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Executives

Jean Fontana - ICR

Christine Day - President and Chief Executive Officer

John Currie - Chief Financial Officer

Chip Wilson - Founder and Chairman

Sheree Waterson - EVP General Merchandise Manager

Analysts

Michelle Tan - Goldman Sachs

Lorraine Hutchinson – Banc of America/Merrill Lynch

Paul Lejuez - Credit Suisse

Edward Yruma – KeyBanc

Janet Kloppenburg – JJK Research

Sharon Zackfia - William Blair & Company

Liz Dunn - Thomas Weisel

Barbara Gray – Odlum Brown

Howard Tubin - RBC Capital Markets

Laura Champine - Cowen 

Dana Telsey – Telsey Advisory Group

Richard Jaffe - Stifel Nicolaus

lululemon athletica inc. (LULU) Q2 2009 Earnings Call September 10, 2009 9:00 AM ET

Operator

(Operator Instructions) Welcome to the lululemon athletica second quarter 2009 results earnings results conference call. At this time for opening remarks and introductions, I’d like to turn the conference over to your host, Jean Fontana with ICR.

Jean Fontana

Thank you for joining lululemon athletica’s conference call to discuss second quarter fiscal 2009 results. A copy of today’s press release is available on the Investor Relations section of the company’s website at www.lululemon.com or alternatively as furnished on Form 8-K with the SEC and available on the Commission’s website at www.sec.gov.

Today’s call is being recorded and will be available for replay for 30 days shortly after the call on the Investor Relations section of the company’s website. Hosting today’s call is Christine Day, the company’s President and Chief Executive Officer, John Currie, the company’s Chief Financial Officer, and Chip Wilson, Founder and Chairman.

Before we get started, I would like to remind you of the company’s Safe Harbor language. The statements contained in this conference call, which are not historical facts, may be deemed to constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results might differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company’s filings with the SEC.

Now I would like to turn the call over to Christine Day, lululemon athletica’s Chief Executive Officer.

Christine Day

Thank you for joining us to discuss our second quarter results. With me today are John Currie, our CFO; and Sheree Waterson, EVP General Merchandise Manager, and Chip Wilson our Founder and Chairman. Following my opening remarks, I will turn the call over to John who will go through the financial details of the quarter, and Chip will make some closing remarks.

At the halfway point of 2009 we see solid signs of recovering our business momentum. The team has done an incredible job responding to the macro environment, while positioning us to take advantage of an upward swing. As we have said before, we believe our performance continues to demonstrate the power of our brand as well as our innovative product offerings, effective market strategy, and the strength of our management team.

Our comparable store sales declined 2% on a constant dollar basis which was better then the negative mid single decline we had expected and represents a nice acceleration over our first quarter performance. Over the quarter we did achieve a positive comp trend driven by increased traffic and we responded by increasing inventories by utilizing our quick turn process to deliver almost 800,000 incremental units to the summer line. We also brought forward some of our fall merchandise modules. The sell through was very quick and we saw our comps rise and fall with product deliveries. We believe that more product inventory could have resulted in a positive comp for the quarter.

As stated earlier, we managed our 2009 inventory buys to a conservative outlook based on the macro environment and created the capacity to chase inventory through supply chain initiatives, flowing our inventory with better forecasting and shipping core items under a new replenishment model, color modules that could be moved either forward or backward, and a quick turn process to replenish items in two weeks to 45 days. We have also seen improved flow of goods and reduced on hand inventory at the stores and warehouse as we begin to annualize our system implementations and move beyond the basic function and into the sophisticated functionality of the merchandise management we implemented last year.

With our increased confidence and our sales momentum we will rebuild our inventory levels for Q4 to create the opportunity for positive comps. Q3 will still be a transition period where demand could outstrip supply which could limit our sales upside so we’re guiding to a flat comp for the quarter. Our earnings per share of $0.13 was aided by stronger sales, improved gross margin leverage on occupancy and our ability to control our operating costs. Our hard work on building a leaner operating model is producing stronger flow through as sales momentum returns.

We are very pleased with our retail business in the quarter, particularly the strong response to our expanded running, organic, cotton, and natural fiber lines. While the recession has created an environment where consumers have primarily been buying on sale, we have gained market share without resorting to mark downs and as discussed in our last call, we did not have a July clearance sales in our stores, but did hold one warehouse sales in Hamilton, Ontario.

Strategically we have delivered more value to the consumer with higher quality, more technical functionality and key features, new colors and fabrics, all without increasing prices and have reduced prices on key accessories to drive traffic while increasing availability of items such as tops for layering, to standard offerings around the $50 to $70 price point. Our strong community relationships and focus on healthy life, combined with continuous flow of well designed functional, high quality merchandise, creates a justifiable purchase even to the cautious consumer.

In Q4 of this year and into 2010 we are planning to see leverage in our sourcing in order to work back towards historical initial merchandise margin. Our yoga mat program was very successful in driving sales and accessories and traffic and our new mats are stronger margins at attractive price points are arriving in the stores now.

We opened two stores in the quarter, Walnut Creek in California and North Park Center in Dallas. Both stores have exceeded our expectations with strong openings. For the year we will open seven stores and two outlet stores. Moving into Q3, we have opened Woodbury Commons Outlet store and a new store in Coquitlam British Columbia. We have also entered the Phoenix market with our first store opening in the Biltmore with strong results.

Last quarter we announced the launch of our ecommerce site in April. After our first quarter of operation, we are pleased to report strong sales results built with grassroots marketing via our internal social media strategies and strong retail customer base. We had over 1.5 million unique visitors to the site and an average order value of around $150. As anticipated, we are also seeing strong interest in areas where we had showrooms but no stores such as Phoenix, which gives us confidence to move forward with stores in these areas.

We see our Canadian guest pre-shops the website and chooses the most convenient purchase venue, our store or website, and increasing overall traffic between the channels. The site now offers over 90% of our total SKUs so our guests can have the added convenience of being able to order almost any of our styles online.

As announced last week, we will open a new concept. ivivva athletica which will focus on active young women from 6-12. We see the market opportunity in Canada in this underserved market. We will open three stores this year, two oqoqo store conversions in BC and one in Calgary, Alberta at Market Mall where the ivivva athletica store will be built out in our former lululemon site as we will relocate to a new larger location.

With that now I will turn it over to John to go through the financial details of the quarter.

John Currie

I’ll begin by reviewing the details of our second quarter 2009 results and then I’ll provide our outlook for the third quarter. For the second quarter of fiscal 2009 total net revenue was $97.7 million up from revenue of $85.5 million in the second quarter of 2008. The increase in revenue was driven primarily by 24 net new corporate owned stores opened since Q2 2008. This more then offset the comparable store sales decline of 2% on a constant dollar basis and a weaker Canadian dollar which had the impact of reducing reported revenue by $8 million or 8%.

During the quarter we opened two corporate owned stores and closed one location. We ended the quarter with 115 total stores versus 92 a year ago, 104 which are corporate owned and 11 which are franchises included the six operating in Australia. Our corporate owned stores represented 87% of total sales or $85.1 million versus 92% in the second quarter last year or $78.3 million. Franchise and other revenues which includes wholesale, showrooms, outlets, warehouse sales, and now ecommerce sales, totaled $12.6 million or the remaining 13% of total revenue for the second quarter. Ecommerce contributed $2.8 million in this its first full quarter of operations.

Gross profit for the second quarter was $45.2 million or 46.2% of net revenue compared to $44.4 million or 51.9% of net revenue in Q2 2008. The factors contributing to this 570 basis point decline were largely the same as those impacting the gross margin in Q1 versus a year ago, including 260 basis points from the negative impact on product costs associated with the weakening of the Canadian dollar versus the second quarter 2008, 140 basis points from occupancy and depreciation de-leverage, and 350 basis points from a combination of strategic pricing initiatives as we discussed on the call last quarter, costs to air freight from our suppliers, coupled with the use of higher cost quick turn strategies, both designed to provide products to meet higher sales demand.

Lastly, we annualized some duty rebates which increased gross margin in Q2 2008. These were partially offset by 180 basis points of leverage gained from a reduction in costs associated with our production design merchandising and distribution departments. These factors impacted gross margin less then in Q1 of this year where you may recall they reduced our gross margin by more then 1,000 basis points to 42.8%. This sequential quarter to quarter improvement of 340 basis points came primarily from fixed costs leverage gained from our stronger sales performance in Q2.

SG&A expenses were $30.8 million or 31.6% of net revenue compared to $28.8 million or 33.7% of net revenue for the same period last year. Our non-corporate store SG&A was higher this quarter compared to the second quarter of 2008 due to the ecommerce launch and operating expenses associated with higher revenue in our other channels. We also incurred approximately $1.5 million in one time expenses associated with the following: $1 million in legal costs associated with lease cancellation and various employment related legal matters, and $500,000 in increased depreciation related to the retirement of legacy IT systems which have now been replaced.

These expenses were offset by cost savings at our stores and at our store support center through labor, distribution, and logistic efficiencies combined with reduced discretionary expenses. In addition, the weaker Canadian dollar reduced reported Canadian SG&A costs by approximately $2 million.

Operating income for the second quarter was $14.3 million or 14.7% of net revenue, compared to $15.5 million or 18.2% of net revenue a year ago. Tax expense was $5.1 million for the second quarter or a rate of 35.6% versus 21.7% last year. Last year our tax rate was low due to the recognition of tax savings associated with the US companies NOL from prior periods. This quarter our tax expense was higher then our expected rate of 34% which is an estimate based on a blend of our statutory tax rates applicable in Canada and the US. A higher then expected portion of our income this quarter came from our US operations which are subject to higher tax rates then in Canada.

Net income was $9.2 million or $0.13 per diluted share. This compares to net income of $11.1 million or $0.16 per diluted share for the second quarter of 2008. Discontinued operations negatively impacts second quarter 2008 earnings by $1.2 million or $0.02 per diluted share. Our weighted average diluted shares outstanding for the quarter were 70.4 million the same as a year ago.

Turning to the key balance sheet highlights, we continue to generate strong positive cash flow and have a healthy working capital position and no debt. We ended the second quarter with cash and cash equivalents totaling $83.8 million. Inventory at the end of the second quarter was $46.5 million down $5.5 million or 11% from $52.1 million at the end of our fiscal 2008. The $3.1 million or 7% higher compared to the $43.4 million at the end of the second quarter 2008.

Although our total inventory is higher our average inventory per square foot has declined 22% year over year as we added 24 net new stores since Q2 2008. As Christine mentioned, we planned our inventory conservatively to be aligned with the economic climate at the start of the year as we saw demand outpace supply. We began to take some tactical steps towards building more inventory and readjusting in-flows for later in the year. Capital expenditures were $3 million in the second quarter resulting from new store build outs, existing store renovations and IT capital expenditures.

Now I’ll turn to our outlook for third quarter 2009. This guidance assumes a Canadian dollar at $0.90 US compared to an average exchange rate of $0.91 in Q3 2008. For the third quarter 2009 we expect comparable store sales will run relatively flat on a constant dollar basis compared to the third quarter of last year.

As Christine mentioned, we currently plan to open a total of seven stores during the fiscal year with four of these openings in the third quarter. We anticipate revenue for Q3 to be in the range of $95 to $100 million. Overall we expect a similar gross margin in Q3 to that of Q2. Merchandise margins are expected to improve with the change over to our fall product mix but higher occupancy costs as a percentage of sales related to new stores opening during the quarter and those scheduled to open in Q4 will contribute to de-leverage on occupancy costs. We’ll also continue to incur air freight and quick churn costs to pull product forward to meet higher demand.

For the third quarter of 2009 we expect SG&A to continue to benefit from our operating efficiencies. This will be offset by pre-opening expenses related to Q3 and Q4 lululemon and ivivva store openings. We expect earnings per share in the range of $0.11 to $0.13 per share for the quarter. This assumes a tax rate of 35% and 70.6 million diluted weighted average shares outstanding.

With that I’ll turn it over to Chip.

Chip Wilson

In summary, we love the direction of our business and we have a high degree of confidence in our business model. We offer a high quality innovative product in unique stores and ecommerce environment that excites the needs of our fitness and health conscious customers. We will continue to innovate and develop our offerings and enhance infrastructure and maximize real estate opportunities which combine to keep our customers and shareholders excited about lululemon athletica.

Our performance demonstrates we are on the right track and our strategy as we grow our company for the long term success. Now I’m going to pass it on to the amazing, Christine Day.

Christine Day

With that we’ll make it open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michelle Tan - Goldman Sachs

Michelle Tan - Goldman Sachs

I was wondering if you could give us some color on some of the key drivers of the sales improvement that you’re seeing outside of the accessories category. Also any sense of magnitude in terms of how much more aggressive you’re getting on inventory in third quarter to position for fourth quarter.

Christine Day

On the first one, we saw tremendous response to our running line. Our shorts were just flying out the window and so we were very excited about that, and I think that made us very competitive about all the layering pieces for running and that’s what we see really driving the business as well as the yoga line continues to be incredibly strong for us.

Accessories do continue to drive sales and traffic but I think in general we’re excited about is our community work that we’ve been doing has really been driving awareness as well as our social media, we really believe we’ve gotten a lift into the stores from ecommerce as well as traffic to ecommerce that’s given us a lot more presence and awareness on the internet which we think has driven sales with people pre-shopping and going in both in Canada and the States. I think what we’re most excited about is traffic and then people have really just been responding well to our product.

Inventory wise, we’re working with the factories. It takes a while to rebuild your inventories and make sure that you have the time with the factories to do that given the time length it takes. With our overall cycle being somewhere in the neighborhood of the eight months, so we’ve been rebuilding with them and that’ll happen more in Q4 then in Q3. Q3 will still be deploying quick turn process which will allow us to get additional product in which will be somewhat situational, we’ll look at what selling and bring in that product.

We have increased our base cloth so we’ll have basics available. What we said for Q3 that basically we expect it will still be flat because we did plan the business down for the year. Even chasing just gets us back to a flat situation until Q4.

Operator

Your next question comes from Lorraine Hutchinson – Banc of America/Merrill Lynch

Lorraine Hutchinson – Banc of America/Merrill Lynch

I was hoping for some more details on your secondary line, what kind of price points we should expect, which categories you expect to be prominent there and will you develop a new logo or use the lulu logo for this?

Chip Wilson

Can you repeat the question for me?

Lorraine Hutchinson – Banc of America/Merrill Lynch

I wanted to hear a little bit more about ivivva, what categories you expect to be prominent in the stores, how you expect to price and if you think you’ll put a new logo on the products or use the lulu logo?

Chip Wilson

It’ll definitely be an entirely different concept from the same marketing. The price will be about 30% less and we may even price by size so that the upper size of the 6-12 year olds doesn’t compete with the lululemon size 0 and size 2. Basically where lululemon is more of a yoga running line, this will be more about gymnastics, dance, driven maybe even equestrian type of influence. In the long run I think we’ll end up moving into the softer lines for that group because that’s the big volume but not very fashionable.

The logos are different. You recognize a lot of the reasons that the logo works for lululemon and I won’t go into details because I don’t want to tell anyone. After looking at that for 10 years we’ve developed a different logo for ivivva that will specifically for the 6-12 year old market.

Lorraine Hutchinson – Banc of America/Merrill Lynch

Any update on new store opening target for 2010?

Christine Day

At this point in time we plan on still continuing with what we disclosed last quarter which is around a 15 range. We feel comfortable that’s probably the right rebuild into the marketplace allowing our existing stores to continue to build plus citing additional new stores. We are very encouraged with the results of our strong store openings in the last quarter, which we think is very exciting.

Operator

Your next question comes from Paul Lejuez - Credit Suisse

Paul Lejuez - Credit Suisse

Can you run through some of the store metrics behind the comp how is traffic running, transactions versus average ticket and also what you saw improve during the quarter which of those metrics sounds like it might be transactions but if you could confirm that. Also just wondering if the ecommerce business is adding or dragging on earnings right now, if so, by how much?

John Currie

In terms of the comp drivers as has always been the case pricing we haven’t done much with so the driver is really traffic. Not a material change in terms of average unit retail of basket, pretty similar, the comp has just been driven by the return of traffic. In terms of ecommerce, as you’ll recall it’s an outsourced model for the most part so a lot of the costs are variable. We have very little internal G&A; we pay a variable fee to the supplier. Therefore it is accretive, it is profitable.

Paul Lejuez - Credit Suisse

Any color that you can give on the US versus Canadian trend and regional differences within the US?

Christine Day

I think we’re very encouraged by the overall results that we’re seeing. As we opened the North Park store in Dallas which historically had been one of our more challenged markets, as we’ve talked about before, sequencing our real estate strategy making sure that we’re opening in the right areas first when we hit our target demographics. We certainly did that in the North Park shopping center, saw an overall lift to the Dallas market, that combined with a lot of the operational attention we’ve paid to that market. Very encouraged even in our underperforming marketing about the rebound.

I think surprisingly making sure that in California or some of the economically distressed areas we’ve actually seen very strong business there as well, and seeing recovery across all the markets in the US. Canada has continued to be strong for us.

Paul Lejuez - Credit Suisse

From a big picture perspective on that down two constant currency can you talk which of the Canadian stores versus US performed better?

John Currie

As you know, we don’t break it out in that much detail.

Operator

Your next question comes from Edward Yruma – KeyBanc

Edward Yruma – KeyBanc

Can you talk about the performance of your new outlet store and if you’ve had to rethink your outlet strategy given your constraint on inventory?

Christine Day

No. The reason that we’ve always chosen to really what’s going to be a four corners strategy, we’ll have one ultimately in the four corners of the US so we can move product out quickly and efficiently. We very definitely say that it is our clearance merchandise; we do not buy for that channel. What’s available is what’s available which is why we report it in other and not included in our comp base or in our retail sales.

It really is just designed to clear merchandise as we need to so that we can maintain our full price strategy in the stores. It’s worked very well for us and then as you know, in Canada we use the warehouse sales and very pleased with our response that there are marketing activity as much as they are anything else to our loyal guests in Canada. We feel very comfortable with our outlet strategy and the fact that we’ve been moving more products through at full price.

Edward Yruma – KeyBanc

Can you also talk about the expenses associated with your new second concept and how significantly that will weigh on the back half results?

John Currie

There will be some G&A incurred for opening. It’ll be using round numbers less then $0.5 million.

Operator

Your next question comes from Janet Kloppenburg – JJK Research

Janet Kloppenburg – JJK Research

On the sales trends, did you see acceleration in both markets sustain as the quarter unfolded or were there inventory constraints that you can call out that may have inhibited the comps as the quarter unfolded?

Christine Day

We did see both markets respond very strongly. We probably starved the US a little bit more because of the sales trends being lower there. We definitely see that increased traffic there we could have done a better job with product in the US. That said we were very pleased with the sales and results that we’ve seen there. As we said, we’re going to lean into it and believe that we have positive momentum there.

What we really saw was when we delivered fresh new product in we saw positive comps the days that it arrived and as soon as it ran out we went back to kind of a flat. We believe that with more product we could have hit a positive comp for the quarter.

John Currie

As you know, we don’t give monthly comps but there was a definite trend. It started off okay early in the quarter, gained momentum in the middle of the quarter and then we started running thin on product towards the end.

Janet Kloppenburg – JJK Research

Now that your cost structure is lower, can you give us an idea of the kind of SG&A leverage we could expect as we go forward say if comps turned positive, could we see some significant leverage or do you think that you’ll have to start spending more to keep the business growing? How should we be thinking about the SG&A line going forward?

John Currie

As you know, we’re still running at lower sales levels then we had been and our existing G&A has the capacity to end our higher volumes. Having said that, as we look forward to renewing growth we will opportunistically add strength to the team as required. It’s a difficult answer to give you a very precise number on but still invest in renewed growth.

Janet Kloppenburg – JJK Research

A lot of the price is coming from the occupancy de-leverage so I’m wondering can you, what is the inflection point on comps to neutralize that de-leverage effect? In other words, the comps have to be up 3% in order to get the de-leverage to neutralize.

John Currie

All else being equal it’s in that 3% plus or minus range.

Janet Kloppenburg – JJK Research

When you talk about sourcing better and improved systems which should enable margins to expand, I was wondering do you see in the future your product margins moving back to where they have historically been.

Christine Day

Yes, and I think we’re very close now expect for some of the investments we’ve made in organic and some of the pricing decisions that we made. We stated earlier that we’d be working through those coming into the fall. Really starting in the fall and into early next year at this point in time we see us getting back on track early next year will all those changes that we’ve made we’ll regain the leverage in those categories. We’re very confident in our ability to manage initial gross margin on the markup. Of course the second part of that is the leverage. As we see sales momentum returning we’ll also see recovery on that.

Janet Kloppenburg – JJK Research

Of the 15 stores that are opening next year or planned to open next year, are they all lulu stores or will some of the girls stores be included in that as well?

Chip Wilson

That’s just lululemon. At this time the ivivva stores we’re doing the three and then we’ll see how those do and we’ll decide on growth after that.

Janet Kloppenburg – JJK Research

There may be more ivivva stores but that’s not slated at this time?

Christine Day

We just want to be clear, our primary focus is lululemon and we see tremendous growth opportunity. In lululemon we saw an attractive market opportunity developing and we took advantage of it with some real estate that we were transitioning anyways. We don’t want to be distracted, we do see it as a viable business opportunity that will be healthy and profitable but our main focus is still lululemon.

Operator

Your next question comes from Sharon Zackfia - William Blair & Company

Sharon Zackfia - William Blair & Company

I wanted to talk through a little bit the inventory issues that arose as the second quarter went on and how you’re looking forward to the holidays. Maybe if you could give us some more color on what kind of upside you’re building to for the fourth quarter? How much of this momentum are you preparing yourselves to capture. From a cost perspective are there any incremental costs that will be associated with the catching up process that you’re going through at this point.

John Currie

What you’re already seeing, you saw in Q2, and it’s in our guidance for Q3 and to some extent Q4 is the cost of catching up, air freight and utilizing our quick turn strategies there are costs associated with that, hopefully diminishing later in the year and certainly into next year. That continues to be a factor.

In terms of how much upside, that would almost constitute guidance.

Sharon Zackfia - William Blair & Company

You’re in an interesting position because your sales trends have started to improve. Essentially you’re going to have to make a bet as to how you want to plan for the inventories for the holidays or how are you assessing the risk of maybe building inventories to capture upside versus inventory obsolescence if you can give us some insight into the thought process.

Christine Day

Let me talk about the thought process without giving guidance because John will kick me under the table if I try to do that. What we’ve done is we’ve increased orders for Q4 and we’ve done it in what we think are the healthiest products. Historically we’ve run out of running in the December, for gift giving which typically most people start training in January for the marathons and the running season.

What we’ve done is we’ve decided to bring those modules that we had for the first set which we were planning on doing earlier in January into the December period so that we have that product available to draw and if sales momentum doesn’t materialize we can move the running products back into that January. It will increase our inventories in the December period but we feel it’s a very low risk strategy because it’s still fresh and our highest demand product that we have.

Sheree Waterson

I’m really pleased because of the supply chain planning that we’ve done that we’ve been actually able to backfill into Q4 so that we can approach a healthier situation which we think will be closer to the increased demand that we’re seeing. Also as Christine said, we have running modules that we’ve actually planned to bring in, in December so our mix is looking healthier then it has before. I’m really pleased with the response that we’ve been actually able to have.

Finally, we have a gift giving strategy in Q4 that we plan for that is different then what we’ve done in the past that should assist not only our inventories but meeting some of the demand that we left on the table prior.

Sharon Zackfia - William Blair & Company

When should we start to see the inventories build, will that start happening towards the end of the third quarter, or is it really going to be more November.

John Currie

Yes, you’ll see higher per square foot or however you want to measure it, you’ll see higher inventories Q3.

Operator

Your next question comes from Liz Dunn - Thomas Weisel

Liz Dunn - Thomas Weisel

You talked about returning to historic merchandise margins. What can you do with reported gross margins, where can you get back to if currency is stable at these levels? I’m assuming that you probably can’t get back to historic levels of reported gross margin with currency at these levels or can you? Where are you planning currency in your Q3 assumptions? Then I also have a question about the 15 stores you plan to open next year. Can you talk about which markets you’ll be addressing?

John Currie

In terms of talking about gross margin we should break into the buckets as Christine mentioned we still expect to get back to our traditional merchandise margin by 2010. Currency, in Q1 it was the biggest impact and as you’ll recall it was over 300 basis points negative to our gross margin. The Canadian dollar has rebounded about half of what it lost.

Even though you didn’t see that come through immediately in Q2 that’s because it takes an inventory turn to show the benefit. If the Canadian dollar stayed at $0.90 again its half way back from where it was so you’d think we’d gain back 150 basis points from what we lost in Q1 which was the 300. Again, you saw very, very little of that coming through in Q2.

The last piece is the occupancy and depreciation it comes back with volume, it also comes back as we sign new leases at more attractive lease rates relative to revenue targets. That will come back over time.

Liz Dunn - Thomas Weisel

Where are you planning it for 3Q, what’s your assumption?

John Currie

The guidance assumes the Canadian dollar is at $0.90, it is where it was last year.

Christine Day

We will primarily focus on continued infill our strongest markets and still pretty much a costal strategy. We’ve got a lot of opportunity filling in, in the Northeast corridor which we’ll focus on, as well as the Northwest. You won’t see us stretching into too many new markets next year. We’ll continue feeding those markets as we have in the past but really hitting the demand and the higher volume, higher density markets will be our strategy for next year.

Operator

Your next question comes from Barbara Gray – Odlum Brown

Barbara Gray – Odlum Brown

Can you tell us what sales per square foot were this quarter versus a year ago? How many ambassadors are you up to? With ivivva, if it is a success do you plan to add the brand to the existing lulu stores or create stand alone stores and what do you think could be the potential target of stores?

John Currie

On the sales per square foot, in the comp base the sales per square foot this quarter were $1,328 per square foot. I actually don’t have last year’s number in front of me.

Barbara Gray – Odlum Brown

Would it be higher or lower then last year?

John Currie

I’m guessing that’s a bit lower, which you’d expect even without the economic downturn because we’ve added so many new stores in newer markets.

Christine Day

For the ivivva, as Chip stated it’s absolutely a stand alone concept. We are not into mommy and me mini outfits, against lululemon. We don’t see it being integrated into our existing store line in any way, shape or form. It really has its own strategy. We do see it a little bit more mall based as opposed to the stand alone street concepts that we have with lululemon. Again, run very separately with its own strategy for stand alone success in the marketplace addressing that target guest, compared to lululemon which has its own strategy as well.

Barbara Gray – Odlum Brown

The number of ambassadors you’re at now?

Christine Day

I don’t know the number off the top of my head. We have been growing the number of ambassadors across as well as increasing the amount of yoga classes we offer. We’ll have to get back to you with that number.

Operator

Your next question comes from Howard Tubin - RBC Capital Markets

Howard Tubin - RBC Capital Markets

On gross margin, the piece of the decline related to the strategic price reductions you guys took, is that just carry over from what you did in the first quarter, did you take any other price or anything new in the second quarter?

John Currie

No, it’s really just a continuation of the same strategy which was give or take 200 basis points of the decline.

Operator

Your next question comes from Laura Champine - Cowen 

Laura Champine - Cowen 

Using the 10-Q that you published this morning it looks like your ecommerce business must be almost grotesquely profitable. Am I reading that right with your operating margin from your other division and is that a sustainable level of profitability?

John Currie

Ecommerce is a very high margin even through we had a healthy payment to our outsourcing partner. It is a healthy margin to ecommerce.

Christine Day

Remember we don’t allocate any internal costs to that they’re all borne in our retail unit, at the operating margin level.

Operator

Your next question comes from Dana Telsey – Telsey Advisory Group

Dana Telsey – Telsey Advisory Group

Given the sales trends showing such nice signs of improvement how do you see your customer changing, whether its age, frequency, men’s business, and the difference between ecommerce and retail? As you think about long term operating margin potential of the business given the new cost structure that you have and what’s been going on in the real estate world, how do you see it, is this a 25% operating margin business in the future, how do you look to it?

Christine Day

We see just generally increased traffic. We see the guests relatively staying the same as we’ve discussed in the past and I think that’s the strength of the fact that we’ve trued up our real estate strategy width. Our guest strategy and who we attract and when so I think we’re seeing a nice cross section of our target guests plus building that bandwidth guest that we’ve talked about in the past. Generally growing in appeal and awareness through our community efforts. That’s what we’re excited about is it does have strong appeal but we’re staying right in that target guest that we’ve been looking for which we think is the healthiest for the brand.

John Currie

In terms of operating margin, I’m glad you said long term because I don’t want to give nearer term guidance. Over time certainly we see the gross margin potential getting back over 50%. I think we hit a high of about 53%. In excess of 50% over time is possible. With SG&A leverage we do think if you ignore growth expenditures this continues to be a business that can be in excess of 20% operating margin. From that of course you deduct what you spend on growth. Our targets are to run at a 20% operating margin which is really what we’ve always targeted.

Christine Day

You also asked about ecommerce, what we’re seeing there is we’re tracking unique new guests plus loyal guests and both in ecommerce and in the stores we see our most loyal guest shops us weekly and she’s always popping in for what’s new. I think that’s the other thing we’re pretty excited about is we see tremendous loyalty once somebody adopts the product, they really stay with us and becomes a big part of their wardrobe which is very exciting for us.

Dana Telsey – Telsey Advisory Group

Do you see introducing new categories over the next year or making some categories bigger or smaller?

Christine Day

Clearly running has become enormous for us. We do see making more of the pipe growing in that direction but really staying focused on the healthy yoga business which for us is the big end we have to stay focused on that core market. We’re seeing really nice response to the organic lines so I think that gives us both the yin and yang of yoga meaning that we have the soft kind of natural line plus we have the high performance line and that’s been really well responded to and brought back a lot of things the traditional yoga shopper to us which has really strengthened that line.

We definitely see both of those platforms continuing to be our mainstay and I don’t think we need a lot of innovation to entice people in other then the work we’re doing with style function and design within those product lines.

Operator

Your next question comes from Richard Jaffe - Stifel Nicolaus

Richard Jaffe - Stifel Nicolaus

I was impressed with the ability to chase, to replenish as sales started to accelerate. I was wondering if you could give us a little bit more insight in how that works. Obviously there were some air freight costs involved but could you describe more about perhaps piece goods that were in reserve or production time that was made available how you were able to respond to the market, accelerate your response time, and your inventory turns. Obviously a key facility this quarter and probably going forward.

Sheree Waterson

We’re really pleased again with the speed that you just mentioned that we were able to respond to our demand. There is no speed without planning and so what we’ve done with our manufacturers is done some really smart raw materials planning so that we could rapidly turn out of Asia as well as looked at some core strategies where we’re actually able to have garments that are readily available to pull at any point.

In addition to that we actually have a local strategy here where we’re producing some goods in Canada. With all these things running in parallel and our ability to pull forward these modules that Christine has talked about has allowed us to really respond.

Operator

There appears to be no additional questions at this time. I’ll turn the conference back over to our speakers for any additional or closing remarks.

Christine Day

Thanks everybody for joining us this morning and we’re very excited about our business momentum and I think our positioning in the overall market and the way that we’ve been able to hold on to the values of the organization and to really build our business in a time that was very challenging for most retailers and very optimistic because of that as the future of the company.

Operator

This concludes today’s conference call. Thank you for your participation.

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Source: lululemon athletica inc. Q2 2009 Earnings Call Transcript
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