lululemon athletica, Inc. F3Q09 (Qtr End 11/01/09) Earnings Call Transcript

lululemon athletica, Inc. (NASDAQ:LULU) F3Q09 Earnings Call December 9, 2009 4:30 PM ET

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
Paul Lejuez - Credit Suisse
Edward Yruma – KeyBanc
Lorraine Hutchinson – Banc of America/Merrill Lynch
Liz Dunn - Thomas Weisel
Janet Kloppenburg – JJK Research
Howard Tubin - RBC Capital Markets
Barbara Gray – Odlum Brown
Jennifer Black – Jennifer Black and Assoc.
Laura Champine - Cowen

Operator

Welcome to the lululemon athletica third quarter earnings results conference call. (Operator Instructions) Now for opening remarks and introductions, I would like to turn the conference over to your host, Jean Fontana with ICR.

Jean Fontana

Thank you. Good afternoon. Thank you for joining lululemon athletica’s conference call to discuss third 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 and John Currie, the company’s Chief Financial Officer.

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 Jean and good afternoon everyone. Thank you for joining us to discuss our third quarter results. With me today are John Currie, our CFO and Sheree Waterson, EVP General Merchandise Manager. Following my opening remarks, I will turn the call over to John who will go through the financial details of the quarter.

Our third quarter performance demonstrates wins in three significant areas. The first is positive comps of 10% for the quarter highlighting our growing sales momentum in both the Canadian and US stores, a return to healthy gross margin levels of almost 50% driven by our supply chain and product mix initiatives and the successful second quarter of our new e-commerce business which delivered $4.2 million in revenue for the quarter.

Looking at what is driving revenue it is important to state that we achieved our sales results without increasing our promotional cadence. The guest is truly responding to our unique product assortment and guest experience. Our focus on new colors and styles delivered weekly creates the scarcity model that drives an immediate guest purchase. This focus combined with an upbeat staff and store environment have proven over and over to be a winning formula.

Our yoga line remains a core revenue driver. Wins include the introduction of increased choices of technical fabric in our tank line and a new, hot yoga line. We also continue to have an incredible reaction to our running line with an expanded line of crop, shorts and outerwear and our running skirt was a runaway hit. Our men’s business continues to grow with new product introductions such as our ripped compression line, more color and technical cloth. Our natural fabric line also continued to perform nicely.

E-commerce now carries our full line of products and we introduced free shipping in October. This drove increased traffic and conversion rates across North America. We continue to enhance the look, feel and performance of our site and to build our online community. To give you a sense of our online presence, lululemon is mentioned every 17 seconds online.

While John will speak to gross margin in detail, as a reminder we took some unique steps over the past year to position our business for the recession without turning to traditional promotions. Basically we added more value to our products such as technical functionality and other key features as well as new fabrics, all without increasing prices. This resulted in helping our sales in the first half of the year but pressuring our gross margin. We also focused our merchandising efforts on pieces that were certain strong selling price points such as layering pieces within our running line and reduced price on some key accessories to drive traffic.

Our focus on sourcing and supply chain initiatives as well as adding value for the guest have paid off with increased sales providing leverage on depreciation and occupancy while supply chain initiatives improved our initial product margins.

As our store managers increase their tenure with the company it has increased our capacity to drive results in sales and profit but it has also enabled us to become more connected to the communities we serve; both our guests with complementary classes and events and our ambassadors in the fitness community. We continue to see a focus on healthy living particularly in the US where the healthcare debate keeps the cost of healthcare top of mind for consumers.

Now looking at the quarter our 10% same store sales comparison in the third quarter was our first positive result since the third quarter of last year. It was driven by positive results in both Canada and the US with the US being very strong, especially in the new stores that opened in Q3 of last year as they opened during the worst period of the recession. We continue to leverage our control of the supply chain provided by our new systems and business process to pull inventory forward in order to meet our growing demand.

Our inventory is in very good shape for the fourth quarter. We finished Q3 with total inventory up 6% placing us in great inventory position heading into the holiday season. While we are utilizing air freight as needed, overall improvements in the gross margin due to sourcing initiatives and supply chain initiatives offset much of the impact to gross margin which we have historically felt when we utilized air freight. Also we will be bringing in March and April inventories in early this year due to the Chinese New Year which falls three weeks later in February, affecting shipments for the first quarter. This also allows us to meet additional demand in the fourth quarter without running the risk of having excess fall/winter goods.

Looking ahead to 2010 we are looking to open up to 15 new stores and again we will be filling in our existing markets. Primarily in our markets in the US. We have now opened our first three initial ivivva athletica stores. As a reminder, this new concept will focus on active young women from 6-12 years old. Initial results tells us we have a winning concept and we will continue to develop and refine the model over the next few quarters.

In addition, we have made the strategic decision to intensify our use of showrooms as not only a brand awareness builder and [bell weather] for new markets but as a source of incremental revenue growth, mostly via our e-commerce site. The success of this strategy has demonstrated to us clear wins in store sales, increased return on investment and reduction of mistakes or under producing stores, especially important in an uncertain economic environment.

Showrooms also allow us to increase our human capital which is our biggest growth constraint. We currently have 13 showrooms open and we are now planning to open an additional 25 by the end of the first quarter and possibly more showrooms later in the year. We remain confident in our long-term potential to have 300 stores and feel the right strategy is to focus on the right locations, strong execution and strong results outweighing a focus on store count. We want to ensure new stores are well thought out and in locations where we have seeded the brand and tested demand. We expect the showrooms to pay for themselves from limited hours of operation while also using them for local community outreach with the added potential to drive business to our e-commerce site.

Our strategy is to have enough showrooms to seed the market for up to two years in advance and to harvest the strongest market producers against our target store list. Finally, while we have strongly controlled our SG&A spend over the past year, we want to note that due to the rapid increase in store sales our labor investment has lagged resulting in some unnatural leverage. In order to maintain the exceptional store experience that our guests are accustomed to, we will be making additional investments in labor in the fourth quarter to catch up. However, Q4 is also a quarter with high sales so the investment will be more apparent in Q1 of the next year.

With great pleasure I now turn the call over to John to go through the details of our financial results.

John Currie

Thanks Christine. I will begin by reviewing the details of our third quarter 2009 results and then I will provide our outlook on the fourth quarter.

For the third quarter fiscal 2009 total net revenue was $112.9 million up 29.7% from revenue of $87 million in the third quarter of 2008. The increase in revenue was driven by comparable store sales increase of 10% on a constant dollar basis, the addition of eight new corporate owned stores open since Q3 of 2008, a stronger Canadian dollar which had the effect of increasing reported revenues by $800,000 or 0.7%, and the addition of e-commerce operations which contributed revenues of $4.2 million in Q3.

During the quarter we opened four corporate owned stores and two stores in our Australia joint venture. We also closed the two Ococo branded locations which have since been reopened as ivivva stores in Q4 2009. We ended the quarter with 119 total stores versus 107 a year ago; 106 which are corporate owned and 13 which are franchises including the eight now operating in Australia.

Our corporate owned stores represented 87% of total revenue or $98.1 million versus 89% or $77.6 million in the third quarter of last year. Franchise and other revenues which includes wholesale, showroom, outlet, warehouse sales and now e-commerce sales totaled $14.8 million for the remaining 13% of revenue for the third quarter.

Gross profit for the third quarter was $56.3 million or 49.9% of net revenue compared to $41.9 million or 48.1% of net revenue in Q3 2008. The primary factors contributing to this 108 basis point increase in gross margin were merchandise margin improvement of 110 basis points which was driven by improved sourcing on our fall merchandise and reduced mark downs. These cost reductions were partially offset by air freight costs incurred throughout the quarter to keep pace with stronger than expected sales demand.

Leverage on non-merchandise costs such as occupancy, depreciation, design and production costs coupled with efficiencies in distribution expenses contributed 180 basis points of improvement. These improvements were partially offset by a 120 basis point negative impact from a lower Canadian dollar. Remember there is a time lag of 1-2 quarters as the impact of currency fluctuations works its way through cost of sales over inventory turns. Therefore the impact seen in this Q3 actually reflects a weaker Canadian dollar during the first half of 2009. This may seem ironic as in fact the Canadian dollar has continued to strengthen and at 93 cents in Q3 was stronger than the 91 cent average in Q3 2008.

Overall we are pleased with the sequential quarter-to-quarter improvement in the three main buckets which contributed to our gross margin decline earlier this year. Namely merchandise margin, occupancy and depreciation and foreign exchange. We are very pleased to have achieved a return to our healthy, historical gross margins in the 50% range.

SG&A expenses were $35.4 million or 31.4% of net revenues compared to $28.8 million or 33.2% of net revenue for the same period last year. The increase in SG&A dollars was due to the following; an increase in store payroll and administrative fees and costs associated with new stores and our e-commerce business, higher professional and legal fees primarily associated with ongoing litigation including legal settlement costs, higher depreciation associated with IT projects placed into service during the quarter, higher management incentive based compensation and the higher Canadian dollar also increased SG&A by $400,000.

As a result, operating income for the third quarter was $20.9 million or 18.5% of net revenue compared to $13.1 million or 15% of net revenue a year ago. Tax expense was $6.9 million for the third quarter or a rate of 32.8% versus 33.1% last year. Based on statutory tax rates, our expected tax rate for Q3 was 35%. The lower tax rate realized this quarter is due primarily to the recognition of deferred tax assets related to a one-time true up to our 2008 tax returns.

Net income was $14.1 million or $0.20 per diluted share. This compares to net income of $8.8 million or $0.13 per diluted share for the third quarter of 2008. Our weighted average diluted shares outstanding for the quarter were 71.1 million versus 70.6 million a year ago.

Turning to the key balance sheet highlights, again this quarter we generated strong positive cash flow and ended the third quarter with cash and cash equivalents totaling $101.8 million. We continue to have a healthy working capital position and no debt. Inventory at the end of the third quarter was $52.2 million or 6.2 higher than the end of the third quarter 2008. Inventory per square foot at the end of Q3 is now down 5% from a year ago after executing some tactical steps towards building out inventory from conservative levels. We feel very good about having been able to readjust our inflows and source the inventory necessary to meet demand in the fourth quarter.

While we are on the topic of inventory levels, as a heads up and due to the planned opening of numerous showrooms early in 2010 coupled with the desire to avoid disruptions in product delivery due to the timing of Chinese New Year we are planning an increase in year-end inventory of 20-25% over year-end fiscal 2008.

Capital expenditures were $3.7 million in the third quarter resulting from new store build outs, existing store renovation and IT capital expenditures. For the year we expect capital expenditures to be approximately $13-14 million.

We will now turn to our outlook for the fourth quarter 2009. This outlook assumes a Canadian dollar of 93 to 95 cents US compared to an average exchange rate of 81 cents in Q4 2008. For the fourth quarter 2009 we expect comparable store sales will increase in mid teens on a constant dollar basis compared to the fourth quarter of last year. In the fourth quarter we have already opened a store on Rush Street in Chicago and three ivivva branded stores in Canada, which has finalized our store openings for fiscal 2009.

We expect revenues for Q4 to be in a range of $140 million to $145 million. Overall, we expect gross margin improvement in Q4 based on additional leverage on occupancy and depreciation but we expect this to be partially offset with air freight incurred to pull forward products to meet higher demand.

For the fourth quarter of 2009 we expect SG&A as a percent of sales to be below Q4 2008 due largely to increased leverage gains from positive comps and annualizing on new store openings. However, as mentioned by Christine, the rapid sales increase in the third quarter created some artificial leverage on store labor costs which we have addressed in Q4. SG&A in Q4 2009 will also be adversely impacted by the higher Canadian dollar versus Q4 of 2008.

Assuming a tax rate of 35% and 71.3 million diluted weighted average shares outstanding; we expect earnings per share in a range of $0.26 to $0.28 per share for the quarter. With that I will turn it back to Christine.

Christine Day

Thanks John. These results would not be possible without the contribution of many people. We deeply appreciate the contribution of our merchant, design and production and logistics teams along with our incredible store managers and educators. We also appreciate our shareholder’s loyalty in the turbulent retail market and really appreciate your continued interest and support for lululemon. Before I turn it over to Q&A I would like to invite Sheree Waterson to make a few comments about products.

Sheree Waterson

Thanks Christine. I would like to give a big shout out to the product and supply chain team here in Vancouver. That is design, merchandising and planning, production, logistics and distribution. A tremendous amount of cross functional hard work and dedication have gone into chasing and pulling forward over 1 million units that have allowed us to meet our guest demand. As we have said before there is no speed without planning, there are no things that are accomplished without a seamless cross-functional teamwork and there is nothing that is done without the excellent factory relationships that lululemon and the production team have established.

All of these have contributed to our excellent results and I would like to thank you all.

Christine Day

Thank you Sheree. With that operator we will turn it over for questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Michelle Tan - Goldman Sachs.

Michelle Tan - Goldman Sachs

I was wondering if you could give us any color on the progression of comp sales that you saw throughout the quarter? Also we had heard about a Hong Kong showroom. I was wondering when that opened, what you are seeing there and Christine given your prior experience in Asia can you tell us how you are thinking about that market?

Christine Day

I will start with that and then turn it over to John to do the comp cadence. We actually have had a long term relationship with Pure Yoga for several years and a couple of years ago prior to my arrival we had opened what was to be the head of international office in Asia which we closed when we closed the Japan market. Then we subsequently opened our liaison office in Hong Kong. Attached to that liaison office which we opened in the summer of last year, we opened a showroom attached to that. It is kind of product demo space and we do sell out of that space to the public but it is located on the seventh floor of an office tower. That said, the sales are kind of incredible. We don’t currently have any plans to further our international expansion beyond that additional showroom space that we have there.

John Currie

In terms of the comp trend during the quarter it definitely strengthened as the quarter progressed. As you recall in the Q2 call I was indicating flat comps and that was somewhat consistent with what we saw at the start of the quarter and then the last week of October updated guidance to something just a little below where we came in. Again that was reflecting continued strengthening of comps sequentially each month.

Michelle Tan - Goldman Sachs

On ivivva you mentioned you have confidence in it being a successful concept. Any color you can give us on what gives you that comfort?

Christine Day

We opened three stores in the last few weeks and each one had a slightly different design of the store layout. Then we have a product range we have put in the store which is very similar and initial guest response to that has been extreme. We are very pleased with the results. We feel we have to continue to refine the prototype of the store and refine the product mix and as we solidify those two we will get ready to look at it. I think the important thing is making sure we can sustain those sales results we have seen initially post holiday period and post initial launch to give us the confidence to develop the final plans for rollout. Initial response has been fantastic. A lot of very excited young girls.

Operator

The next question comes from the line of Paul Lejuez - Credit Suisse.

Paul Lejuez - Credit Suisse

If we take a longer term view I am just wondering if you can frame for us how you prioritize your initiatives? Moving faster in the US, ivivva, international and wholesale distribution as a possibility at some point and let’s say we take a five year view, how do each of those look over the next five years? Second, just thinking back to the store impairment you took, can you just remind us which stores those were and if you have seen an improvement in those stores as you have seen in the rest of the business?

Christine Day

Answering your first question first, US is still very much number one for us which is why you also see us do the push on the number of showrooms really priming the market. We have been very aggressive in what we are holding for real estate deals and we have really seen in the stores that we have opened this year enormous success when we do the showroom model right with year-one sales for the stores. We think it is really important to stay on that strategy.

E-commerce would be what I would rate number two as our other strategic opportunity and the response we have seen in that business platform particularly since we turned on the free shipping. Wholesale is a smaller opportunity. We don’t see doing it big box but we do see tremendous room for strategic improvement in how we are executing and in team sales in particular. But I think it will always still be a minor portion of the business. International and ivivva I think the big strategic decision facing the company that we are really discussing but for us it is not totally going to finish our focus on the US is whether we become multi-concept or we push international.

John Currie

Regarding last year’s impairment there is a combination of things. There are two stores included in that charge that we subsequently closed. One was Chino Hills in California and the other shops were at Highlands in Dallas. There are three stores that I recall that were actually leases signed we did not open and then there were two stores where we wrote down the tenant improvement assets on our books. Those two stores I would rather not disclose. I don’t want to taint them. But they weren’t in any one geographic region. One was in the east and one was in the west.

Paul Lejuez - Credit Suisse

Have you seen improvement in those stores?

John Currie

Yes we are seeing improvement as the economy recovers.

Operator

The next question comes from the line of Edward Yruma – KeyBanc.

Edward Yruma – KeyBanc

You talked about two headwinds to SG&A for next year; one the actual SG&A in store investments and two, the incremental showrooms you are adding. Can you provide some more clarification and how did that impact your comp leverage?

John Currie

With in store labor being the first one, as we both mentioned what we saw in Q3 was accelerating sales levels and quite frankly we just didn’t have the ability to quickly add the labor hours to provide the proper guest experience to keep pace with those sales. So what we are saying is Q4 and then again next year you shouldn’t expect to see the same leverage on store labor because part of the key to our success is the guest experience.

Christine Day

I think that said we are not predicting a deterioration. There is just an unnatural lag we didn’t want anybody to get too excited about building into models, our future leverage on that.

John Currie

What was the next question?

Edward Yruma – KeyBanc

Your increase in your showroom count.

John Currie

Showrooms again are our marketing, our pre-branding. They are our real estate due diligence and they are our management’s pipeline generator. So they generate modest sales but basically the SG&A takes them down to just about break-even. So with us really ramping up and using the showroom strategy to push forward the brand it will be leveraged on our SG&A.

Operator

The next question comes from the line of Lorraine Hutchinson – Banc of America/Merrill Lynch.

Lorraine Hutchinson – Banc of America/Merrill Lynch

Earlier in the year you had added some quality into certain of your products and taking the price points down on the yoga mats. Can you just update us on where you are in sourcing into those product improvements and if we should expect to see some gross margin lift in the first half of next year from the better sourcing?

Sheree Waterson

Our product or sourcing improvements you will see with favorable margin results for the first half of next year. We are looking at really leveraging our running line which is our most technical line because we are extending that line significantly we are going to triple the penetration next year. You will see that we will have the commensurate savings because we are leveraging our piece good buying, etc., etc. Then you asked a second question regarding yoga mats?

Christine Day

We basically worked through late fall basically introduced the new yoga mat and we are through clearing the discounted yoga mats that we have earlier in the year. Those didn’t affect the Q3 numbers. It will show in the Q4 numbers but you will see improvement in those items as well. Then we have also taken action on the hoodies. In the stores you would have seen some special edition hoodies that came through that were premium hoodies just fairly recently that evaporated. We couldn’t keep those in stock so a very nice reintroduction of the hoodies that we had been planning which also we took those back to historical margins and offset some of the hit we have taken for increasing [zippers] but not increasing price. So through some strategic initiatives we feel very comfortable we will have all of those back on track late Q4 into Q1.

Lorraine Hutchinson – Banc of America/Merrill Lynch

We have noticed you have brought in the Sigg branded water bottles and the Manduka yoga mats into the stores. I was just curious if that was more of a couple of one-offs or if we should expect branded product to play a bigger role in the stores?

Christine Day

The initiative to have Manduka and to have Sigg in our stores is actually lululemon is dedicated to providing the best in the world to our guests. When the branded lines are best in the world we will offer those to our guests until we can produce something better.

Lorraine Hutchinson – Banc of America/Merrill Lynch

Is the margin structure similar to your own brand?

Christine Day

Our own brand is actually slightly more profitable but we are responding to the guest demand.

Sheree Waterson

I think it is accessories in general tend to be lower so these are in line with our accessories margins. They wouldn’t be as high as our clothing margins.

Operator

The next question comes from the line of Liz Dunn - Thomas Weisel.

Liz Dunn - Thomas Weisel

Could you talk about how the increased online presence is driving your store business? I was also curious if you could provide some insight into the comp metrics. I know you said conversion and traffic were positive. I don’t think you have traffic counters but maybe that is a comment on transactions and what happened with average unit retail in the quarter?

Christine Day

I will talk e-commerce first. We definitely have seen e-commerce aid traffic to the stores both in the US and Canada because we see the guests pre-shopping off of the site and then going into the stores. But then because we have a scarcity model if they can’t find it at the store they run back and get it online. So we have seen it actually work both ways and as we have created more availability of the full SKU line online. That has definitely increased the number of visits that we have and we have just recently begun sending the shoulder season of items that we maybe move more quickly through in the stores a little longer on the website at full price. That has also really driven the e-commerce business. We feel very good about the cross channel synergy that we have been able to create with that combined with what I spoke to briefly, our social media strategy online creating that community experience has also really driven the business in both the stores and online as well.

Liz Dunn - Thomas Weisel

Are there any specific examples one-off that you could provide? Like you sent out some sort of email and there was an increase commensurate in the stores?

Christine Day

I think we have something pretty incredible like we don’t do promotional emails. We do product notification so we will announce when we do a new drop of a product. Our click open rate on that is something incredible like 41%. We do know the guests from Facebook spend longer on our average site the total week about 20% and the number of Facebook fans we have we are the number 17 fastest growing on number of fans on Facebook. We have over 130 of our stores and showrooms have Facebook pages. We connect with over 100,000 fans daily.

When we send out those product notifications we see average increases in sales. It can drive over $6,000 in sales when we send one of those out. So since we have gone online we have about 2,000 interactions with fans on our Facebook page each week. So the number of guests directly corresponding and looking at products. It is a pretty phenomenal community reaction.

John Currie

Your question on transaction data, we don’t have detailed traffic count information. We don’t have conversion data. Transactions are up but we don’t have a good breakdown between traffic and conversion. Also units per transaction are slightly higher and very little of our comp store increase if any comes from pricing. As has been the case typically it is transactions.

Operator

The next question comes from the line of Janet Kloppenburg – JJK Research.

Janet Kloppenburg – JJK Research

I had a couple of questions on the flow issue. I know you have increased your flows and I am wondering if that is putting any pressure on the distribution center or any logistic issues there or on the work flow for the teams in the stores and if that is driving up SG&A? I also wanted to ask a little bit about it seems to be a higher number of showroom openings and if that would be indicative of a plan perhaps to accelerate store openings in 2011?

Christine Day

I think what we want to be in a position to able to be to do is act with complete certainty and confidence against the stores that and the procurement of our number for 2011 based on the results that we have with those showrooms we are putting in place in the third quarter.

Janet Kloppenburg – JJK Research

Is that pressuring the SG&A line because you are opening more than we had thought you might?

Christine Day

In the showroom yes because that is where that shows up. I am going to let Sheree talk about the flow which is actually a good story on that side.

Sheree Waterson

Actually flow would bring down SG&A or any overhead because an even flow of goods allows the distribution center to actually take the goods, process them and direct them directly to the stores rather than put them up and later on have to take them and pull them down. The other thing that flow does is even out the workload for the stores and so the more predictable the flow the more liable they are to be able to properly schedule their work hours. This flow has really worked to the advantage of not only our operations but also to the guest experience because she is continually seeing new things from us and this also allows us to supply the correct sizes, colors, etc. on a more even basis.

Christine Day

I think the other thing that happens that I would just note, because of our ability now to forecast and to reach back farther into when the goods are shipping we can actually schedule our warehouse in DC more effectively than we have been able to in the past because they didn’t know what was coming in. Now putting in advanced allocation drop the assortment picks for the warehouse to work on over time in a future based way so we have really been able to use the system to create a tremendous amount of more efficiency at the DC.

Janet Kloppenburg – JJK Research

I was wondering how the inventory planning and flow was going in the e-commerce business. I was noticing some outages and out of stock in some products and sizes. I am just wondering, it seems like that business is ramping faster than expected and if it will be in a good inventory situation for holiday.

Christine Day

The reality is we do buy for that separately like a large store. It has significantly exceeded our expectations. We have also had to be chasing goods for the e-commerce. The reality that we are in is all channels are up so we are constantly shuffling inventory on a needed basis to all of the channels. That is creating outages occasionally in different items. There are also some we do buy shallowly on the more seasonal merchandise or special edition jackets, etc. that those are outside designs in limited amounts but really keeping in stock on the basics has been our focus.

Janet Kloppenburg – JJK Research

On the ivivva success would we maybe start to see a test of that product in the United States or some of your flagship locations in 2010? Would you consider launching the e-commerce business internationally?

Christine Day

We are basically planning on keeping ivivva a Canadian concept at this point in time and then we would probably next move on e-commerce and then see where the shipping is in the US and then make a determination what we think the demand is. Right now we want to stay focused on building out lululemon stores in the United States. We would consider and are building contingency plans now to turn international on but right now we do ship internationally for regular lululemon items and we have seen growing demand in that area. So we are taking a look at what would it take to do that. But right now we have some very basic functionality improvement site performance that we want to stay focused on before we add some additional complexity.

Operator

The next question comes from the line of Howard Tubin - RBC Capital Markets.

Howard Tubin - RBC Capital Markets

Can you tell us approximately what percentage of the consumer is made up of running and where you want to take that over the course of 2010?

Christine Day

Right now we are planning for running to be about 25% of our total penetration so it would be larger than the spend this year. Our yoga business is by far our most important as it still is our core. Running is just an addition and an actual extension of the technical wear that we do. So we would go from about the low teens to that 25% our current rate today is where we planning on being by early next year.

Howard Tubin - RBC Capital Markets

John, the inventory position at the end of the year you said up about 20-25%. Is that per foot or is that in total?

John Currie

That is in total. Again I just want to give a heads up that is planned to be that way. It is not going to be a reflection of our sales pace.

Christine Day

That is primarily due to in-transit because we have had to pull two months worth of product forward in order to have it in time because of the closure of the factories in February.

Operator

The next question comes from the line of Barbara Gray – Odlum Brown.

Barbara Gray – Odlum Brown

On ivivva, what is your strategy in terms of leveraging your existing infrastructure in terms of sourcing, IT and your employee base? Then second, on the winter Olympics I know you aren’t the official sponsor but how many of the elite ambassadors do you have will be competing in the Olympics and do you have a strategy to capitalize on this event?

Christine Day

Not that I could tell you out loud. I think it is 18 athletes that are our elite ambassadors that would be competing in the Winter Olympics. For ivivva they have a small operating team that runs the day-to-day operations of the business and the merchandise planning. That is less than five people. Then we leverage the remaining infrastructure from the other departments. All told the impact on the business is probably 4-5 people full time.

Operator

The next question comes from the line of Jennifer Black – Jennifer Black and Assoc.

Jennifer Black – Jennifer Black and Assoc.

You have really done a great job with the jackets. The lengths seem to be more democratic and flattering. I wonder what we should expect to see with your jackets over the next several quarters as far as styling and then I have a follow-up question.

Christine Day

Shout out to the design team for that. We spend an inordinate amount of time actually fitting our garments and we use best in the world fabrics which is one of the reasons that they fit. In terms of our silhouettes I think part of the magic going forward of our mix is going to be that we provide long silhouettes for leggings so that you can outfit long over lean. We also have shorter, more slimming jackets that look great in front of our groove pants and then we have something in between. I think it is about the mix because no woman wants to dress the same way every time for her workouts and we have found this is sort of a magic formula. In addition we provide all of the layering pieces that are just a softer line so that they get the right outfit. So that is part of the magic.

Jennifer Black – Jennifer Black and Assoc.

Can you talk about your store associates? Do you have different incentive programs? Have you made any changes? Do you plan to compensate your employees who order product from the Internet or another store? Anything about that would be great.

Christine Day

We have enriched and created more upside in our store educator and store manager programs and really created by increasing the base for our core managers in this uncertain economic time while at the same time giving them some upside on the stretch. That has worked very well for us. For the e-commerce we are not yet integrated to the store point of sale. As you probably know that is also a complicated situation with landlords in terms of wanting a percentage of sale, etc. etc. So we have chosen to take a portion of the e-commerce sales and increase our staff rewards so they do participate in the benefit of the e-commerce business.

Operator

The next question comes from the line of Laura Champine – Cowen.

Laura Champine - Cowen

A quick housekeeping, the ivivva stores are converted stores so the net new store count is one store for Q4. Is that right?

John Currie

In Q2 it was minus two because we closed the two Ococo stores and then we are opening…sorry, Q3 we closed those two and we are opening those two and one more ivivva in Q4.

Laura Champine - Cowen

As we get into next year I know there are a ton of moving parts but can you tell us generally what your thinking is will gross margins be up or down? Will your SG&A rate be up or down next year versus this year?

John Currie

You are not looking for 2010 guidance, right? Very broadly, as we have seen the last couple of quarters our merchandise margins are getting back to their historical levels. I think we see a little bit of potential improvement as we head into 2010. Sheree talked about getting to critical mass on the run line and other things like that. I think the Canadian dollar if it continues at its current level there is a little bit of returned leverage that we lost last year that has still not flowed through. So those are the high level comments on gross margin. Of course if we are seeing a strong economy and strong sales there is of course leverage on occupancy, depreciation and other.

SG&A is maybe a tougher on. We have indicated already there is a need to invest more in store labor. You are going to see that in Q4 and that will carry on next year. Beyond that it is too early to comment on SG&A increases or investments in growth that are going to come next year. As we have addressed in a previous call, the showroom strategy will add to our SG&A as a percentage of revenue but that is just fine because it is laying the groundwork for future growth.

Operator

That does conclude today’s question and answer session. Now for closing remarks I would like to turn the conference back over to Christine Day. Please go ahead.

Christine Day

We would like to thank you all for joining us here today. We are cautiously optimistic about Q4. We look forward to our next call with all of you. Thank you very much.

Operator

Once again this does conclude today’s conference call. We thank you for your participation.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Dalton Chandler – Needham & Company.