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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 29, 2018
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 001-33608
 
lululemon athletica inc.
(Exact name of registrant as specified in its charter)
 
Delaware
20-3842867
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
1818 Cornwall Avenue
Vancouver, British Columbia
V6J 1C7
(Address of principal executive offices)
(Zip Code)
Registrant's telephone number, including area code:
604-732-6124
Former name, former address and former fiscal year, if changed since last report:
N/A
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (of for such shorter period that the registrant was required to submit and post such files).    Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
þ
Accelerated filer
o
Non-accelerated filer
o (Do not check if a smaller reporting company)
Smaller reporting company
o
Emerging growth company
o
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o No þ
At August 27, 2018, there were 122,594,553 shares of the registrant's common stock, par value $0.005 per share, outstanding.
Exchangeable and Special Voting Shares:
At August 27, 2018, there were outstanding 9,776,421 exchangeable shares of Lulu Canadian Holding, Inc., a wholly-owned subsidiary of the registrant. Exchangeable shares are exchangeable for an equal number of shares of the registrant's common stock.
In addition, at August 27, 2018, the registrant had outstanding 9,776,421 shares of special voting stock, through which the holders of exchangeable shares of Lulu Canadian Holding, Inc. may exercise their voting rights with respect to the registrant. The special voting stock and the registrant's common stock generally vote together as a single class on all matters on which the common stock is entitled to vote.
 


Table of Contents


TABLE OF CONTENTS
 
 
 
Page
 
 
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 6.
 
 

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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
lululemon athletica inc.
CONSOLIDATED BALANCE SHEETS
(Unaudited; Amounts in thousands, except per share amounts)
 
 
July 29,
2018
 
January 28,
2018
ASSETS
Current assets
 
 
 
 
Cash and cash equivalents
 
$
777,841

 
$
990,501

Accounts receivable
 
23,535

 
19,173

Inventories
 
392,672

 
329,562

Prepaid and receivable income taxes
 
62,203

 
48,948

Other prepaid expenses and other current assets
 
51,786

 
48,098

 
 
1,308,037

 
1,436,282

Property and equipment, net
 
487,546

 
473,642

Goodwill and intangible assets, net
 
24,255

 
24,679

Deferred income tax assets
 
28,345

 
32,491

Other non-current assets
 
32,974

 
31,389

 
 
$
1,881,157

 
$
1,998,483

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
110,523

 
$
24,646

Accrued inventory liabilities
 
12,597

 
13,027

Accrued compensation and related expenses
 
62,794

 
70,141

Current income taxes payable
 
3,021

 
15,700

Unredeemed gift card liability
 
64,420

 
82,668

Revolving credit facility
 
100,000

 

Other current liabilities
 
95,806

 
86,416

 
 
449,161

 
292,598

Non-current income taxes payable
 
44,078

 
48,268

Deferred income tax liabilities
 
1,582

 
1,336

Other non-current liabilities
 
66,121

 
59,321

 
 
560,942

 
401,523

Stockholders' equity
 
 
 
 
Undesignated preferred stock, $0.01 par value: 5,000 shares authorized; none issued and outstanding
 

 

Exchangeable stock, no par value: 60,000 shares authorized; 9,776 and 9,781 issued and outstanding
 

 

Special voting stock, $0.000005 par value: 60,000 shares authorized; 9,776 and 9,781 issued and outstanding
 

 

Common stock, $0.005 par value: 400,000 shares authorized; 122,656 and 125,650 issued and outstanding
 
613

 
628

Additional paid-in capital
 
299,702

 
284,253

Retained earnings
 
1,224,044

 
1,455,002

Accumulated other comprehensive loss
 
(204,144
)
 
(142,923
)
 
 
1,320,215

 
1,596,960

 
 
$
1,881,157

 
$
1,998,483

See accompanying notes to the unaudited interim consolidated financial statements

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lululemon athletica inc.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited; Amounts in thousands, except per share amounts)
 
 
Quarter Ended
 
Two Quarters Ended
 
 
July 29, 2018
 
July 30, 2017
 
July 29, 2018
 
July 30, 2017
Net revenue
 
$
723,500

 
$
581,054

 
$
1,373,206

 
$
1,101,361

Cost of goods sold
 
327,306

 
283,632

 
632,279

 
547,044

Gross profit
 
396,194

 
297,422

 
740,927

 
554,317

Selling, general and administrative expenses
 
261,986

 
225,524

 
502,414

 
424,665

Asset impairment and restructuring costs
 

 
3,186

 

 
15,517

Income from operations
 
134,208

 
68,712

 
238,513

 
114,135

Other income (expense), net
 
1,591

 
812

 
4,509

 
1,719

Income before income tax expense
 
135,799

 
69,524

 
243,022

 
115,854

Income tax expense
 
40,029

 
20,813

 
72,099

 
35,897

Net income
 
$
95,770

 
$
48,711

 
$
170,923

 
$
79,957

 
 
 
 
 
 
 
 
 
Other comprehensive (loss) income:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
(18,249
)
 
72,854

 
(61,221
)
 
41,079

Comprehensive income
 
$
77,521

 
$
121,565

 
$
109,702

 
$
121,036

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
0.71

 
$
0.36

 
$
1.27

 
$
0.59

Diluted earnings per share
 
$
0.71

 
$
0.36

 
$
1.26

 
$
0.58

Basic weighted-average number of shares outstanding
 
133,986

 
136,171

 
134,744

 
136,604

Diluted weighted-average number of shares outstanding
 
134,530

 
136,303

 
135,230

 
136,747

See accompanying notes to the unaudited interim consolidated financial statements
 

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lululemon athletica inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited; Amounts in thousands)
 
 
Exchangeable Stock
 
Special Voting Stock
 
Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
Total
 
 
Shares
 
Shares
 
Par Value
 
Shares
 
Par Value
 
 
 
 
Balance at January 28, 2018
 
9,781

 
9,781

 
$

 
125,650

 
$
628

 
$
284,253

 
$
1,455,002

 
$
(142,923
)
 
$
1,596,960

Net income
 
 
 
 
 
 
 
 
 
 
 
 
 
170,923

 
 
 
170,923

Foreign currency translation adjustment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(61,221
)
 
(61,221
)
Common stock issued upon exchange of exchangeable shares
 
(5
)
 
(5
)
 

 
5

 

 

 
 
 
 
 

Stock-based compensation expense
 
 
 
 
 
 
 
 
 
 
 
13,048

 
 
 
 
 
13,048

Common stock issued upon settlement of stock-based compensation
 
 
 
 
 
 
 
437

 
2

 
13,750

 
 
 
 
 
13,752

Shares withheld related to net share settlement of stock-based compensation
 
 
 
 
 
 
 
(81
)
 

 
(7,001
)
 
 
 
 
 
(7,001
)
Repurchase of common stock
 
 
 
 
 
 
 
(3,355
)
 
(17
)
 
(4,348
)
 
(401,881
)
 
 
 
(406,246
)
Balance at July 29, 2018
 
9,776

 
9,776

 
$

 
122,656

 
$
613

 
$
299,702

 
$
1,224,044

 
$
(204,144
)
 
$
1,320,215

See accompanying notes to the unaudited interim consolidated financial statements

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lululemon athletica inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; Amounts in thousands)
 
 
Two Quarters Ended
 
 
July 29, 2018
 
July 30, 2017
Cash flows from operating activities
 
 
 
 
Net income
 
$
170,923

 
$
79,957

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
55,429

 
51,569

Deferred income taxes
 
2,464

 
(12,746
)
Stock-based compensation expense
 
13,048

 
8,710

Asset impairment for ivivva restructuring
 

 
11,593

Settlement of derivatives not designated in a hedging relationship
 
(1,807
)
 

Changes in operating assets and liabilities:
 
 
 
 
Inventories
 
(73,065
)
 
(10,041
)
Prepaid and receivable income taxes
 
(13,255
)
 
15,029

Other prepaid expenses and other current and non-current assets
 
(7,724
)
 
(20,376
)
Accounts payable
 
86,885

 
(6,784
)
Accrued inventory liabilities
 
615

 
9,571

Accrued compensation and related expenses
 
(4,926
)
 
(8,970
)
Current income taxes payable
 
(11,828
)
 
(25,310
)
Unredeemed gift card liability
 
(17,043
)
 
(15,192
)
Non-current income taxes payable
 
(4,190
)
 

Other current and non-current liabilities
 
14,500

 
25,028

Net cash provided by operating activities
 
210,026

 
102,038

Cash flows from investing activities
 
 
 
 
Purchase of property and equipment
 
(84,007
)
 
(49,889
)
Settlement of net investment hedges
 
(4,514
)
 

Other investing activities
 
(771
)
 

Net cash used in investing activities
 
(89,292
)
 
(49,889
)
Cash flows from financing activities
 
 
 
 
Proceeds from settlement of stock-based compensation
 
13,752

 
915

Taxes paid related to net share settlement of stock-based compensation
 
(7,001
)
 
(2,024
)
Repurchase of common stock
 
(406,246
)
 
(90,801
)
Net increase in revolving credit facility
 
100,000

 

Other financing activities
 
(744
)
 

Net cash used in financing activities
 
(300,239
)
 
(91,910
)
Effect of exchange rate changes on cash and cash equivalents
 
(33,155
)
 
26,127

Decrease in cash and cash equivalents
 
(212,660
)
 
(13,634
)
Cash and cash equivalents, beginning of period
 
$
990,501

 
$
734,846

Cash and cash equivalents, end of period
 
$
777,841

 
$
721,212

See accompanying notes to the unaudited interim consolidated financial statements


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lululemon athletica inc.
INDEX FOR NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL
STATEMENTS
Note 1
Note 2
Note 3
Note 4
Note 5
Note 6
Note 7
Note 8
Note 9
Note 10
Note 11
Note 12
Note 13


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lululemon athletica inc.
NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL
STATEMENTS
NOTE 1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Nature of operations
lululemon athletica inc., a Delaware corporation ("lululemon" and, together with its subsidiaries unless the context otherwise requires, the "Company") is engaged in the design, distribution, and retail of healthy lifestyle inspired athletic apparel. The Company primarily conducts its business through company-operated stores and direct to consumer through e-commerce. It also generates net revenue from outlets, sales from temporary locations, sales to wholesale accounts, showrooms, warehouse sales, and license and supply arrangements. The Company operates stores in the United States, Canada, Australia, China, the United Kingdom, New Zealand, Germany, Japan, South Korea, Singapore, Ireland, Sweden, and Switzerland. There were 415 and 404 company-operated stores in operation as of July 29, 2018 and January 28, 2018, respectively.
Basis of presentation
The unaudited interim consolidated financial statements as of July 29, 2018 and for the quarters and two quarters ended July 29, 2018 and July 30, 2017 are presented in United States dollars and have been prepared by the Company under the rules and regulations of the Securities and Exchange Commission ("SEC"). The financial information is presented in accordance with United States generally accepted accounting principles ("GAAP") for interim financial information and, accordingly, does not include all of the information and footnotes required by GAAP for complete financial statements. The financial information as of January 28, 2018 is derived from the Company's audited consolidated financial statements and related notes for the fiscal year ended January 28, 2018, which are included in Item 8 in the Company's fiscal 2017 Annual Report on Form 10-K filed with the SEC on March 27, 2018. These unaudited interim consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented. These unaudited interim consolidated financial statements should be read in conjunction with the Company's consolidated financial statements and related notes included in Item 8 in the Company's fiscal 2017 Annual Report on Form 10-K.
The Company's fiscal year ends on the Sunday closest to January 31 of the following year, typically resulting in a 52-week year, but occasionally giving rise to an additional week, resulting in a 53-week year. Fiscal 2018 will end on February 3, 2019 and will be a 53-week year.
The Company's business is affected by the pattern of seasonality common to most retail apparel businesses. Historically, the Company has recognized a significant portion of its operating profit in the fourth fiscal quarter of each year as a result of increased net revenue during the holiday season.
Certain comparative figures have been reclassified to conform to the financial presentation adopted for the current year.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS

Recently adopted accounting pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers ("ASC 606") which supersedes the revenue recognition requirements in ASC 605 Revenue Recognition. This ASU requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
The Company adopted ASC 606 on January 29, 2018 on a modified retrospective basis. There were no changes to the consolidated statement of operations as a result of the adoption, and the timing and amount of its revenue recognition remained substantially unchanged under this new guidance. Under the provisions of ASC 606, the Company is now required to present its provision for sales returns on a gross basis, rather than a net basis. The Company's liability for sales return refunds is recognized within other current liabilities, and the Company now presents an asset for the value of inventory which is expected to be returned within other current assets on the consolidated balance sheets. Under the modified retrospective approach, the comparative prior period information has not been restated for this change.

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The effect of adoption of ASC 606 on the Company's consolidated balance sheet as of July 29, 2018 was as follows:
 
 
July 29, 2018
 
 
As Reported
 
Adjustment for ASC 606
 
Balances Without Adoption of ASC 606
 
 
(In thousands)
Other prepaid expenses and other current assets
 
$
51,786

 
$
(2,751
)
 
$
49,035

Current assets
 
1,308,037

 
(2,751
)
 
1,305,286

Total assets
 
1,881,157

 
(2,751
)
 
1,878,406

 
 
 
 
 
 

Other current liabilities
 
95,806

 
2,751

 
98,557

Current liabilities
 
449,161

 
2,751

 
451,912

Total liabilities
 
560,942

 
2,751

 
563,693

In May 2017, the FASB amended ASC 718, Stock Compensation, to reduce diversity in practice and to clarify when a change to the terms or conditions of a share-based payment award must be accounted for as a modification and will result in fewer changes to the terms of an award being accounted for as modifications. The new guidance was effective beginning in the first quarter of fiscal 2018 and will apply on a prospective basis. The Company does not expect it to have a material impact on its consolidated financial statements.
Accounting policies as a result of recently adopted accounting pronouncements
Revenue recognition
Net revenue is comprised of company-operated store net revenue, direct to consumer net revenue through websites and mobile apps, including mobile apps on in-store devices that allow demand to be fulfilled via the Company's distribution centers, and other net revenue, which includes revenue from outlets, temporary locations, sales to wholesale accounts, showrooms, warehouse sales, and license and supply arrangement net revenue, which consists of royalties as well as sales of the Company's products to licensees. All revenue is reported net of sales taxes collected from customers on behalf of taxing authorities.
Revenue is recognized when performance obligations are satisfied through the transfer of control of promised goods to the Company's customers. Control transfers once a customer has the ability to direct the use of, and obtain substantially all of the benefits from, the product. This includes the transfer of legal title, physical possession, the risks and rewards of ownership, and customer acceptance. Revenue from company-operated stores and other retail locations is recognized at the point of sale. Direct to consumer revenue and sales to wholesale accounts are recognized upon receipt by the customer.
Revenue is presented net of an allowance for estimated returns, which is based on historic experience. The Company's liability for sales return refunds is recognized within other current liabilities, and an asset for the value of inventory which is expected to be returned is recognized within other prepaid expenses and other current assets on the consolidated balance sheets.
Shipping fees billed to customers are recorded as revenue, and shipping costs are recognized within selling, general and administrative expenses in the same period the related revenue is recognized.
Proceeds from the sale of gift cards are initially deferred and recognized within unredeemed gift card liability on the consolidated balance sheets, and are recognized as revenue when tendered for payment. Based on historical experience, and to the extent there is no requirement to remit unclaimed card balances to government agencies, an estimate of the gift card balances that will never be redeemed is recognized as revenue in proportion to gift cards which have been redeemed.
Recently issued accounting pronouncements
In February 2016, the FASB issued ASC 842, Leases ("ASC 842") to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. Under the new guidance, lessees are required to recognize a lease liability, which represents the discounted obligation to make future minimum lease payments, and a corresponding right-of-use asset on the balance sheet for most leases. This guidance will be effective for the Company beginning in its first quarter of fiscal 2019, with early application permitted. The Company will adopt ASC 842 in its first quarter of fiscal 2019. The new guidance can be applied using either a modified retrospective approach at the beginning of the earliest period presented, or at the beginning of the period in which it is adopted, rather than at the beginning of the earliest comparative period presented. The Company is continuing to evaluate the method of adoption.

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The Company expects to apply the transition package of three practical expedients which allow companies not to reassess whether agreements contain leases, the classification of leases, and the capitalization of initial direct costs. The Company expects to make an accounting policy election to recognize lease expense for leases with a term of 12 months or less on a straight-line basis over the lease term and recognize no right of use asset or lease liability for those leases.
The Company is in the process of implementing new lease accounting software and continues to evaluate the impact this standard will have on its consolidated financial statements, disclosures, and internal controls. It is expected that the primary financial statement impact upon adoption will be the recognition, on a discounted basis, of the Company's minimum commitments under noncancelable operating leases as right of use assets and obligations on the consolidated balance sheets. It is expected that this will result in a significant increase in assets and liabilities on the consolidated balance sheets.
In August 2017, the FASB amended ASC 815, Derivatives and Hedging to more closely align hedge accounting with companies' risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. It will make more financial and nonfinancial hedging strategies eligible for hedge accounting. It also amends the presentation and disclosure requirements and changes how companies assess effectiveness. This guidance will be effective for the Company beginning in its first quarter of fiscal 2019, with early application permitted. The Company is currently evaluating the impact that this new guidance may have on its consolidated financial statements.
In January 2018, the FASB released guidance on the accounting for the global intangible low-taxed income ("GILTI") provisions of the tax bill H.R.1, commonly known as the U.S. Tax Cuts and Jobs Act ("U.S. tax reform"). The GILTI provisions impose a tax on foreign subsidiary earnings in excess of a deemed return on the foreign subsidiary's tangible assets. The guidance indicates that an accounting policy election can be made to treat the GILTI tax as either a current tax in the period in which it is incurred or as a deferred tax. The Company has not yet made its accounting policy election but will do so during the one-year measurement period as allowed by the SEC. In accordance with the FASB guidance, until an accounting policy election is made, any taxes related to the GILTI provisions will be treated as a current income tax expense in the period incurred.
In February 2018, the FASB amended ASC 220, Income Statement—Reporting Comprehensive Income. ASC 740, Income Taxes, requires that the effect of a change in tax laws or rates on deferred tax assets and liabilities be included in income from continuing operations. In situations in which the tax effects of a transaction were initially recognized directly in other comprehensive income, this results in "stranded" amounts in accumulated other comprehensive income related to the income tax rate differential. The amendments to ASC 220 allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the enactment of the U.S. tax reform. The guidance in the ASU is effective for the Company beginning in its first quarter of fiscal 2019 with early adoption permitted. The Company does not expect to elect to reclassify "stranded" amounts from accumulated other comprehensive income to retained earnings.
NOTE 3. CREDIT FACILITY
On June 6, 2018, the Company entered into Amendment No. 1 to its credit agreement. This amends the credit agreement to provide for (i) an increase in the aggregate commitments under the unsecured five-year revolving credit facility to $400.0 million, with an increase of the sub-limits for the issuance of letters of credit and extensions of swing line loans to $50.0 million for each, (ii) an increase in the option, subject to certain conditions as set forth in the credit agreement, to request increases in commitments under the revolving facility from $400.0 million to $600.0 million, and (iii) an extension in the maturity of the revolving facility from December 15, 2021 to June 6, 2023.
In addition, this amendment decreases the applicable margins for LIBOR loans from 1.00%-1.75% to 1.00%-1.50% and for alternate base rate loans from 0.00%-0.75% to 0.00%-0.50%, reduces the commitment fee on average daily unused amounts under the revolving facility from 0.125%-0.200% to 0.10%-0.20%, and reduces fees for unused letters of credit from 1.00%-1.75% to 1.00%-1.50%.
As of July 29, 2018, the Company had borrowings of $100.0 million outstanding under this credit facility, as well as letters of credit of $1.3 million. The weighted-average interest rate on funds borrowed as of July 29, 2018 was 3.32%. The Company had no borrowings outstanding under this credit facility as of January 28, 2018.
NOTE 4. STOCK-BASED COMPENSATION AND BENEFIT PLANS
Stock-based compensation plans
The Company's eligible employees participate in various stock-based compensation plans, which are provided by the Company directly.

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Stock-based compensation expense charged to income for the plans was $13.0 million and $8.7 million for the two quarters ended July 29, 2018 and July 30, 2017, respectively. Total unrecognized compensation cost for all stock-based compensation plans was $59.2 million at July 29, 2018, which is expected to be recognized over a weighted-average period of 2.3 years.
Company stock options, performance-based restricted stock units, restricted shares, and restricted stock units
A summary of the Company's stock option, performance-based restricted stock unit, restricted share, and restricted stock unit activity as of July 29, 2018, and changes during the first two quarters then ended, is presented below:
 
 
Stock Options
 
Performance-Based Restricted Stock Units
 
Restricted Shares
 
Restricted Stock Units
 
 
Number
 
Weighted-Average Exercise Price
 
Number
 
Weighted-Average Grant Date Fair Value
 
Number
 
Weighted-Average Grant Date Fair Value
 
Number
 
Weighted-Average Grant Date Fair Value
 
 
(In thousands, except per share amounts)
Balance at January 28, 2018
 
1,117

 
$
56.44

 
329

 
$
60.42

 
21

 
$
52.45

 
427

 
$
57.54

Granted
 
308

 
86.99

 
85

 
87.19

 
6

 
124.19

 
248

 
87.18

Exercised/released
 
245

 
56.20

 
39

 
63.04

 
21

 
52.45

 
145

 
59.37

Forfeited/expired
 
277

 
58.49

 
127

 
61.35

 

 

 
40

 
64.58

Balance at July 29, 2018
 
903

 
$
66.31

 
248

 
$
68.72

 
6

 
$
124.19

 
490

 
$
71.45

Exercisable at July 29, 2018
 
186

 
$
56.47

 
 
 
 
 
 
 
 
 
 
 
 
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes model. The assumptions used to calculate the fair value of the options granted are evaluated and revised, as necessary, to reflect market conditions and the Company's historical experience. The expected term of the options is based upon the historical experience of similar awards, giving consideration to expectations of future employee behavior. Expected volatility is based upon the historical volatility of the Company's common stock for the period corresponding with the expected term of the options. The risk-free interest rate is based on the U.S. Treasury yield curve for the period corresponding with the expected term of the options. The following are weighted averages of the assumptions that were used in calculating the fair value of stock options granted in the first two quarters of fiscal 2018:
 
 
Two Quarters Ended
 July 29, 2018
Expected term
 
3.75 years

Expected volatility
 
36.88
%
Risk-free interest rate
 
2.46
%
Dividend yield
 
%
The Company's performance-based restricted stock units are awarded to eligible employees and entitle the grantee to receive a maximum of two shares of common stock per performance-based restricted stock unit if the Company achieves specified performance goals and the grantee remains employed during the vesting period. The fair value of performance-based restricted stock units is based on the closing price of the Company's common stock on the award date. Expense for performance-based restricted stock units is recognized when it is probable that the performance goal will be achieved.
The fair value of the restricted shares and restricted stock units is based on the closing price of the Company's common stock on the award date.
Employee share purchase plan
The Company's board of directors and stockholders approved the Company's Employee Share Purchase Plan ("ESPP") in September 2007. Contributions are made by eligible employees, subject to certain limits defined in the ESPP, and the Company matches one-third of the contribution. The maximum number of shares authorized to be purchased under the ESPP is 6.0 million shares. All shares purchased under the ESPP are purchased in the open market. During the quarter ended July 29, 2018, there were 23.8 thousand shares purchased.

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Defined contribution pension plans
During the second quarter of fiscal 2016, the Company began offering defined contribution pension plans to its eligible employees in Canada and the United States. Participating employees may elect to defer and contribute a portion of their eligible compensation to a plan up to limits stated in the plan documents, not to exceed the dollar amounts set by applicable laws. The Company matches 50% to 75% of the contribution depending on the participant's length of service, and the contribution is subject to a two year vesting period. The Company's net expense for the defined contribution plans was $3.1 million and $2.7 million in the first two quarters of fiscal 2018 and fiscal 2017, respectively.
NOTE 5. FAIR VALUE MEASUREMENT
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are made using a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value:
Level 1 - defined as observable inputs such as quoted prices in active markets;
Level 2 - defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and
Level 3 - defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
Assets and liabilities measured at fair value on a recurring basis
The fair value measurement is categorized in its entirety by reference to its lowest level of significant input. As of July 29, 2018 and January 28, 2018, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis:
 
 
July 29, 2018
 
Level 1
 
Level 2
 
Level 3
 
Balance Sheet Classification
 
 
(In thousands)
 
 
Money market funds
 
$
143,478

 
$
143,478

 
$

 
$

 
Cash and cash equivalents
Term deposits
 
337,818

 

 
337,818

 

 
Cash and cash equivalents
Net forward currency contract assets
 
3,254

 

 
3,254

 

 
Other prepaid expenses and other current assets
Net forward currency contract liabilities
 
5,891

 

 
5,891

 

 
Other current liabilities
 
 
January 28, 2018
 
Level 1
 
Level 2
 
Level 3
 
Balance Sheet Classification
 
 
(In thousands)
 
 
Term deposits
 
$
258,238

 
$

 
$
258,238

 
$

 
Cash and cash equivalents
Net forward currency contract assets
 
7,889

 

 
7,889

 

 
Other prepaid expenses and other current assets
Net forward currency contract liabilities
 
8,771

 

 
8,771

 

 
Other current liabilities
The Company records accounts receivable, accounts payable, accrued liabilities, and borrowings under the revolving credit facility at cost. The carrying values of these instruments approximate their fair value due to their short-term maturities.
The Company has short-term, highly liquid investments classified as cash equivalents, which are invested in money market funds, Treasury bills, and term deposits. The Company records cash equivalents at their original purchase prices plus interest that has accrued at the stated rate.
The fair values of the forward currency contract assets and liabilities are determined using observable Level 2 inputs, including foreign currency spot exchange rates, forward pricing curves, and interest rates. The fair values consider the credit risk of the Company and its counterparties. They are presented at their gross fair values. However, the Company's Master International Swap Dealers Association, Inc., Agreements and other similar arrangements allow net settlements under certain conditions.

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Assets and liabilities measured at fair value on a non-recurring basis
In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company has impaired certain long-lived assets and recorded them at their estimated fair value on a non-recurring basis. The fair value of these long-lived assets was determined using Level 3 inputs, principally the present value of the estimated future cash flows expected from their use and eventual disposition. Please refer to Note 7 of these unaudited interim consolidated financial statements for further details regarding the impairment of long-lived assets as a result of the ivivva restructuring.
The Company has also recorded certain lease termination liabilities at fair value on a non-recurring basis, determined using Level 3 inputs based on remaining lease rentals and reduced by estimated sublease income. As of July 29, 2018 and January 28, 2018, the Company had lease termination liabilities of $3.2 million and $6.4 million, respectively. This was primarily as a result of the ivivva restructuring.
NOTE 6. DERIVATIVE FINANCIAL INSTRUMENTS
Foreign exchange risk
The Company is exposed to risks associated with changes in foreign currency exchange rates and uses derivative financial instruments to manage its exposure to certain of these foreign currency exchange rate risks. The Company does not enter into derivative contracts for speculative or trading purposes.
The Company currently hedges against changes in the Canadian dollar to U.S. dollar exchange rate using forward currency contracts.
Net investment hedges
The Company is exposed to foreign exchange gains and losses which arise on translation of its foreign subsidiaries' balance sheets into U.S. dollars. These gains and losses are recorded as a foreign currency translation adjustment in accumulated other comprehensive income or loss within stockholders' equity.
The Company holds a significant portion of its assets in Canada and enters into forward currency contracts designed to hedge a portion of the foreign currency exposure that arises on translation of a Canadian subsidiary into U.S. dollars. These forward currency contracts are designated as net investment hedges. The effective portions of the hedges are reported in accumulated other comprehensive income or loss and will subsequently be reclassified to net earnings in the period in which the hedged investment is either sold or substantially liquidated. Hedge effectiveness is measured using a method based on changes in forward exchange rates. The Company recorded no ineffectiveness from net investment hedges during the first two quarters of fiscal 2018.
The Company classifies the cash flows at settlement of its net investment hedges within investing activities in the consolidated statements of cash flows.
Derivatives not designated as hedging instruments
The Company is exposed to gains and losses arising from changes in foreign exchange rates associated with transactions which are undertaken by its subsidiaries in currencies other than their functional currency. Such transactions include intercompany transactions and inventory purchases. These transactions result in the recognition of certain foreign currency denominated monetary assets and liabilities which are remeasured to the quarter-end or settlement date exchange rate. The resulting foreign currency gains and losses are recorded in selling, general and administrative expenses.
During the first two quarters of fiscal 2018, the Company entered into certain forward currency contracts designed to economically hedge the foreign exchange revaluation gains and losses that are recognized by its Canadian subsidiaries on U.S. dollar denominated monetary assets and liabilities. The Company has not applied hedge accounting to these instruments and the change in fair value of these derivatives is recorded within selling, general and administrative expenses.
The Company classifies the cash flows at settlement of its forward currency contracts which are not designated in hedging relationships within operating activities in the consolidated statements of cash flows.

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Outstanding notional amounts
The Company had foreign exchange forward contracts outstanding with the following notional amounts:
 
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands)
Derivatives designated as net investment hedges
 
$
339,000

 
$
78,000

Derivatives not designated in a hedging relationship
 
321,000

 
65,000

The forward currency contracts designated as net investment hedges mature on different dates between August 2018 and January 2019.
The forward currency contracts not designated in a hedging relationship mature on different dates between August 2018 and January 2019.
Quantitative disclosures about derivative financial instruments
The Company presents its derivative assets and derivative liabilities at their gross fair values within other prepaid expenses and other current assets and other current liabilities on the consolidated balance sheets. However, the Company's Master International Swap Dealers Association, Inc., Agreements and other similar arrangements allow net settlements under certain conditions. As of July 29, 2018, there were derivative assets of $3.3 million and derivative liabilities of $5.9 million subject to enforceable netting arrangements.
The fair values of forward currency contracts were as follows:
 
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands)
Net forward currency contract assets, recognized within other prepaid expenses and other current assets:
 
 
 
 
Derivatives designated as net investment hedges
 
$
3,254

 
$

Derivatives not designated in a hedging relationship
 

 
5,937

Net forward currency contract liabilities, recognized within other current liabilities:
 
 
 
 
Derivatives designated as net investment hedges
 

 
7,068

Derivatives not designated in a hedging relationship
 
5,891

 

The pre-tax gains and losses on foreign exchange forward contracts recorded in accumulated other comprehensive income are as follows:
 
 
Quarter Ended
 
Two Quarters Ended
 
 
July 29, 2018
 
July 30, 2017
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands)
Gains (losses) recognized in foreign currency translation adjustment:
 
 
 
 
 
 
 
 
Derivatives designated as net investment hedges
 
$
5,721

 
$
(8,925
)
 
$
16,538

 
$
(8,925
)
No gains or losses have been reclassified from accumulated other comprehensive income into net income for derivative financial instruments in a net investment hedging relationship, as the Company has not sold or liquidated (or substantially liquidated) its hedged subsidiary.

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The pre-tax net foreign exchange and derivative gains and losses recorded in the consolidated statement of operations are as follows:
 
 
Quarter Ended
 
Two Quarters Ended
 
 
July 29, 2018
 
July 30, 2017
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands)
Gains (losses) recognized in selling, general and administrative expenses:
 
 
 
 
 
 
 
 
Foreign exchange gains (losses)
 
$
2,960

 
$
(9,303
)
 
$
12,605

 
$
(3,511
)
Derivatives not designated in a hedging relationship
 
(5,539
)
 
7,634

 
(15,587
)
 
7,634

Net foreign exchange and derivative (losses) gains
 
$
(2,579
)
 
$
(1,669
)
 
$
(2,982
)
 
$
4,123

Credit risk
The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to the forward currency contracts. The credit risk amount is the Company's unrealized gains on its derivative instruments, based on foreign currency rates at the time of nonperformance.
The Company's forward currency contracts are entered into with large, reputable financial institutions that are monitored by the Company for counterparty risk.
The Company's derivative contracts contain certain credit risk-related contingent features. Under certain circumstances, including an event of default, bankruptcy, termination, and cross default under the Company's revolving credit facility, the Company may be required to make immediate payment for outstanding liabilities under its derivative contracts.
NOTE 7. ASSET IMPAIRMENT AND RESTRUCTURING
During fiscal 2017, the Company restructured its ivivva operations. On August 20, 2017, the Company closed 48 of its 55 ivivva branded company-operated stores and all other ivivva branded temporary locations. As a result of this restructuring, the Company recognized aggregate pre-tax charges of $47.2 million during fiscal 2017, inclusive of $23.2 million recognized during the first two quarters of fiscal 2017.
A summary of the pre-tax charges recognized in connection with the Company's restructuring of its ivivva operations is as follows:
 
 
Quarter Ended
 
Two Quarters Ended
 
 
July 29, 2018
 
July 30, 2017
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands)
Costs recorded in cost of goods sold:
 
 
 
 
 
 
 
 
Provision to reduce inventories to net realizable value
 
$

 
$
962

 
$

 
$
2,904

Expected loss on committed inventory purchases
 

 
(941
)
 

 
2,536

Accelerated depreciation
 

 
2,223

 

 
2,223

 
 

 
2,244

 

 
7,663

Costs recorded in operating expenses:
 
 
 
 
 
 
 
 
Impairment of property and equipment
 

 

 

 
11,593

Employee related costs
 

 
2,458

 

 
3,196

Lease termination and other restructuring costs
 

 
728

 

 
728

Asset impairment and restructuring costs
 

 
3,186

 

 
15,517

Restructuring and related costs
 
$

 
$
5,430

 
$

 
$
23,180

Income tax recoveries of $1.4 million and $6.1 million were recorded on the above items in the second quarter and the first two quarters of fiscal 2017, respectively. These income tax recoveries were based on the expected annual tax rate of the applicable tax jurisdictions.

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Costs recorded in cost of goods sold
During the first two quarters of fiscal 2017, the Company recognized expenses of $7.7 million in cost of goods sold as a result of the restructuring of its ivivva operations. This included $2.9 million to reduce inventories to their estimated net realizable value, and $2.5 million for the losses the Company expected to incur on certain inventory and fabric purchase commitments.
During the second quarter of fiscal 2017, the Company took delivery of inventory that it had previously committed to purchase. As a result, there was a reduction in the Company's liability for expected losses on committed inventory purchases and a corresponding increase in its provision to reduce inventories to net realizable value.
The Company also recorded accelerated depreciation charges of $2.2 million during the first two quarters of fiscal 2017, primarily related to leasehold improvements and furniture and fixtures for company operated-stores that closed during the third quarter of fiscal 2017.
Costs recorded in operating expenses
The Company recognized asset impairment and restructuring costs of $15.5 million during the first two quarters of fiscal 2017 as a result of the restructuring of its ivivva operations.
As a result of the plan to close the majority of the ivivva branded locations, the long-lived assets of each ivivva branded location were tested for impairment as of April 30, 2017. For impaired locations, a loss was recognized representing the difference between the net book value of the long-lived assets and their estimated fair value. Impairment losses totaling $11.6 million were recognized during the first quarter of fiscal 2017. These losses primarily relate to leasehold improvements and furniture and fixtures of the company-operated stores segment. These assets were retired during the third quarter of fiscal 2017 in conjunction with the closures of the company-operated stores.
During the first two quarters of fiscal 2017, the Company recognized employee related expenses as a result of the restructuring of $3.2 million as well as lease termination and other restructuring costs of $0.7 million.
NOTE 8. INCOME TAXES
The U.S. tax reform was enacted on December 22, 2017 and introduced significant changes to U.S. income tax laws. The U.S. tax reform reduced the U.S. federal income tax rate from 35% to 21%, introduced a shift to a territorial tax system and changed how foreign earnings are subject to U.S. tax, and imposed a mandatory one-time transition tax on the deemed repatriation of accumulated undistributed earnings of foreign subsidiaries. The U.S. tax reform also introduced new taxes on certain foreign-sourced earnings and certain related-party payments, which are referred to as the GILTI tax and the base erosion anti-abuse tax. Accounting for the income tax effects of the U.S. tax reform is complex and requires significant judgement and estimates in the interpretation and calculations of its provisions.
The SEC issued Staff Accounting Bulletin 118 ("SAB 118") which allows companies to record provisional estimates of the impacts of the U.S. tax reform within a one year measurement period. As disclosed in Note 14 to the audited consolidated financial statements included in Item 8 of the Company's fiscal 2017 Annual Report on Form 10-K filed with the SEC on March 27, 2018, the Company recorded certain provisional amounts in the fourth quarter of fiscal 2017 and expects the accounting for the income tax effects of the U.S. tax reform to be completed in fiscal 2018.
As the Company completes its analysis of the U.S. tax reform it may make adjustments to the provisional amounts recognized during fiscal 2017, and will incorporate any additional interpretations or guidance that may be issued. The Company may also identify additional effects not reflected as of July 29, 2018. Any such adjustments may materially impact the provision for income taxes and the effective income tax rate in the period in which the adjustments are made.
As of July 29, 2018, no deferred income tax liabilities have been recognized on any of the undistributed earnings of the Company's foreign subsidiaries as these earnings were indefinitely reinvested outside of the United States. The Company is continuing to evaluate the impact that the U.S. tax reform will have upon the taxes which may become payable upon repatriation, its reinvestment plans, and the most efficient means of deploying its capital resources globally. As this analysis has not yet been completed, it is possible that amounts determined to be indefinitely reinvested outside of the U.S. may ultimately be repatriated, resulting in additional tax liabilities being recognized.

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NOTE 9. EARNINGS PER SHARE
The details of the computation of basic and diluted earnings per share are as follows:
 
 
Quarter Ended
 
Two Quarters Ended
 
 
July 29, 2018
 
July 30, 2017
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands, except per share amounts)
Net income
 
$
95,770

 
$
48,711

 
$
170,923

 
$
79,957

Basic weighted-average number of shares outstanding
 
133,986

 
136,171

 
134,744

 
136,604

Assumed conversion of dilutive stock options and awards
 
544

 
132

 
486

 
143

Diluted weighted-average number of shares outstanding
 
134,530

 
136,303

 
135,230

 
136,747

Basic earnings per share
 
$
0.71

 
$
0.36

 
$
1.27

 
$
0.59

Diluted earnings per share
 
$
0.71

 
$
0.36

 
$
1.26

 
$
0.58

The Company's calculation of weighted-average shares includes the common stock of the Company as well as the exchangeable shares. Exchangeable shares are the equivalent of common shares in all material respects. All classes of stock have, in effect, the same rights and share equally in undistributed net income. For the two quarters ended July 29, 2018 and July 30, 2017, 48.5 thousand and 0.2 million stock options and awards, respectively, were anti-dilutive to earnings per share and therefore have been excluded from the computation of diluted earnings per share.
On December 1, 2016, the Company's board of directors approved a program to repurchase shares of the Company's common stock up to an aggregate value of $100.0 million. This stock repurchase program was completed during the third quarter of fiscal 2017.
On November 29, 2017, the Company's board of directors approved a stock repurchase program for up to $200.0 million. On June 6, 2018, the board of directors approved an increase to this stock repurchase program, authorizing the repurchase of up to a total of $600.0 million of the Company's common shares on the open market or in privately negotiated transactions. Common shares repurchased on the open market are at prevailing market prices, including under plans complying with the provisions of Rule 10b5-1 and Rule 10b-18 of the Securities Exchange Act of 1934. The timing and actual number of common shares to be repurchased will depend upon market conditions, eligibility to trade, and other factors, in accordance with Securities and Exchange Commission requirements, and the repurchase program is expected to be completed by November 2019. As of July 29, 2018, the remaining aggregate value of shares available to be repurchased under this program was $192.8 million.
During the two quarters ended July 29, 2018 and July 30, 2017, 3.4 million and 1.7 million shares, respectively, were repurchased under the program at a total cost of $406.2 million and $90.8 million, respectively.
Subsequent to July 29, 2018, and up to August 27, 2018, 0.1 million shares were repurchased at a total cost of $7.9 million.
NOTE 10. SUPPLEMENTARY FINANCIAL INFORMATION
A summary of certain consolidated balance sheet accounts is as follows:
 
 
July 29,
2018
 
January 28,
2018
 
 
(In thousands)
Inventories:
 
 
 
 
Finished goods
 
$
411,801

 
$
344,695

Provision to reduce inventories to net realizable value
 
(19,129
)
 
(15,133
)
 
 
$
392,672

 
$
329,562


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July 29,
2018
 
January 28,
2018
 
 
(In thousands)
Property and equipment, net:
 
 
 
 
Land
 
$
78,829

 
$
83,048

Buildings
 
38,100

 
39,278

Leasehold improvements
 
313,062

 
301,449

Furniture and fixtures
 
94,270

 
91,778

Computer hardware
 
64,060

 
61,734

Computer software
 
181,909

 
173,997

Equipment and vehicles
 
14,993

 
14,806

Work in progress
 
78,503

 
51,260

Property and equipment, gross
 
863,726

 
817,350

Accumulated depreciation
 
(376,180
)
 
(343,708
)
 
 
$
487,546

 
$
473,642

Goodwill and intangible assets, net:
 
 
 
 
Goodwill
 
$
25,496

 
$
25,496

Changes in foreign currency exchange rates
 
(1,241
)
 
(890
)
 
 
24,255

 
24,606

Intangible assets, net
 

 
73

 
 
$
24,255

 
$
24,679

Other non-current assets:
 
 
 
 
Security deposits
 
$
13,869

 
$
11,599

Deferred lease assets
 
8,908

 
10,458

Other
 
10,197

 
9,332

 
 
$
32,974

 
$
31,389

Other current liabilities:
 
 
 
 
Accrued duty, freight, and other operating expenses
 
$
44,808

 
$
33,695

Sales tax collected
 
13,205

 
11,811

Sales return allowance
 
8,911

 
6,293

Accrued rent
 
6,234

 
7,074

Forward currency contract liabilities
 
5,891

 
8,771

Accrued capital expenditures
 
4,671

 
5,714

Lease termination liabilities
 
3,219

 
6,427

Other
 
8,867

 
6,631

 
 
$
95,806

 
$
86,416

Other non-current liabilities:
 
 
 
 
Deferred lease liabilities
 
$
30,061

 
$
27,186

Tenant inducements
 
30,510

 
26,250

Other
 
5,550

 
5,885

 
 
$
66,121

 
$
59,321


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NOTE 11. SEGMENT REPORTING
The Company applies ASC Topic 280, Segment Reporting ("ASC 280"), in determining reportable segments for its financial statement disclosure. The Company reports segments based on the financial information it uses in managing its business. The Company's reportable segments are comprised of company-operated stores and direct to consumer. Direct to consumer represents sales from the Company's e-commerce websites and mobile apps. Outlets, temporary locations, sales to wholesale accounts, showrooms, warehouse sale net revenue, and license and supply arrangements have been combined into other. During the first quarter of fiscal 2018, the Company reviewed its general corporate expenses and determined certain costs which were previously classified as general corporate expense are more appropriately classified within the direct to consumer segment. Accordingly, comparative figures have been reclassified to conform to the financial presentation adopted for the current year.
 
 
Quarter Ended
 
Two Quarters Ended
 
 
July 29, 2018
 
July 30, 2017
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands)
Net revenue:
 
 
 
 
 
 
 
 
Company-operated stores
 
$
486,368

 
$
413,944

 
$
919,499

 
$
793,043

Direct to consumer
 
167,405

 
113,049

 
325,248

 
210,272

Other
 
69,727

 
54,061

 
128,459

 
98,046

 
 
$
723,500

 
$
581,054

 
$
1,373,206

 
$
1,101,361

Segmented income from operations:
 
 
 
 
 
 
 
 
Company-operated stores
 
$
125,868

 
$
92,609

 
$
225,155

 
$
170,139

Direct to consumer
 
67,033

 
38,748

 
129,300

 
72,846

Other
 
13,094

 
6,952

 
24,317

 
9,760

 
 
205,995

 
138,309

 
378,772

 
252,745

General corporate expense
 
71,787

 
64,167

 
140,259

 
115,430

Restructuring and related costs
 

 
5,430

 

 
23,180

Income from operations
 
134,208

 
68,712

 
238,513

 
114,135

Other income (expense), net
 
1,591

 
812

 
4,509

 
1,719

Income before income tax expense
 
$
135,799

 
$
69,524

 
$
243,022

 
$
115,854

 
 
 
 
 
 
 
 
 
Capital expenditures:
 
 
 
 
 
 
 
 
Company-operated stores
 
$
27,765

 
$
16,634

 
$
47,001

 
$
23,802

Direct to consumer
 
593

 
6,861

 
1,314

 
8,841

Corporate and other
 
21,335

 
6,515

 
35,692

 
17,246

 
 
$
49,693

 
$
30,010

 
$
84,007

 
$
49,889

Depreciation and amortization:
 
 
 
 
 
 
 
 
Company-operated stores
 
$
18,489

 
$
15,881

 
$
35,571

 
$
31,081

Direct to consumer
 
2,302

 
4,353

 
4,901

 
6,347

Corporate and other
 
7,865

 
8,172

 
14,957

 
14,141

 
 
$
28,656

 
$
28,406

 
$
55,429

 
$
51,569

The accelerated depreciation related to the restructuring of the ivivva operations is included in corporate and other in the above breakdown of depreciation and amortization.

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The following table disaggregates the Company's net revenue by geographic area. The economic conditions in these areas could affect the amount and timing of the Company's net revenue and cash flows.
 
 
Quarter Ended
 
Two Quarters Ended
 
 
July 29, 2018
 
July 30, 2017
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands)
United States
 
$
512,413

 
$
413,634

 
$
974,683

 
$
793,101

Canada
 
124,278

 
108,446

 
236,427

 
200,092

Outside of North America
 
86,809

 
58,974

 
162,096

 
108,168

 
 
$
723,500

 
$
581,054

 
$
1,373,206

 
$
1,101,361

NOTE 12. LEGAL PROCEEDINGS
In addition to the legal matters described below, the Company is, from time to time, involved in routine legal matters incidental to the conduct of its business, including legal matters such as initiation and defense of proceedings to protect intellectual property rights, personal injury claims, product liability claims, employment claims, and similar matters. The Company believes the ultimate resolution of any such current proceeding will not have a material adverse effect on its consolidated balance sheets, results of operations or cash flows.
On October 9, 2015, certain current and former hourly employees of the Company filed a class action lawsuit in the Supreme Court of New York entitled Rebecca Gathmann-Landini et al v. lululemon USA inc. On December 2, 2015, the case was moved to the United States District Court for the Eastern District of New York. The lawsuit alleges that the Company violated various New York labor codes by failing to pay all earned wages, including overtime compensation. The plaintiffs are seeking an unspecified amount of damages. The Company intends to vigorously defend this matter.
On December 20, 2017, former lululemon employee Shayla Famouri filed a lawsuit in Los Angeles Superior Court against the Company and a former employee of the Company. The plaintiff alleges claims for sexual assault and battery, sexual harassment, retaliation, creating a hostile work environment and related claims. The complaint seeks damages in the amount of $3.0 million, as well as non-monetary relief such as policy change and an apology. The Company intends to vigorously defend this matter.
NOTE 13. SUBSEQUENT EVENT
The Company evaluates events or transactions that occur after the balance sheet date through to the date which the financial statements are issued, for potential recognition or disclosure in its consolidated financial statements in accordance with ASC Topic 855, Subsequent Events.
On August 13, 2018, the Company repaid the $100.0 million outstanding on its revolving credit facility.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Some of the statements contained in this Form 10-Q and any documents incorporated herein by reference constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical facts, included or incorporated in this Form 10-Q are forward-looking statements, particularly statements which 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," "intends," "predicts," "potential" or the negative of these terms or other comparable terminology.
The forward-looking statements contained in this Form 10-Q and any documents incorporated herein by reference 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

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materially from those indicated by the forward-looking statements, including, but not limited to, those factors described in "Risk Factors" and elsewhere in this report.
The forward-looking statements contained in this Form 10-Q reflect our views and assumptions only as of the date of this Form 10-Q and are expressly qualified in their entirety by the cautionary statements included in this Form 10-Q. Except as required by applicable securities law, 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.
This information should be read in conjunction with the unaudited interim consolidated financial statements and the notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in our fiscal 2017 Annual Report on Form 10-K filed with the SEC on March 27, 2018.
We disclose material non-public information through one or more of the following channels: our investor relations website (http://investor.lululemon.com/), the social media channels identified on our investor relations website, press releases, SEC filings, public conference calls, and webcasts.
Overview
lululemon athletica inc. is principally a designer, distributor, and retailer of healthy lifestyle inspired athletic apparel and accessories. We have a mission to create transformational products and experiences which enable people to live a life they love, and have developed a brand for those pursuing an active, mindful lifestyle. Since our inception, we have fostered a distinctive corporate culture; we promote a set of core values in our business which include taking personal responsibility, nurturing entrepreneurial spirit, acting with honesty and courage, valuing connection, and choosing to have fun. These core values attract passionate and motivated employees who are driven to achieve personal and professional goals, and share our purpose of "elevating the world through the power of practice."
Our healthy lifestyle inspired athletic apparel and accessories are marketed under the lululemon and ivivva brand names. We offer a comprehensive line of apparel and accessories for women, men, and female youth. Our apparel assortment includes items such as pants, shorts, tops, and jackets designed for a healthy lifestyle and athletic activities such as yoga, running, training, and most other sweaty pursuits. We also offer fitness-related accessories, including items such as bags, socks, underwear, yoga mats and equipment, and water bottles.
During fiscal 2017, we restructured our ivivva operations. On August 20, 2017, we closed 48 of our 55 ivivva branded company-operated stores and all other ivivva branded temporary locations.
Financial Highlights
The summary below provides both GAAP and adjusted non-GAAP financial measures. In connection with the restructuring of our ivivva operations, we recognized pre-tax costs totaling $5.4 million in the second quarter of fiscal 2017. The adjusted financial measures for the second quarter of fiscal 2017 exclude these charges and their related tax effects.
For the second quarter of fiscal 2018, compared to the second quarter of fiscal 2017:
Net revenue increased 25% to $723.5 million. On a constant dollar basis, net revenue increased 24%.
Total comparable sales, which includes comparable store sales and direct to consumer, increased 20%. On a constant dollar basis, total comparable sales increased 19%.
Comparable store sales increased 10%, or increased 10% on a constant dollar basis.
Direct to consumer net revenue increased 48%, or increased 47% on a constant dollar basis.
Gross profit increased 33% to $396.2 million. It increased 32% compared to adjusted gross profit for the second quarter of fiscal 2017.
Gross margin increased 360 basis points to 54.8%. It increased 320 basis points compared to adjusted gross margin for the second quarter of fiscal 2017.
Income from operations increased 95% to $134.2 million. It increased 81% compared to adjusted income from operations for the second quarter of fiscal 2017.
Operating margin increased 670 basis points to 18.5%. It increased 570 basis points compared to adjusted operating margin for the second quarter of fiscal 2017.

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Income tax expense increased 92% to $40.0 million. Our effective tax rate for the second quarter of fiscal 2018 was 29.5% compared to 29.9% for the second quarter of fiscal 2017. The adjusted effective tax rate was 29.6% in the second quarter of fiscal 2017.
Diluted earnings per share were $0.71 compared to $0.36 in the second quarter of fiscal 2017. Adjusted diluted earnings per share were $0.39 for the second quarter of fiscal 2017.
Refer to the non-GAAP reconciliation tables contained in the "Non-GAAP Financial Measures" section of this "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" for reconciliations between constant dollar changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue, and adjusted gross profit, gross margin, income from operations, operating margin, income tax expense, effective tax rates, and diluted earnings per share, and the most directly comparable measures calculated in accordance with GAAP.
Results of Operations
Second Quarter Results
The following table summarizes key components of our results of operations for the quarters ended July 29, 2018 and July 30, 2017. The percentages are presented as a percentage of net revenue.
 
 
Quarter Ended
 
 
July 29, 2018
 
July 30, 2017

July 29, 2018
 
July 30, 2017
 
 
(In thousands)
 
(Percentages)
Net revenue
 
$
723,500

 
$
581,054

 
100.0
%
 
100.0
%
Cost of goods sold
 
327,306

 
283,632

 
45.2

 
48.8

Gross profit
 
396,194

 
297,422

 
54.8

 
51.2

Selling, general and administrative expenses
 
261,986

 
225,524

 
36.2

 
38.8

Asset impairment and restructuring costs
 

 
3,186

 

 
0.6

Income from operations
 
134,208

 
68,712

 
18.5

 
11.8

Other income (expense), net
 
1,591

 
812

 
0.2

 
0.2

Income before income tax expense
 
135,799

 
69,524

 
18.8

 
12.0

Income tax expense
 
40,029

 
20,813

 
5.5

 
3.6

Net income
 
$
95,770

 
$
48,711

 
13.2
%
 
8.4
%
Net Revenue
Net revenue increased $142.4 million, or 25%, to $723.5 million for the second quarter of fiscal 2018 from $581.1 million for the second quarter of fiscal 2017. On a constant dollar basis, assuming the average exchange rates for the second quarter of fiscal 2018 remained constant with the average exchange rates for the second quarter of fiscal 2017, net revenue increased $139.7 million, or 24%.
The increase in net revenue was primarily due to increased direct to consumer net revenue, net revenue generated by new company-operated stores, and an increase in comparable store sales. Total comparable sales, which includes comparable store sales and direct to consumer, increased 20% in the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017. Total comparable sales increased 19% on a constant dollar basis.
Net revenue on a segment basis for the quarters ended July 29, 2018 and July 30, 2017 is summarized below. The percentages are presented as a percentage of total net revenue.
 
 
Quarter Ended
 
 
July 29, 2018
 
July 30, 2017
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands)
 
(Percentages)
Company-operated stores
 
$
486,368

 
$
413,944

 
67.2
%
 
71.2
%
Direct to consumer
 
167,405

 
113,049

 
23.1

 
19.5

Other
 
69,727

 
54,061

 
9.6

 
9.3

Net revenue
 
$
723,500

 
$
581,054

 
100.0
%
 
100.0
%

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Company-Operated Stores. Net revenue from our company-operated stores segment increased $72.4 million, or 17%, to $486.4 million in the second quarter of fiscal 2018 from $413.9 million in the second quarter of fiscal 2017. The following contributed to the increase in net revenue from our company-operated stores segment:
Net revenue from company-operated stores we opened or significantly expanded subsequent to July 30, 2017, and therefore not included in comparable store sales, contributed $50.6 million to the increase. We opened 42 net new lululemon branded company-operated stores since the second quarter of fiscal 2017, including 22 stores in North America, 12 stores in Asia, six stores in Europe, and two stores in Australia/New Zealand.
A comparable store sales increase of 10% in the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017 resulted in a $35.7 million increase to net revenue. Comparable store sales increased 10%, or $34.6 million on a constant dollar basis. The increase in comparable store sales was primarily a result of increased store traffic, and due to improved conversion rates and increased dollar value per transaction.
These increases in net revenue were partially offset by the closure of 48 of our ivivva branded company-operated stores as part of the restructuring of our ivivva operations. These closures reduced our net revenue from company-operated stores for the second quarter of fiscal 2018 by $13.8 million compared to the second quarter of fiscal 2017.
Direct to Consumer. Net revenue from our direct to consumer segment increased $54.4 million, or 48%, to $167.4 million in the second quarter of fiscal 2018 from $113.0 million in the second quarter of fiscal 2017. Direct to consumer net revenue increased 47% on a constant dollar basis. This was primarily a result of increased website traffic and improved conversion rates, and due to increased dollar value per transaction. During the second quarter of fiscal 2017, we held an online warehouse sale in the United States and Canada which generated net revenue of $12.3 million. We did not hold any online warehouse sales during the second quarter of fiscal 2018.
Other. Net revenue from our other segment increased $15.7 million, or 29%, to $69.7 million in the second quarter of fiscal 2018 from $54.1 million in the second quarter of fiscal 2017. This increase was primarily the result of an increased number of outlets and temporary locations, including seasonal stores, open during the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017. There was also an increase in net revenue at existing outlets during the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017. The increase in net revenue from our other segment was partially offset by lower net revenue from showrooms, primarily due to a decreased number of showrooms open during the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017.
Gross Profit
Gross profit increased $98.8 million, or 33%, to $396.2 million for the second quarter of fiscal 2018 from $297.4 million for the second quarter of fiscal 2017.
Gross profit as a percentage of net revenue, or gross margin, increased 360 basis points to 54.8% in the second quarter of fiscal 2018 from 51.2% in the second quarter of fiscal 2017. The increase in gross margin was primarily the result of:
an increase in product margin of 260 basis points, which was primarily due to lower product costs, a favorable mix of higher margin product, and lower markdowns;
a decrease in occupancy and depreciation costs as a percentage of revenue of 70 basis points;
a favorable impact of foreign exchange rates of 20 basis points; and
the costs incurred in the second quarter of fiscal 2017 in connection with the restructuring of our ivivva operations, which reduced gross margin in that quarter by 40 basis points.
This was partially offset by an increase in fixed costs as a percentage of revenue related to our product and supply chain departments of 30 basis points.
During the second quarter of fiscal 2017, as a result of the restructuring of our ivivva operations, we recognized costs totaling $2.2 million within costs of goods sold, as outlined in Note 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report. Excluding these charges from the comparatives for the second quarter of fiscal 2017, gross profit increased 32% and gross margin increased 320 basis points.

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Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $36.5 million, or 16%, to $262.0 million in the second quarter of fiscal 2018 from $225.5 million in the second quarter of fiscal 2017. The increase in selling, general and administrative expenses was primarily due to:
an increase in costs related to our operating channels of $29.7 million, comprised of:
an increase in employee costs of $14.6 million primarily from a growth in labor hours and benefits, mainly associated with new company-operated stores and other new operating locations, and due to higher retail bonus expenses;
an increase in variable costs of $9.0 million primarily due to an increase in distribution costs, credit card fees, and packaging costs as a result of increased net revenue; and
an increase in other costs of $6.1 million primarily due to an increase in digital marketing expenses, brand and community costs, and other costs associated with our operating locations;
an increase in head office costs of $5.9 million, comprised of:
an increase in employee costs of $3.6 million primarily due to additional employees to support the growth in our business; and
an increase in other costs of $2.2 million primarily due to increases in brand and community costs, information technology costs, and other head office costs; and
an increase in net foreign exchange and derivative revaluation losses of $0.9 million. There were net foreign exchange and derivative revaluation losses of $2.6 million in the second quarter of fiscal 2018 compared to net foreign exchange and derivative revaluation losses of $1.7 million in the second quarter of fiscal 2017. The net foreign exchange gains and losses primarily relate to the revaluation of U.S. dollar denominated monetary assets and liabilities held by Canadian subsidiaries. During the second quarter of fiscal 2017, we began entering into forward currency contracts designed to economically hedge these foreign exchange revaluation gains and losses.
As a percentage of net revenue, selling, general and administrative expenses decreased 260 basis points, to 36.2% in the second quarter of fiscal 2018 from 38.8% in the second quarter of fiscal 2017.
Asset Impairment and Restructuring Costs
During the second quarter of fiscal 2017, we incurred asset impairment and restructuring costs totaling $3.2 million in connection with the restructuring of our ivivva operations. This included employee related costs of $2.5 million and lease termination and other restructuring costs of $0.7 million. Please refer to Note 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report.
We did not have any asset impairment and restructuring costs in the second quarter of fiscal 2018.
Income from Operations
Income from operations increased $65.5 million, or 95%, to $134.2 million in the second quarter of fiscal 2018 from $68.7 million in the second quarter of fiscal 2017. Operating margin increased 670 basis points to 18.5% compared to 11.8% in the second quarter of fiscal 2017.
In connection with the restructuring of our ivivva operations, we recognized pre-tax costs totaling $5.4 million in the second quarter of fiscal 2017. This included costs of $2.2 million recognized in cost of goods sold, and asset impairment and restructuring costs totaling $3.2 million. Excluding these charges from the comparatives for the second quarter of fiscal 2017, income from operations increased 81% and operating margin increased 570 basis points.
On a segment basis, we determine income from operations without taking into account our general corporate expenses and the costs we incurred in connection with the restructuring of our ivivva operations. In the first quarter of fiscal 2018, we reviewed our general corporate expenses and determined certain costs which were previously classified as general corporate expenses are more appropriately classified within our direct to consumer segment. Accordingly, comparative figures have been reclassified to conform to the financial presentation adopted for the current year.

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Segmented income from operations for the quarters ended July 29, 2018 and July 30, 2017 is summarized below. The percentages are presented as a percentage of net revenue of the respective operating segments.
 
 
Quarter Ended
 
 
July 29, 2018
 
July 30, 2017
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands)
 
(Percentage of segment revenue)
Segmented income from operations:
 
 
 
 
 
 
 
 
Company-operated stores
 
$
125,868

 
$
92,609

 
25.9
%
 
22.4
%
Direct to consumer
 
67,033

 
38,748

 
40.0

 
34.3

Other
 
13,094

 
6,952

 
18.8

 
12.9

 
 
205,995

 
138,309

 
 
 
 
General corporate expense
 
71,787

 
64,167

 
 
 
 
Restructuring and related costs
 

 
5,430

 
 
 
 
Income from operations
 
$
134,208

 
$
68,712

 
 
 
 
Company-Operated Stores. Income from operations from our company-operated stores segment increased $33.3 million, or 36%, to $125.9 million for the second quarter of fiscal 2018 from $92.6 million for the second quarter of fiscal 2017. The increase was primarily the result of increased gross profit of $46.3 million which was primarily due to increased net revenue and higher gross margin. This was partially offset by an increase in selling, general and administrative expenses, primarily due to an increase in store employee costs, increased store operating expenses including higher credit card fees, distribution costs and packaging costs as a result of higher net revenues, and due to increased brand and community costs. Income from operations as a percentage of company-operated stores net revenue increased 350 basis points due to higher gross margin and leverage on selling, general and administrative expenses.
Direct to Consumer. Income from operations from our direct to consumer segment increased $28.3 million, or 73%, to $67.0 million for the second quarter of fiscal 2018 from $38.8 million for the second quarter of fiscal 2017. The increase was primarily the result of increased gross profit of $39.5 million which was primarily due to increased net revenue and higher gross margin. This was partially offset by an increase in selling, general and administrative expenses primarily due to higher variable costs including distribution costs, credit card fees, and packaging costs as a result of higher net revenue, as well as higher digital marketing expenses. Income from operations as a percentage of direct to consumer net revenue increased 570 basis points due to higher gross margin and leverage on selling, general and administrative expenses.
Other. Other income from operations increased $6.1 million, or 88%, to $13.1 million for the second quarter of fiscal 2018 from $7.0 million for the second quarter of fiscal 2017. The increase was primarily the result of increased gross profit of $10.8 million which was primarily due to increased net revenue and higher gross margin. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses, primarily due to increased employee costs and due to increased operating expenses including higher credit card fees and distribution costs as a result of higher net revenues. Income from operations as a percentage of other net revenue increased 590 basis points due to higher gross margin and leverage on selling, general and administrative expenses.
General Corporate Expense. General corporate expense increased $7.6 million, or 12%, to $71.8 million for the second quarter of fiscal 2018 from $64.2 million for the second quarter of fiscal 2017. This increase was primarily due to increases in head office employee costs, increased information technology costs, increased brand and community costs, and an increase in net foreign exchange and derivative revaluation losses of $0.9 million. There were net foreign exchange and derivative revaluation losses of $2.6 million in the second quarter of fiscal 2018 compared to net foreign exchange and derivative revaluation losses of $1.7 million in the second quarter of fiscal 2017. The net foreign exchange gains and losses primarily relate to the revaluation of U.S. dollar denominated monetary assets and liabilities held by Canadian subsidiaries, and the derivatives are designed to economically hedge these gains and losses.
Other Income (Expense), Net
Other income, net increased $0.8 million, or 96%, to $1.6 million for the second quarter of fiscal 2018 from income of $0.8 million for the second quarter of fiscal 2017. The increase was primarily due to an increase in net interest income, primarily due to higher rates of return on our cash and cash equivalents, including money market funds, treasury bills, and term deposits, and due to an increase in cash and cash equivalents in the second quarter of fiscal 2018 compared to second quarter of fiscal 2017. This was partially offset by an increase in net interest expense primarily related to borrowings on our revolving credit facility during the second quarter of fiscal 2018.

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Income Tax Expense
Income tax expense increased $19.2 million, or 92%, to $40.0 million for the second quarter of fiscal 2018 from $20.8 million for the second quarter of fiscal 2017.
During the second quarter of fiscal 2017, we recognized a net income tax recovery of $1.4 million on the costs recognized in connection with the ivivva restructuring. Please refer to Note 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report.
The U.S. Tax Cuts and Jobs Act ("U.S. tax reform") was enacted on December 22, 2017 and introduced significant changes to U.S. income tax law. We recorded certain provisional amounts in the fourth quarter of fiscal 2017 and expect the accounting for the income tax effects of the U.S. tax reform to be completed in fiscal 2018. Please refer to Note 8 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report. We recognized a provisional income tax expense relating to the global intangible low-taxed income ("GILTI") tax in our effective tax rate for fiscal 2018. The results for the second quarter of fiscal 2018 did not include any discrete items related to the U.S. tax reform.
The effective tax rate for the second quarter of fiscal 2018 was 29.5% compared to 29.9% for the second quarter of fiscal 2017. Excluding the costs and related tax recoveries which were recognized in connection with the ivivva restructuring, the adjusted effective tax rate was 29.6% for the second quarter of fiscal 2017. The decrease in the effective tax rate for the second quarter of fiscal 2018 compared to the adjusted effective tax rate for the second quarter of fiscal 2017 was primarily due to the lower U.S. federal income tax rate as a result of the U.S. tax reform, partially offset by the provisional income tax expense relating to the GILTI tax and other adjustments following the finalization of certain income tax returns.
Net Income
Net income increased $47.1 million, or 97%, to $95.8 million for the second quarter of fiscal 2018 from $48.7 million for the second quarter of fiscal 2017. This was primarily due to an increase in gross profit of $98.8 million, a reduction in asset impairment and restructuring costs of $3.2 million, and an increase in other income (expense), net of $0.8 million, partially offset by an increase in selling, general and administrative expenses of $36.5 million and an increase in income tax expense of $19.2 million.
First Two Quarters Results
The following table summarizes key components of our results of operations for the first two quarters ended July 29, 2018 and July 30, 2017. The percentages are presented as a percentage of net revenue.
 
 
Two Quarters Ended
 
 
July 29, 2018
 
July 30, 2017
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands)
 
(Percentages)
Net revenue
 
$
1,373,206

 
$
1,101,361

 
100.0
%
 
100.0
%
Cost of goods sold
 
632,279

 
547,044

 
46.0

 
49.7

Gross profit
 
740,927

 
554,317

 
54.0

 
50.3

Selling, general and administrative expenses
 
502,414

 
424,665

 
36.6

 
38.6

Asset impairment and restructuring costs
 

 
15,517

 

 
1.3

Income from operations
 
238,513

 
114,135

 
17.4

 
10.4

Other income (expense), net
 
4,509

 
1,719

 
0.3

 
0.1

Income before income tax expense
 
243,022

 
115,854

 
17.7

 
10.5

Income tax expense
 
72,099

 
35,897

 
5.3

 
3.2

Net income
 
$
170,923

 
$
79,957

 
12.4
%
 
7.3
%
Net Revenue
Net revenue increased $271.8 million, or 25%, to $1.373 billion for the first two quarters of fiscal 2018 from $1.101 billion for the first two quarters of fiscal 2017. On a constant dollar basis, assuming the average exchange rates for the first two quarters of fiscal 2018 remained constant with the average exchange rates for the first two quarters of fiscal 2017, net revenue increased $260.0 million, or 24%.
The increase in net revenue was primarily due to increased direct to consumer net revenue, net revenue generated by new company-operated stores, and an increase in comparable store sales. Total comparable sales, which includes comparable store

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sales and direct to consumer, increased 20% in the first two quarters of fiscal 2018 compared to the first two quarters of fiscal 2017. Total comparable sales increased 19% on a constant dollar basis.
Net revenue on a segment basis for the first two quarters ended July 29, 2018 and July 30, 2017 is summarized below. The percentages are presented as a percentage of total net revenue.
 
 
Two Quarters Ended
 
 
July 29, 2018
 
July 30, 2017
 
July 29, 2018
 
July 30, 2017
 
 
(In thousands)
 
(Percentages)
Company-operated stores
 
$
919,499

 
$
793,043

 
67.0
%
 
72.0
%
Direct to consumer
 
325,248

 
210,272

 
23.7

 
19.1

Other
 
128,459

 
98,046

 
9.3

 
8.9

Net revenue
 
$
1,373,206

 
$
1,101,361

 
100.0
%
 
100.0
%
Company-Operated Stores. Net revenue from our company-operated stores segment increased $126.5 million, or 16%, to $919.5 million in the first two quarters of fiscal 2018 from $793.0 million in the first two quarters of fiscal 2017. The following contributed to the increase in net revenue from our company-operated stores segment:
Net revenue from company-operated stores we opened or significantly expanded subsequent to July 30, 2017, and therefore not included in comparable store sales, contributed $93.2 million to the increase. We opened 42 net new lululemon branded company-operated stores since the second quarter of fiscal 2017, including 22 stores in North America, 12 stores in Asia, six stores in Europe, and two stores in Australia/New Zealand.
A comparable store sales increase of 9% in the first two quarters of fiscal 2018 compared to the first two quarters of fiscal 2017 resulted in a $58.6 million increase to net revenue. Comparable store sales increased 8%, or $53.1 million on a constant dollar basis. The increase in comparable store sales was primarily a result of increased store traffic and improved conversion rates.
These increases in net revenue were partially offset by the closure of 48 of our ivivva branded company-operated stores as part of the restructuring of our ivivva operations. These closures reduced our net revenue from company-operated stores for the first two quarters of fiscal 2018 by $25.4 million compared to the first two quarters of fiscal 2017.
Direct to Consumer. Net revenue from our direct to consumer segment increased $115.0 million, or 55%, to $325.2 million in the first two quarters of fiscal 2018 from $210.3 million in the first two quarters of fiscal 2017. Direct to consumer net revenue increased 53% on a constant dollar basis. This was primarily a result of increased website traffic and increased conversion rates. During the second quarter of fiscal 2017, we held an online warehouse sale in the United States and Canada which generated net revenue of $12.3 million. We did not hold any online warehouse sales during the first two quarters of fiscal 2018.
Other. Net revenue from our other segment increased $30.4 million, or 31%, to $128.5 million in the first two quarters of fiscal 2018 from $98.0 million in the first two quarters of fiscal 2017. This increase was primarily the result of an increased number of outlets and temporary locations, including seasonal stores, open during the first two quarters of fiscal 2018 compared to the first two quarters of fiscal 2017. There was also an increase in net revenue at existing outlets during the first two quarters of fiscal 2018 compared to the first two quarters of fiscal 2017. The increase in net revenue from our other segment was partially offset by lower net revenue from showrooms, primarily due to a decreased number of showrooms open during the first two quarters of fiscal 2018 compared to the first two quarters of fiscal 2017.
Gross Profit
Gross profit increased $186.6 million, or 34%, to $740.9 million for the first two quarters of fiscal 2018 from $554.3 million for the first two quarters of fiscal 2017.
Gross profit as a percentage of net revenue, or gross margin, increased 370 basis points, to 54.0% in the first two quarters of fiscal 2018 from 50.3% in the first two quarters of fiscal 2017. The increase in gross margin was primarily the result of:
an increase in product margin of 190 basis points, which was primarily due to lower product costs, a favorable mix of higher margin product, lower markdowns, and lower inventory provision expense;
a decrease in occupancy and depreciation costs as a percentage of revenue of 80 basis points;
a favorable impact of foreign exchange rates of 30 basis points; and

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the costs incurred in the first two quarters of fiscal 2017 in connection with the restructuring of our ivivva operations, which reduced gross margin in that quarter by 70 basis points.
During the first two quarters of fiscal 2018, as a result of the restructuring of our ivivva operations, we recognized costs totaling $7.7 million within costs of goods sold, as outlined in Note 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report. Excluding these charges from the comparatives for the second quarter of fiscal 2017, gross profit increased 32% and gross margin increased 300 basis points.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $77.7 million, or 18%, to $502.4 million in the first two quarters of fiscal 2018 from $424.7 million in the first two quarters of fiscal 2017. The increase in selling, general and administrative expenses was primarily due to:
an increase in costs related to our operating channels of $52.2 million, comprised of:
an increase in employee costs of $22.5 million, primarily from a growth in labor hours and benefits, mainly associated with new company-operated stores and other new operating locations, and due to higher retail bonus expenses;
an increase in variable costs of $17.7 million, primarily due to an increase in distribution costs, credit card fees, and packaging costs as a result of increased net revenue; and
an increase in other costs of $12.1 million, primarily due to an increase in digital marketing expenses, brand and community costs, and other costs associated with our operating locations; and
an increase in head office costs of $18.4 million, comprised of:
an increase in employee costs of $12.7 million primarily due to additional employees to support the growth in our business; and
an increase in other costs of $5.7 million primarily due to an increase in brand and community costs, depreciation, and information technology related costs, partially offset by a decrease in professional fees.
The increase in selling, general and administrative expenses was partially offset by an increase in net foreign exchange and derivative revaluation losses of $7.1 million. There were net foreign exchange and derivative revaluation losses of $3.0 million in the first two quarters of fiscal 2018 compared to net foreign exchange and derivative revaluation gains of $4.1 million in the first two quarters of fiscal 2017. The net foreign exchange gains and losses primarily relate to the revaluation of U.S. dollar denominated monetary assets and liabilities held by Canadian subsidiaries. During the second quarter of fiscal 2017, we began entering into forward currency contracts designed to economically hedge these foreign exchange revaluation gains and losses.
As a percentage of net revenue, selling, general and administrative expenses decreased 200 basis points, to 36.6% in the first two quarters of fiscal 2018 from 38.6% in the first two quarters of fiscal 2017.
Asset Impairment and Restructuring Costs
During the first two quarters of fiscal 2017, we incurred asset impairment and restructuring costs totaling $15.5 million in connection with the restructuring of our ivivva operations. This included long-lived asset impairment charges of $11.6 million, employee related costs o