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Lululemon Athletica Inc. (LULU - Analyst Report), a leading yoga-inspired athletic apparel and accessories retailer, posted better-than-expected third-quarter fiscal 2013 earnings despite the supply chain issues faced at the beginning of the third quarter. Earnings per share of 45 cents were ahead of the Zacks Consensus Estimate of 41 cents and the company’s projected guidance range of 39–41 cents. Additionally, quarterly earnings reflected a double-digit growth rate of 15.4% from the year-ago quarter figure of 39 cents.

Quarter in Detail

Lululemon’s revenue of $379.9 million was up 20.0% from $316.5 million in the comparable year-ago quarter and marginally beat the Zacks Consensus Estimate of $376.0 million. Revenue growth in the quarter was primarily driven by store openings, a 5% upside in comparable-store sales and a 37.3% increase in Direct-to-Consumer revenues. Direct-to-Consumer revenues of $62.0 million in the quarter constituted about 16.3% of the total revenue.

Gross profit during the quarter rose 16.7% to $204.6 million from the prior-year quarter. However, gross margin contracted 150 basis points (bps) to 53.9% from 55.4% in the third quarter of fiscal 2012. This was primarily due to 220 bps fall in the product margin due to increased shipment charges paid to perk up product supply, unimpressive product mix and increased inventory reserves. The negative impact on gross margin was partially offset by a 30 bps fall in occupancy and depreciation costs as well as a decline of 40 bps in product and supply chain costs.

Selling, general & administrative (SG&A) expenses increased 18.6% to $112.3 million from $94.7 million in the same period of fiscal 2012, while as a percentage of sales it contracted 30 bps to 29.6%. Higher SG&A expenses resulted from rise in store labor and operating expenses at new stores as well as increased costs at existing stores stemming from higher sales volumes, increased variable costs for operation of the online business and higher staff related expenses at stores.

Income from operations rose 14.5% to $92.3 million while as a percentage of sales, it contracted 120 bps to 24.3%. The year-over-year contraction in operating margin was primarily due to lower gross margin, partly offset by decreased SG&A expenses as a percentage of sales.

During the quarter, the company’s tax expenses increased 12.1% to $27.7 million. The effective tax rate for the quarter was 29.5%, as against 30.1% in the comparable year-ago quarter.

Balance Sheet

Lululemon exited the quarter with cash and cash equivalents of $600.7 million, up 36.7% from the year-ago quarter level. Inventories at the quarter-end totaled $206.2 million versus $164.7 million at the end of the year-ago quarter. Stockholders' equity came in at $1,042.8 million. In addition, the company is free from any long-term debts.

In the nine months of fiscal 2013, Lululemon generated about $94.8 million of cash flow from operating activities compared with $113.2 million during the same period in fiscal 2012. The company incurred capital expenditure of $27.9 million in the third quarter mainly due to the opening of 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–$105.0 million in fiscal 2013.

During the reported quarter, the company opened 17 stores in the U.S., 2 in Australia/New Zealand, and 2 ivivva stores, bringing the total store count to 247 across North America, Australia and New Zealand. In fiscal 2013, the company targets to inaugurate 43 new corporate owned stores, including its ivivva locations.

Management Guidance

Despite reporting better-than-expected top and bottom-line results for the quarter, the company lowered its fourth-quarter and fiscal 2013 outlook due to the present supply chain issues that resulted in a soft start of the fourth quarter, overall weak traffic trends and the projection of weaker Canadian dollar. This led the shares of Lululemon to fall 11.65% in the trading session following the company’s before market earnings announcement. The company closed trade at $60.39 per share.

For the fourth quarter, Lululemon tweaked its sales forecast to range between $535 million and $540 million expecting the weak sales trends witnessed so far in the quarter to continue. This forecast is substantially below the company’s previous sales expectation of $565–$570 million. Sales expectation for the upcoming quarter is guided by a flat comparable-store sales growth compared to last year.

Moreover, the company projects fourth-quarter fiscal 2013 earnings in the 78–80 cents per share range forecasting shares outstanding of 146.0 million and a tax rate of 30%. Currently, the Zacks Consensus Estimate for the quarter stands at 84 cents per share, which is above the company’s guidance range.

Lululemon now expects revenues in the fiscal to come in the range of $1,605.0–$1,610.0 million, down from $1,625.0–$1,635.0 million forecasted earlier. Gross margin for the year is expected to come in the 53%–54% range. Management 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 $1.93–$1.96 per share from the earlier projection of $1.94–$1.97. The Zacks Consensus Estimate for the fiscal stands at $1.96 per share, which is at the upper end of the company’s forecast.

Other Stocks to Consider

Lululemon currently carries a Zacks Rank #3 (Hold). However, better-ranked stocks in the apparel retail space include G-III Apparel Group Ltd. (GIII - Snapshot Report), Hanesbrands Inc. (HBI - Analyst Report) and Citi Trends Inc. (CTRN - Analyst Report). While G-III and Hanesbrands carry a Zacks Rank #1 (Strong Buy), Citi Trends has a Zacks Rank #2 (Buy).

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