013.

During the reported quarter, the company opened 8 new stores, bringing the total store count to 226 across North America, Australia and New Zealand.

Management Guidance

Despite reporting better-than-expected top and bottom-line results for the said quarter, the company lowered its fiscal 2013 outlook due to a soft start of the third quarter on account of late delivery of fall products.

Lululemon now expects revenues in the fiscal to come in the range of $1,625.0–$1,635.0 million, down from $1,645.0­­­–$1,665.0 million forecasted earlier. Management also expects SG&A expenses as a percentage of revenues to increase year over year due to lost sales resulting from late deliveries and increased investments.

Further, the company expects the weighted average shares outstanding and effective tax rate at the end of the fiscal to be 146 million and 30.0%, respectively. Based on these assumptions, Lululemon lowered its earnings guidance range to $1.94–$1.97 per share from the earlier projection of $1.96–$2.01. The Zacks Consensus Estimate for the fiscal stands at $1.99 per share.

For the third quarter, Lululemon forecasts sales to be between $370 million and $375 million, with comparable-store sales growth in the mid single-digit range. Moreover, the company projects third-quarter fiscal 2013 earnings to be 39–41 cents per share, based on the forecast of 146.0 million shares outstanding and a 30% tax rate. Currently, the Zacks Consensus Estimate for the quarter stands at 44 cents per share.

Other Stocks to Consider

Lululemon currently carries a Zacks Rank #3 (Hold). Other stocks performing well in the apparel/shoe retail space include Citi Trends, Inc. (CTRN - Analyst Report), DSW Inc. (DSW - Snapshot Report) and L Brands, Inc. . While Citi Trends carries a Zacks Rank #1 (Strong Buy), both DSW and L Brands have a Zacks Rank #2 (Buy).

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