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Michael Kane: Lululemon Athletica Incorporated has released its second quarter results this morning. It beat on the earnings per share but missed the estimates on revenue. With some analysis on the numbers, here’s Rick Wolfe, president at PostStone Corporation. Good to see you Rick.

Rick Wolfe: Good to be here Michael.

MK: OK, so they beat by a nickel on the earnings side but the revenue was down a little bit, but then they opened a bunch of stores and in pre-market trade the stock is down seven and a quarter per cent. We need some order brought to this story here. What are we really looking at when we’re looking at Lululemon?

RW: We are really looking at a very young company with an excellent strategy and strong operations that has a plan for growth, is executing its plan for growth in an incredibly uncertain marketplace and the Street just overreacts at every opportunity.

MK: Do the earnings, we have 18 cents a share there beating the 13-cent consensus estimate, is that where they should be, do you like that?

RW: I think that their earnings are very strong given that they have to be investing in growth. To be able to be building earnings at a time when they’re investing in growth is impressive.

MK: Now, they’ve been opening stores rather aggressively, could they get over-extended that way?

RW: They could. It turns out that a downturn in the economy is a good time to be opening stores because it means that rents are going down. So it’s an opportunity that you don’t want to miss. At the same time, I think investors are going to want to keep an eye on the board to make sure that the board is providing good governance and that the board is asking Christine Day, ‘Are you adding the talent and experience that you need on the executive team, are you making sure that every employee, that there’s a taut string between the executive team and every employee, making sure that the employees are executing your strategy?’

MK: Well certainly we’re getting evidence of that in that the founder of the company said in a disclosure that he’s gong to transfer 625,000 shares in which they’re going to be using that for, I guess, incentives for employee execution.

RW: I think that’s an excellent point. It speaks to his passion for the business and his understanding that you need to be empowering the whole team and making everybody on the team feel like they too are an owner of this business.

MK: Now you alluded to the slowdown in the economy that’s helping rents stay low, but do people really want to buy upper end athletic wear when there isn’t so much disposable cash around?

RW: It’s going to be an influence; it’s going to hurt them a bit. The upper-middle class hasn’t been hurt as much by the downturn as other parts of the population have, and the upper-middle class are their core customer. As the economy has turned down so far, I think that their customer still has the means to shop at their stores.

MK: Well certainly the share price has suffered. I alluded to that, it’s down 60 per cent year-to-date or so and actually is performing a lot worse than the peers, the retail sector. There’s a look at the chart of how this appears. The yellow line is Lululemon; it has crossed over the S&P TSX consumer discretionary index. Lululemon’s been so choppy there. How are investors supposed to think about that?

RW: I think that Lululemon is not a stock for the faint-of-heart investor. It is a small company with a big brand. Investors are having a lot of trouble analyzing it; we don’t have a long history to look at their performance over a long period of time. They’re growing very quickly, but yet you can’t compare its financials to other fast-growing companies, typically in the high tech sector. In this period of its history, this is a company where the best investor is a very sophisticated long-term investor or a sophisticated trader who has a feel for why they are moving into the stock or moving out of the stock. But very tough to try and figure out what they’re going to do in the next quarter.

MK: Because ultimately it could be a takeover target, right?

RW: It could be a takeover target because they have such a terrific strategy and they’re still small enough that they’ d be affordable. But at the same time, with Chip Wilson’s founder’s passion in there, I don’t think an acquirer could duplicate that. So at this point in its history you need Chip Wilson, I think you probably need Christine Day because she’s doing a great job and finding talent. They need more talent in this business; they don’t need to be rotating talent in this business.

MK: It’s interesting that you talk about the personalities involved because we had in the financial services area Larry Sarbit would be one guy who you’d think would never sell the business but an industrial alliance has taken him out because he ran into challenges. Now this, being a niche market, might be just right for somebody like Abercrombie & Fitch.

RW: Yes, and if Abercrombie & Fitch bought them I would take that as a further negative symbol on Abercrombie & Fitch because I don’t think they’re as well run as Lululemon.

MK: OK, so it comes down to management. Did they go public at the right time do you think?

RW: Well, in terms of providing cash to the founders and providing cash for growth, yes they did. But if I can blame the management and the board for anything it’s that they didn’t do a good job of shedding investor expectations at the time they went public, and the stock way overshot. I can’t tell you that the stock is undervalued today; I can tell you that investors should take a Valium.

MK: What I’m concerned about here is that this company, by putting money into it, is that with a declining share price they don’t have that much money for that expansion that they have been counting on. So that is a major negative for them, right?

RW: That’s right, at this point they will need to make sure that they can be funding their expansion from cash flow.

MK: And we have seen this happen with other companies where there has been a real buzz created, it comes to mind Krispy Kreme Donuts for example. Whenever you get that euphoria around a company which is sold really well by the management, then the investor expectation comes off even despite fairly decent earnings.

RW: Michael, I think that Krispy Kreme is a really interesting comparison to Lululemon because you’re right there are lots of similarities, and when it comes down to product there are huge differences. When people took a bite into that Krispy Kreme product the initial impression was fantastic, and then you thought, ‘My god, what have I done, I just put pure butter and sugar into my system!’ Whereas ask a Lululemon customer about the product. They love it. The fabric that they have developed performs very well, the garments are extremely well designed. Small details like the quality of the tie string catch the attention of customers; that’s the foundation of a growing business.

MK: Interesting perspective, thanks for coming in.

RW: My pleasure Michael.

MK: My guest has been Rick Wolfe, president of PostStone Corporation.