lululemon athletica, inc.
lululemon athletica inc. (Form: 10-Q, Received: 12/06/2017 16:19:15)
Table of Contents


 
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 October 29, 2017
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 December 1, 2017 , there were 125,599,066 shares of the registrant's common stock, par value $0.005 per share, outstanding.
Exchangeable and Special Voting Shares:
At December 1, 2017 , there were outstanding 9,780,927 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 December 1, 2017 , the registrant had outstanding 9,780,927 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.
 
 

2

Table of Contents


PART I
FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
lululemon athletica inc.
CONSOLIDATED BALANCE SHEETS
(Unaudited; Amounts in thousands, except per share amounts)
 
 
October 29,
2017
 
January 29,
2017
ASSETS
Current assets
 
 
 
 
Cash and cash equivalents
 
$
650,054

 
$
734,846

Accounts receivable
 
21,281

 
9,200

Inventories
 
396,892

 
298,432

Prepaid and receivable income taxes
 
77,625

 
81,190

Other prepaid expenses and other current assets
 
42,496

 
39,069

 
 
1,188,348

 
1,162,737

Property and equipment, net
 
440,403

 
423,499

Goodwill and intangible assets, net
 
24,476

 
24,557

Deferred income tax assets
 
37,583

 
26,256

Other non-current assets
 
29,639

 
20,492

 
 
$
1,720,449

 
$
1,657,541

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
14,113

 
$
24,846

Accrued inventory liabilities
 
23,420

 
8,601

Accrued compensation and related expenses
 
62,387

 
55,238

Income taxes payable
 
4,403

 
30,290

Unredeemed gift card liability
 
52,500

 
70,454

Lease termination liabilities
 
12,164

 

Other current liabilities
 
71,590

 
52,561

 
 
240,577

 
241,990

Deferred income tax liabilities
 

 
7,262

Other non-current liabilities
 
58,596

 
48,316

 
 
299,173

 
297,568

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; 9,781 and 9,781 issued and outstanding
 

 

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

 

Common stock, $0.005 par value: 400,000 shares authorized; 125,592 and 127,304 issued and outstanding
 
628

 
637

Additional paid-in capital
 
275,871

 
266,622

Retained earnings
 
1,336,216

 
1,294,214

Accumulated other comprehensive loss
 
(191,439
)
 
(201,500
)
 
 
1,421,276

 
1,359,973

 
 
$
1,720,449

 
$
1,657,541

See accompanying notes to the unaudited interim consolidated financial statements

3

Table of Contents


lululemon athletica inc.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited; Amounts in thousands, except per share amounts)
 
 
Quarter Ended
 
Three Quarters Ended
 
 
October 29, 2017
 
October 30, 2016
 
October 29, 2017
 
October 30, 2016
Net revenue
 
$
619,018

 
$
544,416

 
$
1,720,379

 
$
1,554,452

Cost of goods sold
 
297,056

 
265,990

 
844,100

 
782,734

Gross profit
 
321,962

 
278,426

 
876,279

 
771,718

Selling, general and administrative expenses
 
215,367

 
185,451

 
640,032

 
547,195

Asset impairment and restructuring costs
 
21,007

 

 
36,524

 

Income from operations
 
85,588

 
92,975

 
199,723

 
224,523

Other income (expense), net
 
1,052

 
628

 
2,771

 
720

Income before income tax expense
 
86,640

 
93,603

 
202,494

 
225,243

Income tax expense
 
27,696

 
25,318

 
63,593

 
57,997

Net income
 
$
58,944

 
$
68,285

 
$
138,901

 
$
167,246

 
 
 
 
 
 
 
 
 
Other comprehensive (loss) income:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
(31,018
)
 
(24,748
)
 
10,061

 
20,762

Comprehensive income
 
$
27,926

 
$
43,537

 
$
148,962

 
$
188,008

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
0.44

 
$
0.50

 
$
1.02

 
$
1.22

Diluted earnings per share
 
$
0.43

 
$
0.50

 
$
1.02

 
$
1.22

Basic weighted-average number of shares outstanding
 
135,364

 
137,033

 
136,191

 
137,095

Diluted weighted-average number of shares outstanding
 
135,578

 
137,237

 
136,357

 
137,321

See accompanying notes to the unaudited interim consolidated financial statements
 

4

Table of Contents


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 29, 2017
 
9,781

 
9,781

 
$

 
127,304

 
$
637

 
$
266,622

 
$
1,294,214

 
$
(201,500
)
 
$
1,359,973

Net income
 
 
 
 
 
 
 
 
 
 
 
 
 
138,901

 
 
 
138,901

Foreign currency translation adjustment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
10,061

 
10,061

Stock-based compensation expense
 
 
 
 
 
 
 
 
 
 
 
13,048

 
 
 
 
 
13,048

Common stock issued upon settlement of stock-based compensation
 
 
 
 
 
 
 
194

 
1

 
1,647

 
 
 
 
 
1,648

Shares withheld related to net share settlement of stock-based compensation
 
 
 
 
 
 
 
(58
)
 

 
(3,086
)
 
 
 
 
 
(3,086
)
Repurchase of common stock
 
 
 
 
 
 
 
(1,848
)
 
(10
)
 
(2,360
)
 
(96,899
)
 
 
 
(99,269
)
Balance at October 29, 2017
 
9,781

 
9,781

 
$

 
125,592

 
$
628

 
$
275,871

 
$
1,336,216

 
$
(191,439
)
 
$
1,421,276

See accompanying notes to the unaudited interim consolidated financial statements

5

Table of Contents


lululemon athletica inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; Amounts in thousands)
 
 
Three Quarters Ended
 
 
October 29, 2017
 
October 30, 2016
Cash flows from operating activities
 
 
 
 
Net income
 
$
138,901

 
$
167,246

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
80,129

 
63,641

Deferred income taxes
 
(18,385
)
 

Stock-based compensation expense
 
13,048

 
12,939

Asset impairment for ivivva restructuring
 
11,593

 

Settlement of derivatives not designated in a hedging relationship
 
4,178

 

Changes in operating assets and liabilities:
 
 
 
 
Inventories
 
(95,475
)
 
(73,660
)
Prepaid and receivable income taxes
 
3,565

 
(30,580
)
Other prepaid expenses and other current assets
 
(14,885
)
 
(13,471
)
Other non-current assets
 
8,126

 
(8,804
)
Accounts payable
 
(11,141
)
 
(1,558
)
Accrued inventory liabilities
 
14,602

 
5,270

Accrued compensation and related expenses
 
6,579

 
8,835

Income taxes payable
 
(26,420
)
 
(17,563
)
Unredeemed gift card liability
 
(18,272
)
 
(14,123
)
Lease termination liabilities
 
12,164

 

Other accrued and non-current liabilities
 
23,002

 
487

Net cash provided by operating activities
 
131,309

 
98,659

Cash flows from investing activities
 
 
 
 
Purchase of property and equipment
 
(107,128
)
 
(106,168
)
Settlement of net investment hedges
 
(4,599
)
 

Other investing activities
 
(8,324
)
 

Net cash used in investing activities
 
(120,051
)
 
(106,168
)
Cash flows from financing activities
 
 
 
 
Proceeds from settlement of stock-based compensation
 
1,648

 
5,959

Taxes paid related to net share settlement of stock-based compensation
 
(3,086
)
 
(2,691
)
Repurchase of common stock
 
(99,269
)
 
(28,556
)
Net cash used in financing activities
 
(100,707
)
 
(25,288
)
Effect of exchange rate changes on cash and cash equivalents
 
4,657

 
11,701

(Decrease) increase in cash and cash equivalents
 
(84,792
)
 
(21,096
)
Cash and cash equivalents, beginning of period
 
$
734,846

 
$
501,482

Cash and cash equivalents, end of period
 
$
650,054

 
$
480,386

See accompanying notes to the unaudited interim consolidated financial statements


6

Table of Contents


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


7

Table of Contents


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, which is sold through a chain of company-operated stores, direct to consumer through e-commerce, outlets, showrooms, temporary locations, sales to wholesale accounts, license and supply arrangements, and through warehouse sales. Its apparel is marketed under the lululemon and ivivva brand names. The Company operates stores in the United States, Canada, Australia, the United Kingdom, China, New Zealand, Hong Kong, Singapore, South Korea, Germany, Ireland, Japan, Puerto Rico, Switzerland, and Taiwan. There were a total of 388 and 406 company-operated stores in operation as of October 29, 2017 and January 29, 2017 , respectively.
On June 1, 2017, the Company announced a plan to restructure its ivivva operations. On August 20, 2017 , as part of this plan, the Company closed 48 of its 55 ivivva branded company-operated stores. The seven remaining ivivva branded stores remain in operation and are not expected to close. All of the Company's ivivva branded showrooms and other temporary locations have been closed. The Company continues to offer ivivva branded products on its e-commerce websites. Please refer to Note 6 of these unaudited interim consolidated financial statements for further details regarding the ivivva restructuring.
Basis of presentation
The unaudited interim consolidated financial statements as of October 29, 2017 and for the quarters and three quarters ended October 29, 2017 and October 30, 2016 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 29, 2017 is derived from the Company's audited consolidated financial statements and related notes for the fiscal year ended January 29, 2017 , which are included in Item 8 in the Company's fiscal 2016 Annual Report on Form 10-K filed with the SEC on March 29, 2017 . 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 2016 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 2017 will end on January 28, 2018 and will be a 52-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
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09,  Revenue from Contracts with Customers ("ASC 606"). This ASU supersedes the revenue recognition requirements in ASC Topic 605 Revenue Recognition , including most industry-specific revenue recognition guidance. ASU 2014-09 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, and expands the related disclosure requirements. In 2015, the FASB deferred the effective date for this guidance, and in 2016, the FASB issued several updates that clarify the guidance in this topic. ASC 606 may be adopted either on a full retrospective basis or using a modified retrospective method with a cumulative adjustment to equity. This guidance will be adopted by the Company beginning in its first quarter of fiscal 2018. The Company continues to evaluate the impact that this new guidance may have on its consolidated financial statements, and the method of retrospective adoption that it will elect, but does not expect ASC 606 to materially

8



impact the amount, or timing, of its revenue recognition. Under the new requirements, the Company expects to recognize its provision for sales returns on a gross basis, rather than a net basis on the consolidated balance sheets.
In July 2015, the FASB amended ASC Topic 330, Inventory to simplify the measurement of inventory. The amendments require that an entity measure inventory at the lower of cost and net realizable value instead of the lower of cost and market. This guidance became effective for the Company the first quarter of fiscal 2017 and the adoption did not impact its consolidated financial statements.
In February 2016, the FASB issued ASC Topic 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. While the Company is currently evaluating the impact that this new guidance will have on its consolidated financial statements, it is expected that the primary 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 March 2016, the FASB amended ASC Topic 718, Stock Compensation simplifying the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The new guidance also allows an entity to account for forfeitures when they occur. The Company adopted this amendment in the first quarter of fiscal 2017 and elected to continue to estimate expected forfeitures. The Company is now required to include excess tax benefits and deficiencies as a component of income tax expense, rather than a component of stockholders' equity. Additionally, the Company retrospectively adjusted its consolidated statement of cash flows for the three quarters ended October 30, 2016 to reclassify excess tax benefits of $1.3 million from financing activities to operating activities.
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.
NOTE 3. 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.
Stock-based compensation expense charged to income for the plans was $13.0 million and $12.9 million for the three quarters ended October 29, 2017 and October 30, 2016 , respectively. Total unrecognized compensation cost for all stock-based compensation plans was $40.2 million at October 29, 2017 , which is expected to be recognized over a weighted-average period of 2.3  years.

9



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 October 29, 2017 , and changes during the first three 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 29, 2017
 
918

 
$
59.20

 
390

 
$
61.05

 
14

 
$
70.54

 
360

 
$
62.99

Granted
 
614

 
52.16

 
191

 
52.21

 
24

 
52.38

 
332

 
52.65

Exercised/released
 
40

 
40.70

 

 

 
14

 
70.29

 
131

 
60.74

Forfeited
 
247

 
58.18

 
224

 
54.72

 
3

 
51.72

 
111

 
57.18

Balance at October 29, 2017
 
1,245

 
$
56.53

 
357

 
$
60.30

 
21

 
$
52.45

 
450

 
$
57.46

Exercisable at October 29, 2017
 
350

 
$
56.14

 
 
 
 
 
 
 
 
 
 
 
 
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 assumptions were used in calculating the fair value of stock options granted in the first three quarters of fiscal 2017 :
 
 
Three Quarters Ended
 October 29, 2017
Expected term
 
4.00 years

Expected volatility
 
38.28
%
Risk-free interest rate
 
1.72
%
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 October 29, 2017 , there were 34.2 thousand  shares purchased.
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

10



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  $3.9 million and $1.6 million in the first three quarters of fiscal 2017 and fiscal 2016 , respectively.
NOTE 4. 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.
The fair value measurement is categorized in its entirety by reference to its lowest level of significant input. As of October 29, 2017 , the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis:
 
 
October 29, 2017
 
Level 1
 
Level 2
 
Level 3
 
 
(In thousands)
Net forward currency contract (liabilities) assets
 
$
(583
)
 
$

 
$
(583
)
 
$

The Company records cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities at cost. The carrying values of these instruments approximate their fair value due to their short-term maturities.
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.
As a result of the ivivva restructuring, the Company recorded lease termination liabilities of $12.2 million , determined using Level 3 inputs based on remaining lease rentals and reduced by estimated sublease income.
NOTE 5. 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 during the three quarters ended October 29, 2017 , it entered 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. The Company assesses hedge effectiveness based on changes in forward rates. The Company recorded no ineffectiveness from net investment hedges for the three quarters ended October 29, 2017 .

11



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 three quarters ended October 29, 2017 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.
Outstanding notional amounts
The Company had foreign exchange forward contracts outstanding with the following notional amounts:
 
 
October 29, 2017
 
October 30, 2016
 
 
(In thousands)
Derivatives designated as net investment hedges
 
$
50,000

 
$

Derivatives not designated in a hedging relationship
 
40,000

 

The forward currency contracts designated as net investment hedges mature in January 2018.
The forward currency contracts not designated in a hedging relationship mature on different dates between November 2017 and December 2017.
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 October 29, 2017 , there were derivative assets of $1.2 million and derivative liabilities of $1.5 million subject to enforceable netting arrangements.
The fair values of forward currency contracts were as follows:
 
 
October 29, 2017
 
October 30, 2016
 
 
(In thousands)
Derivatives designated as net investment hedges, recognized within:
 
 
 
 
Other current liabilities
 
$
2,902

 
$

Derivatives not designated in a hedging relationship, recognized within:
 
 
 
 
Other prepaid expenses and other current assets
 
2,319

 


12



The pre-tax gains and losses on foreign exchange forward contracts recorded in accumulated other comprehensive income and in the consolidated statement of operations, are as follows:
 
 
Quarter Ended
 
Three Quarters Ended
 
 
October 29, 2017
 
October 30, 2016
 
October 29, 2017
 
October 30, 2016
 
 
(In thousands)
Derivatives designated as net investment hedges:
 
 
 
 
 
 
 
 
Gain (loss) recognized in other comprehensive income
 
$
1,424

 
$

 
$
(7,501
)
 
$

Derivatives not designated in a hedging relationship:
 
 
 
 
 
 
 
 
(Loss) gain recognized in selling, general and administrative expenses
 
(1,137
)
 

 
6,497

 

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.
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 6. ASSET IMPAIRMENT AND RESTRUCTURING
On June 1, 2017, the Company announced a plan to restructure its ivivva operations. On August 20, 2017 , as part of this plan, the Company closed 48 of its 55 ivivva branded company-operated stores. The seven remaining ivivva branded stores remain in operation and are not expected to close. All of the Company's ivivva branded showrooms and other temporary locations have been closed. The Company continues to offer ivivva branded products on its e-commerce websites.
As a result of the closures, the Company recognized aggregate pre-tax charges of $45.4 million during the three quarters ended October 29, 2017 . The restructuring was substantially completed during the third quarter of fiscal 2017.

13



A summary of the pre-tax charges recognized during the third quarter and the first three quarters of fiscal 2017 in connection with the Company's restructuring of its ivivva operations is as follows:
 
 
Quarter Ended
 October 29, 2017
 
Three Quarters Ended
 October 29, 2017
 
 
(In thousands)
Costs recorded in cost of goods sold:
 
 
 
 
Provision to reduce inventories to net realizable value
 
$
1,934

 
$
4,838

Loss (reversal of loss) on committed inventory purchases
 
(2,286
)
 
250

Accelerated depreciation
 
1,530

 
3,753

 
 
1,178

 
8,841

Costs recorded in operating expenses:
 
 
 
 
Lease termination costs
 
19,441

 
19,884

Impairment of property and equipment
 

 
11,593

Employee related costs
 
804

 
4,000

Other restructuring costs
 
762

 
1,047

Asset impairment and restructuring costs
 
21,007

 
36,524

Restructuring and related costs
 
$
22,185

 
$
45,365

Income tax recoveries of $5.8 million and $11.9 million were recorded on the above items in the third quarter and the first three quarters of fiscal 2017 , respectively. These income tax recoveries are based on the expected annual tax rate of the applicable tax jurisdictions.
Costs recorded in cost of goods sold
During the first three quarters of fiscal 2017 , the Company recognized expenses of $8.8 million in cost of goods sold as a result of the restructuring of its ivivva operations. This included $4.8 million to reduce inventories to their estimated net realizable value, and $0.3 million for the losses the Company expects to incur on certain firm inventory and fabric purchase commitments. The liability for the expected losses is included within accrued inventory liabilities on the consolidated balance sheets.
During the second and third quarters 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 $3.8 million during the first three quarters of fiscal 2017 , primarily related to leasehold improvements and furniture and fixtures for stores that closed during the third quarter of fiscal 2017.
Costs recorded in operating expenses
The Company recognized asset impairment and restructuring costs of $36.5 million during the first three 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.
The fair value of the long-lived assets for each store was determined using Level 3 inputs, principally the present value of the estimated future cash flows expected from their use and eventual disposition.
During the first three quarters of fiscal 2017 , the Company recognized employee related expenses as a result of the restructuring of $4.0 million .

14



The Company recognized lease termination costs of $19.9 million during the first three quarters of fiscal 2017 . As of October 29, 2017 , the Company had lease termination liabilities of $12.2 million . During the first three quarters of fiscal 2017 , the Company also recognized other restructuring costs of $1.0 million .
NOTE 7. INCOME TAXES
As disclosed in Note 15 to the audited consolidated financial statements included in Item 8 of the Company's fiscal 2016 Annual Report on Form 10-K filed with the SEC on March 29, 2017 , the Company finalized a bilateral Advance Pricing Arrangement ("APA") with the Internal Revenue Service ("IRS") and the Canada Revenue Agency ("CRA") during fiscal 2016.
The results for the quarter and three quarters ended October 29, 2017 did not include any discrete items or adjustments related to the APA.
The results for the quarter and three quarters ended October 30, 2016 included net interest expenses of $0.2 million and $1.7 million , respectively, that were recorded in other income (expense), net, and net income tax recoveries of $4.0 million and $11.6 million , respectively, related to the expected outcome of the APA and taxes associated with the anticipated repatriation of foreign earnings.
NOTE 8. EARNINGS PER SHARE
The details of the computation of basic and diluted earnings per share are as follows:
 
 
Quarter Ended
 
Three Quarters Ended
 
 
October 29, 2017
 
October 30, 2016
 
October 29, 2017
 
October 30, 2016
 
 
(In thousands, except per share amounts)
Net income
 
$
58,944

 
$
68,285

 
$
138,901

 
$
167,246

Basic weighted-average number of shares outstanding
 
135,364

 
137,033

 
136,191

 
137,095

Assumed conversion of dilutive stock options and awards
 
214

 
204

 
166

 
226

Diluted weighted-average number of shares outstanding
 
135,578

 
137,237

 
136,357

 
137,321

Basic earnings per share
 
$
0.44

 
$
0.50

 
$
1.02

 
$
1.22

Diluted earnings per share
 
$
0.43

 
$
0.50

 
$
1.02

 
$
1.22

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 three quarters ended October 29, 2017 and October 30, 2016 , 0.2 million and 0.1 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 June 11, 2014, the Company's board of directors approved a program to repurchase shares of the Company's common stock up to an aggregate value of $450.0 million . This stock repurchase program was completed during the second quarter of fiscal 2016.
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 . The common stock was repurchased in the open market 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, with the timing and actual number of shares repurchased depending upon market conditions, eligibility to trade, and other factors. This stock repurchase program was completed during the third quarter of fiscal 2017.
During the three quarters ended October 29, 2017 and October 30, 2016 , 1.8 million and 0.4 million shares, respectively, were repurchased under the program at a total cost of $99.3 million and $28.6 million , respectively.
NOTE 9. SUPPLEMENTARY FINANCIAL INFORMATION
For the quarters ended October 29, 2017 and October 30, 2016 , there were net foreign exchange and derivative revaluation gains of $2.7 million and $4.3 million , respectively, included within selling, general and administrative expenses.
For the three quarters ended October 29, 2017 and October 30, 2016 , there were net foreign exchange and derivative revaluation gains of  $6.9 million and losses of $4.1 million , respectively, included within selling, general and administrative expenses.

15



A summary of certain consolidated balance sheet accounts is as follows:
 
 
October 29,
2017
 
January 29,
2017
 
 
(In thousands)
Inventories:
 
 
 
 
Finished goods
 
$
412,648

 
$
306,087

Provision to reduce inventories to net realizable value
 
(15,756
)
 
(7,655
)
 
 
$
396,892

 
$
298,432

Property and equipment, net:
 
 
 
 
Land
 
$
79,852

 
$
78,561

Buildings
 
38,144

 
32,174

Leasehold improvements
 
289,775

 
273,801

Furniture and fixtures
 
88,545

 
84,479

Computer hardware
 
63,882

 
58,270

Computer software
 
199,601

 
160,835

Equipment and vehicles
 
14,858

 
13,704

Accumulated depreciation and impairment
 
(334,254
)
 
(278,325
)
 
 
$
440,403

 
$
423,499

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

 
$
25,496

Changes in foreign currency exchange rates
 
(1,156
)
 
(1,263
)
 
 
24,340

 
24,233

Intangibles - reacquired franchise rights
 
10,150

 
10,150

Accumulated amortization
 
(10,009
)
 
(9,807
)
Changes in foreign currency exchange rates
 
(5
)
 
(19
)
 
 
136

 
324

 
 
$
24,476

 
$
24,557

Other non-current assets:
 
 
 
 
Security deposits
 
$
10,484

 
$
9,009

Deferred lease assets
 
10,099

 
10,560

Other
 
9,056

 
923

 
 
$
29,639

 
$
20,492

Other current liabilities:
 
 
 
 
Accrued duty, freight, and other operating expenses
 
$
42,923

 
$
27,477

Sales tax collected
 
11,686

 
10,182

Accrued rent
 
5,620

 
5,562

Other
 
11,361

 
9,340

 
 
$
71,590

 
$
52,561

Other non-current liabilities:
 
 
 
 
Deferred lease liabilities
 
$
26,763

 
$
26,648

Tenant inducements
 
26,199

 
21,668

Other
 
5,634

 

 
 
$
58,596

 
$
48,316

As of October 29, 2017 , as a result of the restructuring of its ivivva operations, the Company had a provision of $4.8 million to reduce the carrying value of certain ivivva branded finished goods inventories to their estimated net realizable value. In addition, the Company had a liability for the losses it expects to incur on certain firm inventory and fabric purchase commitments of $0.3 million . This liability is included within accrued inventory liabilities on the consolidated balance sheets.

16



Please refer to Note 6 of these unaudited interim consolidated financial statements for further details regarding the ivivva restructuring plans, including impairment of property and equipment, net which was recorded during the first quarter of fiscal 2017 .
NOTE 10. 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. Outlets, showrooms, temporary locations, sales to wholesale accounts, license and supply arrangements, and warehouse sale net revenue have been combined into other. Information for these segments is detailed in the table below:
 
 
Quarter Ended
 
Three Quarters Ended
 
 
October 29, 2017
 
October 30, 2016
 
October 29, 2017
 
October 30, 2016
 
 
(In thousands)
Net revenue:
 
 
 
 
 
 
 
 
Company-operated stores
 
$
425,084

 
$
393,506

 
$
1,218,127

 
$
1,133,599

Direct to consumer
 
131,181

 
104,013

 
341,453

 
288,978

Other
 
62,753

 
46,897

 
160,799

 
131,875

 
 
$
619,018

 
$
544,416

 
$
1,720,379

 
$
1,554,452

Income from operations before general corporate expense:
 
 
 
 
 
 
 
 
Company-operated stores
 
$
97,015

 
$
91,497

 
$
267,178

 
$
245,056

Direct to consumer
 
52,201

 
43,588

 
127,746

 
114,744

Other
 
9,319

 
5,709

 
19,076

 
12,430

 
 
158,535

 
140,794

 
414,000

 
372,230

General corporate expense
 
50,762

 
47,819

 
168,912

 
147,707

Restructuring and related costs
 
22,185

 

 
45,365

 

Income from operations
 
85,588

 
92,975

 
199,723

 
224,523

Other income (expense), net
 
1,052

 
628

 
2,771

 
720

Income before income tax expense
 
$
86,640

 
$
93,603

 
$
202,494

 
$
225,243

 
 
 
 
 
 
 
 
 
Capital expenditures:
 
 
 
 
 
 
 
 
Company-operated stores
 
$
29,747

 
$
18,932

 
$
53,549

 
$
47,197

Direct to consumer
 
7,582

 
3,711

 
16,423

 
9,425

Corporate and other
 
19,910

 
12,263

 
37,156

 
49,546

 
 
$
57,239

 
$
34,906

 
$
107,128

 
$
106,168

Depreciation and amortization:
 
 
 
 
 
 
 
 
Company-operated stores
 
$
16,549

 
$
15,735

 
$
47,630

 
$
44,030

Direct to consumer
 
3,740

 
1,854

 
10,087

 
4,908

Corporate and other
 
8,271

 
6,370

 
22,412

 
14,703

 
 
$
28,560

 
$
23,959

 
$
80,129

 
$
63,641

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.

17



NOTE 11. LEGAL PROCEEDINGS
In addition to the legal matter 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.
NOTE 12. 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 unaudited interim consolidated financial statements in accordance with ASC Topic 855,  Subsequent Events ("ASC 855").
On November 29, 2017, the Company's board of directors approved a stock repurchase program for up to  $200 million  of its common shares in the open market 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 in  two years. Shares may be repurchased from time to time on the open market, through block trades or otherwise. Purchases may be started or stopped at any time without prior notice depending on market conditions and other factors.
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 Section 27A of the Securities Act of 1933 and the Private Securities Litigation Reform Act of 1995. 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 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 2016 Annual Report on Form 10-K filed with the SEC on March 29, 2017 .

18

Table of Contents


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 is a designer, distributor, and retailer of healthy lifestyle inspired athletic apparel. Since our inception, we have developed a distinctive corporate culture, and we have a mission to produce products which create transformational experiences for people to live happy, healthy, fun lives. 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 succeed and share our purpose of "elevating the world from mediocrity to greatness."
We offer a comprehensive line of apparel and accessories for women and men. We also offer activewear for girls under our ivivva brand name. Our apparel assortment includes items such as pants, shorts, tops, and jackets designed for healthy lifestyle and athletic activities such as yoga, running, training, and most other sweaty pursuits. We also offer fitness-related accessories, including an array of items such as bags, socks, underwear, yoga mats, and water bottles.
On June 1, 2017, we announced a plan to restructure our ivivva operations to a primarily e-commerce focused business, with a select number of stores remaining in key communities across North America. The restructuring was substantially completed during the third quarter of fiscal 2017. On August 20, 2017 , as a part of the restructuring plan, we closed 48 of our 55 ivivva branded company-operated stores. The seven remaining ivivva branded stores remain in operation and are not expected to close. All of our ivivva branded showrooms and other temporary locations have been closed. We continue to offer ivivva branded products on our e-commerce websites.
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 $22.2 million in the third quarter of fiscal 2017 . The adjusted financial measures exclude these charges and their related tax effects, and also exclude certain discrete items related to our transfer pricing arrangements and taxes on repatriation of foreign earnings which were recognized during the third quarter of fiscal 2016 .
For the third quarter of fiscal 2017 , compared to the third quarter of fiscal 2016 :
Net revenue increase d 14% to $619.0 million . On a constant dollar basis, net revenue increased 12% .
Total comparable sales, which includes comparable store sales and direct to consumer, increased 8% . On a constant dollar basis, total comparable sales increased 7% .
Comparable store sales increased 2% , or increased 1% on a constant dollar basis.
Direct to consumer net revenue increased 26% , or increased 25% on a constant dollar basis.
Gross profit increase d 16% to $322.0 million . Adjusted gross profit increased 16% to $323.1 million .
Gross margin increase d 90 basis points to 52.0% . Adjusted gross margin increase d 110 basis points to 52.2% .
Income from operations decrease d 8% to $85.6 million . Adjusted income from operations increase d 16% to $107.8 million .
Operating margin decrease d 330 basis points to 13.8% . Adjusted operating margin increased 30 basis points to 17.4% .
Income tax expense increase d 9% to $27.7 million . Our effective tax rate for the third quarter of fiscal 2017 was 32.0% compared to 27.0% for the third quarter of fiscal 2016 . The adjusted effective tax rate was 30.8% in the third quarter of fiscal 2017 compared to 31.3% in the third quarter of fiscal 2016 .
Diluted earnings per share were $0.43 compared to $0.50 in the third quarter of fiscal 2016 . Adjusted diluted earnings per share were $0.56 for the third quarter of fiscal 2017 compared to $0.47 for the third quarter of fiscal 2016 .
Refer to the non-GAAP reconciliation tables contained in the "Results of Operations" 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

19

Table of Contents


gross profit, gross margin, income from operations, operating margin, effective tax rates, and diluted earnings per share, and the most directly comparable measures calculated in accordance with GAAP.
Results of Operations
Third Quarter Results
The following table summarizes key components of our results of operations for the quarters ended October 29, 2017 and October 30, 2016 . The percentages are presented as a percentage of net revenue.
 
 
Quarter Ended
 
 
October 29, 2017
 
October 30, 2016

October 29, 2017
 
October 30, 2016
 
 
(In thousands)
 
(Percentages)
Net revenue
 
$
619,018

 
$
544,416

 
100.0
%
 
100.0
%
Cost of goods sold
 
297,056

 
265,990

 
48.0

 
48.9

Gross profit
 
321,962

 
278,426

 
52.0

 
51.1

Selling, general and administrative expenses
 
215,367

 
185,451

 
34.8

 
34.1

Asset impairment and restructuring costs
 
21,007

 

 
3.4

 

Income from operations
 
85,588

 
92,975

 
13.8

 
17.1

Other income (expense), net
 
1,052

 
628

 
0.2

 
0.1

Income before income tax expense
 
86,640

 
93,603

 
14.0

 
17.2

Income tax expense
 
27,696

 
25,318

 
4.5

 
4.7

Net income
 
$
58,944

 
$
68,285

 
9.5
%
 
12.5
%
Net Revenue
Net revenue increase d $74.6  million, or 14% , to $619.0 million for the third quarter of fiscal 2017 from $544.4  million for the third quarter of fiscal 2016 . On a constant dollar basis, assuming the average exchange rates for the third quarter of fiscal 2017 remained constant with the average exchange rates for the third quarter of fiscal 2016 , net revenue increased $67.8 million , or 12% .
The increase in net revenue was primarily due to net revenue generated by new company-operated stores as well as increased direct to consumer net revenue. Total comparable sales, which includes comparable store sales and direct to consumer, increased 8% in the third quarter of fiscal 2017 compared to the third quarter of fiscal 2016 . Total comparable sales increased 7% on a constant dollar basis.
Net revenue on a segment basis for the quarters ended October 29, 2017 and October 30, 2016 is summarized below. The percentages are presented as a percentage of total net revenue.
 
 
Quarter Ended
 
 
October 29, 2017
 
October 30, 2016
 
October 29, 2017
 
October 30, 2016
 
 
(In thousands)
 
(Percentages)
Company-operated stores
 
$
425,084

 
$
393,506

 
68.7
%
 
72.3
%
Direct to consumer
 
131,181

 
104,013

 
21.2

 
19.1

Other
 
62,753

 
46,897

 
10.1

 
8.6

Net revenue
 
$
619,018

 
$
544,416

 
100.0
%
 
100.0
%
Company-Operated Stores.  Net revenue from our company-operated stores segment increase d $31.6 million , or 8% , to $425.1 million in the third quarter of fiscal 2017 from $393.5 million in the third quarter of fiscal 2016 . 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 October 30, 2016 , and therefore not included in comparable store sales, contributed $33.7 million to the increase . We opened 46 net new lululemon branded company-operated stores since the third quarter of fiscal 2016 , including 30 stores in North America, 13 stores in Asia Pacific, and three stores in Europe.

20

Table of Contents


A comparable store sales increase of 2% in the third quarter of fiscal 2017 compared to the third quarter of fiscal 2016 resulted in a $6.6 million increase to net revenue. Comparable store sales increased 1% , or $3.0 million on a constant dollar basis. The increase in comparable store sales was primarily a result of improved conversion rates and increased dollar value per transaction. This was partially offset by a decrease in store traffic, due in part to shifting retail traffic trends from in-store to online.
The closure of 48 of our ivivva branded company-operated stores as part of the restructuring of our ivivva operations in the third quarter of fiscal 2017 reduced our net revenue from company-operated stores by $8.8 million compared to the third quarter of fiscal 2016 .
Direct to Consumer.  Net revenue from our direct to consumer segment increased $27.2 million , or 26% , to $131.2 million in the third quarter of fiscal 2017 from $104.0 million in the third quarter of fiscal 2016 . Direct to consumer net revenue increased 25% on a constant dollar basis. This was primarily a result of increased website traffic, increased dollar value per transaction, and improved conversion rates.
Other.  Net revenue from our other segment increase d $15.9 million , or 34% , to $62.7 million in the third quarter of fiscal 2017 from $46.9 million in the third quarter of fiscal 2016 . This increase was primarily the result of an increased number of outlets and increased net revenue at existing outlets during the third quarter of fiscal 2017 compared to the third quarter of fiscal 2016 . There was also an increase in net revenue from warehouse sales and temporary locations. 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 third quarter of fiscal 2017 compared to the third quarter of fiscal 2016 .
Gross Profit
Gross profit increase d $43.5 million , or 16% , to $322.0 million for the third quarter of fiscal 2017 from $278.4 million for the third quarter of fiscal 2016 .
Gross profit as a percentage of net revenue, or gross margin, increase d 90  basis points to 52.0% in the third quarter of fiscal 2017 from 51.1% in the third quarter of fiscal 2016 . The increase in gross margin was primarily the result of:
an increase in product margin of 70 basis points which was primarily due to a favorable mix of higher margin product and lower product costs, partially offset by higher markdowns;
a decrease in fixed costs, including occupancy and depreciation costs and costs related to our product and supply chain departments, of 20 basis points; and
a favorable impact of foreign exchange rates of 20 basis points.
This was partially offset by accelerated depreciation charges related to the restructuring of our ivivva operations of 20 basis points.
During the third quarter of fiscal 2017 , as a result of the restructuring of our ivivva operations, we recognized costs totaling $1.2 million within costs of goods sold, as outlined in Note 6 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report. These costs primarily related to accelerated depreciation on leasehold improvements and furniture and fittings for stores which were closed during the third quarter of fiscal 2017. Excluding these charges, adjusted gross profit increased 16% to $323.1 million , and adjusted gross margin increase d 110 basis points to 52.2% compared to the third quarter of fiscal 2016 .
Selling, General and Administrative Expenses
Selling, general and administrative expenses increase d $29.9 million , or 16% , to $215.4 million in the third quarter of fiscal 2017 from $185.5 million in the third quarter of fiscal 2016 . The increase in selling, general and administrative expenses was primarily due to:
an increase in costs related to our operating channels of $25.3 million , comprised of:
an increase in employee costs of $7.7 million primarily from a growth in labor hours and benefits, mainly associated with new company-operated stores and other new operating locations;
an increase in variable costs of $3.7 million primarily due to an increase in credit card fees and packaging costs as a result of increased net revenue; and
an increase in other costs of $13.9 million primarily due to an increase in digital marketing expenses, website related costs including photography costs, brand and community costs, and other costs associated with our operating locations;

21

Table of Contents


an increase in head office costs of $3.1 million , comprised of:
an increase in employee costs of $2.1 million primarily due to additional employees to support the growth in our business; and
an increase in other costs of $1.0 million primarily due to increases in information technology related costs, an increase in brand and community costs, partially offset by a decrease in professional fees; and
a decrease in net foreign exchange and derivative revaluation gains of $1.6 million . There were net foreign exchange and derivative revaluation gains of $2.7 million in the third quarter of fiscal 2017 compared to net foreign exchange revaluation gains of $4.3 million in the third quarter of fiscal 2016 . 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.
As a percentage of net revenue, selling, general and administrative expenses increased 70 basis points, to 34.8% in the third quarter of fiscal 2017 from 34.1% in the third quarter of fiscal 2016 .
Asset Impairment and Restructuring Costs
As a result of the restructuring of our ivivva operations, we recognized restructuring costs of $21.0 million in the third quarter of fiscal 2017 . This included lease termination costs of $19.4 million , employee related costs of $0.8 million , and other restructuring costs of $0.8 million . We did not have any asset impairment and restructuring costs in the third quarter of fiscal 2016 . Please refer to Note 6 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report.
Income from Operations
Income from operations decrease d $7.4 million , or 8% , to $85.6 million in the third quarter of fiscal 2017 from $93.0 million in the third quarter of fiscal 2016 . Operating margin decrease d 330 basis points to 13.8% compared to 17.1% in the third quarter of fiscal 2016 .
In connection with the restructuring of our ivivva operations, we recognized pre-tax costs totaling $22.2 million in the third quarter of fiscal 2017 . This includes restructuring costs of $21.0 million and costs recognized in cost of goods sold totaling $1.2 million . Excluding these charges, adjusted income from operations increase d 16% to $107.8 million and adjusted operating margin increased 30 basis points to 17.4% .
On a segment basis, we determine income from operations without taking into account our general corporate expenses and the costs we incur in connection with the restructuring of our ivivva operations.
Segmented income from operations for the quarters ended October 29, 2017 and October 30, 2016 is summarized below. The percentages are presented as a percentage of net revenue of the respective operating segments.
 
 
Quarter Ended
 
 
October 29, 2017
 
October 30, 2016
 
October 29, 2017
 
October 30, 2016
 
 
(In thousands)
 
(Percentages)
Company-operated stores
 
$
97,015

 
$
91,497

 
22.8
%
 
23.3
%
Direct to consumer
 
52,201

 
43,588

 
39.8

 
41.9

Other
 
9,319

 
5,709

 
14.9

 
12.2

Segmented income from operations
 
158,535

 
140,794

 
 
 
 
General corporate expense
 
50,762

 
47,819

 
 
 
 
Restructuring and related costs
 
22,185

 

 
 
 
 
Income from operations
 
$
85,588

 
$
92,975

 
 
 
 
Company-Operated Stores . Income from operations from our company-operated stores segment increase d $5.5 million , or 6% , to $97.0 million for the third quarter of fiscal 2017 from $91.5 million for the third quarter of fiscal 2016 . The increase was primarily the result of increase d gross profit of  $14.5 million which was primarily due to increased net revenue. This was partially offset by an increase in selling, general and administrative expenses, including increased store employee costs, increased brand and community costs, and increased store operating expenses. Income from operations as a percentage of company-operated stores net revenue  decreased 50 basis points primarily due to deleverage of selling, general and administrative expenses.

22

Table of Contents


Direct to Consumer.  Income from operations from our direct to consumer segment increase d $8.6 million , or 20% , to $52.2 million for the third quarter of fiscal 2017 from $43.6 million for the third quarter of fiscal 2016 . The increase was primarily the result of increase d gross profit of $21.3 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 including higher digital marketing expenses and website related costs, and higher variable costs such as packaging, distribution and credit card fees as a result of higher net revenue. Income from operations as a percentage of direct to consumer net revenue decreased 210 basis points primarily due to deleverage of selling, general and administrative expenses, partially offset by increased gross margin.
Other.  Other income from operations increase d $3.6 million , or 63% , to $9.3 million for the third quarter of fiscal 2017 from $5.7 million for the third quarter of fiscal 2016 . The increase was primarily the result of  increase d gross profit of  $8.8 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, including increased employee costs, increased brand and community costs, and increased other operating costs. Income from operations as a percentage of other net revenue increased 270 basis points primarily due to an increase in gross margin.
General Corporate Expense.  General corporate expense increase d $2.9 million , or 6% , to $50.8 million for the third quarter of fiscal 2017 from $47.8 million for the third quarter of fiscal 2016 . This increase was primarily due to increases in information technology costs, head office employee costs, and other brand and community costs, partially offset by decreased professional fees. There was also a decrease in net foreign exchange and derivative revaluation gains of $1.6 million . There were net foreign exchange and derivative revaluation gains of $2.7 million in the third quarter of fiscal 2017 compared to net foreign exchange revaluation gains of $4.3 million in the third quarter of fiscal 2016 . 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 increase d $0.4 million , or 68% , to $1.1 million for the third quarter of fiscal 2017 from income of $0.6 million for the third quarter of fiscal 2016 . The third quarter of fiscal 2016 included a net interest expense of $0.2 million in relation to certain tax adjustments that are outlined in Note 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report.
Income Tax Expense
Income tax expense increase d $2.4 million , or 9% , to $27.7 million for the third quarter of fiscal 2017 from $25.3 million for the third quarter of fiscal 2016 .
The third quarters of fiscal 2017 and fiscal 2016 included certain adjustments which resulted in net income tax recoveries of $5.8 million and $4.0 million , respectively. As outlined in Notes 6 and 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report, the tax recovery recognized in the third quarter of fiscal 2017 relates to the tax effect of the costs recognized in connection with the ivivva restructuring, and the tax recovery recognized in the third quarter of fiscal 2016 relates to our transfer pricing arrangements and taxes on repatriation of foreign earnings.
The effective tax rate for the third quarter of fiscal 2017 was 32.0% compared to 27.0% for the third quarter of fiscal 2016 . The adjusted effective tax rate was 30.8% for the third quarter of fiscal 2017 compared to 31.3% for the third quarter of fiscal 2016 . The decrease in the adjusted effective tax rate compared to the third quarter of fiscal 2016 is primarily due to certain adjustments which were recorded during the third quarter of fiscal 2017 following the finalization of our U.S. tax return.
Net Income
Net income decrease d $9.3 million , or 14% , to $58.9 million for the third quarter of fiscal 2017 from $68.3 million for the third quarter of fiscal 2016 . This was primarily due to an increase in selling, general and administrative expenses of $29.9 million , asset impairment and restructuring costs of $21.0 million , an increase in income tax expense of $2.4 million , partially offset by an increase in gross profit of $43.5 million and an increase in other income (expense), net of $0.4 million .

23

Table of Contents


First Three Quarters Results
The following table summarizes key components of our results of operations for the first three quarters ended October 29, 2017 and October 30, 2016 . The percentages are presented as a percentage of net revenue.
 
 
Three Quarters Ended
 
 
October 29, 2017
 
October 30, 2016
 
October 29, 2017
 
October 30, 2016
 
 
(In thousands)
 
(Percentages)
Net revenue
 
$
1,720,379

 
$
1,554,452

 
100.0
%
 
100.0
%
Cost of goods sold
 
844,100

 
782,734

 
49.1

 
50.4

Gross profit
 
876,279

 
771,718

 
50.9

 
49.6

Selling, general and administrative expenses
 
640,032

 
547,195

 
37.2

 
35.2

Asset impairment and restructuring costs
 
36,524

 

 
2.1

 

Income from operations
 
199,723

 
224,523

 
11.6

 
14.4

Other income (expense), net
 
2,771

 
720

 
0.2

 
0.1

Income before income tax expense
 
202,494

 
225,243

 
11.8

 
14.5

Income tax expense
 
63,593

 
57,997

 
3.7

 
3.7

Net income
 
$
138,901

 
$
167,246

 
8.1
%
 
10.8
%
Net Revenue
Net revenue increase d $165.9 million , or 11% , to $1.720 billion for the first three quarters of fiscal 2017 from $1.554 billion for the first three quarters of fiscal 2016 . On a constant dollar basis, assuming the average exchange rates for the first three quarters of fiscal 2017 remained constant with the average exchange rates for the first three quarters of fiscal 2016 , net revenue increased $162.9 million , or 10% .
The increase in net revenue was primarily due to net revenue generated by new company-operated stores as well as increased direct to consumer net revenue. Total comparable sales, which includes comparable store sales and direct to consumer, increased 5% in the first three quarters of fiscal 2017 compared to the first three quarters of fiscal 2016 . Total comparable sales increased 4% on a constant dollar basis.
Net revenue on a segment basis for the first three quarters ended October 29, 2017 and October 30, 2016 is summarized below. The percentages are presented as a percentage of total net revenue.
 
 
Three Quarters Ended
 
 
October 29, 2017
 
October 30, 2016
 
October 29, 2017
 
October 30, 2016
 
 
(In thousands)
 
(Percentages)
Company-operated stores
 
$
1,218,127

 
$
1,133,599

 
70.8
%
 
72.9
%
Direct to consumer
 
341,453

 
288,978

 
19.8

 
18.6

Other
 
160,799

 
131,875

 
9.4

 
8.5

Net revenue
 
$
1,720,379

 
$
1,554,452

 
100.0
%
 
100.0
%
Company-Operated Stores . Net revenue from our company-operated stores segment increase d $84.5 million , or 7% , to $1.218 billion in the first three quarters of fiscal 2017 from $1.134 billion in the first three quarters of fiscal 2016 . 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 October 30, 2016 , and therefore not included in comparable store sales, contributed $89.0 million to the increase. We opened 46 net new lululemon branded company-operated stores since the third quarter of fiscal 2016 , including 30 stores in North America, 13 stores in Asia Pacific, and three stores in Europe.
A comparable store sales increase of 1% in the first three quarters of fiscal 2017 compared to the first three quarters of fiscal 2016 which resulted in a $4.3 million increase to net revenue. Comparable store sales increased 1% , or $2.3 million on a constant dollar basis. The increase in comparable store sales was primarily a result of increased dollar value per transaction and improved conversion rates. This was partially offset by a decrease in store traffic, due in part to shifting retail traffic trends from in-store to online.

24

Table of Contents


The closure of 48 of our ivivva branded company-operated stores as part of the restructuring of our ivivva operations in the third quarter of fiscal 2017 reduced our net revenue from company-operated stores by $8.8 million compared to the first three quarters of fiscal 2016 .
Direct to Consumer.  Net revenue from our direct to consumer segment increased $52.5 million , or 18% , to $341.5 million in the first three quarters of fiscal 2017 from $289.0 million in the first three quarters of fiscal 2016 . Direct to consumer net revenue increased 18% on a constant dollar basis. This was primarily a result of increased website traffic and increased dollar value per transaction, partially offset by lower conversion rates. During the second quarter of fiscal 2017, we held online warehouse sales 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 three quarters of fiscal 2016 . Excluding the impact of the online warehouse sales, direct to consumer net revenue increased 14% .
Other.  Net revenue from our other segment increase d $28.9 million , or 22% , to $160.8 million in the first three quarters of fiscal 2017 from $131.9 million in the first three quarters of fiscal 2016 . This increase was primarily the result of increased net revenue at existing outlets, and an increased number of outlets and temporary locations open during the first three quarters of fiscal 2017 compared to the first three quarters of fiscal 2016 . The increase in net revenue from our other segment was partially offset by lower net revenue from showrooms, primarily due a decreased number of showrooms open during the first three quarters of fiscal 2017 compared to the first three quarters of fiscal 2016 .
Gross Profit
Gross profit increased $104.6 million , or 14% , to $876.3 million for the first three quarters of fiscal 2017 from $771.7 million for the first three quarters of fiscal 2016 .
Gross profit as a percentage of net revenue, or gross margin, increase d 130 basis points, to 50.9% in the first three quarters of fiscal 2017 from 49.6% in the first three quarters of fiscal 2016 . The increase in gross margin was primarily the result of:
an increase in product margin of 230 basis points which was primarily due to a favorable mix of higher margin product and lower product costs, partially offset by higher markdowns; and
a favorable impact of foreign exchange rates of 10 basis points.
This was partially offset by an increase in fixed costs, including occupancy and depreciation costs, and costs related to our product and supply chain departments, of 60 basis points and costs incurred in connection with the restructuring of our ivivva operations of 50 basis points.
During the first three quarters of fiscal 2017 , as a result of the restructuring of our ivivva operations, we recognized costs totaling $8.8 million within costs of goods sold, as outlined in Note 6 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report. Excluding these charges, adjusted gross profit increased 15% to $885.1 million and adjusted gross margin increase d 180 basis points to 51.4% compared to the first three quarters of fiscal 2016 .
Selling, General and Administrative Expenses
Selling, general and administrative expenses increase d $92.8 million , or 17% , to $640.0 million in the first three quarters of fiscal 2017 from $547.2 million in the first three quarters of fiscal 2016 . The increase in selling, general and administrative expenses was primarily due to:
an increase in costs related to our operating channels of $63.3 million , comprised of:
an increase in employee costs of $26.8 million , primarily from a growth in labor hours and benefits, mainly associated with new company-operated stores and other new operating locations;
an increase in variable costs of $6.8 million , primarily due to an increase in credit card fees and distribution costs as a result of increased net revenue; and
an increase in other costs of $29.7 million , primarily due to an increase in digital marketing expenses, website related costs, brand and community costs, and other costs associated with our operating locations; and
an increase in head office costs of $40.6 million , comprised of:
an increase in employee costs of $13.4 million primarily due to additional employees to support the growth in our business; and

25

Table of Contents


an increase in other costs of $27.2 million primarily due to a global brand campaign, increases in other brand and community costs, professional fees, depreciation, and information technology related costs.
The increase in selling, general and administrative expenses was partially offset by an increase in net foreign exchange and derivative revaluation gains of $11.0 million . There were net foreign exchange and derivative revaluation gains of $6.9 million in the first three quarters of fiscal 2017 compared to net foreign exchange revaluation losses of $4.1 million in the first three quarters of fiscal 2016 . 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.
As a percentage of net revenue, selling, general and administrative expenses increase d 200 basis points, to 37.2% in the first three quarters of fiscal 2017 from 35.2% in the first three quarters of fiscal 2016 .
Asset Impairment and Restructuring Costs
As a result of the restructuring of our ivivva operations, we recognized asset impairment and restructuring costs of $36.5 million in the first three quarters of fiscal 2017 . This includes lease termination costs of $19.9 million , long-lived asset impairment charges of $11.6 million , employee related costs of $4.0 million , and other restructuring costs of $1.0 million . We did not have any asset impairment and restructuring costs in the first three quarters of fiscal 2016 . Please refer to Note 6 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report.
Income from Operations
Income from operations decrease d $24.8 million , or 11% , to $199.7 million in the first three quarters of fiscal 2017 from $224.5 million  in the first three quarters of fiscal 2016 . Operating margin decrease d 280 basis points to 11.6% compared to 14.4% in the first three quarters of fiscal 2016 .
In connection with the restructuring of our ivivva operations, we recognized pre-tax costs totaling $45.4 million in the first three quarters of fiscal 2017 . This includes asset impairment and restructuring costs of $36.5 million and costs recognized in cost of goods sold totaling $8.8 million . Excluding these charges, adjusted income from operations increase d 9% to $245.1 million and adjusted operating margin decreased 20 basis points to 14.2% .
On a segment basis, we determine income from operations without taking into account our general corporate expenses and the costs we incur in connection with the restructuring of our ivivva operations.
Segmented income from operations for the first three quarters ended October 29, 2017 and October 30, 2016 is summarized below. The percentages are presented as a percentage of net revenue of the respective operating segments.
 
 
Three Quarters Ended
 
 
October 29, 2017
 
October 30, 2016
 
October 29, 2017
 
October 30, 2016
 
 
(In thousands)
 
(Percentages)
Company-operated stores
 
$
267,178

 
$
245,056

 
21.9
%
 
21.6
%
Direct to consumer
 
127,746

 
114,744

 
37.4

 
39.7

Other
 
19,076

 
12,430

 
11.9

 
9.4

Segmented income from operations
 
414,000

 
372,230

 
 

 
 

General corporate expense
 
168,912

 
147,707

 
 

 
 

Restructuring and related costs
 
45,365

 

 
 
 
 
Income from operations
 
$
199,723

 
$
224,523

 
 

 
 

Company-Operated Stores.  Income from operations from our company-operated stores segment increased $22.1 million , or 9% , to $267.2 million for the first three quarters of fiscal 2017 from $245.1 million for the first three quarters of fiscal 2016 . The increase was primarily the result of increase d gross profit of $55.4 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, including increased store employee costs, increased brand and community costs, and increased operating expenses associated with higher net revenues and new stores. Income from operations as a percentage of company-operated stores net revenue increased  by 30 basis points, primarily due to an increase in gross margin, partially offset by deleverage of selling, general and administrative expenses.

26

Table of Contents


Direct to Consumer.  Income from operations from our direct to consumer segment increase d $13.0 million , or 11% , to $127.7 million for the first three quarters of fiscal 2017 from $114.7 million for the first three quarters of fiscal 2016 . The increase was primarily the result of increase d gross profit of $40.6 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 including higher digital marketing expenses, website related costs, and higher variable costs such as packaging and distribution and credit card fees as a result of higher net revenue. Income from operations as a percentage of direct to consumer net revenue decreased 230 basis points primarily due to deleverage of selling, general and administrative expenses, partially offset by increased gross margin.
Other.  Other income from operations increase d $6.6 million , or 53% , to $19.1 million for the first three quarters of fiscal 2017 from $12.4 million for the first three quarters of fiscal 2016 . The increase was primarily the result of increase d gross profit of $17.4 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, including increased employee costs, increased brand and community costs, and increased operating expenses associated with new locations and higher net revenues. Income from operations as a percentage of other net revenue increased 250 basis points primarily due to an increase in gross margin partially offset by deleverage of selling, general and administrative expenses as a percentage of other net revenue.
General Corporate Expense. General corporate expense increase d $21.2 million , or 14% , to $168.9 million for the first three quarters of fiscal 2017 from $147.7 million for the first three quarters of fiscal 2016 . This increase was primarily due to increased head office employee costs, a global brand campaign, increases in other brand and community costs, professional fees, depreciation, and information technology related costs. These increases were partially offset by an increase in net foreign exchange and derivative revaluation gains of $11.0 million . There were net foreign exchange and derivative revaluation gains of $6.9 million in the first three quarters of fiscal 2017 compared to net foreign exchange losses of $4.1 million in the first three quarters of fiscal 2016 . 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 increase d $2.1 million , or 285% , to $2.8 million for the first three quarters of fiscal 2017 from income of $0.7 million for the first three quarters of fiscal 2016 . The increase was primarily due to net interest expense of $1.7 million which was recorded in the first three quarters of fiscal 2016 in relation to certain tax adjustments that are outlined in Note 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report.
Income Tax Expense
Income tax expense increased $5.6 million , or 10% , to $63.6 million for the first three quarters of fiscal 2017 from $58.0 million for the first three quarters of fiscal 2016 .
The first three quarters of fiscal 2017 and fiscal 2016 included certain tax adjustments which resulted in net income tax recoveries of $11.9 million and $11.6 million , respectively. As outlined in Notes 6 and 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report, the tax recovery recognized in the first three quarters of fiscal 2017 relates to the tax effect of the costs recognized in connection with the ivivva restructuring, and the tax recovery recognized in the first three quarters of fiscal 2016 relates to our transfer pricing arrangements and taxes on repatriation of foreign earnings.
The effective tax rate for the first three quarters of fiscal 2017 was 31.4% compared to 25.7% for the first three quarters of fiscal 2016 . The adjusted effective tax rate was 30.5% for the first three quarters of fiscal 2017 compared to 30.7% for the first three quarters of fiscal 2016 . The decrease in the adjusted effective tax rate compared to first three quarters of fiscal 2016 is primarily due to certain adjustments which were recorded during the first three quarters of fiscal 2017 following the finalization of our U.S. and Canadian tax returns.
Net Income
Net income decreased $28.3 million , or 17% , to $138.9 million for the first three quarters of fiscal 2017 from $167.2 million for the first three quarters of fiscal 2016 . This was primarily due to an increase in selling, general and administrative expenses of $92.8 million , long-lived asset impairment and restructuring costs of $36.5 million , and an increase in income tax expense of $5.6 million , partially offset by an increase in gross profit of $104.6 million , and an increase in other income (expense), net of $2.1 million .

27

Table of Contents


Comparable Store Sales and Total Comparable Sales
We separately track comparable store sales, which reflect net revenue from company-operated stores that have been open for at least 12 months, or open for at least 12 months after being significantly expanded. Net revenue from a store is included in comparable store sales beginning with the first month for which the store has a full month of sales in the prior year. Comparable store sales exclude sales from new stores that have not been open for at least 12 months, from stores which have not been in their significantly expanded space for at least 12 months, and from stores which have been temporarily relocated for renovations. Comparable store sales also exclude sales from direct to consumer, outlets, showrooms, temporary locations, wholesale accounts, license and supply arrangements, warehouse sales, and sales from company-operated stores that we have closed.
Total comparable sales combines comparable store sales and direct to consumer sales.
The comparable sales measures we report may not be equivalent to similarly titled measures reported by other companies.
Non-GAAP Financial Measures
Constant dollar changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue, and the adjusted financial results are non-GAAP financial measures.
A constant dollar basis assumes the average foreign exchange rates for the period remained constant with the average foreign exchange rates for the same period of the prior year. We provide constant dollar changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue because we use these measures to understand the underlying growth rate of net revenue excluding the impact of changes in foreign exchange rates. We believe that disclosing these measures on a constant dollar basis is useful to investors because it enables them to better understand the level of growth of our business.
Adjusted gross profit, gross margin, income from operations, operating margin, effective tax rates, and diluted earnings per share exclude the costs recognized in connection with the restructuring of our ivivva operations, its related tax effects, and certain discrete items related to our transfer pricing arrangements and taxes on repatriation of foreign earnings. We believe these adjusted financial measures are useful to investors as the adjustments do not directly relate to our ongoing business operations and therefore do not contribute to a meaningful evaluation of the trend in our operating performance. Furthermore, we do not believe the adjustments are reflective of our expectations of our future operating performance and believe these non-GAAP measures are useful to investors because of their comparability to our historical information.
The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or with greater prominence to, the financial information prepared and presented in accordance with GAAP. A reconciliation of the non-GAAP financial measures follows, which includes more detail on the GAAP financial measure that is most directly comparable to each non-GAAP financial measure, and the related reconciliations between these financial measures.
The below changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue show the change compared to the corresponding period in the prior year.

28

Table of Contents


Constant dollar changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue