Lululemon rises on earnings, vows to defend patents

TORONTO Fri Sep 7, 2012 11:46am EDT

TORONTO (Reuters) - Canadian yogawear retailer Lululemon Athletica Inc LLL.TO reported higher quarterly profit and boosted its outlook on Friday, while vowing to push back against cheaper knock-offs that could threaten its business.

The typically volatile stock rose nearly 8 percent on Friday morning after the company posted the results, which were in line with analysts' expectations excluding the impact of a lower-than-expected tax rate.

Founded in 1998, Lululemon made yoga apparel fashionable with its signature $98 pants, but it now faces rising competition from heavyweight brands at lower prices.

"While others may try to mimic parts of our business, it is impossible to copy a personality," said Chief Executive Christine Day on a conference call with analysts and investors.

Day said the company has an intellectual property portfolio to protect its "classic styles," and acknowledged a patent suit the company filed in August against PVH Corp's (PVH.N) Calvin Klein and manufacturer G-III Apparel Group Ltd (GIII.O).

"When we see attempts to mirror our product we will take the necessary steps to protect our assets," she said.

Lululemon's colorful, form-hugging clothes are ubiquitous in Canada, especially among affluent young women, and the brand is becoming increasingly popular in the United States.

But it trades at a premium, 46 times earnings based on Thursday's close, while Nike trades at 21 times earnings, and recently any sign that its growth might slow has spooked markets.

Lululemon's rivals are expanding. Gap Inc (GPS.N) opened 11 standalone Athleta stores last quarter, bringing its total to 22. The banner features workout gear and free in-store fitness classes, like the free yoga classes that helped build Lululemon's profile.

Lululemon's gross profit margin fell to 55.1 percent in the second quarter ended July 29, from 57.5 percent last year, partly because of "increased innovation and function" in its products.

"They have had to make their product more complex to essentially maintain their market share versus more rivals coming into the marketplace," said independent retail analyst Brian Sozzi.

QUALITY CONCERNS

Quality is key to Lululemon's business - the company has said that it competes with rivals like Nike Inc (NKE.N) and Under Armour Inc (UA.N) by offering better-quality products.

From early on, the buzz was that Lululemon pants would last forever. But on Friday's call, Day addressed some recent quality issues.

In July, Lululemon posted a note to customers on Facebook acknowledging that it was working to solve problems with dye bleeding from some of its brightly colored products.

"When guests felt we were not owning up we reacted appropriately to ensure that our guests were heard," said Day.

Omar Saad, an analyst at International Strategy & Investment Group, was impressed with Lululemon's same-store sales, and gross margin that he said was higher than consensus.

"We would be buyers of Lululemon shares following this morning's earnings release given our belief that the uncertainty that has plagued the stock coming out of last quarter is quickly lifting," he said in a note to clients, referring to the quality concerns.

GAINS ON TAX ADJUSTMENTS

Lululemon's operating margin was 24.8 percent in the quarter, down from 28.0 percent last year and just short of the company's target of 25 percent.

Same-store sales, a key measure for retailers, rose 15 percent on a constant-dollar basis, less than the 20 percent growth posted in the same quarter last year.

The Vancouver-based company raised its forecast for full-year net revenue to $1.345 billion to $1.360 billion, up from last quarter's forecast of $1.32 billion to $1.34 billion. Lululemon said it expects full-year earnings per share from $1.76 to $1.81, up from its previously forecast $1.55 to $1.60.

Inventory rose to $125.4 million by the end of the quarter, compared with $88.9 million a year earlier. The company's products sold faster than it could restock in much of 2011, holding back sales, and in recent quarters its inventory has been much higher year-over-year.

For the current quarter, Lululemon forecast earnings of 34 to 36 cents a share.

Net income rose to $57.2 million, or 39 cents a share, from $38.4 million, or 26 cents, a year earlier.

Earnings were boosted by a lower effective tax rate, thanks in part to a $7.2 million adjustment that reversed taxes provided for in two previous quarters.

Excluding the tax adjustment, which the company said was based on a management review of the impact of intercompany pricing agreements, earnings came in at 34 cents a share.

At the company's previously estimated tax rate, earnings would have been 31 cents a share, in line with analysts' average estimate. Net revenue increased 33 percent to $282.6 million, compared with average estimate of $282.8 million.

Shares rose 7.9 percent to C$72.73 on Friday morning on the Toronto Stock Exchange.

(Editing by Frank McGurty)

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