Nature of operations

 

lululemon athletica inc., a Delaware corporation (“lululemon” or “LAI” 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, independent franchises and a network of wholesale accounts. The Company’s primary markets are Canada, the United States and Australia, where 44, 78 and 11 corporate-owned stores, respectively, were in operation as at January 30, 2011. There were 133, 110, and 103 corporate-owned stores in operation as at January 30, 2011, January 31, 2010, and February 1, 2009, respectively.

 

Basis of presentation

 

The accompanying consolidated financial statements include the financial position, results of operations and cash flows of the Company and its subsidiary companies during the three-year period ended January 30, 2011. The consolidated financial statements have been prepared using the U.S. dollar and are presented in accordance with United States generally accepted accounting principles (“GAAP”).

 

The Company has experienced, and expects to continue to experience, significant seasonal variations in net revenue and income from operations. Seasonal variations in revenue are primarily related to increased sales of products during the fourth fiscal quarter, reflecting historical strength in sales during the holiday season. Historically, seasonal variations in income from operations have been driven principally by increased net revenue in the fourth fiscal quarter.

 

The Company’s fiscal year ends on the Sunday closest to January 31 of the following year, typically resulting in a 52 week year, but occasionally giving rise to an additional week, resulting in a 53 week year. Fiscal 2010, 2009 and 2008 ended on January 30, 2011, January 31, 2010, and February 1, 2009, respectively.

 

 

Principles of consolidation

 

The consolidated financial statements include the accounts of lululemon athletica inc. and its wholly-owned subsidiaries. All inter-company balances and transactions have been eliminated. The results of operations of lululemon athletica australia Pty attributable to the non-controlling interest are presented within equity and net income, and are shown separately from the Company’s equity and net income attributable to the Company. The results of operations of Lululemon Japan Inc. are presented as discontinued operations following the Company’s wind-up of operations in Japan in fiscal 2008. In the opinion of management, all adjustments, consisting primarily of normal recurring accruals, considered necessary for a fair presentation of the Company’s results of operations for the periods reported and of its financial condition as of the date of the balance sheet have been included.

 

Cash and cash equivalents

 

Cash and cash equivalents consist of cash on hand, bank balances and short-term deposits with original maturities of less than three months. The Company has not experienced any losses related to these balances, and management believes its credit risk to be minimal.

 

Accounts receivable

 

Accounts receivable primarily arise out of sales to wholesale accounts, sales of inventory to our franchisees, royalties on sales owed to the Company by its franchisees and landlord deferred lease inducements. The allowance for doubtful accounts represents management’s best estimate of probable credit losses in accounts receivable and is reviewed monthly. Receivables are written off against the allowance when management believes that the amount receivable will not be recovered. As at January 30, 2011, January 31, 2010 and February 1, 2009 the Company recorded an insignificant allowance for doubtful accounts.

 

Inventories

 

Inventories, consisting of finished goods and raw materials, are stated at the lower of cost and market value. Cost is determined using weighted-average costs. For finished goods, market is defined as net realizable value, and for raw materials, market is defined as replacement cost. Cost of inventories includes acquisition costs and all costs incurred to deliver inventory to the Company’s distribution centers including freight, non-refundable taxes, duty and other landing costs.

 

The Company periodically reviews its inventories and makes provisions as necessary to appropriately value obsolete or damaged goods. The amount of the provision is equal to the difference between the cost of the inventory and its estimated net realizable value based upon assumptions about future demand, selling prices and market conditions. In addition, as part of inventory valuations, the Company accrues for inventory shrinkage based on historical trends from actual physical inventory counts. Inventory shrinkage estimates are made to reduce the inventory value for lost or stolen items. The Company performs physical inventory counts and cycle counts throughout the year and adjusts the shrink reserve accordingly.

 

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.

 

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.

 

 

Goodwill and intangible assets

 

Intangible assets are recorded at cost. Non-competition agreements are amortized on a straight-line basis over their estimated useful life of five years. Reacquired franchise rights are amortized on a straight-line basis over their estimated useful lives of 10 years.

 

Goodwill represents the excess of the net assets acquired and liabilities assumed over the aggregate of the consideration transferred, the fair value of any non-controlling interest in the acquiree and the acquisition-date fair value of the Company’s previously held equity interest. Goodwill and intangible assets with indefinite lives are tested annually for impairment or more frequently when an event or circumstance indicates that goodwill or indefinite life intangible assets might be impaired. The Company’s operating segment for goodwill is its corporate-owned stores.

 

Impairment of long-lived assets

 

Long-lived assets, including intangible assets with finite lives, held for use are evaluated for impairment when the occurrence of events or a change in circumstances indicates that the carrying value of the assets may not be recoverable as measured by comparing their carrying value to the estimated undiscounted future cash flows generated by their use and eventual disposition. Impaired assets are recorded at fair value, determined principally by discounting the future cash flows expected from their use and eventual disposition. Reductions in asset values resulting from impairment valuations are recognized in income in the period that the impairment is determined. Long-lived assets, including intangible assets with finite lives, held for sale are reported at the lower of the carrying value of the asset and fair value less cost to sell. Any write-downs to reflect fair value less selling cost is recognized in income when the asset is classified as held for sale. Gains or losses on assets held for sale and asset dispositions are included in provision for impairment and lease exit costs.

 

Leased property and equipment

 

The Company leases corporate-owned stores, distribution centers and administrative offices. Minimum rental payments, including any fixed escalation of rental payments and rent premiums, are amortized on a straight-line basis over the life of the lease beginning on the possession date. Rental costs incurred during a construction period, prior to store opening, are recognized as rental expense. The difference between the recognized rental expense and the total rental payments paid is reflected on the consolidated balance sheet as a deferred lease liability or a prepaid lease asset.

 

Deferred lease inducements, which include leasehold improvements paid for by the landlord and free rent, are recorded as liabilities on the consolidated balance sheet and recognized as a reduction of rent expense on a straight-line basis over the term of the lease.

 

Contingent rental payments based on sales volumes are recorded in the period in which the sales occur.

 

The Company recognizes a liability for the fair value of a required asset retirement obligation (“ARO”) when such obligation is incurred. The Company’s AROs are primarily associated with leasehold improvements which, at the end of a lease, the Company is contractually obligated to remove in order to comply with the lease agreement. At the inception of a lease with such conditions, the Company records an ARO liability and a corresponding capital asset in an amount equal to the estimated fair value of the obligation. The liability is estimated based on a number of assumptions requiring management’s judgment, including store closing costs, cost inflation rates and discount rates, and is accreted to its projected future value over time. The capitalized asset is depreciated using the convention for depreciation of leasehold improvement assets. Upon satisfaction of the ARO conditions, any difference between the recorded ARO liability and the actual retirement costs incurred is recognized as an operating gain or loss in the consolidated statements of earnings.

 

The Company recognizes a liability for a cost associated with a lease exit or disposal activity when such obligation is incurred. A lease exit or disposal activity is measured initially at its fair value in the period in which the liability is incurred. The Company estimates fair value at the cease-use date of its operating leases as the remaining lease rentals, reduced by estimated sublease rentals that could be reasonably obtained for the property, even where the Company does not intend to enter into a sublease. Estimating the cost of certain lease exit costs involves subjective assumptions, including the time it would take to sublease the leased location and the related potential sublease income. The estimated accruals for these costs could be significantly affected if future experience differs from that used in the initial estimate. Lease exit costs are included in provision for impairment and lease exit costs.

 

Deferred revenue

 

Payments received from franchisees for goods not shipped as well as receipts from the sale of gift cards are treated as deferred revenue. Franchise inventory deposits are included in other current liabilities and recognized as sales when the goods are shipped. Amounts received in respect of gift cards are recorded as unredeemed gift card liability. When gift cards are redeemed for apparel, the Company recognizes the related revenue.

 

Revenue recognition

 

Net revenue includes sales of apparel to customers through corporate-owned and operated retail stores, direct to consumer through www.lululemon.com and phone sales, initial license and franchise fees, royalties from franchisees and sales of apparel to franchisees, sales through a network of wholesale accounts, and sales from company-operated showrooms.

 

Sales to customers through corporate-owned retail stores and phone sales are recognized at the point of sale, net of an estimated allowance for sales returns.

 

Sales of apparel to customers through the Company’s retail internet site are recognized when goods are shipped, net of an estimated allowance for sales returns.

 

Franchise royalties are calculated as a percentage of franchise sales and are recognized in the month that the franchisee makes the sale.

 

Sales of apparel to franchisees and wholesale accounts are recognized when goods are shipped and collection is reasonably assured.

 

All revenues are reported net of sales taxes collected for various governmental agencies.

 

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 years ended January 30, 2011, January 31, 2010 and February 1, 2009, net revenue recognized on unredeemed gift card balances was $1,406, $2,183, and $nil, respectively.

 

Cost of goods sold

 

Cost of goods sold includes the cost of purchased merchandise, including in-bound freight, duty and nonrefundable taxes incurred in delivering the goods to the Company’s distribution centers. It also includes all occupancy costs such as minimum rent, contingent rent where applicable, property taxes, utilities and depreciation expense for the Company’s corporate-owned store locations and all costs incurred in operating the Company’s distribution centers and production, design and merchandise departments, hemming and shrink and valuation reserves. Production, design, merchandise and distribution center costs include salaries and benefits as well as operating expenses, which include occupancy costs and depreciation expense for the Company’s distribution centers.

 

Store pre-opening costs

 

Operating costs incurred prior to the opening of new stores are expensed as incurred.

 

Income taxes

 

The Company follows the liability method with respect to accounting for income taxes. Deferred income 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 are expected to be in effect when these differences are anticipated to reverse. 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 the 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.

 

The Company generally provides for taxes at the rate applicable for the appropriate tax jurisdiction. Because present intentions are to reinvest the unremitted earnings into foreign operations, the Company does not provide U.S. income taxes on unremitted earnings of foreign subsidiaries. Management periodically assesses the need to utilize these unremitted earnings to finance foreign operations. This assessment is based on cash flow projections that are the result of estimates of future production, fiscal requirements by tax jurisdiction of our operations and operational and fiscal objectives by tax jurisdiction for our operations. Such estimates are inherently imprecise since many assumptions utilized in the cash flow projections are subject to revision in the future.

 

The Company files income tax returns in the United States, Canada and various foreign and state jurisdictions. The Company is subject to income tax examination by tax authorities in all jurisdictions from our inception to date. Our policy is to recognize interest expense and penalties related to income tax matters as tax expense. At January 30, 2011, the Company does not have any significant accruals for interest related to unrecognized tax benefits or tax penalties. Intercompany transfer pricing policies will be subject to audits by various foreign tax jurisdictions. Although management believes that the Company’s 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 the Company’s income tax provisions and accruals.

 

Currency translation

 

The functional currency for each entity included in these consolidated financial statements that is domiciled outside of the United States (the foreign entities) is the applicable local currency. Assets and liabilities of each foreign entity are translated into U.S. dollars at the exchange rate in effect on the balance sheet date. Revenues and expenses are translated at the average rate in effect during the period. Unrealized translation gains and losses are recorded as a cumulative translation adjustment, which is included in other comprehensive income or loss, which is a component of accumulated other comprehensive income included in stockholders’ equity.

 

Foreign currency transactions denominated in a currency other than an entity’s functional currency are remeasured into the functional currency with any resulting gains and losses included in income, except for gains and losses arising on intercompany foreign currency transactions that are of a long-term investment nature.

 

Fair value of financial instruments

 

The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, trade accounts payable, accrued liabilities, and other liabilities. Unless otherwise noted, it is management’s opinion that the Company is not exposed to significant interest, currency or credit risks arising from these financial instruments. All foreign exchange gains or losses are recorded in the consolidated statements of operations under selling, general and administrative expenses. The fair value of these financial instruments approximates their carrying value, unless otherwise noted.

 

Foreign exchange risk

 

A significant portion of the Company’s sales are denominated in Canadian dollars. The Company’s exposure to foreign exchange risk is mainly related to fluctuations between the Canadian dollar and the U.S. dollar. This exposure is partly mitigated by a natural hedge in that a significant portion of the Company’s operating costs are also denominated in Canadian dollars. The Company is also exposed to changes in interest rates. The Company does not hedge foreign currency and interest rate exposure in a manner that would entirely eliminate the effect of changes in foreign currency exchange rates, or interest rates on net income and cash flows.

 

The aggregate foreign exchange gains (losses) included in income amount to $477, $174, and $(110) for the years ended January 30, 2011, January 31, 2010, and February 1, 2009, respectively.

 

Concentration of credit risk

 

The Company is not exposed to significant credit risk on its cash and cash equivalents and trade accounts receivable. Cash and cash equivalents are held with high quality financial institutions. Trade accounts receivable are primarily from certain franchisees and wholesale accounts. The Company does not require collateral to support the trade accounts receivable; however, in certain circumstances, the Company may require parties to provide payment for goods prior to delivery of the goods. The accounts receivable are net of an allowance for doubtful accounts, which is established based on management’s assessment of the credit risks of the underlying accounts.

 

Stock-based compensation

 

The Company accounts for stock-based compensation using the fair value method. The fair value of awards granted is estimated at the date of grant and recognized as employee compensation expense on a straight-line basis over the requisite service period with the offsetting credit to additional paid-in capital. For awards with service and/or performance conditions, the total amount of compensation expense to be recognized is based on the number of awards expected to vest and is adjusted to reflect those awards that do ultimately vest. For awards with performance conditions, the Company recognizes the compensation expense if and when the Company concludes that it is probable that the performance condition will be achieved. The Company reassesses the probability of achieving the performance condition at each reporting date. For awards with market conditions, all compensation expense is recognized irrespective of whether such conditions are met.

 

Certain employees are entitled to share-based awards from the principal stockholder of the Company. These awards are accounted for by the Company as employee compensation expense in accordance with the above-noted policies.

 

Earnings per share

 

Earnings per share is calculated using the weighted-average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income available to common stockholders for the period by the diluted weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution from common shares issuable through stock options and performance stock units using the treasury stock method.

 

Use of estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period.

 

Recently issued accounting standards

 

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06, Fair Value Measurements and Disclosures Topic 820: Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 requires new disclosures regarding transfers in and out of the Level 1 and 2 and activity within Level 3 fair value measurements and clarifies existing disclosures of inputs and valuation techniques for Level 2 and 3 fair value measurements. The new disclosures and clarifications of existing disclosures are effective for interim and Annual Reporting periods beginning after December 15, 2009, except for the disclosure of activity within Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010, and for interim reporting periods within those years. The company adopted the new disclosures effective January 31, 2010, except for the disclosure of activity within Level 3 fair value measurements. The Level 3 disclosures are effective for the company at the beginning of fiscal 2011. The adoption of ASU 2010-06 did not have a material impact, and is not expected to have a material impact, on the disclosures within the company’s consolidated financial statements.

 

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

 

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

 

Reclassifications

 

Certain prior year amounts have been reclassified to conform to fiscal 2010 presentation.

 

 

 

 

 

Included in the cost of property and equipment are capitalized software costs of $17,252 and $11,823 at January 30, 2011 and January 31, 2010, respectively, associated with internally developed software.

 

Depreciation expense related to property and equipment was $23,549, $19,758 and $14,819 for the years ended January 30, 2011, January 31, 2010, and February 1, 2009, respectively.

 

The Company recorded impairment of $700, $112, and $2,999 for the years ended January 30, 2011, January 31, 2010, and February 1, 2009, respectively, in property and equipment for stores that were relocated or closed. These assets were previously used in the corporate-owned stores segment.

 

 

 

Amortization expense related to intangible assets was $1,065, $1,074, and $1,004 for the years ended January 30, 2011, January 31, 2010, and February 1, 2009, respectively. The estimated aggregate amortization expense is as follows:

 

 

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

 

The acquired business contributed net revenues of $15,794 and income from operations of $1,490 to the Company from the date of acquisition to January 30, 2011. The following unaudited pro forma summary presents consolidated information of the Company as if the business combination had occurred on February 3, 2008:

 

 

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

 

In fiscal 2010, the Company incurred $181 of acquisition-related costs. These costs are included in general and administrative expenses in the Company’s consolidated statements of operations for the year ended January 30, 2011.

 

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

 

Fair value of consideration transferred:

 

 

The following table summarizes the fair values of the net assets acquired at the date of acquisition:

 

 

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

 

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

 

In July 2010, the Company reacquired in an asset purchase transaction a franchised store in Saskatoon, Saskatchewan for total cash consideration of $6,610. Included in the Company’s consolidated statements of operations for the year ended January 30, 2011 are the results of the reacquired Saskatoon franchised store from the date of acquisition to January 30, 2011.

 

The following table summarizes the fair values of the net assets acquired at the date of acquisition:

 

 

On September 15, 2008, the Company reacquired in an asset purchase transaction two franchised stores in Victoria, British Columbia for total cash consideration of $1,181 less working capital adjustments of $4 from a related party. The fair values of the net assets acquired were measured as if the transaction occurred with a arm’s length party. Included in the Company’s consolidated statement of operations for the year ended February 1, 2009, are the results of the two reacquired Victoria franchised stores from the date of acquisition through to February 1, 2009.

 

The following table summarizes the fair values of the net assets acquired as of September 15, 2008:

 

 

On September 8, 2008, the Company reacquired in an asset purchase transaction a franchised store in Bellevue, Washington for total cash consideration of $2,067 plus working capital adjustments of $157. Included in the Company’s consolidated statement of operations for the year ended February 1, 2009, are the results of the reacquired Bellevue franchised store from the date of acquisition through to February 1, 2009.

 

The following table summarizes the fair values of the net assets acquired as of September 8, 2008:

 

 

The acquisition of the franchised stores is part of management’s vertical retail growth strategy. The reacquired franchise rights are amortized on a straight-line basis over their estimated useful lives. Goodwill is reviewed for impairment annually, or as events occur or circumstances arise which may reduce the fair value of goodwill below carrying value. The weighted-average remaining useful lives of the reacquired franchise rights was 5.24 as at January 30, 2011 and 6.28 years as at January 31, 2010.

 

 

 

During fiscal 2008 the Company entered into a Credit Agreement (the “Agreement”) with its Australian franchise partner, under which advances were provided by the Company to the franchisee. The Agreement provides for a secured non-revolving credit facility of up to AUD$3,900 and funds are only advanced upon approval by the Company. The line of credit was converted to equity in May 2010 as part of the Company’s consideration transferred to increase its investment in its Australian franchise partner, as described in Note 5. As of January 31, 2010 a total of AUD$3,255 has been drawn on the line of credit. Prior to the conversion in 2010, the loan was designated as held to maturity and beared interest at 8% per annum which was accrued and capitalized to the loan principal.

 

 

 

8  OTHER NON-CURRENT LIABILITIES

 

 

 

In April 2007, the Company executed a new credit facility with a lending institution that provided for a CDN$20,000 uncommitted demand revolving credit facilities to fund the working capital requirements of the Company. Borrowings under the uncommitted credit facilities are made on a when-and-as-needed basis at the discretion of the Company.

 

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 CDN$ or USD$ 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 percent per annum, iii) Bankers Acceptances — Bankers acceptance borrowings will bear interest at the bankers acceptance rate plus 1.125 percent per annum and 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 percent per annum fee.

 

At January 30, 2011, there were no borrowings outstanding under this credit facility. As well, at January 30, 2011, letters of credit totaling USD$nil and guarantees totaling USD$1,466 had been issued under the facility, which reduced the amount available by a corresponding amount.

 

 

Authorized share capital

 

As part of the reorganization in connection with the Company’s 2007 initial public offering (“the reorganization”), the Company’s stockholders approved an amended and restated certificate of incorporation that provides for the issuance of up to 200,000 shares of common stock, 5,000 shares of undesignated preferred stock and 30,000 shares of special voting stock.

 

The holders of the special voting stock are entitled to one vote for each share held. The special voting shares are not entitled to receive dividends or distributions or receive any consideration in the event of a liquidation, dissolution or wind-up. To the extent that exchangeable shares as described below are exchanged for common stock, a corresponding number of special voting shares will be cancelled without consideration.

 

The holders of the exchangeable shares have dividend and liquidation rights equivalent to those of holders of the common shares of the Company. The exchangeable shares can be converted on a one for one basis by the holder at any time into common shares of the Company plus a cash payment for any accrued and unpaid dividends. Holders of exchangeable shares are entitled to the same or economically equivalent dividend as declared on the common stock of the Company. The exchangeable shares are non-voting. The Company has the right to convert the exchangeable shares into common shares of the Company at any time after the earlier of July 26, 2047, the date on which less than 2,094 exchangeable shares are outstanding or in the event of certain events such as a change in control.

 

 

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 the Company.

 

During the year ended January 31, 2006, LIPO and LIPO USA, entities controlled by a principal stockholder of the Company, created a stockholder sponsored stock-based compensation plans (“LIPO Plans”) for certain eligible employees of the Company in order to provide incentive to increase stockholder value. Under the provisions of the LIPO plans, the eligible employees were granted options to acquire shares of LIPO and LIPO USA, respectively. LIPO and LIPO USA held shares in LACI and the Company, respectively. Shares of the Company that are or will be issued to holders of the options or restricted shares under the LIPO Plans are currently held by LIPO USA, an affiliate of a principal stockholder. The exercise, vesting or forfeiture of any of these awards will not have any impact on the outstanding common shares of the Company.

 

In July 2007, the Company’s Board of Directors adopted, and the Company’s stockholders approved the 2007 Equity Incentive Plan (“2007 Plan”). The 2007 Plan provides for the grants of stock options, stock appreciation rights, performance stock units, restricted stock or restricted stock units to employees (including officers and directors who are also employees) of the Company. The majority of stock options granted to date have a four-year vesting period and vest at a rate of 25% per each year on the anniversary date of the grant. Performance stock units issued under the 2007 Plan generally vest three years from the grant date and restricted stock issued under the 2007 Plan vest one year from the grant date. To date, 40 shares of restricted stock have been issued under the 2007 Plan to certain directors and consultants of the Company.

 

The Company’s policy is to issue shares upon the exercise of Company options from treasury. Any shares issued to employees related to stockholder sponsored plans are provided by the principal stockholder and are not issued from treasury or repurchased by the Company.

 

Stock-based compensation expense charged to income for the plans was $7,273, $5,616 and $6,532 for the years ended January 30, 2011, January 31, 2010, and February 1, 2009, respectively.

 

Total unrecognized compensation cost for all stock option plans was $15,399 as at January 30, 2011, which is expected to be recognized over a weighted-average period of 2.7 years, and was $13,692 as at January 31, 2010 over a weighted-average period of 2.6 years.

 

Employee stock purchase plan

 

The Company’s Board of Directors and stockholders approved the Company’s Employee Share Purchase Plan (“ESPP”) in September 2007. The ESPP allows for the purchase of common stock of the Company by all eligible employees at a 25% discount from fair market value subject to certain limits as defined in the ESPP. The maximum number of shares available under the ESPP is 3,000 shares. During the year ended January 30, 2011, 37 shares were purchased under the ESPP, which were funded by the Company through open market purchases.

 

Stockholder sponsored stock options

 

On December 1, 2005, LIPO and LIPO USA each granted 5,296 Class A options with an exercise price of CDN$0.00001 and an expiry date of December 31, 2009 and 11,062 Class B options with an expiry date of December 31, 2010, respectively, prior to the reorganization. The LIPO and LIPO USA Class B options originally had exercise prices of CDN$0.99 and $0.01, respectively. Each Class A option and each Class B option entitled the holder to acquire one share of common stock of LIPO and LIPO USA respectively.

 

While all of the Class A options of both companies vested on December 5, 2005 and were immediately exercised, 3,549 of the common shares of LIPO and LIPO USA issued were designated as forfeitable. These forfeitable shares were considered to be non-vested for accounting purposes and were considered not to be earned as of December 5, 2005. These non-vested shares became non-forfeitable over a four-year requisite service period to December 5, 2009. In addition, on December 5, 2005, 2,239 of the Series B options vested, with the remaining options vesting over a five-year period ending December 5, 2010.

 

In connection with the reorganization of the Company, modifications were made to the LIPO and LIPO USA plans. The 5,285 LIPO Class A awards and the 4,111 vested LIPO Class B awards were exchanged for a total of 1,960 exchangeable shares of the Company through a series of transactions. At the time of the reorganization, 1,418 of the new awards were considered to be vested and the remaining 541 new awards were considered to be unvested. The unvested exchangeable shares are held in trust by the principal stockholder and are subject to the same vesting schedule as the original LIPO award.

 

The following table summarizes the shares granted under the stockholder sponsored plan. Amounts are presented on a post reorganization basis.

 

 

The total unrecognized compensation cost related to shares was $nil at January 30, 2011.

 

The following table summarizes the LIPO USA options granted under the stockholder sponsored plan. Amounts are presented on a post reorganization basis and are shown in lululemon share equivalents.

 

 

The total unrecognized compensation cost related to LIPO USA options was $nil at January 30, 2011.

 

The Company records compensation expense for shares issued under the stockholder sponsored awards, over the requisite service periods.

 

The vesting schedule of the stockholder sponsored awards in lululemon share equivalents is as follows:

 

 

The fair value of the non-forfeitable and forfeitable shares issued under LIPO Class A was measured at the fair value of the underlying stock on the grant date. The fair value of the LIPO Class B options was determined using the Black-Scholes option pricing model with the following assumptions:

 

 

The expected volatility was based on available information on volatility from a peer group of publicly traded U.S. and Canadian retail apparel companies. The expected life of the options was determined by reviewing data about exercise patterns of employees in the retail industry as well as considering the probability of a liquidity event such as the sale of the Company or an IPO and the potential impact of such an event on the exercise pattern. The risk-free interest rate approximates the yield on benchmark Government of Canada bonds for terms similar to the contract life of the options.

 

The total fair value of awards under the stockholder sponsored plans that vested during the years ended January 30, 2011, January 31, 2010 and February 1, 2009 was $261, $464,and $1,137, respectively.

 

Company stock options and performance stock units

 

A summary of the Company’s stock options, performance share units and restricted shares activity as of January 30, 2011, January 31, 2010, and February 1, 2009, and changes during the years then ended is presented below:

 

 

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

 

The following table summarizes information about stock options outstanding and exercisable at January 30, 2011:

 

 

As of January 30, 2011, the unrecognized compensation cost related to these options was $15,399, which is expected to be recognized over a weighted-average period of 2.7 years; and the total aggregate intrinsic value for stock options outstanding and exercisable was $26,001. The intrinsic value of stock options exercised during the years ended January 30, 2011, January 31, 2010, and February 1, 2009 was $28,463, $8,093, and $50,053. The weighted-average grant date fair value of options granted during the years ended January 31, 2011, January 31, 2010, and February 1, 2009 was $25.66, $8.07, and $10.20, respectively.

 

The fair value of options with service conditions was determined at the date of grant using the Black-Scholes model. Expected volatilities are based on a review of a peer group of publicly traded apparel retailers. The expected term of options with service conditions is the simple average of the term and the requisite service period as stated in the respective option contracts. The risk-free interest rate is the Federal Reserve federal funds rate. The following assumptions were used in calculating the fair value of stock options issued in fiscal 2010:

 

 

12  EARNINGS PER SHARE

 

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

 

 

13  COMMITMENTS AND CONTINGENCIES

 

The Company has obligations under operating leases for its office, distribution centers and corporate-owned store premises in Canada, the United States, Australia and Hong Kong. As of January 30, 2011, the lease terms of various leases are from two to 10 years. A substantial number of the Company’s leases for corporate-owned store premises include renewal options and certain of the Company’s leases include rent escalation clauses, rent holidays and leasehold rental incentives. Certain of the Company’s leases for corporate-owned store premises also include contingent rental payments based on sales volume. The Company is required to make deposits for rental payments pursuant to certain lease agreements, which have been included in other non-current assets. Minimum annual basic rent payments excluding other executory operating costs, pursuant to lease agreements are approximately as laid out in the table below. These amounts include commitment in respect of corporate-owned stores that have not yet opened but for which lease agreements have been executed.

 

 

Rent expense for the years ended January 30, 2011, January 31, 2010, and February 1, 2009 was $53,071, $41,639, and $32,701, respectively, under operating lease agreements, consisting of minimum rental expense of $36,754, $29,607, and $23,198, respectively, and contingent rental amounts of $16,317, $12,032, and $9,503, respectively.

 

The Company is, from time to time, involved in routine legal matters incidental to its business. Management believes that the ultimate resolution of any such current proceedings will not have a material adverse effect on the Company’s continued financial position, results of operations or cash flows except as follows:

 

On September 7, 2010, a former hourly employee filed a class action lawsuit in the United States District Court For the Northern District of Illinois, Eastern Division entitled Lydia Brown v. lululemon athletica inc. The lawsuit alleges that the Company requires employees to work “off the clock” without compensation. The plaintiff seeks on behalf of herself and other putative class members back wages, interest, attorney fees and costs, and equitable relief under the Fair Labor Standards Act and the Illinois Wage Payment and Collection Act. On February 24, 2011, the District Court granted the Company’s motion to dismiss the plaintiff’s claims in their entirety without prejudice. The plaintiff was granted leave to file an amended complaint on or before March 17, 2011. The Company continues to deny the allegations and intends to vigorously defend the matter.

 

14  RELATED PARTY BALANCES AND TRANSACTIONS

 

The Company entered into the following transactions with related parties:

 

 

“Franchises controlled by related parties” referred to above relate to two franchise operations in which our principal stockholder previously owned a 50% interest. During the year ended January 31, 2007, the principal stockholder disposed of his interest in these franchises to a family member.

 

During the year ended January 30, 2011, our principal stockholder increased his interest from 50% to 100% in a company that leases retail space to one corporate-owned store.