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Lululemon Athletica Inc. (LULU - Analyst Report), a leading yoga-inspired athletic apparel and accessories retailer, posted better-than-expected fourth-quarter and fiscal 2013 earnings that cruised ahead of the Zacks Consensus Estimate as well as the company’s recently lowered fourth-quarter forecast. In January, the company had slashed its fourth-quarter fiscal 2013 guidance, citing a tremendous fall in customer traffic and sales trends since the start of January.

Investors were encouraged by the company’s performance despite the pessimistic outlook, which resulted in the shares rallying about 6.2% during yesterday’s trade.

Earnings of 75 cents per share in the fourth quarter were ahead of the Zacks Consensus Estimate of 72 cents and the company’s guidance range of 71–73 cents, while it came in line with the year-ago quarter figure. For the full year, the company reported earnings per share of $1.91, up 3.2% year over year and past the Zacks Consensus Estimate of $1.89.

Lululemon’s revenue of $521.0 million in the quarter rose 7% from $485.5 million in the comparable year-ago quarter and marginally beat the Zacks Consensus Estimate of $518.0 million as well as the company’s projected guidance range of $513 – $518 million. Revenue growth in the quarter was primarily driven by improved comparable-store sales (comps), including Direct-to-Consumer, and higher revenue contribution from Direct-to-Consumer business.

Fiscal 2013 revenue rose 16% to $1,591.2 million, cruising ahead of the Zacks Consensus Estimate of $1,588.0 million.

Quarter in Detail

Comps for the quarter were down 2%, while including Direct-to-Consumer, total company comps rose 4%. Direct-to-Consumer revenues of $97.8 million in the quarter constituted about 18.8% of the total revenue, marking year-over-year growth of 25% and higher contribution compared to 16.1% contributed to revenue in the prior-year quarter.

Gross profit rose 1.6% to $278.8 million from the prior-year quarter. However, gross margin contracted 300 basis points (bps) to 53.5% from 56.5% in the fourth quarter of fiscal 2012. This was primarily due to a 270 bps fall in the product margin due to a mix shift to seasonal low margin products, elevated air freight usage, higher inventory reserves, increased foreign exchange translation due to weaker Canadian and Australian dollar and a 30 bps increase in fixed costs, namely occupancy and depreciation costs as well as product and supply chain costs.

Selling, general & administrative (SG&A) expenses increased 2.2% to $124.6 million from $121.9 million in the same period of fiscal 2012, while as a percentage of sales it contracted 120 bps to 23.9%. Higher SG&A expenses resulted from a rise in store labor and operating expenses at new stores as well as increased variable costs for operating the online business and higher expenses at store support center stemming from salaries, administrative expenses and professional fees.

Income from operations rose 1.0% to $154.1 million while as a percentage of sales, it contracted 180 bps to 29.6%. 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 2.9% to $46.0 million. The effective tax rate for the quarter was 29.5%, as against 29.0% in the comparable year-ago quarter.

Other Financials

Lululemon exited the year with cash and cash equivalents of $698.6 million, up 18.4% from the year-ago quarter level. Inventories at fiscal year-end 2013 totaled $186.1 million, 19.9% higher than $155.2 million at the end of fiscal 2012. Stockholders' equity came in at $1,096.7 million.

In fiscal 2013, Lululemon generated about $278.3 million of cash flow from operating activities compared with $280.1 million during fiscal 2012. The company incurred capital expenditure of $34.5 million in the fourth quarter mainly slated towards the opening of new stores, renovating existing stores and expenses related to IT and head office capital.

During the reported quarter, the company opened 7 stores including 4 corporate-owned stores in the U.S., and 1 store each in Canada and New Zealand, and 1 ivivva store. This brought the company’s total store count to 254 across North America, Australia and New Zealand at the end of fiscal 2013 compared to 211 operating at the end of fiscal 2012.

Management Guidance

For first-quarter fiscal 2014, Lululemon forecasts sales to range between $377 million and $382 million on the back of flat comparable-store sales growth projections compared to last year. Starting with the first quarter of fiscal 2014, the company will report comparable store sales including both physical stores and e-Commerce, as is prevalent across the industry.

The company projects gross margin in the 50% – 51% range, impacted by higher costs related to the mix shift to seasonal products. While occupancy and depreciation are expected to be flat, product and supply costs are expected to deleverage due to investments made to enhance operations. Moreover, the company projects higher SG&A expenses as a percentage of sales compared to last year due to investments and headcount made in 2013 as well as execution of strategic initiatives in 2014.

The company anticipates first-quarter earnings in the 31–33 cents per share range, forecasting shares outstanding of 146.2 million and a tax rate of 30%.

For fiscal 2014, Lululemon expects revenue in the range of $1.77–$1.82 billion with combined comps growth in the low to mid-single digits. Gross margin for the year is expected to be in the low 50s range. Management expects SG&A expenses as a percentage of revenues to increase year over year due to investments in infrastructure to drive growth in areas such as brand, product innovation and guest experience as well as the difficult comparisons from the prior year, which included foreign exchange gains and reduced management incentive compensation.

Further, the company expects the weighted average shares outstanding and effective tax rate at the end of the fiscal to be 146.3 million and 30.0%, respectively. Based on these assumptions, Lululemon projects earnings in the range of $1.80–$1.90 per share.

Moreover, Lululemon intends to make a capital expenditure of $110.0–$115.0 million in fiscal 2014 slated for new store buildouts, renovation and relocation capital for existing stores, IT systems, and other head office capital.

In fiscal 2014, the company targets to inaugurate 42 new corporate owned stores, including Australia and the U.K. and about 10 new ivivva locations.

Other Stocks to Consider

Lululemon currently carries a Zacks Rank #5 (Strong Sell). Better-ranked stocks in the apparel retail space include Hanesbrands Inc. (HBI - Analyst Report), Michael Kors Holdings Limited (KORS - Analyst Report) and American Apparel Inc. (APP - Snapshot Report). Of these, Hanesbrands and Michael Kors hold a Zacks Rank #1 (Strong Buy) while American Apparel carries a Zacks Rank #2 (Buy).

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