lululemon athletica - 10-Q quarterly report FY

 

 

 

 

See accompanying notes to the interim consolidated financial statements

 

 

See accompanying notes to the interim consolidated financial statements

 

 

See accompanying notes to the interim consolidated financial statements

 

 

See accompanying notes to the interim consolidated financial statements

 

 

 

 

lululemon athletica inc., a Delaware corporation (“lululemon”, 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 consumers through oure-commercesales channel, through independent franchises and through a network of wholesale accounts. At November 1, 2009 the Company’s primary markets were Canada and the United States where 41 and 65 corporate-owned stores were in operation, respectively. Additionally, at November 1, 2009, there were 8 franchised stores in operation in Australia. There were 106 and 103 corporate-owned stores in operation as of November 1, 2009 and February 1, 2009 respectively.

 

The unaudited interim consolidated financial statements as of November 1, 2009 and for the thirty-nine week periods ended November 1, 2009 and November 2, 2008 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, does not include all of the information and footnotes required by GAAP for complete financial statements. The financial information as of February 1, 2009 is derived from the Company’s audited consolidated financial statements and notes for the fiscal year ended February 1, 2009, included in Item 8 in the fiscal 2008 Annual Report onForm 10-K.These unaudited interim consolidated financial statements reflect all adjustments which in the opinion of management are necessary to provide 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 2008 Annual Report onForm 10-Kfiled with the SEC on March 27, 2009.

 

The Company’s fiscal year ends on the Sunday closest to January 31st of the following year. This typically results in a fifty-two week year, but occasionally gives rise to an additional week, resulting in a fifty-three week year.

 

Our 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.

 

 

Revenues from the Company’s gift cards are recognized when tendered for payment, or upon redemption. Outstanding customer balances are included in “Unredeemed gift card liability” on the consolidated balance sheets. There are no expiration dates on the Company’s gift cards, and lululemon does not charge any service fees that cause a decrement to customer balances.

 

While the Company will continue to honor all gift cards presented for payment, management may determine the likelihood of redemption to be remote for certain card balances due to, among other things, long periods of inactivity. In these circumstances, to the extent management determines there is no requirement for remitting card balances to government agencies under unclaimed property laws, card balances may be recognized in the consolidated statements of operations in “Net revenue.” For the thirteen and thirty-nine weeks ended November 1, 2009, net revenue recognized on unredeemed gift card balances was $230 and $1,886, respectively. There was no net revenue recognized on unredeemed gift card balances during the year ended February 1, 2009.

 

 

 

 

The Company follows the liability method with respect to accounting for income taxes. Deferred tax assets and liabilities are determined based on temporary differences between the carrying amounts and the tax basis of assets and liabilities. Deferred income tax assets and liabilities are measured using enacted tax rates that will be in effect when these differences are expected to reverse, except for the amount of earnings related to our foreign operations where repatriation is not contemplated in the foreseeable future. Deferred income tax assets are reduced by a valuation allowance, if based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

The recognition of a deferred income tax asset is based primarily on management’s forecasts, including current and proposed tax legislation, current and anticipated taxable income, utilization of previously unrealized non-operating loss carryforwards and regulatory reviews of tax filings. Given judgments and estimates required and the sensitivity of the results to the significant assumptions used, the accounting estimates used in relation to the recognition of deferred income tax assets are subject to measurement uncertainty and are susceptible to a material change if the underlying assumptions change.

 

We file income tax returns in the United States, Canada and various foreign and state jurisdictions. We are subject to income tax examination by tax authorities in all such jurisdictions from our inception to date. Our policy is to recognize interest expense and penalties related to income tax matters as tax expense. At February 1, 2009, we did not have any significant accruals for interest related to unrecognized tax benefits or tax penalties. Our intercompany transfer pricing policies will be subject to audits by various foreign tax jurisdictions. Although we believe that our intercompany transfer pricing policies and tax positions are reasonable, the final determination of tax audits or potential tax disputes may be materially different from that which is reflected in our income tax provisions and accruals.

 

United States income taxes and foreign withholding taxes are not provided 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 $89,369 at November 1, 2009.

 

During the second quarter of fiscal 2009, an adjustment was made to deferred tax assets and additional paid-in capital in the amount of $12,024 relating to windfall taxes recorded in the year ended February 1, 2009 in excess of taxes payable. A similar entry for $192 was recorded in the same period related to windfall taxes recorded in the first quarter of fiscal 2009. The Company has concluded that the adjustment was not material to the financial statements.

 

On July 1, 2009, the Accounting Standards Codification (“ASC”) became the Financial Accounting Standards Board’s (“FASB”) officially recognized source of authoritative GAAP, superseding existing FASB, the American Institute of Certified Accountants, the Emerging Issues Task Force and related literature. Rules and interpretive releases of the SEC under the authority of federal securities law are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to GAAP in financial statements and accounting policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Section and Paragraph structure. This standard was effective prospectively for reporting periods ended after September 15, 2009 and, accordingly, the Company adopted it during the third quarter of fiscal 2009. The adoption of this standard did not have an effect on the Company’s consolidated financial position, results of operations or cash flows. As a result of adopting this standard, the Company’s references to GAAP standards have been changed to refer to topics, subtopics, sections or subsections of the ASC, as appropriate.

 

In June 2009, the FASB amended ASC topic 810 Consolidation(“ASC 810”), which requires a qualitative approach to identifying a controlling financial interest in a variable interest entity (“VIE”), and requires ongoing assessment of whether an entity is a VIE and whether an interest in a VIE makes the holder a primary beneficiary of

 

 

 

the VIE. The amendment will be effective for the Company at the beginning of fiscal 2010. The Company is currently evaluating the impact that adoption may have on its consolidated financial statements.

 

In May 2009, the FASB issued ASC topic 855 Subsequent Events(“ASC 855”). ASC 855 establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, ASC 855 sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the consolidated financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its consolidated financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. Subsequent events were evaluated through December 9, 2009 which is the date the financial statements were issued. The Company has determined that the standard does not have any impact on its consolidated financial statements.

 

In April 2008, the FASB amended ASC topic 350, Intangibles and Other (“ASC 350”). This new accounting standard, currently contained in ASC350-30-35,specifically amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The objective of this amendment is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset. This new standard is effective for fiscal years beginning after December 15, 2008. The effective date, as well as the adoption date for the Company, was February 2, 2009. Although ASC 350 may impact the Company’s reporting in future financial periods, the Company has determined that the standard did not have any impact on its historical consolidated financial statements at the time of adoption.

 

In December 2007, the FASB revised the accounting standards for business combinations. This new standard (currently contained in ASC topic 805, Business Combinations (“ASC 805”)), among other things, generally requires that an acquirer recognize the assets acquired and liabilities assumed at their “full fair values” on the acquisition date. This practice replaces the practice, under predecessor accounting standards, of allocating the cost of an acquisition to the individual assets acquired and liabilities assumed based on their relative estimated fair values. This new standard further requires that acquisition-related costs be recognized separately from the related acquisition. In April 2009, the FASB issued ASC805-20,Business Combinations — Identifiable Assets and Liabilities and Any Non-controlling Interest, which further amends and clarifies ASC 805 and applies to assets acquired and liabilities assumed that arise from contingencies in a business combination. This new standard and the amendment must be applied prospectively to business combinations consummated on or after the first annual reporting period beginning on or after December 15, 2008. The effective date, as well as the adoption date for the Company, was February 2, 2009. Although ASC 805 may impact the Company’s reporting in future financial periods, the Company has determined that the standard did not have any impact on its historical consolidated financial statements at the time of adoption.

 

 

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

 

Stock-based compensation expense charged to income for the plans was $4,229 and $5,234 for the thirty-nine weeks ended November 1, 2009 and November 2, 2008, respectively. Total unrecognized compensation cost as at November 1, 2009 was $13,201 for all stock option plans, which is expected to be recognized over a weighted-average period of 2.72 years.

 

 

 

 

A summary of the Company’s stock options and restricted shares activity as of November 1, 2009 and changes during the period then ended is presented below:

 

 

During the thirty-nine weeks ended November 1, 2009 holders of the exchangeable shares converted 109 exchangeable shares into 109 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 thirty-nine weeks ended November 1, 2009 there were no grants or forfeitures related to any of the stock options issued and outstanding under the stockholder-sponsored awards.

 

The Company’s Board of Directors and stockholders approved the Company’s Employee Stock Purchase Plan (“ESPP”) in September 2007. The 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 our common stock under the ESPP. Additionally, we, or the subsidiary 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 our 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 November 1, 2009, there were 12 shares purchased under the ESPP, which were funded by the Company through open market purchases.

 

In accordance with ASC topic 360, Property, Plant and Equipment (“ASC 360”), the Company reviews its long-lived assets for impairment when changes in circumstances indicate that the carrying amount of the asset may not be recoverable. ASC 360 requires that long-lived assets to be held and used be recorded at the lower of the carrying amount or the fair value. Long-lived assets to be disposed of are to be recorded at the lower of the carrying amount or the fair value, less estimated cost to sell.

 

During the thirty-nine weeks ended November 1, 2009, in conjunction with the Company’s ongoing assessment to ensure that each of the Company’s properties fit into the Company’s strategy, the Company recorded a charge of $820 in lease exit costs related to certain locations and reversed lease exit costs of $714 previously recorded in the fourth quarter of fiscal 2008. The fair market values were estimated using an expected present value technique.

 

 

 

A reconciliation of the associated accrued liability is as follows:

 

On April 2, 2009, three former hourly Company employees filed a class action lawsuit in San Diego Superior Court 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 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 agreed upon the general terms of a settlement which has not yet been finalized and which must be submitted to the court for preliminary and final 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 plaintiff is seeking an unspecified amount of damages. The Company intends to vigorously defend the matter.

 

We are a party to various other legal proceedings arising in the ordinary course of our business, but we are not currently a party to any legal proceeding that management believes would have a material adverse effect on our consolidated financial position or results of operations.

 

 

 

 

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

Our 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 respects. For the thirteen and thirty-nine weeks ended November 1, 2009, 333 and 1,001 stock options were anti-dilutive to earnings and therefore have been excluded from the computation of diluted earnings per share. For the thirteen and thirty-nine weeks ended November 2, 2008, 830 and 637 stock options were anti-dilutive to earnings and therefore have been excluded from the computation of diluted earnings per share.

 

 

 

 

A summary of certain balance sheet accounts is as follows:

 

 

 

 

The Company’s reportable segments are comprised of corporate-owned stores, franchises and other. Phone sales, warehouse sales,e-commercesales and showrooms sales have been combined into other. Information for these segments from continuing operations is detailed in the table below:

 

During the first quarter of fiscal 2008 the Company committed to plans towind-upoperations in Japan and in the second quarter of fiscal 2008 the plans were finalized and disposition of the assets commenced with the closure of three of the four corporate-owned stores that the Company was operating as a joint venture with Descente Ltd. The fourth corporate-owned store was closed during the third quarter of fiscal 2008. The shut down costs related to the closure of the stores in Japan were fully accrued in the second quarter of fiscal 2008. The Company and Descente Ltd. agreed to end all operations as a joint venture in the third quarter of fiscal 2008.

 

 

 

The results of discontinued operations are summarized as follows:

The net loss from discontinued operations represents all activity up to November 1, 2009.

 

Some of the statements contained in thisForm 10-Qand 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 thisForm 10-Qare 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 thisForm 10-Qand 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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report onForm 10-Kfor fiscal 2008 filed on March 27, 2009. These factors include without limitation:

 

 

The forward-looking statements contained in thisForm 10-Qreflect our views and assumptions only as of the date of thisForm 10-Qand are expressly qualified in their entirety by the cautionary statements included in thisForm 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 31st of the following year. This typically results in a fifty-two week year, but occasionally gives rise to an additional week, resulting in a fifty-three week year.

 

The world economy and capital markets are currently undergoing a period of unprecedented volatility. During fiscal 2008, there was a considerable slow down as problems in global financial markets became more widespread and consumers cut back on retail spending amid fears of a global recession. Our sales growth slowed in the latter part of fiscal 2008, driven in part by this reduced spending. This challenging economic climate and the continued weakness of the Canadian dollar continued to negatively affect our financial results during the beginning of fiscal 2009. Recently, the global economy has shown some signs of improvement, as reflected in our current quarter net revenues growth, and the Canadian dollar has strengthened relative to the United States dollar. This growth however, does not match the rapid growth we realized in prior years. Management recognizes the difficult economic situation that many of our consumers are still facing and does not expect our rate of growth to significantly change throughout the remainder of the fiscal year.

 

In response to the changes in the world economy and the impact on our operating results, we have taken several steps to address the deterioration in the retail environment and to address our support structure. These steps, which we discussed in our Annual Report onForm 10-Kfor fiscal 2008 filed with the SEC on March 27, 2009, included the development and implementation of several important initiatives as part of our strategy designed to increase customer traffic in our corporate-owned store locations, reduce infrastructure expenses and improve our operating results.

 

We continue to realize the positive effects of our cost reductions and efficiency initiatives, and expect that such initiatives, combined with modest net revenue growth, will continue to impact our financial results through the remainder of fiscal 2009. These targeted cost reductions and associated efficiency efforts were designed to structure our business for long-term profitable growth and to protect our brand integrity. We believe our continued strong cash flow generation, solid balance sheet and healthy liquidity provide us with the financial flexibility to continue executing the initiatives we implemented at the end of fiscal 2008 as well as make investments at strategic times going forward which will benefit our company.

 

lululemon is a designer and retailer of technical athletic apparel operating in North America and Australia. Our yoga-inspired apparel is marketed under the lululemon athletica brand name. We offer a comprehensive line of apparel and accessories including fitness pants, shorts, tops and jackets designed for athletic pursuits such as yoga, dance, running and general fitness. As of November 1, 2009, our branded apparel was principally sold through 119 corporate-owned and franchised stores that are primarily located in Canada and the United States. 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 third quarter of fiscal 2009, approximately 61% of our net revenue was derived from sales of our products in Canada, 39% of our net revenue was derived from the sales of our products in the United States and an immaterial amount 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 $353.5 million in fiscal 2008. This represents a compound annual growth rate of 72%. Our net revenue from continuing operations also increased from $249.6 million in the first three quarters of fiscal 2008 to $292.3 million in the first three quarters of fiscal 2009, representing a 17% increase. Our increase in net revenue from fiscal 2004 to fiscal 2008 resulted from the addition of retail locations in North America, including 34 net openings in fiscal 2008 and 31 net openings in fiscal 2007, and comparable store sales growth as high as 34%, which we realized in fiscal 2007. 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, franchises 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 franchises segment accounted for 3% of our net revenues in the first three quarters of fiscal 2009, 5% of our net revenues from continuing operations in fiscal 2008 and 7% of our net revenues from continuing operations in fiscal 2007. Opening new franchised stores is not a significant part of our near-term growth strategy, and we therefore expect that if the revenue derived from our franchised stores continues to comprise less than 10% of the net revenue we report in future fiscal years, we will re-evaluate our segment reporting disclosures. Our other operations accounted for less than 10% of our net revenues from continuing operations in each of the first three quarters of fiscal 2009, fiscal 2008 and fiscal 2007.

 

 

The following table summarizes key components of our results of operations for the thirteen weeks ended November 1, 2009 and November 2, 2008. The operating results are expressed in dollar amounts as well as relevant percentages, presented as a percentage of net revenue.

 

 

Net revenue increased $25.8 million, or 30%, to $112.9 million for the third quarter of fiscal 2009 from $87.0 million for the third quarter of fiscal 2008. This increase was the result of increased comparable store sales and sales from new stores opened. Assuming the average exchange rate between the Canadian and United States dollars for the third quarter of fiscal 2008 remained constant, our net revenue would have increased $24.8 million, or 28%, for the third quarter of fiscal 2009.

 

Corporate-Owned Stores.  Net revenue from our corporate-owned stores segment increased $20.5 million, or 26%, to $98.1 million for the third quarter of fiscal 2009 from $77.6 million for the third quarter of fiscal 2008. The following contributed to the $20.5 million increase in net revenue from our corporate-owned stores segment:

 

 

Franchises.  Net revenue from our franchises segment decreased $0.7 million, or 14%, to $4.1 million for the third quarter of fiscal 2009 from $4.8 million for the third quarter of fiscal 2008. The decrease in net revenue from our franchises segment resulted primarily from our reacquisition of two franchised stores in Victoria, British Columbia and one franchised store in Bellevue, Washington in the third quarter of fiscal 2008.

 

Other.  Net revenue from our other segment increased $6.0 million, or 128%, to $10.7 million for the third quarter of fiscal 2009 from $4.7 million for the third quarter of fiscal 2008. The $6.0 million increase was primarily the result of an increase in sales from the launch of oure-commercechannel in the first quarter of fiscal 2009 which contributed $4.2 million in net revenues, as well as increased sales from wholesale and outlet sales which contributed $1.8 million in net revenues.

 

Gross profit increased $14.4 million, or 34%, to $56.3 million for the third quarter of fiscal 2009 from $41.9 million for the third quarter of fiscal 2008. The increase in gross profit was driven principally by:

 

 

These amounts were partially offset by:

 

 

 

Gross profit as a percentage of net revenue, or gross margin, increased 1.8%, to 49.9% for the third quarter of fiscal 2009 from 48.1% for the third quarter of fiscal 2008. The increase in gross margin resulted primarily from:

 

 

This increase in gross margin was offset by unfavorable foreign exchange differences on inventory of 1.2%.

 

Our costs of goods sold in the third quarter of fiscal 2009 and the third quarter of fiscal 2008 included $0.1 million and $0.2 million, respectively, of stock-based compensation expense.

 

Selling, general and administrative expenses increased $6.6 million, or 23%, to $35.4 million for the third quarter of fiscal 2009 from $28.8 million for the third quarter of fiscal 2008. As a percentage of net revenue, selling, general and administrative expenses decreased 1.8%, to 31.4% from 33.1%. The $6.6 million increase in selling, general and administrative expenses was principally comprised of:

 

 

These amounts were partially offset by a decrease in travel, meals and entertainment and supplies during the third quarter of fiscal 2009 of $0.5 million related to our efforts to reduce discretionary spending.

 

Our selling, general and administrative expenses in the third quarter of fiscal 2009 and the third quarter of fiscal 2008 included $1.3 million and $1.3 million, respectively, of stock-based compensation expense.

 

Income from operations increased $7.9 million, or 60%, to $20.9 million for the third quarter of fiscal 2009 from $13.1 million for the third quarter of fiscal 2008. The increase of $7.9 million in income from operations for

the third quarter of fiscal 2009 was primarily due to an increase of $14.4 million in gross profit resulting from increased comparable store sales and additional sales from corporate-owned stores opened, and was partially offset by a $6.6 million increase in selling, general and administrative expenses.

 

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 occupancy cost. 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, merchandise, and distribution departments have been allocated to this segment.

 

Income from operations (before general corporate expenses) from:

 

 

Other income (expense), net decreased $0.1 million to $nil for the third quarter of fiscal 2009 from $0.1 million for the third quarter of fiscal 2008. The decrease was primarily due to lower interest rates earned on cash balances.

 

Income tax expense for the third quarter of fiscal 2009 was $6.9 million compared to $4.4 million for the corresponding period in fiscal 2008. The Company’s financial statement effective tax rate for the third quarter of fiscal 2009 was 32.8% compared to 33.1% for the third quarter of fiscal 2008. The decrease is due to a one-timetrue-up from the recognition of deferred tax assets in the third quarter of fiscal 2009 which was partially offset by state taxes and a true-up in a foreign jurisdiction. The effective tax rate will vary from the statutory rate because (i) stock-based compensation expense recorded is a permanent difference in certain jurisdictions, (ii) the realization of the benefits of the tax assets from stock-based compensation, and (iii) the realization of the benefits of the tax assets related primarily to historical tax differences between financial and tax bases of assets and liabilities.

 

Net income from continuing operations increased $5.2 million, to $14.1 million for the third quarter of fiscal 2009 from $8.8 million for the third quarter of fiscal 2008. The increase in net income of $5.2 million for the third quarter of fiscal 2009 was primarily due to an increase of $14.4 million in gross profit resulting from increased comparable store sales and additional sales from corporate-owned stores opened, partially offset by an increase of $6.6 million in selling, general and administrative expenses, an increase of $2.5 million in income tax expense and a decrease in other income (expense), net of $0.1 million. During both the third quarter of fiscal 2009 and fiscal 2008 there were immaterial revenues, expenses or losses from discontinued operations, resulting in a $nil impact on basic and diluted earnings per share.

 

The following table summarizes key components of our results of operations for the thirty-nine weeks ended November 1, 2009 and November 2, 2008. The operating results are expressed in dollar amounts as well as relevant percentages, presented as a percentage of net revenue.

 

 

Net revenue increased $42.7 million, or 17%, to $292.3 million for the first three quarters of fiscal 2009 from $249.6 million for the first three quarters of fiscal 2008. This increase was the result of sales from new stores opened and sales through other sales channels. Assuming the average exchange rate between the Canadian and United States dollars for the first three quarters of fiscal 2008 remained constant, our net revenue would have increased $60.0 million, or 24%, for the first three quarters of fiscal 2009.

 

Corporate-Owned Stores.  Net revenue from our corporate-owned stores segment increased $30.8 million, or 14%, to $256.1 million for the first three quarters of fiscal 2009 from $225.2 million for the first three quarters of fiscal 2008. The following contributed to the $30.8 million increase in net revenue from our corporate-owned stores segment:

 

 

 

Franchises.  Net revenue from our franchises segment decreased $3.8 million, or 28%, to $9.8 million for the first three quarters of fiscal 2009 from $13.6 million for the first three quarters of fiscal 2008. The decrease in net revenue from our franchises segment resulted primarily from our reacquisition of two franchised stores in Victoria, British Columbia and one franchised store in Bellevue, Washington in the third quarter of fiscal 2008.

 

Other.  Net revenue from our other segment increased $15.7 million, or 146%, to $26.4 million for the first three quarters of fiscal 2009 from $10.8 million for the first three quarters of fiscal 2008. The $15.7 million increase was primarily the result of an increase in sales from the launch of oure-commercechannel in the first quarter of fiscal 2009 which contributed $7.5 million in net revenues, as well as increased sales from wholesale, outlet and warehouse sales which contributed $8.2 million in net revenues.

 

Gross profit increased $9.1 million, or 7%, to $136.5 million for the first three quarters of fiscal 2009 from $127.4 million for the first three quarters of fiscal 2008. The increase in gross profit was driven principally by:

 

 

These amounts were partially offset by:

 

 

Gross profit as a percentage of net revenue, or gross margin, decreased 4.4%, to 46.7% for the first three quarters of fiscal 2009 from 51.1% for the first three quarters of fiscal 2008. The decrease in gross margin resulted primarily from:

 

 

This was offset by a decrease in expenses related to our production, design, merchandising and distribution departments, relative to the increase in net revenue, which had a leveraging effect on gross margin and contributed an increase of 1.1%.

 

Our cost of goods sold in the first three quarters of fiscal 2009 and the first three quarters of fiscal 2008 included $0.6 million and $0.7 million, respectively, of stock-based compensation expense.

 

Selling, general and administrative expenses increased $4.5 million, or 5%, to $91.4 million for the first three quarters of fiscal 2009 from $86.9 million for the first three quarters of fiscal 2008. As a percentage of net revenue, selling, general and administrative expenses decreased 3.5%, to 31.3% from 34.8%. The $4.5 million increase in selling, general and administrative expenses was principally comprised of:

 

 

These amounts were partially offset by:

 

 

Our selling, general and administrative expenses in the first three quarters of fiscal 2009 and the first three quarters of fiscal 2008 included $3.7 million and $4.5 million, respectively, of stock-based compensation expense.

 

Income from operations increased $4.6 million, or 11%, to $45.1 million for the first three quarters of fiscal 2009 from $40.5 million for the first three quarters of fiscal 2008. The increase of $4.6 million in income from operations for the first three quarters of fiscal 2009 was primarily due to an increase of $9.1 million in gross profit resulting from increased comparable store sales and additional sales from corporate-owned stores opened, partially offset by a $4.5 million increase in selling, general and administrative expenses.

 

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 occupancy costs. 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 and distribution departments have been allocated to this segment.

Income from operations (before general corporate expenses) from:

 

 

Other income (expense), net decreased $0.5 million to $0.1 million for the first three quarters of fiscal 2009 from $0.6 million for the first three quarters of fiscal 2008. The decrease was primarily due to lower interest rates offered on cash balances.

 

Income tax expense for the first three quarters of fiscal 2009 was $15.4 million compared to $11.6 million for the corresponding period in fiscal 2008. The Company’s financial statement effective tax rate for the first three quarters of fiscal 2009 was 34.0% compared to 28.1% for the first three quarters of fiscal 2008. The increase is a result of a true-up in fiscal 2008 related to amendments to our transfer pricing structure. The effective tax rate will vary from the statutory rate because (i) stock-based compensation expense recorded is a permanent difference in certain jurisdictions, (ii) the realization of the benefits of the tax assets from stock-based compensation, and (iii) the realization of the benefits of the tax assets related primarily to historical tax differences between financial and tax bases of assets and liabilities.

 

During the second quarter of fiscal 2008, after considering a number of factors, including a history of cumulative earnings, utilization of previously generated NOL carryforwards and estimated taxable income in future years, we determined we would more likely than not realize substantial future tax benefits from our deferred income tax assets generated in the United States prior to February 1, 2009. As a result of this analysis the Company recorded deferred tax assets of (i) $1.4 million related primarily to historical tax differences between financial and tax bases of assets and liabilities, (ii) $0.9 million cumulative tax benefit recorded from stock-based compensation expense prior to the second quarter of fiscal 2008, and (iii) $2.7 million excess tax benefit from the exercise of stock options during and prior to the second quarter of fiscal 2008.

 

During the second quarter of fiscal 2009, an adjustment was made to deferred tax assets and additional paid-in capital in the amount of $12.0 million relating to windfall taxes recorded in the year ended February 1, 2009 in excess of US taxes payable. A similar entry for $0.2 million was recorded in the same period related to windfall taxes recorded in the first quarter of fiscal 2009. The Company has concluded that the adjustment was not material to the financial statements.

 

Net income from continuing operations increased $0.3 million, to $29.8 million for the first three quarters of fiscal 2009 from $29.6 million for the first three quarters of fiscal 2008. The increase in net income of $0.3 million for the first three quarters of fiscal 2009 was primarily due to an increase of $9.1 million in gross profit resulting from increased comparable store sales and additional sales from corporate-owned stores opened, partially offset by an increase of $4.5 million in selling, general and administrative expenses, an increase of $3.8 million in income tax expense and a decrease in other income (expense), net of $0.5 million.

 

During the first three quarters of fiscal 2009, there were no revenues, expenses or losses from discontinued operations. The loss from discontinued operations was $1.1 million for the first three quarters of fiscal 2008, resulting in a reduction of basic and diluted earnings per share of $0.02. The shut down costs related to the closure of our stores in Japan were fully accrued in the second quarter of fiscal 2008.

 

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.

 

Our cash requirements are principally for working capital and capital expenditures, including the build-out cost of new stores, renovations of existing stores, and improvements to our distribution facility and corporate infrastructure. Our need for working capital is seasonal, with the greatest requirements from August through the end of November each year as a result of our inventorybuild-up and concentration of new store openings during this period for our holiday selling season. Historically, our main sources of liquidity have been cash flow from operating activities and borrowings under our existing and previous revolving credit facilities, and our initial public offering that closed on August 2, 2007.

 

At November 1, 2009, our working capital (excluding cash and cash equivalents) was $24.8 million and our cash and cash equivalents were $101.8 million.

 

The following presents the major components of net cash flows provided by and used in operating, investing and financing activities for the periods indicated:

 

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 $22.3 million, to $51.5 million for the thirty-nine weeks ended November 1, 2009 compared to cash used by operating activities of $29.2 million for the thirty-nine weeks ended November 2, 2008. The $22.3 million increase was primarily a result of a decrease in inventories and an increase in items not affecting cash and was offset by a decrease in miscellaneous accruals. The net decrease in the change in inventories is a result of selling our on-hand spring inventories we had built up at the end of fiscal 2008 for a larger store base. The net increase in items not affecting cash is primarily a result of increased depreciation and amortization for a larger store base and decreased deferred income tax assets. The net change in miscellaneous accruals are a result of changes in the timing of receipts and payments of invoices from and to third parties.

 

Investing Activities relate to capital expenditures, advances to and investments in franchise and acquisition of franchises.

 

Cash used in investing activities decreased $25.4 million to $10.2 million for the thirty-nine weeks ended November 1, 2009 from $35.6 million for the thirty-nine weeks ended November 2, 2008. The $25.4 million decrease was a result of reduced corporate-owned store openings in the thirty-nine weeks ended November 1, 2009 compared to the same period in fiscal 2008 and the reacquisition of franchise rights for three stores in the thirty-nine weeks ended November 2, 2008.

 

Financing Activities consist primarily of cash received on the exercise of stock options. Cash provided by financing activities decreased to $0.3 million for the thirty-nine weeks ended November 1, 2009 from $11.1 million of cash used in financing activities for the thirty-nine weeks ended November 2, 2008.

 

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” of our Annual Report onForm 10-Kfor fiscal 2008 filed on March 27, 2009. In addition, we may make discretionary capital improvements with respect to our stores, distribution facility, store support center, 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.

 

In April 2007, we executed a credit facility with the Royal Bank of Canada that provided for a CDN$20,000,000 uncommitted demand revolving credit facility to fund our working capital requirements. This agreement cancelled our previous CDN$8,000,000 credit facility. Borrowings under this uncommitted credit facility are made on awhen-and-as-neededbasis 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 November 1, 2009, aside from letters of credit and guarantees, there were no borrowings outstanding under this credit facility.

 

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 November 1, 2009, letters of credit and letters of guarantee totaling $2.2 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.

 

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 onForm 10-Kfor our 2008 fiscal year end filed with the SEC on March 27, 2009 and in Note 2 included in Item 1 of Part 1 of this Quarterly Report onForm 10-Q.We believe that there have been no other significant changes during the thirty-nine weeks ended November 1, 2009 to our critical accounting policies.

 

Our operating locations by country, state and province as of November 1, 2009 are summarized in the table below.