UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-Q

 

 

Commission file number 001-33608

 

 

 

 

lululemon athletica inc.

(Exact name of registrant as specified in its charter)

 

 

 

 

 

Registrant’s telephone number, including area code:

604-732-6124

 

Former name, former address and former fiscal year, if changed since last report:

N/A

 

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 Web site, 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

At September 7, 2010, there were 51,781,740 shares of the registrant’s common stock, par value $0.01 per share, outstanding.

 

Exchangeable and Special Voting Shares:

 

At September 7, 2010, there were outstanding 19,110,042 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 September 7, 2010, the registrant had outstanding 19,110,042 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.

 

 

TABLE OF CONTENTS

 

 

 

lululemon athletica inc. and Subsidiaries

 

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except per share amounts)

 

 

See accompanying notes to the interim consolidated financial statements

lululemon athletica inc. and Subsidiaries

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except per share amounts)

 

 

See accompanying notes to the interim consolidated financial statements

lululemon athletica inc. and Subsidiaries

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Amounts in thousands)

 

 

See accompanying notes to the interim consolidated financial statements

lululemon athletica inc. and Subsidiaries

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

 

 

See accompanying notes to the interim consolidated financial statements

lululemon athletica inc. and Subsidiaries

 

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except per share and store count information, unless otherwise indicated)

 

 

Nature of operations

 

lululemon athletica inc., a Delaware corporation (“lululemon” and, together with its subsidiaries unless the context otherwise requires, the “Company”) is engaged in the design, manufacture and distribution of healthy lifestyle inspired athletic apparel, which is sold through a chain of corporate-owned and operated retail stores, direct to consumer through e-commerce, through independent franchises and through a network of wholesale accounts. The Company’s primary markets are Canada, the United States and Australia, where 45, 71 and 10 corporate-owned stores were in operation as of August 1, 2010, respectively. There were 126 and 110 corporate-owned stores in operation as of August 1, 2010 and January 31, 2010, respectively.

 

Basis of presentation

 

The unaudited interim consolidated financial statements as of August 1, 2010 and for the thirteen and twenty-six weeks ended August 1, 2010 and August 2, 2009 are presented using the United States dollar and have been prepared by the Company under the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the financial information is presented in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and, accordingly, do not include all of the information and footnotes required by GAAP for complete financial statements. The financial information as of January 31, 2010 is derived from the Company’s audited consolidated financial statements and notes for the fiscal year ended January 31, 2010, included in Item 8 in the Company’s fiscal 2009 Annual Report on Form 10-K. These unaudited interim consolidated financial statements reflect all adjustments which are in the opinion of management necessary to a fair statement of the results for the interim periods presented. These unaudited interim consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes included in the Company’s fiscal 2009 Annual Report on Form 10-K filed with the SEC on March 25, 2010.

 

The Company’s 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 2010 will end on January 30, 2011 and will be a 52 week year.

 

The Company’s business is affected by the pattern of seasonality common to most retail apparel businesses. The results for the periods presented are not necessarily indicative of future financial results.

 

 

United States income taxes and foreign withholding taxes are not provided for on undistributed earnings of foreign subsidiaries which are considered to be indefinitely reinvested in the operations of such subsidiaries. The amount of these earnings was approximately $117,387 and $110,849 at August 1, 2010 and January 31, 2010, respectively. The Company recorded a deferred tax liability of $5,284 in the first two quarters of fiscal 2010 for the estimated future income taxes and foreign withholding taxes attributable to the undistributed earnings of foreign subsidiaries for which it does not have plans for reinvestment in the operations of such subsidiaries.

 

Recent accounting pronouncements

 

In February 2010, the Financial Accounting Standards Board (“FASB”) amended Accounting Standards Codification (“ASC”) Topic 855 Subsequent Events (“ASC 855”). Under the amended guidance, SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. This guidance was effective immediately and the Company adopted these new requirements in the first quarter of fiscal 2010.

 

lululemon athletica inc. and Subsidiaries

 

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

In April 2010, the FASB amended ASC Topic 718 Compensation (“ASC 718”) to clarify that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a market, performance or service condition. Therefore, an entity should not classify such an award as a liability if it otherwise qualifies for classification in equity. This guidance is effective for interim and annual periods beginning on or after December 15, 2010 and is to be applied prospectively. The Company is evaluating the impact the amendment will have on its consolidated financial statements.

 

 

Share option plans

 

The Company’s employees participate in various stock-based compensation plans, which are either provided by a principal stockholder of the Company or by the Company directly.

 

Stock-based compensation expense charged to income for the plans was $3,563 and $2,816 for the twenty-six weeks ended August 1, 2010 and August 2, 2009, respectively. Total unrecognized compensation cost as at August 1, 2010 was $15,336 for all stock option plans, which is expected to be recognized over a weighted-average period of 2.5 years.

 

Company stock options and performance stock units

 

A summary of the Company’s stock option, performance stock unit and restricted share activity as of August 1, 2010 and changes during the period then ended is presented below:

 

 

The Company’s performance stock units are awarded to eligible employees and entitle the grantee to receive up to 1.5 shares of common stock per performance stock unit if the Company achieves specified performance goals and the grantee remains employed during the vesting period. The fair value of performance stock units is based on the closing price of the Company’s common stock on the award date. Expense for performance stock units is recognized when it is probable the performance goal will be achieved.

 

Stockholder- sponsored stock options

 

During the thirteen weeks ended August 1, 2010, holders of exchangeable shares converted 214 exchangeable shares into 214 shares of common stock of the Company for no additional consideration. In connection with the exchange of exchangeable shares, an equal number of outstanding shares of the Company’s special voting stock were cancelled.

 

During the thirteen weeks ended August 1, 2010, there were no grants or forfeitures related to any of the stock options issued and outstanding under the stockholder-sponsored awards.

 

Employee stock purchase plan

 

The Company’s Employee Stock Purchase Plan (“ESPP”) allows for the purchase of common stock of the Company by all eligible employees. Eligible employees may elect to have whatever portion of his or her base salary equates, after deduction of applicable taxes, to either 3%, 6% or 9% of his or her base salary withheld during each payroll period for purposes of purchasing shares of the Company’s common stock under the ESPP. Additionally, the Company or the

 

lululemon athletica inc. and Subsidiaries

 

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

subsidiary of the Company employing the participant, will make a cash contribution as additional compensation to each participant equal to one-third of the aggregate amount of that participant’s contribution for that pay period, which will be used to purchase shares of the Company’s common stock, subject to certain limits as defined in the ESPP. The maximum number of shares available under the ESPP is 3,000 shares. During the quarter ended August 1, 2010, there were 9 shares purchased under the ESPP, which were funded by the Company through open market purchases.

 

 

On May 12, 2010, the Company increased its investment in lululemon athletica australia PTY (“lululemon australia”) from 13 percent to 80 percent. The transaction provides the Company control over lululemon australia, which became a subsidiary of the Company on this date. lululemon australia is engaged in the distribution of healthy lifestyle inspired athletic apparel, which is sold through a chain of corporate-owned retail locations and through a network of wholesale accounts, in Australia. The Company previously accounted for its 13 percent interest in lululemon australia as an equity investment.

 

The acquired business contributed net revenues of $3,782 and losses from operations of $456 to the Company from the date of acquisition to August 1, 2010. The following unaudited pro forma summary presents consolidated information of the Company as if the business combination had occurred on February 2, 2009:

 

 

These amounts have been calculated after applying the Company’s accounting policies and adjusting the results of lululemon australia to reflect the additional depreciation and amortization that would have been charged assuming the fair value adjustments to inventory, and intangible assets had been applied from February 1, 2010, together with the consequential tax effects.

 

In 2010, the Company incurred $173 of acquisition-related costs. These expenses are included in general and administrative expense in the Company’s consolidated statement of income for the first two quarters of fiscal 2010.

 

The following tables summarize the consideration transferred to acquire lululemon australia and the preliminary amounts of identified assets acquired and liabilities assumed at the acquisition date, as well as the preliminary fair value of the noncontrolling interest in lululemon australia at the acquisition date:

 

Fair Value of Consideration Transferred:

 

 

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NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

     Preliminary amounts of identifiable assets acquired and liabilities assumed:

 

 

As a result of the Company obtaining control over lululemon australia, the Company’s previously held 13 percent interest was remeasured to fair value, resulting in a gain of $1,792. This has been recognized in the line item Other income (expense), net in the consolidated statement of income.

 

The preliminary fair value of the noncontrolling interest of $3,554 in lululemon australia was estimated by applying a market approach and an income approach. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement as defined in ASC 820. The fair value estimates use standard valuation techniques, including discounted cash flows, comparable transactions and internal projections, and include assumed adjustments due to the lack of control or lack of marketability that market participants would consider when estimating the fair value of the noncontrolling interest in lululemon australia.

 

On July 20, 2010, the Company reacquired in an asset purchase transaction a franchised store in Saskatoon, Saskatchewan for total cash consideration of $6,610. Included in the Company’s consolidated statements of income for the unaudited thirteen and twenty-six week periods ended August 1, 2010 are the results of the reacquired Saskatoon franchised store from the date of acquisition to August 1, 2010.

 

The following table summarizes the preliminary fair values of the net assets acquired as of August 1, 2010:

 

 

The reacquisition of the franchised stores is part of management’s vertical retail growth strategy. The reacquired franchise rights are amortized on a straight-line basis over their estimated useful lives. Reacquired franchise rights with indefinite useful lives are reviewed for impairment annually, or as events occur or circumstances arise which may reduce the fair value of indefinite lived reacquired franchise rights below carrying value. These are preliminary values that may change as the Company’s fair value assessment is ongoing.

 

 

On April 2, 2009, three former hourly Company employees filed a class action lawsuit in San Diego Superior Court, California, entitled Mia Stephens et al v. lululemon athletica inc. The lawsuit alleges that the Company violated various California Labor Code sections by requiring employees to wear lululemon clothing during working hours without reimbursing such employees for the cost of the clothing and by paying certain bonus payments to its employees in the

 

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NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

form of lululemon gift cards redeemable only for lululemon merchandise. The complaint also alleges that the Company owes waiting time penalties as the result of failing to pay employees all wages due at the time of termination. The Company and the plaintiffs have reached an agreement on settlement terms and the agreement has received tentative approval from the court. Plaintiffs and the Company must now go through the process of obtaining final court approval.

 

On March 26, 2009, a former hourly Company employee filed a class action lawsuit in Orange County Superior Court, California, entitled Brett Kohlenberg et al v. lululemon athletica inc. The lawsuit alleges that the Company violated various California Labor Code sections by failing to pay its employees for certain rest and meal breaks and “off the clock” work, and for penalties related to waiting times and failure to provide itemized wage statements. The Company and the plaintiffs have reached an agreement on settlement terms and the agreement has received tentative approval from the court. Plaintiffs and the Company must now go through the process of obtaining final court approval.

 

The Company is a party to various other legal proceedings arising in the ordinary course of its business, but the Company is not currently a party to any legal proceeding that management believes would have a material adverse effect on the Company’s consolidated financial position or results of operations.

 

 

The details of the computation of basic and diluted earnings per share are as follows:

 

 

The Company’s calculation of weighted-average shares includes the common stock of the Company as well as the exchangeable shares. Exchangeable shares are the equivalent of common shares in all material respects. All classes of stock have in effect the same rights and share equally in undistributed net income. For the twenty-six weeks ended August 1, 2010 and August 2, 2009, 64 and 896 stock options, respectively, were anti-dilutive to earnings and therefore have been excluded from the computation of diluted earnings per share.

 

lululemon athletica inc. and Subsidiaries

 

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

A summary of certain balance sheet accounts is as follows:

 

lululemon athletica inc. and Subsidiaries

 

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The Company reports segments based on the financial information it uses in managing its business. Previously, the Company reported its franchise channel as an operating segment, however it has accounted for less than 10% of net revenue from operations in each of fiscal 2009 and fiscal 2008. Opening new franchise stores is not a significant part of the Company’s near-term growth strategy and the Company does not expect that the revenue derived from franchises to be greater than 10% of net revenue in future years. Therefore, the Company has re-evaluated segment reporting in the first quarter of fiscal 2010. The Company’s reportable segments are comprised of corporate-owned stores, direct to consumer and other. Direct to consumer includes sales from the Company’s e-commerce website and phone sales. Franchise sales, wholesale, showrooms sales and outlet sales have been combined into other. Information for these segments is detailed in the table below:

 

 

Some of the statements contained in this Form 10-Q and any documents incorporated herein by reference constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, included or incorporated in this Form 10-Q are forward-looking statements, particularly statements which relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts, such as statements regarding our future financial condition or results of operations, our prospects and strategies for future growth, the development and introduction of new products, and the implementation of our marketing and branding strategies. In many cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “intends,” “predicts,” “potential” or the negative of these terms or other comparable terminology.

 

The forward-looking statements contained in this Form 10-Q and any documents incorporated herein by reference reflect our current views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause events or our actual activities or results to differ significantly from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, actions, levels of activity, performance or achievements. Readers are cautioned not to place undue reliance on these forward-looking statements. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements, including, but not limited to, those factors described in “Risk Factors” and elsewhere in this report.

 

The forward-looking statements contained in this Form 10-Q reflect our views and assumptions only as of the date of this Form 10-Q and are expressly qualified in their entirety by the cautionary statements included in this Form 10-Q. Except as required by applicable securities law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

 

Our fiscal year ends on the Sunday closest to January 31 of the following year, typically resulting in a 52 week year, but occasionally gives rise to an additional week, resulting in a 53 week year. Fiscal 2010 will end on January 30, 2011 and will be a 52 week year.

 

Overview

 

The world economy and capital markets have shown some signs of improvement, however, many companies and consumers continue to be impacted by uncertainty in the macro-economy. This has proven to be challenging for retailers in past periods, where declines in comparable store sales were posted. Although our current quarter results demonstrate the success of our efforts to overcome instability in the economy, the current market volatility may still negatively affect our financial results in future periods.

 

We believe that through strong execution of our strategic plans, we are well placed to succeed in this market. In fiscal 2009, we were able to introduce our new e-commerce sales channel which has further increased our brand awareness and has made our product available in new markets, including those outside of North America. In fiscal 2010 we have begun to execute a new plan for growth, which includes increasing our store base, when and where we see opportunities for success. For example, we have opened 16 net new corporate-owned stores and 33 net new showrooms in North America and Australia since the second quarter of fiscal 2009, including reacquired franchises. We believe our strong cash flow generation, solid balance sheet and healthy liquidity provide us with the financial flexibility to continue executing the initiatives which we believe will benefit our company.

 

While we have committed to investment in stores, people and infrastructure enhancements and funding working capital requirements in fiscal 2010, we remain conscious of our discretionary spending. These expenditures are designed to position our business for long-term profitable growth and protect our brand integrity. We expect to continually assess the economic environment and market conditions to guide our decisions regarding our timing of investments.

Operating Segment Overview

 

lululemon is a designer and retailer of technical athletic apparel operating primarily in North America and Australia. Our yoga-inspired apparel is marketed under the lululemon athletica and ivivva athletica brand names. We offer a comprehensive line of apparel and accessories including fitness pants, shorts, tops and jackets designed for athletic pursuits such as yoga, running and general fitness, and dance-inspired apparel for female youth. As of August 1, 2010, our branded apparel was principally sold through 130 corporate-owned and franchise stores that are primarily located in Canada, the United States and Australia, and via our retail website through our direct to consumer channel. We believe our vertical retail strategy allows us to interact more directly with and gain insights from our customers while providing us with greater control of our brand. For the second quarter of fiscal 2010, approximately 53% of our net revenue was derived from sales of our products in Canada, 44% of our net revenue was derived from the sales of our products in the United States and 3% of our net revenue was derived from sales of our products outside of North America.

 

Our net revenue increased from $179.4 million in the first two quarters of fiscal 2009 to $290.5 million in the first two quarters of fiscal 2010, representing a 62% increase. Our ability to open new stores and grow sales in existing stores has been driven by increasing demand for our technical athletic apparel and a growing recognition of the lululemon athletica brand. We believe our superior products, strategic store locations, inviting store environment, grassroots marketing approach and distinctive corporate culture are responsible for our strong financial performance.

 

We have three reportable segments: corporate-owned stores, direct to consumer and other. We report our segments based on the financial information we use in managing our businesses. While we receive financial information for each corporate-owned store, we have aggregated all of the corporate-owned stores into one reportable segment due to the similarities in the economic and other characteristics of these stores. Our direct to consumer segment is an increasingly substantial part of our business, representing 7% of our net revenues in the first two quarters of fiscal 2010, 4% of our net revenue in fiscal 2009 and less than 1% of our net revenue in fiscal 2008. Expanding this sales channel is a significant part of our near-term growth strategy, and we therefore expect the revenue derived from our direct to consumer sales to comprise more than 10% of the net revenue we report in future fiscal years. Our other operations, which include franchise sales, wholesale, showrooms sales and outlet sales, accounted for less than 10% of our net revenues from continuing operations in each of the first two quarters of fiscal 2010, fiscal 2009 and fiscal 2008. We previously reported our franchise channel as an operating segment; however, opening new franchise stores is not a significant part of our near-term store growth strategy, and as such we expect net revenue from our franchise stores to continue to decrease, including as a percentage of total net revenue, in future years.

 

Results of Operations

 

Thirteen Week Results

 

The following table summarizes key components of our results of operations for the thirteen week periods ended August 1, 2010 and August 2, 2009. The operating results are expressed in dollar amounts as well as relevant percentages, presented as a percentage of net revenue.

 

 

Net Revenue

 

Net revenue increased $54.5 million, or 56%, to $152.2 million for the second quarter of fiscal 2010 from $97.7 million for the second quarter of fiscal 2009. Assuming the average exchange rate between the Canadian and United States dollars for the second quarter of fiscal 2009 remained constant, our net revenue would have increased $47.6 million, or 49%, for the second quarter of fiscal 2010.

 

The net revenue increase was driven by increased sales at locations in our comparable stores base, sales from new stores and showrooms opened, sales from franchised stores that were reacquired during the quarter and the growth of our e-commerce website sales included in our direct to consumer segment. The constant dollar increase in comparable store sales was driven primarily by the strength of our existing product lines, our successful introduction of new products and increasing recognition of the lululemon athletica brand name, especially at our U.S. stores.

 

Our net revenue on a segment basis for the thirteen week periods ended August 1, 2010 and August 2, 2009 are expressed in dollar amounts as well as relevant percentages, presented as a percentage of total net revenue below.

 

Corporate-Owned Stores.  Net revenue from our corporate-owned stores segment increased $44.4 million, or 52%, to $129.4 million in the second quarter of fiscal 2010 from $85.1 million in the second quarter of fiscal 2009. The following contributed to the $44.4 million increase in net revenue from our corporate-owned stores segment:

 

 

Direct to Consumer.  Net revenue from our direct to consumer segment increased $6.6 million, or 218%, to $9.6 million in the second quarter of fiscal 2010 from $3.0 million in the second quarter of fiscal 2009. The increase was a result of net revenue from our e-commerce website, which was launched towards the end of the first quarter of fiscal 2009. Prior to the launch of our e-commerce website, our direct to consumer segment consisted only of phone sales.

 

Other.  Net revenue from our other segment increased $3.5 million, or 37%, to $13.1 million in the second quarter of fiscal 2010 from $9.6 million in the second quarter of fiscal 2009. There were increases in net revenues across most of our operating channels included in our other segment: wholesale, showrooms and outlets. Net revenues from our franchise channel decreased due to our reacquisition of ten franchised stores in Australia and Canada. Our other segment continues to grow year over year through new showroom and outlet locations, new wholesale partners and net revenue growth at existing locations attributable to a strong product offering and brand interest. We continue to employ our other segment strategy to increase interest in our product in markets we have not otherwise entered with corporate-owned stores.

 

Gross Profit

 

Gross profit increased $35.1 million, or 78%, to $80.3 million for the second quarter of fiscal 2010 from $45.2 million for the second quarter of fiscal 2009. Increased net revenues as well as a strengthening Canadian dollar relative to the U.S. dollar improved product margin in all of our operating segments, and ultimately resulted in an increased gross profit.

 

The increase in gross profit was partially offset by increases in fixed costs, such as occupancy costs and depreciation, as well as increased costs related to our production, design, distribution and merchandising departments.

 

Gross profit as a percentage of net revenue, or gross margin, increased by 660 basis points, to 52.8% in the second quarter of fiscal 2010 from 46.2% in the second quarter of fiscal 2009. The increase in gross margin resulted primarily from:

 

 

The increases were partially offset by an increase in discounts relative to net revenue compared to discounts in the second quarter of fiscal 2009. Our other expenses including those related to our production, design, distribution and merchandising departments, remained constant relative to the increase in net revenue, and had no significant impact on gross margin.

 

Our cost of goods sold in the second quarter of fiscal 2010 and fiscal 2009 included $0.4 million and $0.2 million, respectively, of stock-based compensation.

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased $15.2 million, or 49%, to $46.1 million in the second quarter of fiscal 2010 from $30.8 million in the second quarter of fiscal 2009. The $15.2 million increase in selling, general and administrative expenses was principally comprised of:

 

 

As a percentage of net revenue, selling, general and administrative expenses decreased 140 basis points, to 30.2% in the second quarter of fiscal 2010 from 31.6% in the second quarter of fiscal 2009. This improvement was largely due to leverage associated with increased net revenues.

 

Our selling, general and administrative expenses in the second quarter of fiscal 2010 and fiscal 2009 included $1.5 million and $1.2 million, respectively, of stock-based compensation expense.

 

Income from Operations

 

Income from operations increased $19.9 million, or 139%, to $34.2 million in the second quarter of fiscal 2010 from $14.3 million in the second quarter of fiscal 2009. The increase was a result of increased gross profit of $35.1 million, partially offset by increased selling, general and administrative costs of $15.2 million. The increase in selling, general and administrative costs was primarily driven by the increase in our business, as seen in our net revenue increases.

 

On a segment basis, we determine income from operations without taking into account our general corporate expenses such as corporate employee costs, travel expenses and corporate rent. For purposes of our management’s analysis of our financial results, we have allocated some general product expenses to our corporate-owned stores segment. For example, all expenses related to our production, design, distribution and merchandising departments have been allocated to this segment.

 

Income from operations (before general corporate expenses) for the thirteen weeks ended August 1, 2010 and August 2, 2009 are expressed in dollar amounts as well as percentages, presented as a percentage of net revenue of their respective operating segments below.

 

 

Corporate-Owned Stores.  Net income from our corporate-owned stores segment increased $20.8 million, or 80%, to $44.4 million for the second quarter of fiscal 2010 from $23.5 million for the second quarter of fiscal 2009 primarily due to an increase of $32.8 million in gross profit, which was offset partially by a natural increase in selling, general and

administrative expenses related to employee costs as well as operating expenses associated with new stores and net revenue growth at existing stores.

 

Direct to Consumer.  Net income from our direct to consumer segment increased $1.6 million, or 135%, to $2.8 million for the second quarter of fiscal 2010 from $1.2 million for the second quarter of fiscal 2009. Prior to the launch of our e-commerce website, our direct to consumer segment consisted only of phone sales. The addition of our e-commerce website towards the end of the first quarter of fiscal 2009 has driven the increase in income from operations for our direct to consumer segment. Income from operations as a percentage of direct to consumer revenues decreased in the second quarter of fiscal 2010 compared to the second quarter of fiscal 2009 due to the introduction of promotional shipping.

 

Other.  Net income from our other segment increased $0.5 million, or 17%, to $3.3 million for the second quarter of fiscal 2010 from $2.8 million for the second quarter of fiscal 2009. Gross profit related to our other segment increased $0.7 million in the second quarter of fiscal 2010 from the second quarter of fiscal 2009 primarily due to a higher proportion of full margin sales channels in the current period, such as our showroom sales channel, than in the same period of last year.

 

Other Income (Expense), Net

 

Other Income (Expense), Net increased $2.1 million, or 9144%, to $2.1 million in the second quarter of fiscal 2010 from $0.1 million in the second quarter of fiscal 2009. The increase was primarily a result of re-measuring our 13 percent non-controlling equity investment in Australia immediately before obtaining control of the same business.

 

Provision for Income Taxes

 

Provision for income taxes increased $9.5 million, or 186%, to $14.6 million in the second quarter of fiscal 2010 from $5.1 million in the second quarter of fiscal 2009. In the second quarter of fiscal 2010, our effective tax rate was 40.3% compared to 35.6% in the second quarter of fiscal 2009. The increase in the effective tax rate was primarily a result of recording a deferred tax liability of $3.1 million in the second quarter of fiscal 2010 for estimated future income taxes and foreign withholding taxes attributable to the undistributed earnings of Canadian subsidiaries which are in excess of our reinvestment plans for those subsidiaries.

 

Net Income

 

Net income increased $12.5 million to $21.7 million for the second quarter of fiscal 2010 from $9.2 million for the second quarter of fiscal 2009. The increase in net income of $12.5 million for the second quarter of fiscal 2010 was a result of an increase in gross profit of $35.1 million resulting from decreased product costs, including improved foreign exchange differences, and an increase in Other Income (Expense), Net of $2.1 million, offset by increases in selling, general and administrative expenses of $15.2 million and an increase of $9.5 million in provision for income taxes.

Twenty-Six Week Results

 

The following table summarizes key components of our results of operations for the twenty-six week periods ended August 1, 2010 and August 2, 2009. The operating results are expressed in dollar amounts as well as relevant percentages, presented as a percentage of net revenue.

 

 

Net Revenue

 

Net revenue increased $111.1 million, or 62%, to $290.5 million for the first two quarters of fiscal 2010 from $179.4 million for the first two quarters of fiscal 2009. Assuming the average exchange rate between the Canadian and United States dollars for the first two quarters of fiscal 2009 remained constant, our net revenue would have increased $90.7 million, or 51%, for the first two quarters of fiscal 2010.

 

The net revenue increase was driven by increased sales at locations in our comparable stores base, sales from new stores opened, sales from franchised stores that were reacquired during the second quarter and the growth of our e-commerce website sales included in our direct to consumer segment. The constant dollar increase in comparable store sales was driven primarily by the strength of our existing product lines, our successful introduction of new products and increasing recognition of the lululemon athletica brand name, especially at our U.S. stores.

 

Our net revenue on a segment basis for the twenty-six week periods ended August 1, 2010 and August 2, 2009 are expressed in dollar amounts as well as relevant percentages, presented as a percentage of total net revenue below.

 

 

Corporate-Owned Stores.  Net revenue from our corporate-owned stores segment increased $87.0 million, or 55%, to $245.0 million in the first two quarters of fiscal 2010 from $158.0 million in the first two quarters of fiscal 2009. The following contributed to the $87.0 million increase in net revenue from our corporate-owned stores segment:

 

 

 

The increase was partially offset by a decrease in net revenue related to gift card breakage. In the first quarter of fiscal 2009 we recorded a one-time credit of $1.3 million related to a change in our estimated rate of redemption.

 

Direct to consumer.  Net revenue from our direct to consumer segment increased $14.9 million, or 382%, to $18.8 million in the first two quarters of fiscal 2010 from $3.9 million in the first two quarters of fiscal 2009. The increase was a result of net revenue from our e-commerce website, which was launched towards the end of the first quarter of fiscal 2009. Prior to the launch of our e-commerce website, our direct to consumer segment consisted only of phone sales.

 

Other.  Net revenue from our other segment increased $9.2 million, or 53%, to $26.7 million in the first two quarters of fiscal 2010 from $17.5 million in the first two quarters of fiscal 2009. There were increases in net revenues across all operating channels included in our other segment: franchises, wholesale, showrooms and outlets. Net revenues from our other segment continues to grow year over year through new showroom and outlet locations, new wholesale partners and net revenue growth at existing locations attributable to a strong product offering and brand interest. We continue to employ our other segment strategy to increase interest in our product in markets we have not otherwise entered with corporate-owned stores.

 

Gross Profit

 

Gross profit increased $74.5 million, or 93%, to $154.7 million for the first two quarters of fiscal 2010 from $80.2 million for the first two quarters of fiscal 2009. Increased net revenues as well as a strengthening Canadian dollar relative to the U.S. dollar improved product margin in all of our operating segments, and ultimately resulted in an increased gross profit.

 

The increase in gross profit was partially offset by increases in fixed costs, such as occupancy costs and depreciation, as well as increased costs related to our production, design, distribution and merchandising departments.

 

Gross profit as a percentage of net revenue, or gross margin, increased by 850 basis points, to 53.2% in the first two quarters of fiscal 2010 from 44.7% in the first two quarters of fiscal 2009. The increase in gross margin resulted primarily from:

 

 

The increases were partially offset by an increase in discounts relative to net revenue compared to discounts in the first two quarters of fiscal 2009. Our other expenses including those related to our production, design, distribution and merchandising departments, remained constant relative to the increase in net revenue, and had no significant impact on gross margin.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased $31.9 million, or 57%, to $87.9 million in the first two quarters of fiscal 2010 from $56.0 million in the first two quarters of fiscal 2009. The $31.9 million increase in selling, general and administrative expenses was principally comprised of:

 

 

 

As a percentage of net revenue, selling, general and administrative expenses decreased 90 basis points, to 30.3% in the second quarter of fiscal 2010 from 31.2% in the second quarter of fiscal 2009. The improvement was largely due to leverage associated with increased net revenues.

 

Our selling, general and administrative expenses in the first two quarters of fiscal 2010 and fiscal 2009 included $2.8 million and $2.4 million, respectively, of stock-based compensation expense.

 

Income from Operations

 

Income from operations increased $42.5 million, or 176%, to $66.7 million in the first two quarters of fiscal 2010 from $24.2 million in the first two quarters of fiscal 2009. The increase was a result of increased gross profit of $74.5 million, partially offset by increased selling, general and administrative costs of $31.9 million. The increase in selling, general and administrative costs was primarily driven by the increase in our business, as seen in our net revenue increases.

 

On a segment basis, we determine income from operations without taking into account our general corporate expenses such as corporate employee costs, travel expenses and corporate rent. For purposes of our management’s analysis of our financial results, we have allocated some general product expenses to our corporate-owned stores segment. For example, all expenses related to our production, design, distribution and merchandising departments have been allocated to this segment.

 

Income from operations (before general corporate expenses) for the twenty-six week periods ended August 1, 2010 and August 2, 2009 are expressed in dollar amounts as well as percentages, presented as a percentage of net revenue of their respective operating segments below.

 

 

Corporate-Owned Stores.  Net income from our corporate-owned stores segment increased $42.6 million, or 102%, to $84.3 million for the first two quarters of fiscal 2010 from $41.6 million for the first two quarters of fiscal 2009 primarily due to an increase of $63.8 million in gross profit, which was offset partially by a natural increase in selling, general and administrative expenses related to employee costs as well as operating expenses associated with new stores and net revenue growth at existing stores.

Direct to consumer.  Net income from our direct to consumer segment increased $4.5 million, or 289%, to $6.1 million for the first two quarters of fiscal 2010 from $1.6 million for the first two quarters of fiscal 2009. Prior to the launch of our e-commerce website, our direct to consumer segment consisted only of phone sales. The addition of our e-commerce website towards the end of the first quarter of fiscal 2009 has driven the increase in income from operations for our direct to consumer segment. Income from operations as a percentage of direct to consumer revenues decreased in the first two quarters of fiscal 2010 compared to the first two quarters of fiscal 2009 due to the introduction of promotional shipping.

 

Other.  Net income from our other segment increased $3.9 million, or 101%, to $7.7 million for the first two quarters of fiscal 2010 from $3.8 million for the first two quarters of fiscal 2009. Gross profit related to our other segment increased in the first two quarters of fiscal 2010 from the first two quarters of fiscal 2009 primarily due to a higher proportion of full margin sales channels in the current period, such as our showroom sales channel, than in the same period of last year. There was an increase in selling, general and administrative expenses as a result of opening and operating an increased number of showrooms in the first two quarters of fiscal 2010 compared to the first two quarters of fiscal 2009, which offset a portion of the gross profit increase.

 

Other Income (Expense), Net

 

Other Income (Expense), Net increased $2.2 million, or 2132%, to $2.3 million in the first two quarters of fiscal 2010 from $0.1 million in the first two quarters of fiscal 2009. The increase was primarily a result of re-measuring our 13 percent non-controlling equity investment in Australia immediately before obtaining control of the same business.

 

Provision for Income Taxes

 

Provision for income taxes increased $19.2 million, or 225%, to $27.7 million in the first two quarters of fiscal 2010 from $8.5 million in the first two quarters of fiscal 2009. In the first two quarters of fiscal 2010, our effective tax rate was 40.1% compared to 35.1% in the first two quarters of fiscal 2009. The increase in the effective tax rate was primarily a result of recording a deferred tax liability of $5.2 million in the first two quarters of fiscal 2010 for estimated future income taxes and foreign withholding taxes attributable to the undistributed earnings of Canadian subsidiaries which are in excess of our reinvestment plans for those subsidiaries.

 

Net Income

 

Net income increased $25.5 million to $41.3 million for the first two quarters of fiscal 2010 from $15.8 million for the first two quarters of fiscal 2009. The increase in net income of $25.5 million for the first two quarters of fiscal 2010 was a result of an increase in gross profit of $74.5 million resulting from decreased product costs, including improved foreign exchange differences, and an increase in Other Income (Expense), Net of $2.2 million, offset by increases in selling, general and administrative expenses of $31.9 million and an increase of $19.2 million in provision for income taxes.

 

Seasonality

 

Historically, we have recognized a significant portion of our income from operations in the fourth fiscal quarter of each year as a result of increased sales during the holiday selling season. Despite the fact that we have experienced a significant amount of our net revenue and gross profit in the fourth quarter of each fiscal year, we believe that the true extent of the seasonality or cyclical nature of our business may have been overshadowed by our rapid growth to date.

 

Liquidity and Capital Resources

 

Our primary sources of liquidity are our current balances of cash and cash equivalents, cash flows from operations and borrowings available under our revolving credit facility. Our primary cash needs are capital expenditures for opening new stores and remodeling existing stores, making information technology system enhancements and funding working capital requirements. Cash and cash equivalents in excess of our needs are held in interest bearing accounts with financial institutions.

 

At August 1, 2010, our working capital (excluding cash and cash equivalents) was $34.2 million and our cash and cash equivalents were $178.2 million.

The following table summarizes our net cash flows provided by and used in operating, investing and financing activities for the periods indicated:

 

 

Operating Activities

 

Operating Activities consist primarily of net income adjusted for certain non-cash items, including depreciation and amortization, deferred income taxes, stock-based compensation expense and the effect of the changes in non-cash working capital items, principally accounts receivable, inventories, accounts payable and accrued expenses.

 

Cash provided by operating activities increased $6.0 million, to $34.7 million for the first two quarters of fiscal 2010 compared to $28.7 million for the first two quarters of fiscal 2009. The $6.0 million increase was primarily a result of an increase in net income from operations due to improvement in store productivity, an increase in our store base, and a net decrease in the change in other working capital balances.

 

Investing Activities

 

Investing Activities relate entirely to capital expenditures, advances to and investments in franchises and reacquisition of franchises.

 

Cash used in investing activities increased $17.8 million, to $24.1 million for the first two quarters of fiscal 2010 from $6.3 million for the first two quarters of fiscal 2009. The $17.8 million increase was a result of our reacquisition of franchised stores in Australia and Saskatoon, Saskatchewan as well as increased corporate-owned store openings. In the first two quarters of fiscal 2010 we opened six new corporate-owned stores compared to three new corporate-owned stores we opened in the first two quarters of fiscal 2009.