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 6, 2011, there were 108,803,942 shares of the registrant’s common stock, par value $0.005 per share, outstanding.

 

Exchangeable and Special Voting Shares:

 

At September 6, 2011, there were outstanding 34,524,680 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 6, 2011, the registrant had outstanding 34,524,680 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

 

 

See accompanying notes to the interim consolidated financial statements

lululemon athletica inc. and Subsidiaries

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See accompanying notes to the interim consolidated financial statements

lululemon athletica inc. and Subsidiaries

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

 

See accompanying notes to the interim consolidated financial statements

lululemon athletica inc. and Subsidiaries


CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

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, 89 and 13 corporate-owned stores were in operation as at July 31, 2011, respectively. There were 147 and 133 corporate-owned stores in operation as of July 31, 2011 and January 30, 2011, respectively.

 

Basis of presentation

 

The unaudited interim consolidated financial statements as of July 31, 2011 and for the twenty-six weeks ended July 31, 2011 and August 1, 2010 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 30, 2011 is derived from the Company’s audited consolidated financial statements and notes for the fiscal year ended January 30, 2011, included in Item 8 in the fiscal 2010 Annual Report on Form 10-K filed with the SEC on March 17, 2011. 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 2010 Annual Report on Form 10-K.

 

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 2011 will end on January 29, 2012.

 

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.

 

 

Property and equipment

 

Property and equipment are recorded at cost less accumulated depreciation. Direct internal and external costs related to software used for internal purposes which are incurred during the application development stage or for upgrades that add functionality are capitalized. All other costs related to internal use software are expensed as incurred.

 

Buildings are amortized on a straight-line basis over the expected useful life of the asset. Leasehold improvements are amortized on a straight-line basis over the lesser of the length of the lease, without consideration of option renewal periods, and the estimated useful life of the assets, to a maximum of five years. All other property and equipment are amortized using the declining balance method as follows. Amortization commences when an asset is ready for its intended use.

 

lululemon athletica inc. and Subsidiaries

 

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

 

Recent accounting pronouncements

 

In April 2010, the Financial Accounting Standards Board (“FASB”) amended Accounting Standards Codification (“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 adopted the amendment in the first quarter of fiscal 2011 with no material impact on the Company’s consolidated financial statements.

 

In May 2011, the FASB amended ASC Topic 820 Fair Value Measurement (“ASC 820”) to clarify requirements for how to measure fair value and for disclosing information about fair value measurements common to US GAAP and International Financial Reporting Standards. This guidance is effective for interim and annual periods beginning on or after December 15, 2011. The Company will adopt the amendment in the first quarter of fiscal 2012 and expects no material impact on the Company’s consolidated financial statements.

 

In June 2011, the FASB amended ASC 820 to require (i) that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements, and (ii) presentation of reclassification adjustments from other comprehensive income (“OCI”) to net income on the face of the financial statements. This guidance eliminates the option to present the components of OCI as part of the statement of changes in stockholders’ equity, but does not change the items that must be reported in OCI or when an item of OCI must be reclassified to net income. This guidance is effective for years, and interim periods within those years, beginning after December 15, 2011. The Company will adopt the amendment in fiscal 2012 and expects no material impact on the Company’s consolidated financial statements.

 

 

On June 8, 2011 the Company’s stockholders approved a two-for-one stock split (“the Stock Split”) of the Company’s common stock and an increase in the Company’s authorized common stock from 200,000 shares to 400,000 shares. Shares of the Company’s common stock traded on a post-split basis on July 12, 2011 on the Nasdaq Stock Market and July 6, 2011 on the Toronto Stock Exchange. In connection with the Stock Split, the stockholders also approved a two-for-one split of the Company’s exchangeable special voting stock and an increase in the Company’s authorized exchangeable special voting stock from 30,000 to 60,000.

 

 

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 $5,066 and $3,563 for the twenty-six weeks ended July 31, 2011 and August 1, 2010, respectively. Total unrecognized compensation cost as at July 31, 2011 was $22,323 for all stock award plans, which is expected to be recognized over a weighted-average period of 2.5 years.

lululemon athletica inc. and Subsidiaries

 

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

 

Company stock options and performance stock units

 

A summary of the Company’s stock option, performance stock unit and restricted share activity as of July 31, 2011 and changes during the twenty-six week period then ended is presented on a post-split basis 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 that the performance goal will be achieved.

 

Stockholder- sponsored stock options

 

During the thirteen weeks ended July 31, 2011, holders of exchangeable shares converted 491 exchangeable shares into 491 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 July 31, 2011, there were no grants or forfeitures related to 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 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 6,000 shares. During the thirteen weeks ended July 31, 2011, there were 15 shares purchased under the ESPP, which were funded by the Company through open market purchases.

lululemon athletica inc. and Subsidiaries

 

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

 

 

Following with the Stock Split, the Company retroactively adjusted EPS for the thirteen and twenty-six week periods ended July 31, 2011 and August 1, 2010 in accordance with ASC topic 260, Earnings Per Share (“ASC 260”). 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. Weighted-average shares for the thirteen and twenty-six weeks ended August 1, 2010 have been calculated as if the Stock Split was in effect at February 1, 2010. 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 July 31, 2011 and August 1, 2010, 31 and 128 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. 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. The Company has reviewed its general corporate expenses and determined some costs previously classified as general corporate are direct segment expenses. Accordingly, all prior year comparable information has been reclassified to conform to the current year classification. 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 2011 will end on January 29, 2012.

 

Overview

 

Our results for the first two quarters of fiscal 2011 demonstrate the ongoing success of our efforts to execute our strategic plan. We remain committed to investing in our stores and our people, making infrastructure enhancements and funding working capital requirements, while remaining conscious of our discretionary spending. We continually assess the economic environment and market conditions when making decisions regarding our expansion investments. 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 be beneficial for the Company.

 

We believe that our brand is recognized as premium in our offerings of yoga and run assortment, as well as a leader in technical fabrics and quality construction. This has made our product desirable to our consumers and has driven demand, and resulted in top-line growth. We experienced strong sell through of our merchandise which minimized markdowns and discounts, driving a strong gross margin in the first two quarters of fiscal 2011.

 

We saw continuing increases in traffic and conversion rates on our e-commerce website in fiscal 2010, which led us to believe that there is potential for our direct to consumer segment to become an increasingly substantial part of our business. We committed a portion of our resources to further developing this channel, making infrastructure changes in the first half of fiscal 2011 which included bringing the operations in-house and updating the operating platform. Investments in the infrastructure will continue through the remainder of the fiscal year as we see our e-commerce website as an opportunity to increase our brand awareness in international markets.

In the first half of fiscal 2011, we opened 12 new corporate-owned stores in North America and two new corporate-owned stores in Australia. In March 2011, we purchased the building that housed our administrative offices. We also invested in our people, which included wage increases to employees in our corporate-owned stores and other channels.

 

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 technical clothing for active female youth. As of July 31, 2011, our branded apparel was principally sold through 151 corporate-owned and franchise stores that are primarily located in Canada, the United States and Australia, and via our e-commerce 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 2011, approximately 45% of our net revenue was derived from sales of our products in Canada, 51% of our net revenue was derived from the sales of our products in the United States, and the remaining 4% of our net revenue was derived from sales of our products outside of North America.

 

Our net revenue has grown from $40.7 million in fiscal 2004 to $711.7 million in fiscal 2010. This represents a compound annual growth rate of 61%. Our net revenue also increased from $152.2 million in the second quarter of fiscal 2010 to $212.3 million in the second quarter of fiscal 2011, representing a 39% increase. Our increase in net revenue from fiscal 2004 to fiscal 2010 resulted from comparable store sales growth as high as 37%, which we realized in fiscal 2010, and from the addition of retail locations, including:

 

 

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, 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. Expanding our direct to consumer 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, each accounted for less than 10% of our net revenues from continuing operations in each of the first and second quarter of fiscal 2011, and fiscal 2010.

Results of Operations

 

Thirteen Week Results

 

The following table summarizes key components of our results of operations for the thirteen week periods ended July 31, 2011 and August 1, 2010. 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 $60.1 million, or 39%, to $212.3 million for the second quarter of fiscal 2011 from $152.2 million for the second quarter of fiscal 2010. Assuming the average exchange rate between the Canadian and United States dollars and the Australian and United States dollars for the second quarter of fiscal 2010 remained constant, our net revenue would have increased $51.8 million, or 34%, for the second quarter of fiscal 2011.

 

The net revenue increase was driven by increased sales at locations in our comparable stores base, sales from new stores opened 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, 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 July 31, 2011 and August 1, 2010 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 $48.8 million, or 38%, to $178.2 million in the second quarter of fiscal 2011 from $129.4 million in the second quarter of fiscal 2010. The following contributed to the increase in net revenue from our corporate-owned stores segment:

 

 

Direct to Consumer.  Net revenue from our direct to consumer segment increased $9.0 million, or 93%, to $18.6 million in the second quarter of fiscal 2011 from $9.6 million in the second quarter of fiscal 2010. The increase in net revenue was the result of increased traffic to our e-commerce website, as well as higher conversion rates and average order value.

 

Other.  Net revenue from our other segment increased $2.4 million, or 18%, to $15.5 million in the second quarter of fiscal 2011 from $13.1 million in the second quarter of fiscal 2010. This increase was a result of increased net revenues from strategic sales, showrooms and outlets, partially offset by decreased net revenues from our franchise operating channel. Our other segment continues to grow year over year through new showroom locations, new wholesale customers 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 $41.8 million, or 52%, to $122.1 million for the second quarter of fiscal 2011 from $80.3 million for the second quarter of fiscal 2010. 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 design, merchandising, and production departments.

 

Gross profit as a percentage of net revenue, or gross margin, increased by 470 basis points, to 57.5% in the second quarter of fiscal 2011 from 52.8% in the second quarter of fiscal 2010. The increase in gross margin resulted primarily from:

 

 

Our cost of goods sold in the second quarter of fiscal 2011 and fiscal 2010 included $0.4 million and $0.4 million, respectively, of stock-based compensation.

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased $16.5 million, or 36%, to $62.6 million in the second quarter of fiscal 2011 from $46.1 million in the second quarter of fiscal 2010. The $16.5 million increase in selling, general and administrative expenses was principally comprised of:

 

 

The increase in selling, general and administrative expenses was partially offset by a decrease in administrative costs related to our direct to consumer segment of $1.4 million. This decrease was primarily associated with reduced professional fees resulting from bringing our e-commerce operations in-house.

 

As a percentage of net revenue, selling, general and administrative expenses decreased 80 basis points, to 29.5% in the second quarter of fiscal 2011 from 30.3% in the second quarter of fiscal 2010. The decrease in selling, general and administrative expenses as a percentage of net revenue was mainly due to the decreased administrative costs related to our direct to consumer segment.

 

Our selling, general and administrative expenses in the second quarter of fiscal 2011 and fiscal 2010 included $1.9 million and $1.5 million, respectively, of stock-based compensation expense.

 

Income from Operations

 

Income from operations increased $25.2 million, or 74%, to $59.5 million in the second quarter of fiscal 2011 from $34.2 million in the second quarter of fiscal 2010. The increase was a result of increased gross profit of $41.8 million, partially offset by increased selling, general and administrative costs of $16.5 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. We have reviewed our general corporate expenses and determined some costs previously classified as general corporate are direct segment expenses. Accordingly, all prior year comparable information has been reclassified to conform to the current year classification.

 

Income from operations (before general corporate expenses) for the thirteen weeks ended July 31, 2011 and August 1, 2010 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.  Income from operations from our corporate-owned stores segment increased $21.9 million, or 52%, to $64.3 million for the second quarter of fiscal 2011 from $42.4 million for the second quarter of fiscal 2010 primarily due to an increase of $33.6 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.  Income from operations from our direct to consumer segment increased $6.2 million, or 310%, to $8.2 million for the second quarter of fiscal 2011 from $2.0 million for the second quarter of fiscal 2010. This increase was primarily the result of increased sales through our e-commerce website.

 

Other.  Income from operations from our other segment increased $1.6 million, or 52%, to $4.7 million for the second quarter of fiscal 2011 from $3.1 million for the second quarter of fiscal 2010. Gross profit related to our other segment increased $2.1 million in the second quarter of fiscal 2011 from the second quarter of fiscal 2010. This increase was a result of increased income from strategic sales, showrooms and outlets, partially offset by decreased income from our franchise operating channel. Our other segment continues to grow year over year through new showroom locations, new wholesale customers 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.

 

Other Income (Expense), Net

 

Other income (expense), net decreased $1.5 million, or 71%, to $0.6 million in the second quarter of fiscal 2011 from $2.1 million in the second quarter of fiscal 2010. The decrease was primarily a result of a gain being recorded in fiscal 2010 as 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 $6.8 million, or 46.7%, to $21.5 million in the second quarter of fiscal 2011 from $14.6 million in the second quarter of fiscal 2010. In the second quarter of fiscal 2011, our effective tax rate was 35.7% compared to 40.3% in the second quarter of fiscal 2010. The decrease resulted from a revision to management’s plans for repatriation of unremitted earnings of the Canadian operating subsidiary.

 

Net Income

 

Net income increased $16.6 million to $38.4 million for the second quarter of fiscal 2011 from $21.8 million for the second quarter of fiscal 2010. The increase in net income of $16.6 million for the second quarter of fiscal 2011 was a result of an increase in gross profit of $41.8 million resulting from increased product sales and improved foreign exchange differences, offset by an increase in selling, general and administrative expenses of $16.5 million, an increase in provision for income taxes of $6.8 million, and a decrease in Other Income (Expense), Net of $1.5 million.

Twenty-Six Week Results

 

The following table summarizes key components of our results of operations for the twenty-six week periods ended July 31, 2011 and August 1, 2010. 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 $108.6 million, or 37%, to $399.1 million for the first two quarters of fiscal 2011 from $290.5 million for the first two quarters of fiscal 2010. Assuming the average exchange rate between the Canadian and United States dollars and the Australian and United States dollars for the first two quarters of fiscal 2010 remained constant, our net revenue would have increased $95.9 million, or 33%, for the first two quarters of fiscal 2011.

 

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 of fiscal 2010 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 July 31, 2011 and August 1, 2010 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 $89.7 million, or 37%, to $334.7 million in the first two quarters of fiscal 2011 from $245.0 million in the first two quarters of fiscal

2010. The following contributed to the $89.7 million increase in net revenue from our corporate-owned stores segment:

 

 

Direct to consumer.  Net revenue from our direct to consumer segment increased $13.6 million, or 72%, to $32.4 million in the first two quarters of fiscal 2011 from $18.8 million in the first two quarters of fiscal 2010. The increase in net revenue was primarily the result of increased traffic at our e-commerce website.

 

Other.  Net revenue from our other segment increased $5.3 million, or 20%, to $32.0 million in the first two quarters of fiscal 2011 from $26.7 million in the first two quarters of fiscal 2010. This increase was a result of increased net revenues from strategic sales, showrooms and outlets, partially offset by decreased net revenues from our franchise operating channel. Our other segment continues to grow year over year through new showroom locations, new wholesale customers 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 $77.1 million, or 50%, to $231.8 million for the first two quarters of fiscal 2011 from $154.7 million for the first two quarters of fiscal 2010. 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 490 basis points, to 58.1% in the first two quarters of fiscal 2011 from 53.2% in the first two quarters of fiscal 2010. The increase in gross margin resulted primarily from:

 

 

Our cost of goods sold in the first two quarters of fiscal 2011 and fiscal 2010 included $1.2 million and $0.7 million, respectively, of stock-based compensation.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased $32.6 million, or 37%, to $120.6 million in the first two quarters of fiscal 2011 from $87.9 million in the first two quarters of fiscal 2010. The $32.6 million increase in selling, general and administrative expenses was principally comprised of:

 

 

The increase in selling, general and administrative expenses was partially offset by a $0.5 million decrease in administrative expenses related to our direct to consumer segment. This decrease was primarily associated of reduced professional fees resulting from bringing our e-commerce operations in-house, offset by costs associated with our infrastructure changes.

 

As a percentage of net revenue, selling, general and administrative expenses decreased 10 basis points, to 30.2% in the second quarter of fiscal 2011 from 30.3% in the second quarter of fiscal 2010.

 

Our selling, general and administrative expenses in the first two quarters of fiscal 2011 and fiscal 2010 included $3.9 million and $2.8 million, respectively, of stock-based compensation expense.

 

Income from Operations

 

Income from operations increased $44.5 million, or 67%, to $111.2 million in the first two quarters of fiscal 2011 from $66.7 million in the first two quarters of fiscal 2010. The increase was a result of increased gross profit of $77.1 million, partially offset by increased selling, general and administrative costs of $32.6 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. We have reviewed our general corporate expenses and determined some costs previously classified as general corporate are direct segment expenses. Accordingly, all prior year comparable information has been reclassified to conform to the current year classification.

 

Income from operations (before general corporate expenses) for the twenty-six week periods ended July 31, 2011 and August 1, 2010 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 $42.7 million, or 53%, to $123.6 million for the first two quarters of fiscal 2011 from $80.9 million for the first two quarters of fiscal 2010 primarily due to an increase of $63.1 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 $7.8 million, or 170%, to $12.4 million for the first two quarters of fiscal 2011 from $4.6 million for the first two quarters of fiscal 2010. The increase in net revenue was primarily the result of increased traffic at our e-commerce website.

 

Other.  Net income from our other segment increased $2.5 million, or 35%, to $9.7 million for the first two quarters of fiscal 2011 from $7.2 million for the first two quarters of fiscal 2010. This increase was a result of increased income from strategic sales, showrooms and outlets, partially offset by decreased income from our franchise operating channel. Our other segment continues to grow year over year through new showroom locations, new wholesale customers 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.

 

Other Income (Expense), Net

 

Other income (expense), net decreased $0.8 million, or 33%, to $1.5 million in the first two quarters of fiscal 2011 from $2.3 million in the first two quarters of fiscal 2010. The decrease was primarily a result of a gain being recorded in fiscal 2010 as 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 $12.9 million, or 47%, to $40.5 million in the first two quarters of fiscal 2011 from $27.7 million in the first two quarters of fiscal 2010. In the first two quarters of fiscal 2011, our effective tax rate was 36.0% compared to 40.1% in the first two quarters of fiscal 2010. The decrease resulted from a revision to managements’ plans for repatriation of unremitted earnings of the Canadian operating subsidiary.

 

Net Income

 

Net income increased $30.4 million to $71.8 million for the first two quarters of fiscal 2011 from $41.4 million for the first two quarters of fiscal 2010. The increase in net income of $71.8 million for the first two quarters of fiscal 2011 was a result of an increase in gross profit of $77.1 million resulting from increased sales and improved foreign exchange differences, offset by an increase in selling, general and administrative expenses of $32.6 million, an increase of $12.9 million in provision for income taxes, and a decrease in other income (expense), net of $0.8 million.

 

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 July 31, 2011, our working capital (excluding cash and cash equivalents) was a deficit of $54.2 million and our cash and cash equivalents were $264.7 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 decreased $15.1 million, to $19.5 million for the first two quarters of fiscal 2011 compared to $34.6 million for the first two quarters of fiscal 2010. The $15.1 million decrease was primarily a result of increased inventory purchases and higher income taxes paid in the first two quarters of fiscal 2011 compared to fiscal 2010.

 

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 $63.2 million, to $87.3 million for the first two quarters of fiscal 2011 from $24.1 million for the first two quarters of fiscal 2010. The $63.2 million increase was primarily the result of the purchase of our principal executive and administrative offices for $65.1 million plus acquisition-related costs. In the first two quarters of fiscal 2011 we opened 14 new corporate-owned stores compared to six new corporate-owned stores we opened in the first two quarters of fiscal 2010.

 

Financing Activities

 

Financing Activities consist primarily of cash received on the exercise of stock options and excess tax benefits from stock-based compensation. Cash provided by financing activities increased to $12.1 million for the first two quarters of fiscal 2011 from $6.1 million for the first two quarters of fiscal 2010.

 

We believe that our cash from operations and borrowings available to us under our revolving credit facility will be adequate to meet our liquidity needs and capital expenditure requirements for at least the next 24 months. Our cash from operations may be negatively impacted by a decrease in demand for our products as well as the other factors described in “Risk Factors” and elsewhere in this report. In addition, we may make discretionary capital improvements with respect to our stores, distribution facility, headquarters, or other systems, which we would expect to fund through the issuance of debt or equity securities or other external financing sources to the extent we were unable to fund such capital expenditures out of our cash from operations.

Revolving Credit Facility

 

In April 2007, we executed a credit facility with the Royal Bank of Canada that provided for a CDN$20.0 million uncommitted demand revolving credit facility to fund our working capital requirements. This agreement canceled our previous CDN$8.0 million credit facility. Borrowings under this uncommitted credit facility are made on a when-and-as-needed basis at our discretion.

 

Borrowings under the credit facility can be made either as i) Revolving Loans — Revolving loan borrowings will bear interest at a rate equal to the bank’s CA$ or US$ annual base rate (defined as zero% plus the lender’s annual prime rate) per annum, ii) Offshore Loans — Offshore rate loan borrowings will bear interest at a rate equal to a base rate based upon LIBOR for the applicable interest period, plus 1.125% per annum, iii) Bankers Acceptances — Bankers acceptance borrowings will bear interest at the bankers acceptance rate plus 1.125% per annum, or iv) Letters of Credit and Letters of Guarantee — Borrowings drawn down under letters of credit or guarantee issued by the banks will bear a 1.125% per annum fee.

 

At July 31, 2011, aside from letters of credit and guarantees, there were no borrowings outstanding under this credit facility.

 

Off-Balance Sheet Arrangements

 

We enter into documentary letters of credit to facilitate the international purchase of merchandise. We also enter into standby letters of credit to secure certain of our obligations, including insurance programs and duties related to import purchases. As of July 31, 2011, letters of credit and letters of guarantee totaling $1.5 million have been issued.

 

Other than these standby letters of credit and guarantee, we do not have any off-balance sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt. In addition, we have not entered into any derivative contracts or synthetic leases.

 

Critical Accounting Policies

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. Predicting future events is inherently an imprecise activity and, as such, requires the use of judgment. Actual results may vary from estimates in amounts that may be material to the financial statements. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact our consolidated financial statements. Our critical accounting policies and estimates are discussed in our Annual Report on Form 10-K for our 2010 fiscal year end filed with the SEC on March 17, 2011 and in Note 2 included in Item 1 of Part I of this Quarterly Report on Form 10-Q.

Operating Locations

 

Our operating locations by Canadian province, U.S. state and internationally as of July 31, 2011, and the overall totals as of July 31, 2011 and January 30, 2011, are summarized in the table below. While most of our stores are branded lululemon athletica, 3 of our corporate-owned stores are branded ivivva athletica and specialize in dance-inspired apparel for female youth.