As filed with the Securities and Exchange Commission on April 30, 2007

Registration No. 333-       

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

 

 

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

 

 

 

 

 

 

2285 Clark Drive

Vancouver, British Columbia

Canada, V5N 3G9

(604) 732-6124

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

 

 

Lululemon Corp.

c/o PHS Corporate Services, Inc.

1313 North Market Street, Suite 5100

Wilmington, DE 19801

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)

 

 

 

 

Approximate date of commencement of proposed sale to the public:   As soon as practicable after the effective date of this Registration Statement.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.   o

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o              

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o              

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o              

 

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.   o

 

 

 

 

 

EXPLANATORY NOTE

 

This registration statement contains two forms of prospectus: one to be used in connection with the offerings of the securities described herein in the United States (the U.S. Prospectus), and one to be used in connection with the offering of such securities in Canada (the Canadian Prospectus). The U.S. Prospectus and the Canadian Prospectus are identical except for the cover page, the table of contents, page 142, page 143 and the back page, and except that the Canadian Prospectus includes a “Certificate of Lululemon,” a “Certificate of the Canadian Underwriters” and “Auditors’ Consent.” The form of the U.S. Prospectus is included herein and is followed by the alternate pages to be used in the Canadian Prospectus. Each of the alternate pages for the Canadian Prospectus included herein is labeled “Alternate Page for Canadian Prospectus.”

 

 

 

[ALTERNATE PAGE FOR CANADIAN PROSPECTUS]

 

A copy of this preliminary prospectus has been filed with the securities regulatory authorities in each of the provinces and territories of Canada but has not yet become final for the purpose of the sale of securities. Information contained in this preliminary prospectus may not be complete and may have to be amended. The securities may not be sold until a receipt for the prospectus is obtained from the securities regulatory authorities.

 

This prospectus has been filed under procedures in each of the provinces and territories of Canada that permit certain information about these securities to be determined after the prospectus has become final and that permit the omission of that information from this prospectus. The procedures require the delivery to purchasers of a supplemented PREP prospectus containing the omitted information within a specified period of time after agreeing to purchase any of the securities. All disclosure contained in a supplemented PREP prospectus that is not contained in this prospectus will be incorporated by reference into this prospectus as of the date of the supplemented PREP prospectus.

 

No securities regulatory authority has expressed an opinion about these securities and it is an offence to claim otherwise. This prospectus constitutes a public offering of these securities only in those jurisdictions where they may be lawfully offered for sale and therein only by persons permitted to sell such securities. The Company has filed a Registration Statement on Form S-1 with the U.S. Securities and Exchange Commission, under the United States Securities Act of 1933, as amended, with respect to these securities.

 

PRELIMINARY BASE PREP PROSPECTUS

 

Lululemon Corp.

 

U.S. $

SHARES OF COMMON STOCK

 

This prospectus qualifies the distribution of shares of common stock of Lululemon Corp. Of the           shares of common stock being offered,           shares are being offered by us and           shares are being offered by certain of our stockholders (the “Selling Stockholders”).

We are offering our common stock for sale concurrently in Canada under the terms of this prospectus and in the United States under the terms of a registration statement on Form S-1 filed with the U.S. Securities and Exchange Commission. Our common stock is being offered in Canada by Goldman Sachs Canada Inc., Merrill Lynch Canada Inc., Credit Suisse Securities (Canada) Inc., UBS Securities Canada Inc. and CIBC World Markets Inc. (the “Canadian Underwriters”) and in the United States by Goldman, Sachs & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Credit Suisse Securities (USA) LLC, UBS Securities LLC, William Blair & Company, L.L.C., CIBC World Markets Corp., Wachovia Capital Markets, LLC and Thomas Weisel Partners LLC (together with the Canadian Underwriters, the “Underwriters”).

 

 

 

[ALTERNATE PAGE FOR CANADIAN PROSPECTUS]

 

TABLE OF CONTENTS

 

 

Exchange Rate Information

 

We publish our combined consolidated financial statements in U.S. dollars. All references in this prospectus to “dollars”, “$” or “US$” are to U.S. dollars and all references to “CDN$” are to Canadian dollars, unless otherwise noted. The following table presents, in U.S. dollars, the exchange rates for the Canadian dollar, determined based on the inverse of the noon buying rate in New York City for cable transfers in U.S. dollars as certified for customs purposes by the Federal Reserve Bank of New York (the “noon buying rate”) for the periods indicated.

 

 

The average exchange rate is calculated using the average of the exchange rates on the last business day of each month during the applicable fiscal year. On April 25, 2007, the noon buying rate was CDN$1.00 = $0.897.

In making an investment decision, investors must rely on their own examination of the issuer and the terms of the offering, including the merits and risks involved. These securities have not been recommended by any federal or state securities commission or regulatory authority. Furthermore, the foregoing authorities have not confirmed the accuracy or determined the adequacy of this document. Any representation to the contrary is a criminal offense.

 

 

We have filed with the U.S. Securities and Exchange Commission, or the SEC, a registration statement on Form S-1 under Securities Act of 1933, as amended, or the Securities Act, with respect to the common stock offered by this prospectus. This prospectus, filed as part of the registration statement, does not contain all the information set forth in the registration statement and its exhibits and schedules, portions of which have been omitted as permitted by the rules and regulations of the SEC. For further information about us and our common stock, we refer you to the registration statement and to its exhibits and schedules. With respect to statements in this prospectus about the contents of any contract, agreement or other document, in each instance, we refer you to the copy of such contract, agreement or document filed as an exhibit to the registration statement, and each such statement is qualified in all respects by reference to the document to which it refers.

 

A copy of the registration statement and the exhibits that were filed with the registration statement may be inspected without charge at the public reference facilities maintained by the SEC in Room 1590, 100 F Street, N.E., Washington, D.C. 20549, and copies of all or any part of the registration statement may be obtained from the SEC upon payment of the prescribed fee. Information on the operation of the public reference facilities may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding registrants that file electronically with the SEC. The address of the site is http://www.sec.gov.

 

 

PROSPECTUS SUMMARY

	•	design and develop innovative athletic apparel that combines performance with style and incorporates real-time customer feedback;
	•	locate our stores in street locations, lifestyle centers and malls that position each lululemon athletica store as an integral part of its community;
	•	create an inviting and educational store environment that encourages product trial and repeat visits; and
	•	market on a grassroots level in each community, including through influential fitness practitioners who embrace and create excitement around our brand.

	•	assumes an initial public offering price of $      per share (the midpoint of the price range set forth on the front cover of this prospectus);
	•	reflects the consummation of our corporate reorganization on an assumed date of          , 2007, and (assuming an initial public offering price of $      per share) the issuance of           shares of our common stock and the issuance by Lulu Canadian Holding, Inc., our wholly owned subsidiary, of           exchangeable shares in connection therewith, as described in “Pre-Offering Transactions” included elsewhere in this prospectus;
	•	assumes the issuance of           shares of our common stock issuable upon the exchange of all of the exchangeable shares of Lulu Canadian Holding, Inc. to be outstanding as a result of our corporate reorganization;
	•	assumes the underwriters’ option to purchase additional shares in this offering has not been exercised;
	•	excludes 1,885,250 shares of our common stock issuable upon exercise of options outstanding as of the date of this prospectus under our 2007 Equity Incentive Plan at a weighted average exercise price of $1.39; and
	•	excludes           shares of our common stock reserved for future issuance under our 2007 Equity Incentive Plan.

	•	A $1.00 increase in the assumed initial public offering price of $      per share would decrease the number of shares of common stock outstanding after this offering by approximately           shares, assuming that our corporate reorganization occurs on          , 2007;
	•	A $1.00 decrease in the assumed initial public offering price of $      per share would increase the number of shares of common stock outstanding after this offering by approximately           shares, assuming that our corporate reorganization occurs on          , 2007; and
	•	If our corporate reorganization occurred five days later or earlier than the assumed date of          , 2007, the common stock outstanding after this offering would increase or decrease, respectively, by approximately           shares, assuming an initial public offering price of $      per share.

		For the Fiscal Year Ended January 31,
		2005				2006				2007
		(In thousands, except share data)
Combined consolidated statements of income:
Net revenue		$	40,748			$	84,129			$	148,885
Cost of goods sold(1)			19,448				41,177				72,903
Gross profit			21,300				42,952				75,982
Operating expenses:
Selling, general and administrative expenses(1)			10,840				26,416				52,540
Principal stockholder bonus			12,134				12,809				—
Settlement of lawsuit			—				—				7,228
Income (loss) from operations			(1,674	)			3,727				16,213
Other expenses (income)
Interest income			(11	)			(55	)			(142	)
Interest expense			46				51				47
Income (loss) before income taxes			(1,709	)			3,730				16,308
Provision for (recovery of) income taxes			(298	)			2,336				8,753
Non-controlling interest			—				—				(112	)
Net income (loss)		$	(1,411	)		$	1,394			$	7,666
Pro forma weighted average number of shares outstanding(2):
For pro forma basic earnings per share
Series A preferred stock
Common stock equivalents
Pro forma diluted earnings per share
Pro forma Series A preferred basic earnings per share(2)
Pro forma common stock equivalents basic earnings per share(2)
Pro forma diluted earnings per share(2)
Selected store data:
Number of corporate-owned stores open at end of period			14				27				41
Corporate-owned stores sales per gross square foot		$	1,328			$	1,279			$	1,411
Comparable store sales change			18	%			19	%			25	%

(1)		Includes stock-based compensation as follows:

		For the Fiscal Year Ended January 31,
		2005				2006				2007
		(In thousands)
Cost of goods sold		$	—			$	755			$	360
Selling, general and administrative expenses			—				1,945				2,470
Total		$	—			$	2,700			$	2,830

(2)		We have not computed basic and diluted earnings per share as the combined consolidated results reflect the results of two separate companies (Lululemon Corp. and LIPO Investments (Canada) Inc.), each with its own distinct and separate capital structure. As a result of our corporate reorganization, various securities (including Series A preferred stock issued by Lululemon Corp. and common stock equivalents issued by LIPO Investments (Canada) Inc.) will be exchanged for shares of our common stock based in part on the quotient of the value of accrued but unpaid dividends (which, where applicable, accrue on a daily basis until the consummation of our corporate reorganization) to our initial public offering price. We have accordingly presented pro forma earnings per share for the fiscal year ended January 31, 2007 giving effect to our corporate reorganization as if it had been consummated on the first day of that period. In addition, the outstanding stock options of the two companies will be converted into options to purchase shares of our common stock. See “Pre-Offering Transactions” and Note 11 to our combined consolidated financial statements appearing elsewhere in this prospectus.

	•	on an actual basis, derived from our audited combined consolidated balance sheet as of January 31, 2007;
	•	on a “pro forma” basis, giving effect to:

	•	the consummation of our corporate reorganization on an assumed date of          , 2007, and (assuming an initial public offering price of $      per share) the issuance of           shares of our common stock;
	•	the issuance by Lulu Canadian Holding, Inc., our wholly owned subsidiary, of           exchangeable shares in connection therewith, as described in “Pre-Offering Transactions” included elsewhere in this prospectus, and the issuance of           shares of our common stock upon the exchange of the Lulu Canadian Holding exchangeable shares; and

	•	on a “pro forma as adjusted” basis, further reflecting the sale by us of           shares of our common stock in this offering (assuming an initial public offering price of $      per share, and after deducting estimated offering expenses and underwriting discounts and commissions payable by us).

		As of January 31, 2007
										Pro Forma
		Actual				Pro Forma				as Adjusted
		(In thousands)
Combined consolidated balance sheet data:
Cash and cash equivalents		$	16,029			$	16,029			$	36,279
Working capital (excluding cash and cash equivalents)			1,180				1,180				1,180
Property and equipment, net			18,822				18,822				18,822
Total assets			71,855				71,855				92,105
Long term debt			—				—				—
Total stockholders’ equity			37,379

 

An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below together with all of the other information included in this prospectus before making an investment decision. If any of the following risks actually occurs, our business, financial condition or results of operations could materially suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.

 

Risks Related to Our Business

 

We have grown rapidly in recent years and we have limited operating experience at our current scale of operations; if we are unable to manage our operations at our current size or to manage any future growth effectively, our brand image and financial performance may suffer.

 

We have expanded our operations rapidly since our inception in 1998 and we have limited operating experience at our current size. We opened our first store in Canada in January 1999 and our first store in the United States in 2003. Our net revenue increased from $40.7 million for fiscal 2004 to $148.9 million for fiscal 2006, a compound annual increase of approximately 91.1%. Our substantial growth to date has placed a significant strain on our management systems and resources. If our operations continue to grow, we will be required to continue to expand our sales and marketing, product development and distribution functions, to upgrade our management information systems and other processes, and to obtain more space for our expanding administrative support and other headquarters personnel. Our continued growth could increase the strain on our resources, and we could experience serious operating difficulties, including difficulties in hiring, training and managing an increasing number of employees, difficulties in obtaining sufficient raw materials and manufacturing capacity to produce our products, and delays in production and shipments. These difficulties would likely result in the erosion of our brand image and lead to a decrease in net revenue, income from operations and the price of our common stock.

 

We may not be able to successfully open new store locations in a timely manner, if at all, which could harm our results of operations.

 

Our growth will largely depend on our ability to successfully open and operate new stores. Our ability to successfully open and operate new stores depends on many factors, including, among others, our ability to:

 

 

Successful new store openings may also be affected by our ability to initiate our grassroots marketing efforts in advance of opening our first store. We typically rely on our grassroots marketing efforts to build awareness of our brand and demand for our products. Our grassroots marketing efforts are often lengthy and must be tailored to each new market based on our emerging understanding of the market. Accordingly, there can be no assurance that we will be able to successfully implement our grassroots marketing efforts in a particular market in a timely manner, if at all. Additionally, we may be unsuccessful in identifying new markets where our technical athletic apparel and other products and brand image will be accepted or the performance of our stores will be considered successful. Further,

we will encounter pre-operating costs and we may encounter initial losses while new stores commence operations.

 

We plan to open a large number of stores in the near future in comparison to our existing store base and our historical rate of store launches. Of the 52 stores in operation as of April 1, 2007, 7 new stores were opened in Canada, 6 new stores were opened in the United States and 1 new store was opened outside of North America during fiscal 2006. During fiscal 2005, 13 new stores were opened in Canada, 3 new stores were opened in the United States and 1 new store was opened outside of North America. We expect to open 20 to 25 stores in fiscal 2007 and 30 to 35 additional stores in fiscal 2008 in the United States and Canada. We estimate that we will incur approximately $28.0 million to $34.0 million of capital expenditures to open these additional stores by the end of fiscal 2008. In addition, our new stores will not be immediately profitable and we will incur losses until these stores become profitable. There can be no assurance that we will open the planned number of new stores in fiscal 2007 or thereafter. Any failure to successfully open and operate new stores would harm our results of operations.

 

Our limited operating experience and limited brand recognition in new markets may limit our expansion strategy and cause our business and growth to suffer.

 

Our future growth depends, to a considerable extent, on our expansion efforts outside of Canada, especially in the United States. Our current operations are based largely in Canada. As of April 1, 2007, we had only 12 stores in the United States, 1 store in Australia and 2 stores in Japan. Therefore we have a limited number of customers and limited experience in operating outside of Canada. We also have limited experience with regulatory environments and market practices outside of Canada, and cannot guarantee that we will be able to penetrate or successfully operate in any market outside of Canada. In connection with our initial expansion efforts, especially in the United States, we have encountered increased costs of operations resulting from higher payroll expenses and increased rent expense. In connection with our initial expansion efforts outside of North America, we have encountered many obstacles we do not face in Canada or the United States, including cultural and linguistic differences, differences in regulatory environments and market practices and difficulties in keeping abreast of market, business and technical developments. We may also encounter difficulty expanding into new markets because of limited brand recognition leading to delayed acceptance of our technical athletic apparel by customers in these new markets. In particular, we have no assurance that our grassroots marketing efforts will prove successful outside of the narrow geographic regions in which they have been used in the United States and Canada. The expansion into new markets may also present competitive, merchandising, forecasting and distribution challenges that are different from or more severe than those we currently face. Failure to develop new markets outside of Canada or disappointing growth outside of Canada may harm our business and results of operations.

 

We plan to primarily use cash from operations to finance our growth strategy, and if we are unable to maintain sufficient levels of cash flow we may not meet our growth expectations.

 

We intend to finance our growth through the cash flows generated by our existing stores, borrowings under our available credit facilities and the net proceeds from this offering. However, if our stores are not profitable or if our store profits decline, we may not have the cash flow necessary in order to pursue or maintain our growth strategy. We may also be unable to obtain any necessary financing on commercially reasonable terms to pursue or maintain our growth strategy. If we are unable to pursue or maintain our growth strategy, the market price of our common stock could decline and our results of operations and profitability could suffer.

 

Our ability to attract customers to our stores depends heavily on successfully locating our stores in suitable locations and any impairment of a store location, including any decrease in customer traffic, could cause our sales to be less than expected.

 

Our approach to identifying locations for our stores typically favors street locations and lifestyle centers where we can be a part of the community. As a result, our stores are typically located near retailers or fitness facilities that we believe are consistent with our customers’ lifestyle choices. Sales at these stores are derived, in part, from the volume of foot traffic in these locations. Store locations may become unsuitable due to, and our sales volume and customer traffic generally may be harmed by, among other things:

 

 

Changes in areas around our store locations that result in reductions in customer foot traffic or otherwise render the locations unsuitable could cause our sales to be less than expected.

 

We operate in a highly competitive market and the size and resources of some of our competitors may allow them to compete more effectively than we can, resulting in a loss of our market share and a decrease in our net revenue and profitability.

 

The market for technical athletic apparel is highly competitive. Competition may result in pricing pressures, reduced profit margins or lost market share or a failure to grow our market share, any of which could substantially harm our business and results of operations. We compete directly against wholesalers and direct retailers of athletic apparel, including large, diversified apparel companies with substantial market share and established companies expanding their production and marketing of technical athletic apparel, as well as against retailers specifically focused on women’s athletic apparel. We also face competition from wholesalers and direct retailers of traditional commodity athletic apparel, such as cotton T-shirts and sweat shirts. Many of our competitors are large apparel and sporting goods companies with strong worldwide brand recognition, such as Nike, Inc. and adidas AG, which includes the adidas and Reebok brands. Because of the fragmented nature of the industry, we also compete with other apparel sellers, including those specializing in yoga apparel. Many of our competitors have significant competitive advantages, including longer operating histories, larger and broader customer bases, more established relationships with a broader set of suppliers, greater brand recognition and greater financial, research and development, marketing, distribution and other resources than we do.

 

Our competitors may be able to achieve and maintain brand awareness and market share more quickly and effectively than we can. In contrast to our “grassroots” marketing approach, many of our competitors promote their brands primarily through traditional forms of advertising, such as print media and television commercials, and through celebrity athlete endorsements, and have substantial resources to devote to such efforts. Our competitors may also create and maintain brand awareness using traditional forms of advertising more quickly in new markets than we can. Our competitors may also be able to increase sales in their new and existing markets faster than we do by emphasizing different distribution channels than we do, such as wholesale, internet or catalog sales or an extensive franchise network, as opposed to distribution through retail stores, and many of our competitors have substantial resources to devote toward increasing sales in such ways.

 

In addition, because we own no patents or exclusive intellectual property rights in the technology, fabrics or processes underlying our products, our current and future competitors are able to manufacture and sell products with performance characteristics, fabrication techniques and styling similar to our products.

 

Our business depends on a strong brand, and if we are not able to maintain and enhance our brand we may be unable to sell our products, which would harm our business and cause the results of our operations to suffer.

 

We believe that the brand image we have developed has significantly contributed to the success of our business. We also believe that maintaining and enhancing the lululemon athletica brand is critical to maintaining and expanding our customer base. Maintaining and enhancing our brand may require us to make substantial investments in areas such as research and development, store operations, community relations and employee training, and these investments may not be successful. As of April 1, 2007, our brand is sold in only 13 cities in Canada, 9 cities in the United States and 1 metropolitan area in each of Japan and Australia. A primary component of our strategy involves expanding into other geographic markets, particularly within the United States. As we expand into new geographic markets, consumers in these markets may not accept our brand image and may not be willing to pay a premium to purchase our technical athletic apparel as compared to traditional athletic apparel. We anticipate that, as our business expands into new markets and as the market becomes increasingly competitive, maintaining and enhancing our brand may become increasingly difficult and expensive. Conversely, as we penetrate these markets and our brand becomes more widely available, it could potentially detract from the appeal stemming from the scarcity of our brand. Our brand may also be adversely affected if our public image or reputation is tarnished by negative publicity. Maintaining and enhancing our brand will depend largely on our ability to be a leader in the athletic apparel industry, to offer a unique store experience to our customers and to continue to provide high quality products and services, which we may not do successfully. If we are unable to maintain or enhance our brand image our results of operations may suffer and our business may be harmed.

 

If our grassroots marketing efforts are not successful our business, results of operations and financial condition could be harmed.

 

We rely principally on grassroots marketing efforts to advertise our brand. These efforts include working with local athletes and fitness professionals chosen by us, who we refer to as ambassadors, who assist us by introducing our brand and culture to the communities around our stores. Our grassroots marketing efforts must be tailored to each particular market, which may require substantial ongoing attention and resources. For instance, we must successfully identify and retain suitable ambassadors in each of our new and existing markets. Our future growth and profitability and the success of our new stores will depend in part upon the effectiveness and efficiency of these grassroots marketing efforts.

 

Because we do not rely on traditional advertising channels, such as print or television advertisements, if our grassroots marketing efforts are not successful, there may be no immediately available alternative marketing channel for us to build awareness of our products in a manner that we think will be successful. This may impair our ability to successfully integrate new stores into the surrounding communities, to expand into new markets at all or to maintain the strength or distinctiveness of our brand in our existing markets. In addition, if our grassroots marketing efforts are unsuccessful and we are required to use traditional advertising channels in our overall marketing strategy, then we will incur additional expense associated with the transition to and operation of a traditional advertising channel. Failure to successfully market our products and brand in new and existing markets could harm our business, results of operations and financial condition.

 

Our inability to maintain recent levels of comparable store sales or average sales per square foot could cause our stock price to decline.

 

We may not be able to maintain the levels of comparable store sales that we have experienced historically. In addition, we may not be able to replicate in the United States and outside of North America our historic average sales per square foot. Our sales per square foot in stores we have opened in the United States have generally been lower than those we have been able to achieve in Canada. As sales in the United States grow to become a larger percentage of our overall sales, our average sales per square foot will likely decline. If our future comparable store sales or average sales per square foot

decline or fail to meet market expectations, the price of our common stock could decline. In addition, the aggregate results of operations of our stores have fluctuated in the past and can be expected to continue to fluctuate in the future. For example, over the past twelve fiscal quarters, our quarterly comparable store sales have ranged from a decrease of 1% in the second quarter of fiscal 2004 to an increase of 32% in the second quarter of fiscal 2006. A variety of factors affect both comparable store sales and average sales per square foot, including fashion trends, competition, current economic conditions, pricing, inflation, the timing of the release of new merchandise and promotional events, changes in our merchandise mix, the success of marketing programs and weather conditions. These factors may cause our comparable store sales results to be materially lower than recent periods and our expectations, which could harm our results of operations and result in a decline in the price of our common stock.

 

If we fail to continue to innovate and provide consumers with design features that meet their expectations, we may not be able to generate sufficient consumer interest in our technical athletic apparel to remain competitive.

 

We must continue to invest in research and development in connection with the innovation and design of our products in order to attract and retain consumers. If we are unable to anticipate consumer preferences or industry changes, or if we are unable to modify our products on a timely basis, we may lose customers or become subject to greater pricing pressures. Our operating results would also suffer if our innovations do not respond to the needs of our customers, are not appropriately timed with market opportunities or are not effectively brought to market. Any failure on our part to innovate and design new products or modify existing products will hurt our brand image and could result in a decrease in our net revenue and an increase in our inventory levels. In addition, we may not be able to generate sufficient consumer interest in our technical athletic apparel to remain competitive. Any of these factors could harm our business or stock price.

 

Our plans to improve and expand our product offerings may not be successful, and implementation of these plans may divert our operational, managerial and administrative resources, which could harm our competitive position and reduce our net revenue and profitability.

 

In addition to our store expansion strategy, we plan to grow our business by improving and expanding our product offerings, which includes introducing new product technologies, increasing the range of athletic activities our products target, growing our men’s business and expanding our accessories, undergarments and outerwear offerings. The principal risks to our ability to successfully carry out our plans to improve and expand our product offering are that:

 

 

In addition, our ability to successfully carry out our plans to improve and expand our product offerings may be affected by economic and competitive conditions, changes in consumer spending patterns and changes in consumer athletic preferences and style trends. These plans could be abandoned, could cost more than anticipated and could divert resources from other areas of our

business, any of which could impact our competitive position and reduce our net revenue and profitability.

 

We rely on third-party suppliers to provide fabrics for and to produce our products. We do not have long-term contracts with our suppliers, have limited control over them and may not be able to obtain quality products on a timely basis or in sufficient quantity.

 

We do not manufacture our products or the raw materials for them and rely instead on third-party suppliers. Many of the specialty fabrics used in our products are technically advanced textile products developed by third parties and may be available, in the short-term, from only one or a very limited number of sources. For example, our Luon fabric, which is included in many of our products, is supplied to the mills we use by a single manufacturer in Taiwan, and the fibers used in manufacturing our Luon fabric are supplied to our Taiwanese manufacturer by a single company. In fiscal 2006, approximately 85% of our products were produced by our top ten manufacturing suppliers.

 

We generally do not enter into long-term formal written agreements with our suppliers, including those for Luon, and typically transact business with our suppliers on an order-by-order basis. There can be no assurance that there will not be a significant disruption in the supply of fabrics or raw materials from current sources or, in the event of a disruption, that we would be able to locate alternative suppliers of materials of comparable quality at an acceptable price, or at all. Identifying a suitable supplier is an involved process that requires us to become satisfied with their quality control, responsiveness and service, financial stability and labor and other ethical practices. In addition, we cannot be certain that our manufacturers will be able to fill our orders in a timely manner. If we experience significant increased demand, or need to replace an existing manufacturer, there can be no assurance that additional supplies of fabrics or raw materials or additional manufacturing capacity will be available when required on terms that are acceptable to us, or at all, or that any supplier or manufacturer would allocate sufficient capacity to us in order to meet our requirements. Even if we are able to expand existing or find new manufacturing or fabric sources, we may encounter delays in production and added costs as a result of the time it takes to train our suppliers and manufacturers in our methods, products and quality control standards. Delays related to supplier changes could also arise due to an increase in shipping times if new suppliers are located farther away from our markets or from other participants in our supply chain. Any delays, interruption or increased costs in the supply of fabric or manufacture of our products could have an adverse effect on our ability to meet customer demand for our products and result in lower net revenue and income from operations both in the short and long term.

 

In addition, there can be no assurance that our suppliers and manufacturers will continue to provide fabrics and raw materials or manufacture products that are consistent with our standards. We have occasionally received, and may in the future continue to receive, shipments of products that fail to conform to our quality control standards. In that event, unless we are able to obtain replacement products in a timely manner, we risk the loss of net revenue resulting from the inability to sell those products and related increased administrative and shipping costs.

 

We do not have patents or exclusive intellectual property rights in our fabrics and manufacturing technology. If our competitors sell similar products to ours, our net revenue and profitability could suffer.

 

The intellectual property rights in the technology, fabrics and processes used to manufacture our products are owned or controlled by our suppliers and are generally not unique to us. Our ability to obtain intellectual property protection for our products is therefore limited and we currently own no patents or exclusive intellectual property rights in the technology, fabrics or processes underlying our products. As a result, our current and future competitors are able to manufacture and sell products with performance characteristics, fabrications and styling similar to our products. Because many of our competitors, such as Nike, Inc. and adidas AG, which includes the adidas and Reebok brands, have significantly greater financial, distribution, marketing and other resources than we do, they may be able

to manufacture and sell products based on our fabrics and manufacturing technology at lower prices than we can. If our competitors do sell similar products to ours at lower prices, our net revenue and profitability could suffer.

 

Our future success is substantially dependent on the continued service of our senior management.

 

Our future success is substantially dependent on the continued service of our senior management, particularly Dennis Wilson, our founder and Chairman and Chief Product Designer, as well as Robert Meers, our Chief Executive Officer. The loss of the services of our senior management could make it more difficult to successfully operate our business and achieve our business goals.

 

We also may be unable to retain existing management, technical, sales and client support personnel that are critical to our success, which could result in harm to our customer and employee relationships, loss of key information, expertise or know-how and unanticipated recruitment and training costs.

 

In addition, while we maintain a key man insurance policy for Mr. Wilson, we have not obtained key man life insurance policies on Mr. Meers or any of our other members of our senior management team. As a result, we would have no way to cover the financial loss if we were to lose the services of members of our senior management team.

 

Our senior management team has limited experience working together as a group, and may not be able to manage our business effectively.

 

Most of the members of our senior management team, including our Chief Executive Officer, Chief Financial Officer and Chief Operating Officer have been hired since December 2005. As a result, our senior management team has limited experience working together as a group. This lack of shared experience could harm our senior management team’s ability to quickly and efficiently respond to problems and effectively manage our business. If our management team is not able to work together as a group, our results of operations may suffer and our business may be harmed.

 

If we are unable to attract, assimilate and retain new team members, including store and regional managers, we may not be able to grow or successfully operate our business.

 

Our success has largely been the result of significant contributions by our employees, including members of our current senior management and product design teams. However, to be successful in continuing to grow our business, we will need to continue to attract, assimilate, retain and motivate highly talented employees with a range of skills and experience, especially at the store and regional management levels. Competition for employees in our industry is intense and we have from time to time experienced difficulty in attracting the personnel necessary to support the growth of our business, and we may experience similar difficulties in the future. These problems could be exacerbated as we embark on our strategy of opening a significant number of new stores in the United States and elsewhere over the next few years. If we are unable to attract, assimilate and retain additional employees with the necessary skills, we may not be able to grow or successfully operate our business.

 

Sales of technical athletic apparel may not continue to increase, and this could impair our ability to grow our business and achieve the level of sales necessary to support new stores.

 

We believe that continued increases in sales of technical athletic apparel will largely depend on customers continuing to demand technically advanced apparel designed for specific athletic pursuits. If the number of customers demanding technical athletic apparel does not continue to increase, if the trend towards wearing technical athletic apparel when engaged in athletic pursuits or as casual wear subsides, if the style of our technical athletic apparel falls out of fashion with customers, or if customers engaging in athletic pursuits are not convinced that our technical athletic apparel is a better choice than traditional alternatives, then we may not achieve the level of sales necessary to support new stores and our ability to grow our business will be severely impaired.

 

We are planning a replacement of our core systems that might disrupt our supply chain operations.

 

We are in the process of substantially modifying our information technology systems supporting our financial management and reporting, inventory and purchasing management, order management, warehouse management and forecasting. Modifications will involve replacing legacy systems with successor systems during the course of fiscal 2007 and fiscal 2008. There are inherent risks associated with replacing our core systems, including supply chain disruptions that may affect our ability to deliver products to our stores and customers. We believe that other companies have experienced significant delays and cost overruns in implementing similar systems changes, and we may encounter similar problems. We may not be able to successfully implement these new systems or implement them without supply chain disruptions in the future. Any resulting supply chain disruptions could harm our business, prospects, financial condition and results of operations. Although our existing systems may be satisfactory in the short term, we do not believe these systems are adequate to support our long-term growth. Thus, if we are not able to implement these new systems successfully, our business, prospects, financial condition and results of operations may suffer.

 

Problems with our distribution system could harm our ability to meet customer expectations, manage inventory, complete sales and achieve objectives for operating efficiencies.

 

We rely on our distribution facility in Vancouver, British Columbia and a distribution center located in Renton, Washington operated by a third-party vendor for substantially all of our product distribution. Our contract for the Renton, Washington distribution facility expired in February 2007 and there can be no assurance that we will be able to enter into another contract for a distribution center on acceptable terms. Currently, our operations at this facility are on a month-to-month basis and, as a result, we may lose our ability to use this facility with limited notice. Such an event could disrupt our operations. In addition, in August 2007, we are scheduled to relocate our Vancouver distribution facility to a new, larger distribution facility. Our distribution facilities include computer controlled and automated equipment, which means their operations are complicated and may be subject to a number of risks related to security or computer viruses, the proper operation of software and hardware, electronic or power interruptions or other system failures. In addition, because substantially all of our products are distributed from two locations, our operations could also be interrupted by labor difficulties, or by floods, fires or other natural disasters near our distribution centers. We maintain business interruption insurance, but it may not adequately protect us from the adverse effects that could result from significant disruptions to our distribution system, such as the long-term loss of customers or an erosion of our brand image. In addition, our distribution capacity is dependent on the timely performance of services by third parties, including the shipping of our products to and from our Renton, Washington distribution facility. If we encounter problems with our distribution system, our ability to meet customer expectations, manage inventory, complete sales and achieve objectives for operating efficiencies could be harmed.

 

Our operating results are subject to seasonal and quarterly variations in our net revenue and income from operations, which could cause the price of our common stock to decline.

 

We have experienced, and expect to continue to experience, significant seasonal variations in our net revenue and income from operations. Seasonal variations in our net revenue are primarily related to increased sales of our products during our fiscal fourth quarter, reflecting our historical strength in sales during the holiday season. We generated approximately 37% and 35% of our full year gross profit during the fourth quarters of fiscal 2005 and fiscal 2006, respectively. Historically, seasonal variations in our income from operations have been driven principally by increased net revenue in our fiscal fourth quarter.

 

Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including, among other things, the following:

 

 

 

As a result of these seasonal and quarterly fluctuations, we believe that comparisons of our operating results between different quarters within a single fiscal year are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of our future performance.

 

We began selling our products in Canada in January 1999 and in the United States in 2003. Our limited operating history makes it difficult to assess the exact impact of seasonal factors on our business or whether or not our business is susceptible to cyclical fluctuations in the economy in the markets in which we operate. In addition, our rapid growth may have overshadowed whatever seasonal or cyclical factors might have influenced our business to date. Seasonal or cyclical variations in our business may become more pronounced over time and may harm our results of operations in the future.

 

Any future seasonal or quarterly fluctuations in our results of operations may not match the expectations of market analysts and investors. Disappointing quarterly results could cause the price of our common stock to decline. Seasonal or quarterly factors in our business and results of operations may also make it more difficult for market analysts and investors to assess the longer-term profitability and strength of our business at any particular point, which could lead to increased volatility in our stock price. Increased volatility could cause our stock price to suffer in comparison to less volatile investments.

 

If we are unable to accurately forecast customer demand for our products our manufacturers may not be able to deliver products to meet our requirements, and this could result in delays in the shipment of products to our stores and may harm our results of operations and customer relationships.

 

We stock our stores based on our estimates of future demand for particular products. Our inventory management and planning team determines the number of pieces of each product that we will order from our manufacturers based upon past sales of similar products, feedback from our focus groups, sales trend information and anticipated retail price. However, if our inventory and planning team fails to accurately forecast customer demand, we may experience excess inventory levels or a shortage of products available for sale in our stores. There can be no assurance that we will be able to successfully manage our inventory at a level appropriate for future customer demand.

 

Factors that could affect our inventory and planning team’s ability to accurately forecast customer demand for our products include:

 

 

Inventory levels in excess of customer demand may result in inventory write-downs or write-offs and the sale of excess inventory at discounted prices, which would cause our gross margin to suffer and could impair the strength and exclusivity of our brand. In fiscal 2006, we wrote-off $1.0 million of inventory. We are a relatively young company and may experience significant write-offs in the future.

 

In addition, if we underestimate customer demand for our products, our manufacturers may not be able to deliver products to meet our requirements, and this could result in delays in the shipment of products to our stores and may damage our reputation and customer relationships. There can be no assurance that we will be able to successfully manage our inventory at a level appropriate for future customer demand.

 

A downturn in the economy may affect consumer purchases of discretionary items, which could materially harm our sales, profitability and financial condition.

 

Many factors affect the level of consumer spending for discretionary items such as our technical athletic apparel and related products. These factors include general business conditions, interest and tax rates, the availability of consumer credit and consumer confidence in future economic conditions. Consumer purchases of discretionary items, such as our technical athletic apparel, tend to decline during recessionary periods when disposable income is lower. Due to our limited operating history, we have not experienced a recessionary period and can therefore not predict the effect on our sales and profitability of a downturn in the economy. However, a downturn in the economy in markets in which we sell our products may materially harm our sales, profitability and financial condition.

 

We may fail to find suitable joint venture partners to expand outside North America and this may cause our growth strategy to suffer and may harm our revenue and results of operations.

 

As part of our growth strategy, we plan to expand our stores and sales of our products into new locations outside North America, particularly in the Asia-Pacific region. Our successful expansion and operation of new stores outside North America will depend on our ability to find suitable partners and to successfully implement and manage joint venture relationships. We have a joint venture with Descente Ltd. in Japan. In addition, we expect to convert our franchise in Australia into a joint venture. Failure to find sufficient or capable partners in a particular geographic region may delay the rollout of our products in that area. If we are unable to find suitable partners through joint venture relationships, our growth strategy will suffer and our revenue and results of operations could be harmed.

 

Even if we are able to find a joint venture partner in a specific geographic area, there can be no guarantee that such a relationship will be successful. Such a relationship often creates additional risk. For example, our partners in joint venture relationships may have interests that differ from ours or that conflict with ours, such as the timing of new store openings and the pricing of our products, or our partners may become bankrupt which may as a practical matter subject us to such partners’ liabilities in connection with the joint venture. In addition, joint ventures can magnify several other risks for us, including the potential loss of control over our cultural identity in the markets where we enter into joint ventures and the possibility that our brand image could be impaired by the actions of our partners. Although we generally will seek to maintain sufficient control of any joint venture to permit our objectives to be achieved, we might not be able to take action without the approval of our partners. Reliance on joint venture relationships and our partners exposes us to increased risk that our joint ventures will not be successful and will result in competitive harm to our brand image that could cause our expansion efforts, profitability and results of operations to suffer.

 

We may need to raise additional capital that may be required to grow our business, and we may not be able to raise capital on terms acceptable to us or at all.

 

Operating our business and maintaining our growth efforts will require significant cash outlays and advance capital expenditures and commitments. If cash on hand and cash generated from operations and from this offering are not sufficient to meet our cash requirements, we will need to seek additional capital, potentially through debt or equity financings, to fund our growth. We cannot assure you that we will be able to raise needed cash on terms acceptable to us or at all. Financings may be on terms that are dilutive or potentially dilutive to our stockholders, and the prices at which new investors would be willing to purchase our securities may be lower than the price per share of our common stock in this offering. The holders of new securities may also have rights, preferences or privileges which are senior to

those of existing holders of common stock. If new sources of financing are required, but are insufficient or unavailable, we will be required to modify our growth and operating plans based on available funding, if any, which would harm our ability to grow our business.

 

We are subject to risks associated with leasing retail space subject to long-term non-cancelable leases and are required to make substantial lease payments under our operating leases, and any failure to make these lease payments when due would likely harm our business, profitability and results of operations.

 

We do not own any of our stores, but instead lease all of our corporate-owned stores under operating leases. Our leases generally have initial terms of between five and ten years, and generally can be extended only in five-year increments (at increased rates) if at all. All of our leases require a fixed annual rent, and most require the payment of additional rent if store sales exceed a negotiated amount. Generally, our leases are “net” leases, which require us to pay all of the cost of insurance, taxes, maintenance and utilities. We generally cannot cancel these leases at our option. Payments under these operating leases account for a significant portion of our cost of goods sold. For example, as of January 31, 2007, we were a party to operating leases associated with our corporate-owned stores as well as other corporate facilities requiring future minimum lease payments aggregating $35.1 million through fiscal 2011 and approximately $34.7 million thereafter. We expect that any new stores we open will also be leased by us under operating leases, which will further increase our operating lease expenses.

 

Our substantial operating lease obligations could have significant negative consequences, including:

 

 

We depend on cash flow from operations to pay our lease expenses and to fulfill our other cash needs. If our business does not generate sufficient cash flow from operating activities, and sufficient funds are not otherwise available to us from borrowings under our available credit facilities or from other sources, we may not be able to service our operating lease expenses, grow our business, respond to competitive challenges or to fund our other liquidity and capital needs, which would harm our business.

 

In addition, additional sites that we lease are likely to be subject to similar long-term non-cancelable leases. If an existing or future store is not profitable, and we decide to close it, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. In addition, as our leases expire, we may fail to negotiate renewals, either on commercially acceptable terms or at all, which could cause us to close stores in desirable locations. Of our 51 stores as of January 31, 2007, no leases expire in fiscal 2007 and three leases expire in fiscal 2008. If we are unable to enter into new leases or renew existing leases on terms acceptable to us or be released from our obligations under leases for stores that we close, our business, profitability and results of operations may be harmed.

 

If we are unable to adequately demonstrate that our independent manufacturers use ethical business practices and comply with applicable laws and regulations, our brand image could be harmed due to negative publicity.

 

Our core values, which include developing the highest quality products while operating with integrity, are an important component of our brand image, which makes our reputation particularly

sensitive to allegations of unethical business practices. While our internal and vendor operating guidelines promote ethical business practices such as environmental responsibility, fair wage practices, and compliance with child labor laws, among others, and we, along with a third party that we retain for this purpose, monitor compliance with those guidelines, we do not control our independent manufacturers or their business practices. Accordingly, we cannot guarantee their compliance with our guidelines. A lack of demonstrated compliance could lead us to seek alternative suppliers, which could increase our costs and result in delayed delivery of our products, product shortages or other disruptions of our operations.

 

Violation of labor or other laws by our independent manufacturers or the divergence of an independent manufacturer’s labor or other practices from those generally accepted as ethical in Canada, the United States or other markets in which we do business could also attract negative publicity for us and our brand. This could diminish the value of our brand image and reduce demand for our merchandise if, as a result of such violation, we were to attract negative publicity. Other apparel manufacturers have encountered significant problems in this regard, and these problems have resulted in organized boycotts of their products and significant adverse publicity. If we, or other manufacturers in our industry, encounter similar problems in the future, it could harm our brand image, stock price and results of operations.

 

Monitoring compliance by independent manufacturers is complicated by the fact that expectations of ethical business practices continually evolve, may be substantially more demanding than applicable legal requirements and are driven in part by legal developments and by diverse groups active in publicizing and organizing public responses to perceived ethical shortcomings. Accordingly, we cannot predict how such expectations might develop in the future and cannot be certain that our guidelines would satisfy all parties who are active in monitoring and publicizing perceived shortcomings in labor and other business practices worldwide.

 

Parties active in promoting ethical business practices, in addition to evaluating the substance of companies’ practices, also often scrutinize companies’ transparency as to such practices and the policies and procedures they use to ensure compliance by their suppliers and other business partners. Prior to this offering, we have been a private company, and so do not have extensive experience in assembling and disclosing information on such matters as required for public companies or as may be expected by such parties. Moreover, we do not expect as a general matter to publicly disclose information that we deem competitively sensitive, except as required by law. If we do not meet the transparency standards expected by parties active in promoting ethical business practices, we may attract negative publicity, regardless of whether the actual labor and other business practices adhered to by us and our independent manufacturers satisfy substantive expectations of ethical business practices. Such negative publicity could harm our brand image and results of operations and result in a decline in the price of our common stock.

 

The cost of raw materials could increase our cost of goods sold and cause our results of operations and financial condition to suffer.

 

The fabrics used by our suppliers and manufacturers include synthetic fabrics whose raw materials include petroleum-based products. Our products also include natural fibers, including cotton. Significant price fluctuations or shortages in petroleum or other raw materials may increase our cost of goods sold and cause our results of operations and financial condition to suffer.

 

Because a significant portion of our sales are generated in Canada, fluctuations in foreign currency exchange rates could harm our results of operations.

 

Net revenue in Canada accounted for 91.5% and 87.1% of our total net revenue for fiscal 2005 and fiscal 2006, respectively. In addition to our new stores in the United States, we anticipate opening additional stores outside of North America in Japan and Australia and potentially in other countries with new joint venture partners. The reporting currency for our combined consolidated financial statements is

the U.S. dollar. The local currency of each country is the functional currency for each of our stores operating in that country. In the future, we expect to continue to derive a significant portion of our sales and incur a significant portion of our operating costs in Canada, and changes in exchange rates between the Canadian dollar and the U.S. dollar and the currencies of our foreign stores may have a significant, and potentially adverse, effect on our results of operations. Our primary risk of loss regarding foreign currency exchange rate risk is caused by fluctuations in the exchange rates between U.S. dollar and Canadian dollars, Australian dollars and Japanese yen. Due to the large percentage of our operations conducted outside the United States, strengthening or weakening of the U.S. dollar relative to one or more of the foregoing currencies could have an adverse impact on future results of operations. We have not historically engaged in hedging transactions and do not currently contemplate engaging in hedging transactions to mitigate foreign exchange risks. As we continue to recognize gains and losses in foreign currency transactions, depending upon changes in future currency rates, such gains or losses could have a significant, and potentially adverse, effect on our results of operations.

 

Our international operations and the operations of many of our suppliers are subject to additional risks that are beyond our control and that could harm our business, financial condition and results of operations.

 

We plan to expand our business into international markets and almost all of our suppliers are located outside the United States. Manufacturers in Canada, the People’s Republic of China and Taiwan produced approximately 94% of our apparel for fiscal 2006. The remaining 6% of our apparel was produced in Australia, Italy and the United States for fiscal 2006. Beginning in fiscal 2007, we expect to purchase products from manufacturers in Indonesia, Israel, Peru and Vietnam. As a result of our international operations and our international suppliers, we are subject to risks associated with doing business abroad, including:

 

 

These and other factors beyond our control could interrupt our suppliers’ production in offshore facilities, influence the ability of our suppliers to export our products cost-effectively or at all, inhibit our and our suppliers’ ability to procure certain materials and influence our ability to sell our products in international markets, any of which could harm our business, financial condition and results of operations.

 

Our ability to source our merchandise profitably or at all could be hurt if new trade restrictions are imposed or existing trade restrictions become more burdensome.

 

All of our apparel products are currently manufactured for us outside of the United States. The United States and the countries in which our products are produced or sold internationally have imposed and may impose additional quotas, duties, tariffs, or other restrictions or regulations, or may adversely adjust prevailing quota, duty or tariff levels. For example, under the provisions of the World Trade Organization, or WTO, Agreement on Textiles and Clothing, effective as of January 1, 2005, the United States and other WTO member countries eliminated quotas on textiles and apparel-related products from WTO member countries. In the beginning of 2005, China’s exports into the United States surged as a result of the eliminated quotas. In response to the perceived disruption of the market, the United States imposed new quotas, which are permitted to remain in place through the end of 2008, on certain categories of natural-fiber products that we import from China. As a result, we have expanded our relationships with suppliers outside of China, which among other things, has resulted in increased costs and shipping times for some products. Countries impose, modify and remove tariffs and other trade restrictions in response to a diverse array of factors, including global and national economic and political conditions, which make it impossible for us to predict future developments regarding tariffs and other trade restrictions. Trade restrictions, including tariffs, quotas, embargoes, safeguards and customs restrictions, could increase the cost or reduce the supply of products available to us or may require us to modify our supply chain organization or other current business practices, any of which could harm our business, financial condition and results of operations.

 

We are subject to potential challenges relating to overtime pay and other regulations that impact our employees, which could cause our business, financial condition, results of operations or cash flows to suffer.

 

Various labor laws, including U.S. federal, U.S. state and Canadian provincial laws, among others, govern our relationship with our employees and affect our operating costs. These laws include minimum wage requirements, overtime pay, unemployment tax rates, workers’ compensation rates and citizenship requirements. These laws change frequently and may be difficult to interpret and apply. In particular, as a retailer, we may be subject to challenges regarding the application of overtime and related pay regulations to our employees. A determination that we do not comply with these laws could harm our brand image, business, financial condition and results of operation. Additional government-imposed increases in minimum wages, overtime pay, paid leaves of absence or mandated health benefits could also cause our business, financial condition, results of operations or cash flows to suffer.

 

Our franchisees may take actions that could harm our business or brand, and franchise regulations and contracts limit our ability to terminate or replace under-performing franchises.

 

As of April 1, 2007, we had three franchise stores in Canada, three franchise stores in the United States and one franchise store in Australia, which we expect to restructure into a joint venture relationship. Additionally, we may open one additional franchise store in the United States pursuant to an understanding with one of our existing franchisees. Franchisees are independent business operators and are not our employees, and we do not exercise control over the day-to-day operations of their retail stores. We provide training and support to franchisees, and set and monitor operational standards, but the quality of franchise store operations may decline due to diverse factors beyond our control. For example, franchisees may not successfully operate stores in a manner consistent with our standards and requirements, or may not hire and train qualified employees, which could harm their sales and as a result harm our results of operations or cause our brand image to suffer.

 

Franchisees, as independent business operators, may from time to time disagree with us and our strategies regarding the business or our interpretation of our respective rights and obligations under applicable franchise agreements. This may lead to disputes with our franchisees, and we expect such disputes to occur from time to time, such as the collection of royalty payments or other matters related to the franchisee’s successful operation of the retail store. Such disputes could divert the attention of our

management and our franchisees from our operations, which could cause our business, financial condition, results of operations or cash flows to suffer.

 

In addition, as a franchisor, we are subject to Canadian, U.S. federal, U.S. state and international laws regulating the offer and sale of franchises. These laws impose registration and extensive disclosure requirements on the offer and sale of franchises, frequently apply substantive standards to the relationship between franchisor and franchisee and limit the ability of a franchisor to terminate or refuse to renew a franchise. We may therefore be required to retain an under-performing franchise and may be unable to replace the franchisee, which could harm our results of operations. We cannot predict the nature and effect of any future legislation or regulation on our franchise operations.

 

Our failure or inability to protect our intellectual property rights could diminish the value of our brand and weaken our competitive position.

 

We currently rely on a combination of copyright, trademark, trade dress and unfair competition laws, as well as confidentiality procedures and licensing arrangements, to establish and protect our intellectual property rights. We cannot assure you that the steps taken by us to protect our intellectual property rights will be adequate to prevent infringement of such rights by others, including imitation of our products and misappropriation of our brand. In addition, intellectual property protection may be unavailable or limited in some foreign countries where laws or law enforcement practices may not protect our intellectual property rights as fully as in the United States or Canada, and it may be more difficult for us to successfully challenge the use of our intellectual property rights by other parties in these countries. If we fail to protect and maintain our intellectual property rights, the value of our brand could be diminished and our competitive position may suffer.

 

Our trademarks and other proprietary rights could potentially conflict with the rights of others and we may be prevented from selling some of our products.

 

Our success depends in large part on our brand image. We believe that our trademarks and other proprietary rights have significant value and are important to identifying and differentiating our products from those of our competitors and creating and sustaining demand for our products. We have obtained and applied for some U.S. and foreign trademark registrations, and will continue to evaluate the registration of additional trademarks as appropriate. However, we cannot guarantee that any of our pending trademark applications will be approved by the applicable governmental authorities. Moreover, even if the applications are approved, third parties may seek to oppose or otherwise challenge these registrations. Additionally, we cannot assure you that obstacles will not arise as we expand our product line and the geographic scope of our sales and marketing. Third parties may assert intellectual property claims against us, particularly as we expand our business and the number of products we offer. Our defense of any claim, regardless of its merit, could be expensive and time consuming and could divert management resources. Successful infringement claims against us could result in significant monetary liability or prevent us from selling some of our products. In addition, resolution of claims may require us to redesign our products, license rights from third parties or cease using those rights altogether. Any of these events could harm our business and cause our results of operations, liquidity and financial condition to suffer.

 

We currently own the exclusive right to use various domain names containing or relating to our brand. We may be unable to prevent third parties from acquiring and using domain names that infringe or otherwise decrease the value of our trademarks and other proprietary rights. Failure to protect our domain names could adversely affect our brand, and make it more difficult for users to find our website.

 

We will incur significant expenses as a result of being a public company, which will negatively impact our financial performance and could cause our results of operations and financial condition to suffer.

 

We will incur significant legal, accounting, insurance and other expenses as a result of being a public company. The Sarbanes-Oxley Act of 2002, as well as related rules implemented by the SEC and

the securities regulators in each of the provinces and territories of Canada and by The Nasdaq Stock Market LLC, have required changes in corporate governance practices of public companies. We expect that compliance with these laws, rules and regulations, including compliance with Section 404 of the Sarbanes-Oxley Act as discussed in the following risk factor, will substantially increase our expenses, including our legal and accounting costs, and make some activities more time-consuming and costly. We also expect these laws, rules and regulations to make it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as officers. As a result of the foregoing, we expect a substantial increase in legal, accounting, insurance and certain other expenses in the future, which will negatively impact our financial performance and could cause our results of operations and financial condition to suffer.

 

Failure to maintain adequate financial and management processes and controls could lead to errors in our financial reporting, which could harm our business and cause a decline in our stock price.

 

Reporting obligations as a public company and our anticipated growth are likely to place a considerable strain on our financial and management systems, processes and controls, as well as on our personnel. In addition, as a public company we will be required to document and test our internal controls over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 so that our management can certify the effectiveness of our internal controls and our independent registered public accounting firm can render an opinion on management’s assessment and on the effectiveness of our internal control over financial reporting by the time our fiscal 2008 annual report is due and thereafter. As a result, we will be required to improve our financial and managerial controls, reporting systems and procedures, to incur substantial expenses to test our systems and to make such improvements and to hire additional personnel. If our management is unable to certify the effectiveness of our internal controls or if our independent registered public accounting firm cannot render an opinion on management’s assessment and on the effectiveness of our internal control over financial reporting, or if material weaknesses in our internal controls are identified, we could be subject to regulatory scrutiny and a loss of public confidence, which could harm our business and cause a decline in our stock price. In addition, if we do not maintain adequate financial and management personnel, processes and controls, we may not be able to accurately report our financial performance on a timely basis, which could cause a decline in our stock price and harm our ability to raise capital. Failure to accurately report our financial performance on a timely basis could also jeopardize our continued listing on the Nasdaq Global Market, the Toronto Stock Exchange or any other stock exchange on which our common stock may be listed. Delisting of our common stock on any exchange would reduce the liquidity of the market for our common stock, which would reduce the price of our stock and increase the volatility of our stock price.

 

Risks Related to this Offering and Our Common Stock

 

We cannot assure you that a market will develop for our common stock or what the price of our common stock will be.

 

Before this offering, there was no public trading market for our common stock, and we cannot assure you that one will develop or be sustained after this offering. If a market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at an attractive price or at all. We cannot predict the prices at which our common stock will trade. The initial public offering price for our common stock will be determined through our negotiations with the underwriters and may not bear any relationship to the market price at which our common stock will trade after this offering or to any other established criteria of the value of our business. It is possible that, in future quarters, our operating results may be below the expectations of securities analysts and investors. As a result of these and other factors, the price of our common stock may decline, possibly materially.

 

Our stock price may be volatile and your investment in our common stock could suffer a decline in value.

 

Broad market and industry factors may harm the price of our common stock, regardless of our actual operating performance. Factors that could cause fluctuation in the price of our common stock may include, among other things:

 

 

In the past, securities class action litigation has often been instituted against companies following periods of volatility in their stock price. This type of litigation, even if it does not result in liability for us, could result in substantial costs to us and divert management’s attention and resources.

 

A total of          , or  %, of our total outstanding shares after the offering are restricted from immediate resale, but may be sold on the Nasdaq Global Market and the Toronto Stock Exchange in the near future. The large number of shares eligible for public sale or subject to rights requiring us to register them for public sale could depress the market price of our common stock.

 

The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market after this offering, and the perception that these sales could occur may also depress the market price of our common stock. Based on shares outstanding as of          , 2007, we will have           shares of common stock outstanding after this offering. Of these

shares, the common stock sold in this offering will be freely tradable in the United States, except for any shares purchased by our “affiliates” as defined in Rule 144 under the Securities Act of 1933, and freely tradeable in Canada, except for any shares held by a control person for the purposes of Canadian securities laws. The holders of           shares of outstanding common stock have agreed with the underwriters, subject to certain exceptions, not to dispose of or hedge any of their common stock during the 180-day period beginning on the date of this prospectus, except with the prior written consent of Goldman, Sachs & Co. and Merrill Lynch, Pierce, Fenner & Smith Incorporated. This 180-day restricted period may be extended under the circumstances described in the “Underwriting” section of this prospectus. After the expiration of the 180-day restricted period, including any extension, these shares may be sold in the public market in the United States or Canada, subject to prior registration in the United States or qualification by prospectus in Canada, if required, or reliance upon an exemption from U.S. registration or Canadian prospectus requirements, including, in the case of shares held by affiliates or control persons, compliance with the volume restrictions of Rule 144 in the United States and compliance with the control block notice of sale requirements in Canada, respectively.

 

 

As of          , 2007, stockholders owning an aggregate of           shares are entitled, under contracts providing for registration rights, to require us to register shares of our common stock owned by them for public sale in the United States. In addition, we intend to file a registration statement to register the approximately           shares reserved for future issuance under our equity compensation plans. Upon effectiveness of that registration statement, subject to the satisfaction of applicable exercise periods and, in certain cases, lock-up agreements with the representatives of the underwriters referred to above, the shares of common stock issued upon exercise of outstanding options will be available for immediate resale in the United States in the open market.

 

After the first anniversary of the date of this prospectus, we will file a registration statement in the United States to register either the issuance of up to           shares of our common stock upon the exchange of the then outstanding exchangeable shares of Lulu Canadian Holding, Inc. or the resale of up to           shares of our common stock. In the case of a registration of shares of our common stock issuable upon the exchange of exchangeable shares, the registered shares will be freely tradeable, subject to the restrictions applicable to affiliates or control persons described above. In the case of a resale registration, although the registered shares will be freely tradeable under applicable securities laws, the holders of the registered shares or the exchangeable shares exchangeable for such registered shares will be required to agree in writing to limit the volume of public sales of the registered shares to the number of shares which such holders would have been permitted to sell under Rule 144 if the shares were “control securities” under Rule 144.

 

Sales of our common stock as restrictions end or pursuant to registration rights may make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. These sales also could cause our stock price to fall and make it more difficult for you to sell shares of our common stock.

 

If you purchase shares of our common stock in this offering, you will experience substantial and immediate dilution.

 

If you purchase shares of our common stock in this offering, you will experience substantial and immediate dilution of $      per share, because the price that you pay will be substantially greater than the net tangible book value per share of the common stock that you acquire. This dilution is due in large part to the fact that our earlier investors paid substantially less than the initial public offering price when they purchased their shares of our capital stock. You will experience additional dilution upon the exercise of options to purchase common stock under our equity incentive plans.

 

We do not intend to pay dividends for the foreseeable future.

 

We have never declared or paid any dividends on our common stock. We intend to retain all of our earnings for the foreseeable future to finance the operation and expansion of our business, and we do not anticipate paying any cash dividends in the future. As a result, you may only receive a return on your investment in our common stock if the market price of our common stock increases. Our board of directors retains the discretion to change this policy.

 

Insiders will continue to have substantial control over us after this offering, which could limit your ability to influence the outcome of key transactions, including a change of control.

 

Mr. Wilson, our founder and Chairman and Chief Product Designer, will control approximately  % of the voting power of our outstanding stock after this offering or  % if the underwriters exercise in full their option to purchase additional shares in this offering. Additionally, after this offering, funds controlled by Advent International will control an aggregate of    % of the voting power of our outstanding stock after this offering or    % if the underwriters exercise in full their option to purchase additional shares in this offering. As a result, these stockholders, if acting together, would be able to influence or control matters requiring approval by our stockholders, including the election of directors and the approval of mergers, acquisitions or other extraordinary transactions. They may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. This concentration of ownership may have the effect of delaying, preventing or deterring a change of control of our company, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company and might ultimately affect the market price of our common stock.

 

We will have broad discretion over the use of proceeds from this offering.

 

We will have broad discretion over the use of the net proceeds to us from this offering, and you will be relying on the judgment of our board of directors and management regarding the application of these proceeds. Although we expect to use the net proceeds from this offering for new store openings, working capital and other general corporate purposes, which may include general and administrative expenses, we have not allocated these net proceeds for specific purposes. It is possible that a substantial portion of the net proceeds will be invested in a way that does not yield a favorable, or any, return for us.

 

Anti-takeover provisions of Delaware law and our certificate of incorporation and bylaws could delay and discourage takeover attempts that stockholders may consider to be favorable.

 

Certain provisions of our certificate of incorporation and bylaws that will be in effect upon completion of this offering and applicable provisions of the Delaware General Corporation Law may make it more difficult or impossible for a third party to acquire control of us or effect a change in our board of directors and management. These provisions include:

 

 

 

In addition, we are governed by Section 203 of the Delaware General Corporation Law which, subject to some specified exceptions, prohibits “business combinations” between a Delaware corporation and an “interested stockholder”, which is generally defined as a stockholder who becomes a beneficial owner of 15% or more of a Delaware corporation’s voting stock, for a three-year period following the date that the stockholder became an interested stockholder. Section 203 could have the effect of delaying, deferring or preventing a change in control that our stockholders might consider to be in their best interests.

 

These and other provisions of the Delaware General Corporation Law and our articles of incorporation and bylaws could delay, defer or prevent us from experiencing a change of control or changes in our board of directors and management and may adversely affect our stockholders’ voting and other rights. Any delay or prevention of a change of control transaction or changes in our board of directors and management could deter potential acquirors or prevent the completion of a transaction in which our stockholders could receive a substantial premium over the then current market price for their shares of our common stock.

 

Some of the statements contained in this prospectus constitute forward-looking statements. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts, such as statements regarding our future financial condition or results of operations, our prospects and strategies for future growth, the development and introduction of new products, and the implementation of our marketing and branding strategies. In many cases, you can identify forward-looking statements by terms such as “may”, “will”, “should”, “expects”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential” or the negative of these terms or other comparable terminology.

 

The forward-looking statements contained in this prospectus reflect our current views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause events or our actual activities or results to differ significantly from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, actions, levels of activity, performance or achievements. Readers are cautioned not to place undue reliance on these forward-looking statements. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements, including, but not limited to, those factors described in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These factors include without limitation:

 

 

Although we believe that the assumptions inherent in the forward-looking statements contained in this prospectus are reasonable, undue reliance should not be placed on these statements, which only apply as of the date hereof. In addition to the assumptions specifically identified herein, assumptions have been made regarding, among other things:

 

 

The forward-looking statements contained in this prospectus reflect our views and assumptions only as of the date of this prospectus. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

USE OF PROCEEDS

 

We estimate that we will receive net proceeds from the sale of the shares of our common stock in this offering of approximately $20.3 million, assuming an initial public offering price of $      per share, which is the mid-point of the range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. A $1.00 increase or decrease in the assumed initial public offering price of $      per share would increase or decrease, respectively, the net proceeds to us from this offering by approximately $      million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any proceeds from the sale of shares being sold by the selling stockholders, including any shares sold by the selling stockholders in connection with the underwriters’ exercise of their option to purchase additional shares, although we will pay the expenses (other than underwriting discounts and commissions) associated with the sale of those shares.

 

We intend to use the net proceeds from this offering, together with cash flow from operations, to fund new store openings and working capital, and for other general corporate purposes, which may include general and administrative expenses, and potential acquisitions of franchises. For fiscal 2007 and fiscal 2008, we have budgeted an aggregate of $28.0 million to $34.0 million for new store openings although the actual amounts that we spend on such items may vary. As a result, we will retain broad discretion over the use of the net proceeds from this offering. Pending the uses described above, we intend to invest the net proceeds of this offering in short-term, interest-bearing, investment-grade securities. We cannot predict whether the proceeds invested will yield a favorable return for us.

DIVIDEND POLICY

 

We have never declared or paid any cash dividends on our capital stock and do not anticipate paying any cash dividends on our common stock in the foreseeable future. We anticipate that we will retain all of our available funds for use in the operation and expansion of our business. Any future determination as to the payment of cash dividends will be at the discretion of our board of directors and will depend on our financial condition, operating results, current and anticipated cash needs, plans for expansion and other factors that our board of directors considers to be relevant. In addition, financial and other covenants in any instruments or agreements that we enter into in the future may restrict our ability to pay cash dividends on our common stock.

 

Prior to the private equity investment in our capital stock in December 2005 by a group of private equity investors, all of our equity owners were subject to Canadian taxation. With the intention of allowing our Canadian equity owners, including Mr. Wilson, to defer tax in Canada following that investment transaction, we established the corporate structure described below. Upon completion of the private equity investment, Mr. Wilson, along with entities he controls, effectively beneficially owned 52% of the equity of lululemon, while Advent International Corporation, Brooke Private Equity Advisors and Highland Capital Partners together effectively beneficially owned a total of approximately 48% of the equity of lululemon, before giving effect to employee stock options.

 

Prior to our corporate reorganization, our equity owners held their ownership interests at various different corporations in our structure incorporated in the U.S. or Canada, including directly in our operating subsidiaries. Following our corporate reorganization, we will in effect own 100% of our operating subsidiaries, and all of our equity owners will own all of their equity interests only in our capital stock or shares exchangeable for our capital stock. With the intention of allowing our Canadian equity owners, including Mr. Wilson, to continue to defer tax in Canada following our corporate reorganization with respect to such equity owners’ continuing equity ownership, in our corporate reorganization we will issue to our Canadian shareholders shares in one of our Canadian subsidiaries which are exchangeable for our common stock, together with special voting shares in Lululemon Corp. These exchangeable shares and special voting shares are intended to be the economic and voting equivalent of shares of our common stock.

 

The following information describes in more detail our capital structure immediately before and immediately after our corporate reorganization. The diagrams included in this section are simplified illustrations that summarize our capital structure and are intended only as a supplement to, and not a substitute for, the following information regarding our corporate reorganization.

 

 

Pre-Reorganization Structure

 

Set forth below is a diagram that graphically illustrates, in simplified form, our corporate structure prior to our corporate reorganization.

 

 

 

Our U.S. operations are conducted through Lulu USA, a company in which we hold a direct interest. Our Canadian operations are conducted through Lululemon Athletica Inc., or LAI, a company in which we hold an indirect 48% interest through our wholly-owned subsidiary, Lulu Canadian Holding, Inc., or Lulu Canadian Holding.

 

Lulu USA had two classes of capital stock outstanding, participating preferred stock and non-participating preferred stock. We owned all of the issued and outstanding shares of the participating preferred stock which entitled us to a majority of the voting and economic rights associated with Lulu USA. All of the shares of non-participating preferred stock of Lulu USA were held by substantially all of our stockholders, including LIPO Investments (USA) Inc., or LIPO USA, an entity controlled by Mr. Wilson. In addition, as of April 6, 2007, there were outstanding vested and unvested options to purchase 1,885,250 shares of Lulu USA common stock held by employees of Lulu USA and LAI.

 

LAI also had two classes of capital stock outstanding, class A shares and class B shares. Lulu Canadian Holding owned all of the issued and outstanding class A shares of LAI which entitles Lulu Canadian Holding to 48% of the voting and economic interests associated with LAI. All of the issued and outstanding class B shares of LAI were held by an entity controlled by Mr. Wilson, LIPO Investments (Canada) Inc., or LIPO Canada, which entitles LIPO Canada to 52% of the voting and economic interests associated with LAI. In addition, as of April 6, 2007, there were outstanding vested and

unvested options outstanding to purchase 1,885,250 LAI class C shares held by employees of Lulu USA and LAI.

 

Our stockholders agreement, which terminates upon completion of this offering, provided that upon a decision by our stockholders to proceed with an initial underwritten public offering, including this offering, each of our stockholders was required to support a reorganization of our capital stock and the capital stock of our subsidiaries so that Lulu USA and LAI will in effect become our direct (or indirect) wholly-owned subsidiaries. We refer to these transactions as our corporate reorganization. Upon completion of our corporate reorganization, with the exception of exchangeable shares that will be issued by Lulu Canadian Holding and which are described in greater detail below, all equity and voting interests in lululemon will be held through Lululemon Corp., the issuer of the shares offered in this prospectus.

 

Agreement and Plan of Reorganization

 

In order to carry out our corporate reorganization, we have entered into a reorganization agreement with all of our stockholders, Lulu USA, LAI, Lulu Canadian Holding, LIPO Canada, LIPO USA, Mr. Wilson, in his individual capacity and in his capacity as trustee pursuant to a trust arrangement established for the benefit of the minority stockholders and option holders of LIPO Canada and LIPO USA, and Slinky Financial ULC, or Slinky, an entity owned by Mr. Wilson which owns shares of LIPO Canada. Our corporate reorganization will be completed immediately following the execution and delivery of an underwriting agreement to be entered into with the underwriters named in this prospectus relating to the shares of common stock being offered hereby. We refer to the date on which our corporate reorganization is completed as the reorganization date. In furtherance of our corporate reorganization, prior to the time the SEC declares a registration statement relating to this offering effective, we will file an amended and restated certificate of incorporation with the Secretary of State of the State of Delaware and Lulu Canadian Holding will file a notice of alteration of its articles of incorporation with the Province of British Columbia Registrar of Companies.

 

Securities to be Issued in Our Corporate Reorganization.   Upon completion of our corporate reorganization, we will issue shares of our common stock to our existing stockholders, to holders of shares of non-participating preferred stock of Lulu USA and to Slinky. The shares of our common stock being issued to Slinky are being offered pursuant to this prospectus. In connection with our corporate reorganization, each outstanding share of our common stock will be split into           shares of our common stock. In addition, Lulu Canadian Holding will issue a newly created class of shares, or exchangeable shares, to certain holders of LIPO Canada common shares. Holders of these exchangeable shares will be entitled, at any time, to exchange their exchangeable shares for an equal number of shares of our common stock (subject to anti-dilution provisions attaching to such shares).

 

In connection with our corporate reorganization, we will issue shares of a newly formed special class of voting stock, which we call the special voting shares, to holders of exchangeable shares. The total number of special voting shares that we will issue will be equal to the number of exchangeable shares that are issued. Holders of special voting shares and holders of shares of our common stock will vote together as a single class on all matters, except to the extent voting as a separate class is required by applicable law or our certificate of incorporation. For additional information on our special voting shares and the exchangeable shares, see “Description of Capital Stock — Special Voting Stock” and Description of Capital Stock — Exchangeable Shares of Lulu Canadian Holding and Related Agreements.”

 

The exchangeable shares are intended to be a means for LIPO Canada stockholders who are resident in Canada, including Mr. Wilson, to defer tax in Canada. The exchangeable shares, together with the special voting shares, are intended to be the economic and voting equivalent of shares of our common stock.

 

In connection with the reorganization, we established a direct wholly-owned subsidiary, Lululemon Callco ULC, or Callco. Callco will be a party to the exchangeable share support agreement

described under “Description of Capital Stock — Exchangeable Shares of Lulu Canadian Holding and Related Agreements.” Callco will have the right, but not the obligation, to purchase any exchangeable shares tendered to Lulu Canadian Holding in exchange for shares of our common stock or to purchase all outstanding exchangeable shares if Lulu Canadian Holding elects to redeem these shares, which it is only entitled to do in certain limited circumstances. In each case, the purchase price payable by Callco would be paid through the delivery of one share of our common stock for each exchangeable share being purchased by Callco, plus the payment of any accrued and unpaid dividends on such exchangeable share at the time of purchase. Since Callco is our wholly-owned subsidiary, any exchangeable shares that Callco acquires will be indirectly owned by us. Pursuant to the terms of the exchangeable share support agreement, we have agreed to take any actions necessary for Callco to satisfy its obligations if it elects to exercise its right to acquire the exchangeable shares, including, without limitation, the issuance of shares of our common stock to holders of exchangeable shares.

 

Rights Attaching to Exchangeable Shares.   As described above, holders of exchangeable shares will be entitled, at any time, to exchange their exchangeable shares for an equal number of shares of our common stock. However, shares of our common stock issuable upon an exchange of exchangeable shares will not be delivered other than pursuant to an effective registration statement filed with the SEC, which we will not file prior to the first anniversary of the closing of this offering, or pursuant to an exemption from registration under U.S. and Canadian securities laws. The exchangeable shares will be accompanied by, and may not be traded separately from, shares of our special voting stock. The holders of exchangeable shares will not be entitled to vote on resolutions of shareholders of Lulu Canadian Holding except in certain limited circumstances as prescribed by law.

 

Corporate Reorganization.   The following discussion of shares issued in connection with our corporate reorganization assumes a reorganization date of          , 2007 and assumes an initial public offering price of $      per share (the mid-point of the range set forth on the cover of this prospectus). The actual number of shares issued in connection with our corporate reorganization will depend upon the actual reorganization date due to the accrual of dividends on shares of preferred stock, and the initial public offering price.

 

Series A Preferred Stock.   Each holder of our series A preferred stock will be entitled to receive:

 

 

Assuming an initial public offering price of $      per share (the mid-point of the range set forth on the cover of this prospectus), we expect to issue an aggregate of           shares of our common stock to our existing holders of series A preferred stock upon completion of this offering.

 

Lulu USA Non-Participating Preferred Stock.   Lulu USA will repurchase all shares of non-participating preferred stock of Lulu USA which are outstanding as of the reorganization date for a purchase price of $1.00 per share in cash, or US$10,000 in the aggregate.

 

LIPO USA and LIPO Canada.   LIPO USA and LIPO Canada, or the LIPO Entities, are the holding companies formed by Mr. Wilson to hold his interests in lululemon. Substantially all of the assets of LIPO USA are composed of shares of our series TS preferred stock and Lulu USA non-participating preferred stock and substantially all of the assets of LIPO Canada are composed of LAI class B shares. In our corporate reorganization, we and Lulu Canadian Holding will issue a combination of shares of our common stock and exchangeable shares of Lulu Canadian Holding, respectively, in exchange for the

securities of our company held by LIPO USA and in exchange for the securities of LIPO Canada that are held by the shareholders of LIPO Canada in the following amounts (the LIPO Share Amount):

 

 

Assuming an initial public offering price of $      per share (the mid-point of the range set forth on the cover of this prospectus), we expect to issue an aggregate of           shares of our common stock with respect to the LIPO Entities’ interest in the company and LAI.

 

LIPO USA, on the one hand, and the shareholders of LIPO Canada, on the other hand, are entitled to their respective pro rata shares of the LIPO Share Amount. The portion of the LIPO Share Amount issuable to LIPO USA will be issued in the form of our common stock. The portion of the LIPO Share Amount issuable to the LIPO Canada shareholders will be issued in the form of shares of our common stock or exchangeable shares.

 

As part of our corporate reorganization, Slinky will transfer its LIPO Canada common shares to us in exchange for shares of our common stock, which Slinky will sell in this offering. Mr. Wilson and the remainder of the LIPO Canada shareholders will transfer the balance of the issued and outstanding common shares of LIPO Canada to Lulu Canadian Holding in exchange for exchangeable shares of Lulu Canadian Holding. The holders of the exchangeable shares other than Mr. Wilson are employees of lululemon. A portion of the exchangeable shares to be issued to these employees will be held by them outright, while the balance will be held in trust for them by Mr. Wilson pursuant to an incentive arrangement under which shares will vest, and will thereupon be released from the trust, ratably over time, as long as the employee remains employed by lululemon as of each vesting date. To the extent that shares do not vest, they will be forfeited and revert to the ownership of Mr. Wilson.

 

In connection with our corporate reorganization, we will issue to each holder of exchangeable shares a number of special voting shares that is equal to the number of exchangeable shares that is held by such holder.

 

LIPO Canada Stock Options.   As part of our corporate reorganization, each vested option to purchase LIPO Canada common shares will be exercised for LIPO Canada common shares, which will be transferred to Lulu Canadian Holding, as discussed above. Each unvested option to purchase LIPO Canada common shares will be exchanged for options to purchase LIPO USA common stock.

 

Lulu USA and LAI Stock Options.   In addition, each option to purchase shares of Lulu USA common stock or LAI class C shares will be exchanged for options to purchase shares of our common stock at an adjusted exercise price. Upon completion of this option adjustment, we will have outstanding options to purchase 1,885,250 shares of our common stock at a weighted average per share exercise price of $1.39.

 

After all of the foregoing share issuances and option adjustments have occurred, LIPO Canada will become a wholly owned subsidiary of Lulu Canadian Holding. At such time, Lulu Canadian Holding and LIPO Canada will be amalgamated (i.e., merged) and become one entity.

 

Upon completion of our corporate reorganization and the amalgamation of Lulu Canadian Holding and LIPO Canada, Lulu USA and LAI in effect will be our direct or indirect wholly-owned subsidiaries.

 

Post-reorganization Capitalization

 

Immediately after our corporate reorganization, we will have outstanding:

 

 

 

We will have no shares of series A preferred stock, series B preferred stock or series TS preferred stock outstanding. In addition, no person other than us or our subsidiaries will have a direct voting or economic interest in Lulu USA or LAI since each of these companies will in effect be our direct or indirect wholly-owned subsidiaries.

 

Immediately after our corporate reorganization, Lulu Canadian Holding will have           exchangeable shares outstanding, each exchangeable for one share of our common stock, and the former stockholders of LIPO Canada, through their ownership of exchangeable shares, will be the only group of persons who will have an interest in one of our subsidiaries.

 

Post-reorganization Structure

 

Set forth below is a diagram that graphically illustrates, in simplified form, our corporate structure immediately following completion of our corporate reorganization.

 

Termination of Stockholders Agreement

 

The reorganization agreement provides that our stockholders agreement will terminate upon the completion of this offering.

 

Hold-back Provisions

 

The reorganization agreement includes “hold-back” provisions that prohibit dispositions of shares of our common stock for a 180-day period following an underwritten public offering of our common stock, including this offering. Specifically, our stockholders who are party to the reorganization agreement have agreed not to offer, sell, assign, transfer, pledge or contract to sell or otherwise dispose of or hedge any shares of our common stock or any securities convertible into or exchangeable for shares of our common stock, including the exchangeable shares of Lulu Canadian Holding, in connection with an underwritten public offering of our common stock.

 

Registration Rights

 

Pursuant to the reorganization agreement, we have granted to Advent International GPE V Limited Partnership, Advent International GPE V-A Limited Partnership, Advent International GPE V-B Limited Partnership, Advent International GPE V-G Limited Partnership, Advent International GPE V-I Limited Partnership, Advent Partners III Limited Partnership, Advent Partners GPE V Limited Partnership, Advent Partners GPE V-A Limited Partnership, Advent Partners GPE V-B Limited Partnership, Brooke Private Equity Advisors Fund I-A, Limited Partnership, Brooke Private Equity Advisors Fund I (D), Limited Partnership, Highland Capital Partners VI Limited Partnership, Highland Capital Partners VI-B Limited Partnership, Highland Entrepreneurs’ Fund VI Limited Partnership and Slinky Financial ULC, the right to include certain of their shares in this offering. These holders may request that we include up to an aggregate of           of the shares of our common stock that they receive in our corporate reorganization in this offering. This number may be decreased prior to the effectiveness of the registration statement to which this offering relates upon the request of Goldman Sachs & Co., the lead co-managing underwriter in this offering. We are obligated to pay all expenses in connection with such registration (other than underwriting commissions or discounts).

 

In addition, the reorganization agreement provides for the amendment and restatement of a registration rights agreement providing for certain registration rights after the closing of this offering. See “Description of Capital Stock — Registration Rights” for a description of these rights.

 

The following table describes our capitalization and cash and cash equivalents as of January 31, 2007. Our capitalization and cash and cash equivalents are presented:

 

 

 

 

The number of shares of our common stock to be issued in connection with our corporate reorganization and upon exchange of the exchangeable common stock of Lulu Canadian Holding depends in part on the initial offering price and the date of our corporate reorganization. This is because, as further described in “Pre-Offering Transactions,” various securities will be exchanged in our corporate reorganization based in part on the ratio of the value of accrued but unpaid dividends (which, where applicable, accrue on a daily basis until the consummation of our corporate reorganization) to our initial public offering price. Accordingly:

 

 

We expect our corporate reorganization to occur immediately following the execution of an underwriting agreement with the underwriters relating to the shares of common stock being offered by this prospectus.

 

You should read the information below in conjunction with our combined consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

 

 

The number of pro forma as adjusted shares of common stock shown as issued and outstanding excludes:

 

 

 

If you invest in our common stock, your interest will be diluted to the extent of the difference between the public offering price per share of our common stock and the pro forma net tangible book value per share of our common stock after this offering.

 

Our pro forma net tangible book value as of January 31, 2007 was approximately $      million, or approximately $      per share. Pro forma net tangible book value per share is determined by dividing the amount of our tangible net worth, or total tangible assets less total liabilities, as of January 31, 2007 by the pro forma number of shares of our common stock outstanding after giving effect to our corporate reorganization as described in “Pre-Offering Transactions” included elsewhere in this prospectus, and assuming the exchange, for shares of our common stock, of all the exchangeable shares of Lulu Canadian Holding, Inc. to be issued in connection with our corporate reorganization. The number of shares of our common stock and the number of exchangeable shares of Lulu Canadian Holding, Inc. to be issued in connection with our corporate reorganization depends in part on the initial offering price and the date of our corporate reorganization. See “Capitalization” for a discussion of how changes in the initial public offering price or the date of our corporate reorganization may affect the number of shares to be issued in connection with our corporate reorganization.

 

Dilution to new investors represents the difference between the amount per share paid by investors in this offering and the net tangible book value per share of our common stock immediately after the completion of this offering. After giving effect to our sale of the shares offered hereby on an assumed date of          , 2007 and at an assumed initial public offering price of $      per share, the midpoint of the range set forth on the cover of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us and the application of the estimated net proceeds therefrom, our pro forma net tangible book value as of January 31, 2007 would have been $      million, or $      per share. This represents an immediate increase in pro forma net tangible book value of $      per share to existing stockholders and an immediate dilution in pro forma net tangible book value of $      per share to new investors. The following table illustrates this per share dilution:

 

 

A $1.00 increase (decrease) in the assumed public offering price of $      per share, the midpoint of the range set forth on the cover of this prospectus, would increase (decrease) our pro forma net tangible book value after this offering by $     , our pro forma net tangible book value per share after this offering by $      per share, and the dilution in pro forma net tangible book value to new investors in this offering by $      per share (assuming the number of shares set forth on the cover of this preliminary prospectus remains the same).

 

The following table sets forth, on a pro forma basis as of January 31, 2007, after giving effect to our reorganization as described in “Pre-Offering Transactions” included elsewhere in this prospectus, the total number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid to us by existing stockholders and by new investors who purchase shares of common stock in this offering, before deducting the estimated underwriting discounts and commissions

and estimated offering expenses payable by us, assuming an initial public offering price of $      per share:

 

 

A $1.00 increase (decrease) in the assumed public offering price of $      per share, the midpoint of the range set forth on the cover of this prospectus, would increase (decrease) total consideration paid by new investors by $     , and increase (decrease) the percent of total consideration paid by all new investors by  % (assuming the number of shares set forth on the cover of this preliminary prospectus remains the same).

 

If the underwriters exercise their option to purchase additional shares in full, our existing stockholders would own  %, and new investors would own    %, of the total number of shares of common stock outstanding after this offering.

 

The foregoing tables and calculations assume no exercise of any options outstanding as of January 31, 2007. Specifically, these tables and calculations exclude 1,899,000 shares of our common stock issuable upon exercise of outstanding options at a weighted average exercise price of $1.39 per share. If all of these options were exercised, then:

 

 

The selected combined consolidated financial data set forth below are derived from our combined consolidated financial statements and should be read in conjunction with our combined consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this prospectus. The combined consolidated statement of operations data for each of the fiscal years ended January 31, 2005, 2006 and 2007 and the combined consolidated balance sheet data as of January 31, 2006 and 2007 are derived from, and qualified by reference to, our audited combined consolidated financial statements and related notes appearing elsewhere in this prospectus. The combined consolidated statement of operations data for each of the fiscal years ended January 31, 2003 and 2004, and the combined consolidated balance sheet data as of January 31, 2003, 2004 and 2005 are derived from our unaudited combined consolidated statements of income and balance sheets. The unaudited combined consolidated statements of income and balance sheets have been prepared on the same basis as our audited combined consolidated financial statements and, in the opinion of management, contain all adjustments necessary to fairly present the information set forth below.

 

 

 

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the “Selected Combined Consolidated Financial Data” section of this prospectus and our combined consolidated financial statements and related notes appearing elsewhere in this prospectus. In addition to historical information, this discussion and analysis contains forward-looking statements based on current expectations that involve risks, uncertainties and assumptions, such as our plans, objectives, expectations and intentions set forth in the “Special Note Regarding Forward-Looking Statements.” Our actual results and the timing of events may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in the “Risk Factors‘ section and elsewhere in this prospectus. Certain tables may not sum due to rounding.

 

Overview

 

lululemon is one of the fastest growing designers and retailers of technical athletic apparel in North America. Our yoga-inspired apparel is marketed under the lululemon athletica brand name. We offer a comprehensive line of apparel and accessories including fitness pants, shorts, tops and jackets designed for athletic pursuits such as yoga, dance, running and general fitness. As of April 1, 2007, our branded apparel was principally sold through 52 corporate and franchise stores that are primarily located in Canada and the United States. We believe our vertical retail strategy allows us to interact more directly with and gain insights from our customers while providing us with greater control of our brand. For fiscal 2006, 87.1% of our net revenue was derived from sales of our products in Canada, 11.7% of our net revenue was derived from the sales of our products in the United States and 1.2% of our net revenue was derived from sales of our products in Australia and Japan.

 

Our net revenue has grown from $40.7 million for fiscal 2004 to $148.9 million for fiscal 2006. This represents a compound annual growth rate of 91.1%. By the end of fiscal 2004, we operated 20 stores including 14 corporate-owned stores and 6 franchise stores in Canada, the United States and Australia. The majority of our stores were located in Canada, with only three corporate-owned stores in the United States and one franchise store in Australia. Our increase in net revenue from fiscal 2004 to fiscal 2006 resulted from the addition of 17 retail locations in fiscal 2005 and 14 retail locations in fiscal 2006 and strong comparable store sales growth of 19% and 25% in fiscal 2005 and fiscal 2006, respectively. Our ability to open new stores and grow sales in existing stores has been driven by increasing demand for our technical athletic apparel and a growing recognition of the lululemon athletica brand. We believe our superior products, strategic store locations, inviting store environment, grassroots marketing approach and distinctive corporate culture are responsible for our strong financial performance. We have recently increased our focus on our men’s apparel line, which represented approximately 11% of net revenue for fiscal 2006 and our accessories business, which represented approximately 9% of net revenue for fiscal 2006. The continued growth of our business and any future increase in our net revenue, earnings or cash flows are dependent on the successful expansion of our corporate-owned store base and on us continuing to develop innovative technical athletic apparel that our consumers demand.

 

lululemon was founded in 1998 by Dennis “Chip” Wilson in Vancouver, Canada. We initially conducted our operations through our Canadian operating company, Lululemon Athletica Inc. In 2002, in connection with our expansion into the United States, we formed a sibling operating company to conduct our U.S. operations, Lululemon Athletica USA Inc. Both operating companies were wholly-owned by affiliates of Mr. Wilson. In December 2005, Mr. Wilson sold 48% of his interest in lululemon to a group of private equity investors led by Advent International Corporation and Highland Capital Partners. Prior to this time, Mr. Wilson was our sole stockholder. Pursuant to the terms of the December 2005 transaction, we formed Lululemon Corp. (formerly known as Lulu Holding, Inc.), the issuer of the shares offered by this prospectus, to serve as a holding company for all of our related entities, including our two primary operating subsidiaries.

 

We have three reportable segments: corporate-owned stores, franchises and other. We report our segments based on the financial information we use in managing our businesses. While we receive financial information for each corporate-owned store, we have aggregated all of the corporate-owned stores into one reportable segment due to the similarities in the economic and other characteristics of these stores. Our franchises segment accounted for more than 10% of our net revenues for each of fiscal 2005 and fiscal 2006. Opening new franchise stores is not a significant part of our near-term store growth strategy, and we therefore expect that revenue derived from our franchise stores will eventually comprise less than 10% of the net revenue we report in future fiscal years, at which time we will reevaluate our segment reporting disclosures. Our other operations accounted for less than 10% of our revenues in each of fiscal 2005 and fiscal 2006.

 

As of April 1, 2007, we sold our products through 45 corporate-owned stores located in Canada, the United States and Japan. Most of our corporate-owned stores are located in North America, with only two corporate-owned stores located in Japan. We plan to increase our net revenue in North America by opening additional corporate-owned stores in new and existing markets. For fiscal 2006, corporate-owned stores net revenue accounted for 81.1% of total net revenue.

 

As of April 1, 2007, we also had six franchise stores located in North America and one franchise store located in Australia. In the past, we have entered into franchise agreements to distribute lululemon athletica branded products to more quickly disseminate our brand name and increase our net revenue and net income. In exchange for the use of our brand name and the ability to operate lululemon athletica stores in certain regions, our franchisees generally pay us a one-time franchise fee and ongoing royalties based on their gross revenue. Additionally, unless otherwise approved by us, our franchisees are required to sell only lululemon athletica branded products, which are purchased from us at a discount to the suggested retail price. Pursuing new franchise partnerships or opening new franchise stores is not a significant part of our near-term store growth strategy. In some cases, we may exercise our contractual rights to purchase franchises where it is attractive to us. For fiscal 2006, franchises net revenue accounted for 14.3% of total net revenue.

 

We believe that our athletic apparel has and will continue to appeal to consumers outside of North America who value its technical attributes as well as its function and style. In 2004, we opened a franchise store in Australia, our first store outside of North America. We intend to convert this Australian franchise into a joint venture partnership. In 2005, we opened a franchise store in Japan. In 2006, we terminated our franchise arrangement and entered into a joint venture agreement with Descente Ltd, or Descente, a global leader in fabric technology, to operate our stores in Japan. This joint venture company is named Lululemon Japan Inc. As of April 1, 2007, we operated two stores through Lululemon Japan Inc. Because we own 60% of the joint venture and maintain control over it, the financial results of Lululemon Japan Inc. are consolidated and included in our corporate-owned stores segment. We plan to increase net revenue in markets outside of North America primarily by opening additional stores with joint venture partners in existing markets as well as opening stores in new markets with new joint venture partners.

 

In addition to deriving revenue from sales through our corporate-owned stores and our franchises, we also derive other net revenue, which includes the sale of our products directly to wholesale customers, telephone sales to retail customers, including related shipping and handling charges, warehouse sales and sales through a limited number of company operated showrooms. Wholesale customers include select premium yoga studios, health clubs and fitness centers. Telephone sales are taken directly from retail customers through our call center. Warehouse sales are typically held a few times a year to sell slow moving inventory or inventory from prior seasons to retail customers at discounted prices. Our showrooms are typically small locations that we open from time to time when we enter new markets and feature a limited selection of our product offering during select hours. For fiscal 2006, other net revenue accounted for 4.6% of total net revenue.

 

We believe that a number of trends relevant to our industry have affected our results and may continue to do so. Specifically, we believe that there is an increasing appreciation for the health benefits

of yoga and related fitness activities in our markets and that women, our primary customers, are increasingly embracing an active healthy lifestyle. As such, we believe that participation in yoga and related fitness activities will continue to grow. There is also an increasing demand for technical athletic apparel relative to traditional athletic apparel, and we believe that more people are wearing technical apparel in casual environments to create a healthy lifestyle perception.

 

Basis of Presentation

 

Net revenue is comprised of:

 

 

in each case, less returns and discounts.

 

Comparable store sales reflects net revenue at corporate-owned stores, that have been open for at least twelve months. Therefore, net revenue from a store is included in comparable store sales beginning with the first month for which the store has a full month of comparable prior year sales. Comparable store sales includes stores that have been remodeled or relocated and stores operated by our majority owned joint venture, although as of January 31, 2007, the joint venture stores had not had a full month of comparable prior year sales. Non-comparable store sales include sales from new stores that have not been open for twelve months, sales from showrooms, and sales from stores that were closed within the past twelve months.

 

By measuring the change in year-over-year net revenue in stores that have been open for twelve months or more, comparable store sales allows us to evaluate how our core store base is performing. Various factors affect comparable store sales, including:

 

 

As we continue our store expansion program, we expect that a greater percentage of our net revenue will come from non-comparable store sales. Opening new stores is an important part of our growth strategy. Accordingly, comparable store sales has limited utility for assessing the success of our

growth strategy insofar as comparable store sales do not reflect the performance of stores open less than twelve months.

 

Cost of goods sold includes:

 

 

Our cost of goods sold is substantially higher in the holiday season because cost of goods sold generally increases as net revenue increases. Cost of goods sold also may change as we open or close stores because of the resulting change in related occupancy costs. The primary drivers of the costs of individual goods are the costs of raw materials and labor in the countries where we source our merchandise. For fiscal 2006, cost of goods sold included $0.4 million of compensation charges related to stock-based compensation. We anticipate that our cost of goods sold will increase in absolute dollars compared to fiscal 2006, but will remain relatively stable as a percentage of net revenue.

 

Our selling, general and administrative expenses consist of all operating costs not otherwise included in cost of goods sold, principal stockholder bonus or settlement of lawsuit. Our selling, general and administrative expenses include marketing costs, accounting costs, information technology costs, professional fees, corporate facility costs, corporate and store-level payroll and benefits expenses including stock-based compensation, (other than the salaries and benefits and stock-based compensation for our production and design departments included in cost of goods sold and other corporate costs). For fiscal 2006, selling, general and administrative expenses included $2.5 million of charges related to stock-based compensation. Our selling, general and administrative expenses also include depreciation and amortization expense for all assets other than depreciation and amortization expenses related to store-level capital expenditures and our distribution centers, each of which are included in cost of goods sold. We anticipate that our selling, general and administrative expenses for fiscal 2007 will increase in absolute dollars compared to fiscal 2006, due to the full year of compensation expense related to personnel hired at the end of fiscal 2006, as well as the anticipated continued growth of our corporate support staff and store-level employees. We believe that we have now assembled a management team that should allow us to grow our business for the foreseeable future. Accordingly, we expect our selling, general and administrative expenses as a percentage of our net revenue to decline as we achieve higher revenues.

 

Principal stockholder bonus consists of annual bonus payments paid to Mr. Wilson prior to December 2005. These bonuses were paid to Mr. Wilson as our sole stockholder and were in an amount equal to our Canadian taxable income for the year above a particular threshold. For Canadian income tax purposes, these payments were fully taxable to Mr. Wilson as ordinary income and fully deductible by us as a compensation expense. Following his sale of 48% of his interest in lululemon to a group of private equity investors in December 2005, these payments to Mr. Wilson were discontinued.

 

Settlement of lawsuit consists of a payment we made in February 2007 in the amount of $7.2 million to a third party web site developer arising from the termination of a profit sharing

arrangement associated with our retail web site for our products. We accrued for the entire settlement amount in fiscal 2006.

 

Stock-based compensation includes charges incurred in recognition of compensation expense associated with grants of stock options and stock purchases. In December 2005, we adopted the fair value recognition and measurement provisions of SFAS No. 123(R), Share-Based Payment (SFAS 123(R)). SFAS 123(R) is applicable to stock-based awards exchanged for employee services and in certain circumstances for non-employee directors. Pursuant to SFAS 123(R), stock-based compensation cost is measured at the grant date, based on the fair value of the award and is recognized as an expense over the requisite service period. We record our stock-based compensation in cost of goods sold and selling, general and administrative expenses as stock-based awards have been made to employees whose salaries are classified in both expense categories. As of January 31, 2007, we had options to purchase 1,899,000 shares of our common stock outstanding with a weighted average exercise price of $1.39 per share, 187,250 of which were exercisable at January 31, 2007. Additionally, as of January 31, 2007, each of LIPO Investments (USA) Inc., or LIPO USA, and LIPO Investments (Canada) Inc., or LIPO Canada, had granted to some of our employees restricted stock of those entities and options to purchase shares of stock in those entities. LIPO USA and LIPO Canada, the sole assets of which are a 52% interest in lululemon, are entities controlled by Mr. Wilson. Accordingly, we recognize a stock-based compensation expense for the restricted stock and options granted by those entities. As of January 31, 2007, pursuant to SFAS 123(R), there was $18.3 million of total unrecognized stock-based compensation expense, of which we expect to amortize $5.3 million in fiscal 2007, $5.1 million in fiscal 2008 and the remainder thereafter.

 

Interest income includes interest earned on our cash balances. We expect to continue to generate interest income to the extent that our cash generated from operations exceeds our cash used for investment.

 

Interest expense includes interest costs associated with our credit facilities and with letters of credit drawn under these facilities for the purchase of merchandise. We have maintained relatively small outstanding balances on our credit facilities and expect to continue to do so.

 

Provision for income taxes depends on the statutory tax rates in the countries where we sell our products. Historically we have generated taxable income in Canada and we have generated tax losses in the United States. As of January 31, 2007, we had $5.0 million of federal net operating loss carry-forwards available to reduce future taxable income in the United States. These tax operating loss carry-forwards begin to expire in 2023. The consummation of the corporate reorganization transactions contemplated by this prospectus combined with this offering could result in an annual limitation on the amount of tax operating loss carry-forwards that we can use in future years to offset future taxable income in the United States. These annual limitations may result in the expiration of net operating loss carry-forwards before they may be used. We currently record a full valuation allowance against our losses in the United States.

 

Several factors have contributed to our effective tax rate in recent periods being significantly higher than our anticipated long-term effective tax rate. First, in both fiscal 2005 and fiscal 2006, we generated losses in the United States which we were unable to offset against our income in Canada for tax purposes. Second, in fiscal 2005 and fiscal 2006 we incurred stock-based compensation expenses of $2.7 million and $2.8 million, respectively, which were not deductible for tax purposes in Canada and the United States during these periods. The impact of these losses and non-deductible expenses on our effective tax rate was exacerbated in fiscal 2005 by the payment of a bonus to our principal stockholder in that period. Prior to December 2005 our sole stockholder, Mr. Wilson, received a bonus payout each year representing a substantial percentage of our earnings before income taxes. Following Mr. Wilson’s sale of 48% of his interest in lululemon to a group of private equity investors in December 2005 we discontinued this practice. Payments of these bonuses therefore decreased to $0 in fiscal 2006 from $12.8 million in fiscal 2005. This payment in fiscal 2005 significantly decreased our income before income taxes in this period and accordingly resulted in us realizing a higher effective tax rate in this

period as we gave effect to the non-deductible nature of the losses and the stock-based compensation expenses. Our effective tax rate in fiscal 2006 was 53.7%, compared to 62.6% in fiscal 2005.

 

As we begin to generate taxable income in the United States and Japan, we expect our effective tax rate to decline. We expect that our long term effective tax rate will be between approximately 35% and 40%. In addition, we anticipate that in the future we may start to sell our products directly to some customers located outside of Canada, the United States and Japan, in which case we would become subject to taxation based on the foreign statutory rates in the countries where these sales take place and our effective tax rate could fluctuate accordingly.

 

Internal Controls

 

The process of improving our internal controls has required and will continue to require us to expend significant resources to design, implement and maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. There can be no assurance that any actions we take will be completely successful. We will continue to evaluate the effectiveness of our disclosure controls and procedures and internal control over financial reporting on an on-going basis.

 

We have not begun testing or documenting our internal control procedures in order to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 requires annual management assessments of the effectiveness of our internal control over financial reporting and a report by our independent auditors addressing these assessments. We must comply with Section 404 no later than the time we file our annual report for fiscal 2008 with the SEC. As part of this process, we may identify specific internal controls as being deficient. We anticipate retaining additional personnel to assist us in complying with our Section 404 obligations. We are currently evaluating whether such personnel will be retained as consultants or as our employees.

 

 

Comparison of Fiscal 2005 and Fiscal 2006

 

Net Revenue

 

Net revenue increased $64.8 million, or 77.0%, to $148.9 million for fiscal 2006 from $84.1 million for fiscal 2005. This increase was the result of increased comparable store sales, sales from new stores opened in fiscal 2005 and fiscal 2006, higher franchises net revenues and the strengthening of the average exchange rate for the Canadian dollar against the United States dollar during the year. Assuming the average exchange rate between Canadian and United States dollars for fiscal 2005 remained constant, our net revenue would have increased $58.1 million or 69.0% for fiscal 2006.

 

 

Corporate-Owned Stores.   Net revenue from our corporate-owned stores segment increased $55.2 million, or 84.1%, to $120.7 million for fiscal 2006 from $65.6 million for fiscal 2005. The following contributed to the $55.2 million increase in net revenue from our corporate-owned stores segment.

 

 

 

Franchises.   Net revenue from our franchises segment increased $6.8 million, or 46.8%, to $21.4 million for fiscal 2006 from $14.6 million for fiscal 2005. Of the $6.8 million increase in net revenue from our franchises segment, $4.4 million or 64.1% of the increase resulted from sales of goods to franchise stores and $2.4 million or 35.9% of the increase resulted from an increase in royalty revenue. During fiscal 2006, two franchise stores were opened and two franchise stores were converted to corporate-owned stores.

 

Other.   Net revenue from our other segment increased $2.8 million, or 69.9%, to $6.8 million for fiscal 2006 from $4.0 million for fiscal 2005. The following contributed to the $2.8 million increase in net revenue from our other segment.