Edgar Filing: lululemon athletica inc.

Quarter Ended
July 30, 2017

Two Quarters Ended
July 30, 2017

Change in total comparable sales^1,2

Adjustments due to foreign exchange rate changes

Change in total comparable sales in constant dollars^1,2

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)



þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 30, 2017



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, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting 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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

At August 28, 2017, there were 125,601,122 shares of the registrant's common stock, par value $0.005 per share, outstanding.

Exchangeable and Special Voting Shares:

At August 28, 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 August 28, 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.

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TABLE OF CONTENTS



		Page
PART I. FINANCIAL INFORMATION

Item 1.	FINANCIAL STATEMENTS:	3
	CONSOLIDATED BALANCE SHEETS	3
	CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME	4
	CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY	5
	CONSOLIDATED STATEMENTS OF CASH FLOWS	6
	INDEX FOR NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS	7
Item 2.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	18
Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	33
Item 4.	CONTROLS AND PROCEDURES	35

PART II. OTHER INFORMATION

Item 1.	LEGAL PROCEEDINGS	36
Item 1A.	RISK FACTORS	36
Item 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	45
Item 6.	EXHIBITS	46

SIGNATURES		47

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PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

lululemon athletica inc.

CONSOLIDATED BALANCE SHEETS

(Unaudited; Amounts in thousands, except per share amounts)



	July 30, 2017			January 29, 2017
ASSETS
Current assets
Cash and cash equivalents	$	721,212		$	734,846
Accounts receivable	15,873			9,200
Inventories	316,368			298,432
Prepaid and receivable income taxes	66,161			81,190
Other prepaid expenses and other current assets	51,408			39,069
	1,171,022			1,162,737
Property and equipment, net	426,961			423,499
Goodwill and intangible assets, net	24,749			24,557
Deferred income tax assets	40,016			26,256
Other non-current assets	24,175			20,492
	$	1,686,923		$	1,657,541
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable	$	19,049		$	24,846
Accrued inventory liabilities	21,292			8,601
Accrued compensation and related expenses	47,920			55,238
Income taxes payable	6,519			30,290
Unredeemed gift card liability	56,170			70,454
Other current liabilities	73,341			52,561
	224,291			241,990
Deferred income tax liabilities	7,668			7,262
Other non-current liabilities	57,155			48,316
	289,114			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; 125,697 and 127,304 issued and outstanding	628			637
Additional paid-in capital	272,043			266,622
Retained earnings	1,285,559			1,294,214
Accumulated other comprehensive loss	(160,421		)	(201,500		)
	1,397,809			1,359,973
	$	1,686,923		$	1,657,541

See accompanying notes to the unaudited interim consolidated financial statements

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lululemon athletica inc.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited; Amounts in thousands, except per share amounts)



	Quarter Ended					Two Quarters Ended
	July 30, 2017		July 31, 2016			July 30, 2017		July 31, 2016
Net revenue	$	581,054	$	514,520		$	1,101,361	$	1,010,036
Cost of goods sold	283,632		260,359			547,044		516,744
Gross profit	297,422		254,161			554,317		493,292
Selling, general and administrative expenses	225,524		180,202			424,665		361,744
Asset impairment and restructuring costs	3,186		—			15,517		—
Income from operations	68,712		73,959			114,135		131,548
Other income (expense), net	812		578			1,719		92
Income before income tax expense	69,524		74,537			115,854		131,640
Income tax expense	20,813		20,912			35,897		32,679
Net income	$	48,711	$	53,625		$	79,957	$	98,961

Other comprehensive income (loss):
Foreign currency translation adjustment	72,854		(28,052		)	41,079		45,510
Comprehensive income	$	121,565	$	25,573		$	121,036	$	144,471

Basic earnings per share	$	0.36	$	0.39		$	0.59	$	0.72
Diluted earnings per share	$	0.36	$	0.39		$	0.58	$	0.72
Basic weighted-average number of shares outstanding	136,171		136,987			136,604		137,071
Diluted weighted-average number of shares outstanding	136,303		137,229			136,747		137,309

See accompanying notes to the unaudited interim consolidated financial statements

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lululemon athletica inc.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Unaudited; Amounts in thousands)



	Exchangeable Stock	Special Voting Stock			Common Stock					Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total
	Shares	Shares	Par Value		Shares		Par Value			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total
Balance at January 29, 2017	9,781	9,781	$	—	127,304		$	637		$	266,622		$	1,294,214		$	(201,500	)	$	1,359,973
Net income													79,957						79,957
Foreign currency translation adjustment																41,079			41,079
Stock-based compensation expense										8,710									8,710
Common stock issued upon settlement of stock-based compensation					141		1			914									915
Shares withheld related to net share settlement of stock-based compensation					(41	)	—			(2,024		)							(2,024		)
Repurchase of common stock					(1,707	)	(10		)	(2,179		)	(88,612		)				(90,801		)
Balance at July 30, 2017	9,781	9,781	$	—	125,697		$	628		$	272,043		$	1,285,559		$	(160,421	)	$	1,397,809

See accompanying notes to the unaudited interim consolidated financial statements

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lululemon athletica inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; Amounts in thousands)



	Two Quarters Ended
	July 30, 2017			July 31, 2016
Cash flows from operating activities
Net income	$	79,957		$	98,961
Items not affecting cash
Depreciation and amortization	51,569			39,683
Stock-based compensation expense	8,710			8,126
Asset impairment	11,593			—
Changes in operating assets and liabilities
Inventories	(10,041		)	16,947
Prepaid and receivable income taxes	15,029			(6,020		)
Other prepaid expenses and other current assets	(17,502		)	(9,595		)
Other non-current assets	(15,620		)	(9,317		)
Accounts payable	(6,784		)	(2,512		)
Accrued inventory liabilities	9,571			(8,432		)
Accrued compensation and related expenses	(8,970		)	(5,967		)
Income taxes payable	(25,310		)	(6,948		)
Unredeemed gift card liability	(15,192		)	(12,679		)
Other accrued and non-current liabilities	25,028			(1,054		)
Net cash provided by operating activities	102,038			101,193
Cash flows from investing activities
Purchase of property and equipment	(49,889		)	(71,261		)
Net cash used in investing activities	(49,889		)	(71,261		)
Cash flows from financing activities
Proceeds from settlement of stock-based compensation	915			5,079
Taxes paid related to net share settlement of stock-based compensation	(2,024		)	(1,605		)
Repurchase of common stock	(90,801		)	(28,556		)
Net cash used in financing activities	(91,910		)	(25,082		)
Effect of exchange rate changes on cash and cash equivalents	26,127			29,018
(Decrease) increase in cash and cash equivalents	(13,634		)	33,868
Cash and cash equivalents, beginning of period	$	734,846		$	501,482
Cash and cash equivalents, end of period	$	721,212		$	535,350

See accompanying notes to the unaudited interim consolidated financial statements

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lululemon athletica inc.

INDEX FOR NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL

STATEMENTS



Note 1	Nature of Operations and Basis of Presentation	8
Note 2	Recent Accounting Pronouncements	8
Note 3	Stock-Based Compensation and Benefit Plans	9
Note 4	Fair Value Measurement	11
Note 5	Derivative Financial Instruments	11
Note 6	Asset Impairment and Restructuring	13
Note 7	Income Taxes	14
Note 8	Earnings Per Share	15
Note 9	Supplementary Financial Information	15
Note 10	Segment Reporting	17
Note 11	Legal Proceedings	18

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lululemon athletica inc.

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL

STATEMENTS

NOTE 1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION

Nature of operations

lululemon athletica inc., a Delaware corporation ("lululemon" and, together with its subsidiaries unless the context otherwise requires, the "Company") is engaged in the design, distribution, and retail of healthy lifestyle inspired athletic apparel, which is sold through a chain of company-operated stores, direct to consumer through e-commerce, outlets, showrooms, temporary locations, sales to wholesale accounts, warehouse sales, and through license and supply arrangements. Its apparel is marketed under the lululemon and ivivva brand names. The Company operates stores in the United States, Canada, Australia, the United Kingdom, New Zealand, China, Hong Kong, Singapore, South Korea, Germany, Ireland, Japan, Puerto Rico, and Switzerland. There were a total of 421 and 406 company-operated stores in operation as of July 30, 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 47 of the 55 ivivva branded company-operated stores. Of the eight remaining ivivva branded stores, seven are expected to remain in operation and one is expected to be converted to a lululemon branded store. 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 plans.

Basis of presentation

The unaudited interim consolidated financial statements as of July 30, 2017 and for the quarters and two quarters ended July 30, 2017 and July 31, 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

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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 two quarters ended July 31, 2016 to reclassify excess tax benefits of $1.2 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 $8.7 million and $8.1 million for the two quarters ended July 30, 2017 and July 31, 2016, respectively. Total unrecognized compensation cost for all stock-based compensation plans was $51.7 million at July 30, 2017, which is expected to be recognized over a weighted-average period of 2.4 years.

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Company stock options, performance-based restricted stock units, restricted shares, and restricted stock units

A summary of the Company's stock option, performance-based restricted stock unit, restricted share, and restricted stock unit activity as of July 30, 2017, and changes during the first two quarters then ended, is presented below:



	Stock Options			Performance-Based Restricted Stock Units			Restricted Shares			Restricted Stock Units
	Number	Weighted-Average Exercise Price		Number	Weighted-Average Grant Date Fair Value		Number	Weighted-Average Grant Date Fair Value		Number	Weighted-Average Grant Date Fair Value
	(In thousands, except per share amounts)
Balance at January 29, 2017	918	$	59.20	390	$	61.05	14	$	70.54	360	$	62.99
Granted	597	51.91		184	51.90		22	51.72		312	52.08
Exercised/released	26	35.27		—	—		14	70.29		92	65.94
Forfeited	137	57.96		188	53.74		—	—		67	57.08
Balance at July 30, 2017	1,352	$	56.56	386	$	60.25	22	$	51.72	513	$	56.60
Exercisable at July 30, 2017	314	$	57.57

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 two quarters of fiscal 2017:



	Two Quarters Ended July 30, 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 July 30, 2017, there were 43.5 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

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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 $2.7 million and $0.9 million in the first two 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 July 30, 2017, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis:



	July 30, 2017			Level 1		Level 2			Level 3
	(in thousands)
Net forward currency contract (liabilities) assets	$	(1,131	)	$	—	$	(1,131	)	$	—

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.

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 quarter ended July 30, 2017 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 quarter ended July 30, 2017.

The Company classifies the cash flows at settlement of its net investment hedges within investing activities in the consolidated statements of cash flows.

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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 quarter ended July 30, 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 of the consolidated statements of cash flows.

Outstanding notional amounts

The Company had foreign exchange forward contracts outstanding with the following notional amounts:



	July 30, 2017		July 31, 2016
	(in thousands)
Derivatives designated as net investment hedges	$	78,000	$	—
Derivatives not designated in a hedging relationship	65,000		—

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 October 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 July 30, 2017, there were derivative assets of $4.1 million and derivative liabilities of $4.8 million subject to enforceable netting arrangements.

The fair values of forward currency contracts were as follows:



	July 30, 2017		July 31, 2016
	(in thousands)
Derivatives designated as net investment hedges, recognized within:
Other current liabilities	$	7,068	$	—
Derivatives not designated in a hedging relationship, recognized within:
Other prepaid expenses and other current assets	5,937		—

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:



	July 30, 2017			July 31, 2016
	(in thousands)
Derivatives designated as net investment hedges:
(Loss) gain recognized in other comprehensive income	$	(8,925	)	$	—
Derivatives not designated in a hedging relationship:
Gain (loss) recognized in selling, general and administrative expenses	7,634			—

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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) any of its hedged subsidiaries.

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 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 47 of its 55 ivivva branded company-operated stores. Of the eight remaining ivivva branded stores, seven are expected to remain in operation and one is expected to be converted to a lululemon branded store. 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.

The Company expects the restructuring to be substantially complete by the end of the third quarter of fiscal 2017.

As a result of the closures, the Company currently estimates that it will incur aggregate pre-tax charges of between $50.0 million and $60.0 million in fiscal 2017, inclusive of $23.2 million recognized during the two quarters ended July 30, 2017. The remaining costs, primarily related to lease terminations and employee related costs, are expected to be substantially recognized in the third quarter of fiscal 2017. These estimates are based on significant assumptions and could change materially.

A summary of the pre-tax charges recognized during the second quarter and the first two quarters of fiscal 2017 in connection with the Company's restructuring of its ivivva operations is as follows:



	Quarter Ended July 30, 2017			Two Quarters Ended July 30, 2017
	(In thousands)
Costs recorded in cost of goods sold:
Provision to reduce inventories to net realizable value	$	962		$	2,904
Expected loss on committed inventory purchases	(941		)	2,536
Accelerated depreciation	2,223			2,223
	2,244			7,663
Costs recorded in operating expenses:
Impairment of property and equipment	—			11,593
Employee related costs	2,458			3,196
Lease termination and other restructuring costs	728			728
Asset impairment and restructuring costs	3,186			15,517
Restructuring and related costs	$	5,430		$	23,180

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

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Costs recorded in cost of goods sold

During the first two quarters of fiscal 2017, the Company recognized expenses of $7.7 million in cost of goods sold as a result of the restructuring of its ivivva operations. This included $2.9 million to reduce inventories to their estimated net realizable value, and $2.5 million for the losses the Company 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 quarter of fiscal 2017, the Company took delivery of inventory that it had previously committed to purchase. As a result, there was a reduction in the Company's liability for expected losses on committed inventory purchases and a corresponding increase in its provision to reduce inventories to net realizable value.

The Company also recorded accelerated depreciation charges of $2.2 million during the first two quarters of fiscal 2017, primarily related to leasehold improvements and furniture and fixtures for stores which have been closed during the third quarter of fiscal 2017.

Costs recorded in operating expenses

The Company recognized asset impairment and restructuring costs of $15.5 million during the first two quarters of fiscal 2017 as a result of the restructuring of its ivivva operations.

As a result of the plan to close the majority of the ivivva branded locations, the long-lived assets of each ivivva branded location were tested for impairment as of April 30, 2017. For impaired locations, a loss was recognized representing the difference between the net book value of the long-lived assets and their estimated fair value. Impairment losses totaling $11.6 million were recognized during the first quarter of fiscal 2017. These losses primarily relate to leasehold improvements and furniture and fixtures of the company-operated stores segment.

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 two quarters of fiscal 2017, the Company recognized employee related expenses as a result of the restructuring of $3.2 million.

The Company recognized lease termination and other restructuring costs of $0.7 million during the first two quarters of fiscal 2017.

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 two quarters ended July 30, 2017 did not include any discrete items or adjustments related to the APA.

The results for the quarter and two quarters ended July 31, 2016 included net interest expenses of $0.3 million and $1.5 million, respectively, that were recorded in other income (expense), net, and net income tax recoveries of $1.9 million and $7.6 million, respectively, related to the expected outcome of the APA and taxes associated with the anticipated repatriation of foreign earnings.

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NOTE 8. EARNINGS PER SHARE

The details of the computation of basic and diluted earnings per share are as follows:



	Quarter Ended				Two Quarters Ended
	July 30, 2017		July 31, 2016		July 30, 2017		July 31, 2016
	(In thousands, except per share amounts)
Net income	$	48,711	$	53,625	$	79,957	$	98,961
Basic weighted-average number of shares outstanding	136,171		136,987		136,604		137,071
Assumed conversion of dilutive stock options and awards	132		242		143		238
Diluted weighted-average number of shares outstanding	136,303		137,229		136,747		137,309
Basic earnings per share	$	0.36	$	0.39	$	0.59	$	0.72
Diluted earnings per share	$	0.36	$	0.39	$	0.58	$	0.72

The Company's calculation of weighted-average shares includes the common stock of the Company as well as the exchangeable shares. Exchangeable shares are the equivalent of common shares in all material respects. All classes of stock have, in effect, the same rights and share equally in undistributed net income. For the two quarters ended July 30, 2017 and July 31, 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 generally is repurchased in the open market at prevailing market prices, with the timing and actual number of shares repurchased depending upon market conditions, eligibility to trade, and other factors. The repurchases may be made until December 9, 2018. As of July 30, 2017, the remaining aggregate value of shares available to be repurchased under this program was $8.5 million.

During the two quarters ended July 30, 2017 and July 31, 2016, 1.7 million and 0.4 million shares, respectively, were repurchased under the program at a total cost of $90.8 million and $28.6 million, respectively.

Subsequent to July 30, 2017, and up to August 28, 2017, 0.1 million shares were repurchased at a total cost of $5.8 million.

NOTE 9. SUPPLEMENTARY FINANCIAL INFORMATION

For the quarters ended July 30, 2017 and July 31, 2016, there were net foreign exchange and derivative revaluation losses of $1.7 million and gains of $5.1 million, respectively, included within selling, general and administrative expenses.

For the two quarters ended July 30, 2017 and July 31, 2016, there were net foreign exchange and derivative revaluation gains of $4.1 million and losses of $8.5 million, respectively, included within selling, general and administrative expenses.

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A summary of certain consolidated balance sheet accounts is as follows:



	July 30, 2017			January 29, 2017
	(In thousands)
Inventories:
Finished goods	$	329,535		$	306,087
Provision to reduce inventories to net realizable value	(13,167		)	(7,655		)
	$	316,368		$	298,432
Property and equipment, net:
Land	$	82,358		$	78,561
Buildings	39,032			32,174
Leasehold improvements	285,931			273,801
Furniture and fixtures	86,610			84,479
Computer hardware	61,611			58,270
Computer software	187,040			160,835
Equipment and vehicles	14,670			13,704
Accumulated depreciation	(330,291		)	(278,325		)
	$	426,961		$	423,499
Goodwill and intangible assets, net:
Goodwill	$	25,496		$	25,496
Changes in foreign currency exchange rates	(947		)	(1,263		)
	24,549			24,233
Intangibles - reacquired franchise rights	10,150			10,150
Accumulated amortization	(9,942		)	(9,807		)
Changes in foreign currency exchange rates	(8		)	(19		)
	200			324
	$	24,749		$	24,557
Other current liabilities:
Accrued duty, freight, and other operating expenses	$	38,871		$	27,477
Sales tax collected	12,551			10,182
Accrued rent	4,988			5,562
Other	16,931			9,340
	$	73,341		$	52,561
Other non-current liabilities:
Deferred lease liability	$	27,514		$	26,648
Tenant inducements	23,808			21,668
Other	5,833			—
	$	57,155		$	48,316

As of July 30, 2017, as result of the restructuring of its ivivva operations, the Company had a provision of $2.9 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 $2.5 million. This liability is included within accrued inventory liabilities on the consolidated balance sheets.

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.

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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, sales to wholesale accounts, temporary locations, warehouse sales, and license and supply arrangement net revenue have been combined into other. Information for these segments is detailed in the table below:



	Quarter Ended				Two Quarters Ended
	July 30, 2017		July 31, 2016		July 30, 2017		July 31, 2016
	(In thousands)
Net revenue:
Company-operated stores	$	413,944	$	381,389	$	793,043	$	740,093
Direct to consumer	113,049		87,399		210,272		184,965
Other	54,061		45,732		98,046		84,978
	$	581,054	$	514,520	$	1,101,361	$	1,010,036
Income from operations before general corporate expense:
Company-operated stores	$	92,609	$	80,277	$	170,139	$	153,564
Direct to consumer	40,139		32,644		75,566		71,152
Other	6,952		4,636		9,760		6,720
	139,700		117,557		255,465		231,436
General corporate expense	65,558		43,598		118,150		99,888
Restructuring and related costs	5,430		—		23,180		—
Income from operations	68,712		73,959		114,135		131,548
Other income (expense), net	812		578		1,719		92
Income before income tax expense	$	69,524	$	74,537	$	115,854	$	131,640

Capital expenditures:
Company-operated stores	$	16,634	$	11,515	$	23,802	$	28,265
Direct to consumer	6,861		4,551		8,841		5,715
Corporate and other	6,515		28,552		17,246		37,281
	$	30,010	$	44,618	$	49,889	$	71,261
Depreciation and amortization:
Company-operated stores	$	15,881	$	14,511	$	31,081	$	28,295
Direct to consumer	4,353		1,725		6,347		3,054
Corporate and other	8,172		4,261		14,141		8,334
	$	28,406	$	20,497	$	51,569	$	39,683

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

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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.

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.

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

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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. On August 20, 2017, as a part of this plan, we closed 47 of our 55 ivivva branded company-operated stores. Of the eight remaining ivivva branded stores, seven are expected to remain in operation and one is expected to be converted to a lululemon branded store. 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. We anticipate that we will substantially complete the restructuring by the end of the third quarter of fiscal 2017.

Financial Highlights

The summary below provides both GAAP and adjusted non-GAAP financial measures. In connection with the restructuring of our ivivva operations, we recognized pre-tax costs totaling $5.4 million in the second quarter of fiscal 2017. The adjusted financial measures 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 second quarter of fiscal 2016.

For the second quarter of fiscal 2017, compared to the second quarter of fiscal 2016:


•	Net revenue increased 13% to $581.1 million. On a constant dollar basis, net revenue increased 13%.


•	Total comparable sales, which includes comparable store sales and direct to consumer, increased 7%. On a constant dollar basis, total comparable sales increased by 7%.


–	Comparable store sales increased 2%, or increased by 2% on a constant dollar basis.


–	Direct to consumer net revenue increased 29%, or increased by 30% on a constant dollar basis. During the quarter we held an online warehouse sale. Excluding the impact of this sale, direct to consumer net revenue increased 15%, or increased 16% on a constant dollar basis.


•	Gross profit increased 17% to $297.4 million. Adjusted gross profit increased 18% to $299.7 million.


•	Gross margin increased 180 basis points to 51.2%. Adjusted gross margin increased 220 basis points to 51.6%.


•	Income from operations decreased by 7% to $68.7 million. Adjusted income from operations increased by $0.2 million, or less than 1%, to $74.1 million.


•	Operating margin decreased 260 basis points to 11.8%. Adjusted operating margin decreased by 160 basis points to 12.8%.


•	Income tax expense decreased less than 1% to $20.8 million. Our effective tax rate for the second quarter of fiscal 2017 was 29.9% compared to 28.1% for the second quarter of fiscal 2016. The adjusted effective tax rate was 29.6% in the second quarter of fiscal 2017 compared to 30.5% in the second quarter of fiscal 2016.


•	Diluted earnings per share were $0.36 compared to $0.39 in the second quarter of fiscal 2016. Adjusted diluted earnings per share were $0.39 for the second quarter of fiscal 2017 compared to $0.38 for the second 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, direct to consumer net revenue, and direct to consumer net revenue excluding the online warehouse sale, and adjusted 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.

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Results of Operations

Second Quarter Results

The following table summarizes key components of our results of operations for the quarters ended July 30, 2017 and July 31, 2016. The percentages are presented as a percentage of net revenue.



	Quarter Ended
	July 30, 2017		July 31, 2016		July 30, 2017		July 31, 2016
	(In thousands)				(Percentages)
Net revenue	$	581,054	$	514,520	100.0	%	100.0	%
Cost of goods sold	283,632		260,359		48.8		50.6
Gross profit	297,422		254,161		51.2		49.4
Selling, general and administrative expenses	225,524		180,202		38.8		35.0
Asset impairment and restructuring costs	3,186		—		0.6		—
Income from operations	68,712		73,959		11.8		14.4
Other income (expense), net	812		578		0.2		0.1
Income before income tax expense	69,524		74,537		12.0		14.5
Income tax expense	20,813		20,912		3.6		4.1
Net income	$	48,711	$	53,625	8.4	%	10.4	%

Net Revenue

Net revenue increased $66.5 million, or 13%, to $581.1 million for the second quarter of fiscal 2017 from $514.5 million for the second quarter of fiscal 2016. On a constant dollar basis, assuming the average exchange rates for the second quarter of fiscal 2017 remained constant with the average exchange rates for the second quarter of fiscal 2016, net revenue increased $68.9 million, or 13%.

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 7% in the second quarter of fiscal 2017 compared to the second quarter of fiscal 2016. Total comparable sales increased 7% on a constant dollar basis.

Net revenue on a segment basis for the quarters ended July 30, 2017 and July 31, 2016 is summarized below. The percentages are presented as a percentage of total net revenue.



	Quarter Ended
	July 30, 2017		July 31, 2016		July 30, 2017		July 31, 2016
	(In thousands)				(Percentages)
Company-operated stores	$	413,944	$	381,389	71.2	%	74.1	%
Direct to consumer	113,049		87,399		19.5		17.0
Other	54,061		45,732		9.3		8.9
Net revenue	$	581,054	$	514,520	100.0	%	100.0	%

Company-Operated Stores. Net revenue from our company-operated stores segment increased $32.6 million, or 9%, to $413.9 million in the second quarter of fiscal 2017 from $381.4 million in the second 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 July 31, 2016, and therefore not included in comparable store sales, contributed $28.9 million to the increase. We have opened 42 net new company-operated stores since the second quarter of fiscal 2016, including 24 stores in the United States, five stores in China, four stores in Canada, three stores in the United Kingdom, two stores in South Korea, and one store in each of Hong Kong, Ireland, Japan, and New Zealand.


•	A comparable store sales increase of 2% in the second quarter of fiscal 2017 compared to the second quarter of fiscal 2016 resulted in a $3.7 million increase to net revenue. Comparable store sales increased 2%, or $4.9 million on a

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constant dollar basis. The increase in comparable store sales was primarily as a result of increased dollar value per transaction and improved conversion rates. This was partially offset by a decrease in store traffic.

Direct to Consumer. Net revenue from our direct to consumer segment increased $25.7 million, or 29%, to $113.0 million in the second quarter of fiscal 2017 from $87.4 million in the second quarter of fiscal 2016. Direct to consumer net revenue increased 30% on a constant dollar basis. This was primarily as a result of increased website traffic and improved conversion rates. This was partially offset by a decrease in dollar value per transaction. 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 warehouse sales during the second quarter of fiscal 2016. Excluding the impact of the online warehouse sales, direct to consumer net revenue increased 15%, or increased 16% on a constant dollar basis.

Other. Net revenue from our other segment increased $8.3 million, or 18%, to $54.1 million in the second quarter of fiscal 2017 from $45.7 million in the second quarter of fiscal 2016. This increase was primarily the result of increased net revenue at existing outlets and due to an increased number of outlets during the second quarter of fiscal 2017 compared to the second quarter of fiscal 2016. There was also an increase in net revenue from temporary locations. The increase in net revenue from outlets and temporary locations was partially offset by a lower net revenue from showrooms, primarily due to a decreased number of showrooms open during the second quarter of fiscal 2017 compared to the second quarter of fiscal 2016.

Gross Profit

Gross profit increased $43.3 million, or 17%, to $297.4 million for the second quarter of fiscal 2017 from $254.2 million for the second quarter of fiscal 2016. Gross profit as a percentage of net revenue, or gross margin, was 51.2% in the second quarter of fiscal 2017 compared to 49.4% in the second quarter of fiscal 2016.

Gross margin increased by 180 basis points to 51.2% in the second quarter of fiscal 2017 from 49.4% in the second quarter of fiscal 2016. The increase in gross margin was primarily the result of an increase in product margin of 260 basis points which was primarily due to a favorable mix of higher margin product and lower product costs, partially offset by higher markdowns.

This was partially offset by accelerated depreciation charges related to the restructuring of our ivivva operations of 40 basis points, an unfavorable impact of foreign exchange rates of 20 basis points, an increase in occupancy and depreciation costs of 10 basis points, and an increase in costs related to our product and supply chain departments of 10 basis points.

During the second quarter of fiscal 2017, we recorded accelerated depreciation charges of $2.2 million in cost of goods sold as a result of the restructuring of our ivivva operations. This was primarily related to leasehold improvements and furniture and fittings for stores which have been closed during the third quarter of fiscal 2017. See 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 18% to $299.7 million, and adjusted gross margin increased 220 basis points to 51.6% compared to the second quarter of fiscal 2016.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $45.3 million, or 25%, to $225.5 million in the second quarter of fiscal 2017 from $180.2 million in the second 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 $20.8 million, comprised of:


–	an increase in employee costs of $8.3 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 $3.8 million primarily due to an increase in distribution costs and credit card fees as a result of increased net revenue; and


–	an increase in other costs of $8.7 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 $17.7 million, comprised of:


–	an increase in employee costs of $5.0 million primarily due to additional employees to support the growth in our business;

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–	an increase in other costs of $12.7 million primarily due to a global brand campaign, increases in other brand and community costs, photography costs, professional fees, depreciation, and information technology related costs; and

•

an increase in net foreign exchange and derivative revaluation losses of $6.8 million. There were net foreign exchange and derivative revaluation losses of $1.7 million in the second quarter of fiscal 2017 compared to net foreign exchange revaluation gains of $5.1 million in the second 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. During the second quarter of fiscal 2017 we entered into certain forward currency contracts designed to hedge against changes in the Canadian dollar to U.S. dollar exchange rate. See Note 5 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report.

As a percentage of net revenue, selling, general and administrative expenses increased 380 basis points, to 38.8% in the second quarter of fiscal 2017 from 35.0% in the second quarter of fiscal 2016.

Asset Impairment and Restructuring Costs

As a result of the restructuring of our ivivva operations, we recognized restructuring costs of $3.2 million in the second quarter of fiscal 2017. This included employee related costs of $2.5 million and lease termination and other restructuring costs of $0.7 million. We did not have asset impairment and restructuring costs in the second 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 decreased $5.2 million, or 7%, to $68.7 million in the second quarter of fiscal 2017 from $74.0 million in the second quarter of fiscal 2016. Operating margin decreased 260 basis points to 11.8% compared to 14.4% in the second quarter of fiscal 2016.

In connection with the restructuring of our ivivva operations, we recognized pre-tax costs totaling $5.4 million in the second quarter of fiscal 2017. This includes restructuring costs of $3.2 million, and accelerated depreciation charges of $2.2 million which were recorded in cost of goods sold. Excluding these charges, adjusted income from operations increased by less than 1% to $74.1 million and adjusted operating margin decreased by 160 basis points to 12.8%.

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 July 30, 2017 and July 31, 2016 is summarized below. The percentages are presented as a percentage of net revenue of the respective operating segments.



	Quarter Ended
	July 30, 2017		July 31, 2016		July 30, 2017		July 31, 2016
	(In thousands)				(Percentages)
Company-operated stores	$	92,609	$	80,277	22.4	%	21.0	%
Direct to consumer	40,139		32,644		35.5		37.4
Other	6,952		4,636		12.9		10.1
Segmented income from operations	139,700		117,557
General corporate expense	65,558		43,598
Restructuring and related costs	5,430		—
Income from operations	$	68,712	$	73,959

Company-Operated Stores. Income from operations from our company-operated stores segment increased $12.3 million, or 15%, to $92.6 million for the second quarter of fiscal 2017 from $80.3 million for the second quarter of fiscal 2016. The increase was primarily the result of increased gross profit of $23.5 million which was primarily due to increased net revenue from new stores, and higher gross margin. The increase in gross margin was primarily due to a favorable mix of higher margin products, lower product costs, and improved average retail prices. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses, including increased store employee costs and operating expenses associated with new stores. Income from operations as a percentage of company-operated stores net revenue increased by 140 basis points primarily due to increased gross margin, partially offset by deleverage of selling, general and administrative expenses.

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Direct to Consumer. Income from operations from our direct to consumer segment increased $7.5 million, or 23%, to $40.1 million for the second quarter of fiscal 2017 from $32.6 million for the second quarter of fiscal 2016. The increase was primarily the result of increased gross profit of $16.6 million due to increased website traffic and improved conversion rates, partially offset by a decrease in dollar value per transaction. 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 warehouse sales during the second quarter of fiscal 2016. This 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 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 by 190 basis points primarily due to deleverage of selling, general and administrative expenses, partially offset by increased gross margin.

Other. Other income from operations increased $2.3 million, or 50%, to $7.0 million for the second quarter of fiscal 2017 from $4.6 million for the second quarter of fiscal 2016. The increase was primarily the result of increased gross profit of $5.3 million which was primarily due to increased net revenue at existing outlets, an increased number of outlets and temporary locations, 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, and increased brand and community costs. Income from operations as a percentage of other net revenue increased by 280 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 increased $22.0 million, or 50%, to $65.6 million for the second quarter of fiscal 2017 from $43.6 million for the second quarter of fiscal 2016. This increase was primarily due to a global brand campaign, increases in other brand and community costs, photography costs, professional fees, depreciation, information technology costs, and head office employee costs. There was also a $6.8 million increase in net foreign exchange and derivative revaluation losses. There were net foreign exchange and derivative revaluation losses of $1.7 million in the second quarter of fiscal 2017 compared to net foreign exchange gains of $5.1 million in the second 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.

Other Income (Expense), Net

Other income, net increased $0.2 million, or 40%, to $0.8 million for the second quarter of fiscal 2017 from income of $0.6 million for the second quarter of fiscal 2016. The second quarter of fiscal 2016 included a net interest expense of $0.3 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 decreased $0.1 million, or less than 1%, to $20.8 million for the second quarter of fiscal 2017 from $20.9 million for the second quarter of fiscal 2016.

The second quarters of fiscal 2017 and fiscal 2016 included certain adjustments which resulted in net income tax recoveries of $1.4 million and $1.9 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, these tax recoveries relate to the tax effect of the costs recognized in connection with the ivivva restructuring, and to our transfer pricing arrangements and taxes on repatriation of foreign earnings.

The effective tax rate for the second quarter of fiscal 2017 was 29.9% compared to 28.1% for the second quarter of fiscal 2016. The adjusted effective tax rate was 29.6% for the second quarter of fiscal 2017 compared to 30.5% for the second quarter of fiscal 2016. The decrease in the adjusted effective tax rate compared to the second quarter of fiscal 2016 is primarily due to a decrease in the expected non-deductible stock based compensation expense for fiscal 2017, and due to certain true-ups which were recorded during the second quarter of fiscal 2017 following the finalization of the Company's Canadian tax returns.

Net Income

Net income decreased $4.9 million, or 9%, to $48.7 million for the second quarter of fiscal 2017 from $53.6 million for the second quarter of fiscal 2016. This was primarily due to an increase in selling, general and administrative expenses of $45.3 million and long-lived asset impairment and restructuring costs of $3.2 million, partially offset by an increase in gross profit of $43.3 million, an increase in other income (expense), net of $0.2 million, and a decrease in income tax expense of $0.1 million.

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First Two Quarters Results

The following table summarizes key components of our results of operations for the first two quarters ended July 30, 2017 and July 31, 2016. The percentages are presented as a percentage of net revenue.



	Two Quarters Ended
	July 30, 2017		July 31, 2016		July 30, 2017		July 31, 2016
	(In thousands)				(Percentages)
Net revenue	$	1,101,361	$	1,010,036	100.0	%	100.0	%
Cost of goods sold	547,044		516,744		49.7		51.2
Gross profit	554,317		493,292		50.3		48.8
Selling, general and administrative expenses	424,665		361,744		38.6		35.8
Asset impairment and restructuring costs	15,517		—		1.3		—
Income from operations	114,135		131,548		10.4		13.0
Other income (expense), net	1,719		92		0.1		—
Income before income tax expense	115,854		131,640		10.5		13.0
Income tax expense	35,897		32,679		3.2		3.2
Net income	$	79,957	$	98,961	7.3	%	9.8	%

Net Revenue

Net revenue increased $91.3 million, or 9%, to $1.101 billion for the first two quarters of fiscal 2017 from $1.010 billion for the first two quarters of fiscal 2016. On a constant dollar basis, assuming the average exchange rates for the first two quarters of fiscal 2017 remained constant with the average exchange rates for the first two quarters of fiscal 2016, net revenue increased $95.2 million, or 9%.

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 3% in the first two quarters of fiscal 2017 compared to the first two quarters of fiscal 2016. Total comparable sales increased 3% on a constant dollar basis.

Net revenue on a segment basis for the first two quarters ended July 30, 2017 and July 31, 2016 is summarized below. The percentages are presented as a percentage of total net revenue.



	Two Quarters Ended
	July 30, 2017		July 31, 2016		July 30, 2017		July 31, 2016
	(In thousands)				(Percentages)
Company-operated stores	$	793,043	$	740,093	72.0	%	73.3	%
Direct to consumer	210,272		184,965		19.1		18.3
Other	98,046		84,978		8.9		8.4
Net revenue	$	1,101,361	$	1,010,036	100.0	%	100.0	%

Company-Operated Stores. Net revenue from our company-operated stores segment increased $53.0 million, or 7%, to $793.0 million in the first two quarters of fiscal 2017 from $740.1 million in the first two quarters of fiscal 2016. Net revenue from company-operated stores we opened or significantly expanded subsequent to July 31, 2016, and therefore not included in comparable store sales, contributed $55.4 million to the increase. We have opened 42 net new company-operated stores since the second quarter of fiscal 2016, including 24 stores in the United States, five stores in China, four stores in Canada, three stores in the United Kingdom, two stores in South Korea, and one store in each of Hong Kong, Ireland, Japan, and New Zealand. The increase in net revenue from our company-operated stores segment was partially offset by a comparable store sales decrease of less than 1% in the first two quarters of fiscal 2017 which resulted in a $2.5 million decrease to net revenue. Comparable store sales decreased less than 1%, or $0.8 million on a constant dollar basis. The decrease in comparable store sales was primarily as a result of decreased traffic, partially offset by increased dollar value per transaction and improved conversion rates.

Direct to Consumer. Net revenue from our direct to consumer segment increased $25.3 million, or 14%, to $210.3 million in the first two quarters of fiscal 2017 from $185.0 million in the first two quarters of fiscal 2016. Direct to consumer net revenue increased 14% on a constant dollar basis. This was primarily as a result of increased website traffic, partially offset by

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lower conversion rates and a decrease in dollar value per transaction. 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 two quarters of fiscal 2016. Excluding the impact of the online warehouse sales, direct to consumer net revenue increased 7%, or increased 8% on a constant dollar basis.

Other. Net revenue from our other segment increased $13.1 million, or 15%, to $98.0 million in the first two quarters of fiscal 2017 from $85.0 million in the first two quarters of fiscal 2016. This increase was primarily the result of increased net revenue at existing outlets, and an increased number of temporary locations and outlets open during the first two quarters of fiscal 2017 compared to the first two quarters of fiscal 2016. The increase in net revenue from outlets and temporary locations was partially offset by a lower net revenue from showrooms, primarily due a decreased number of showrooms open during the first two quarters of fiscal 2017 compared to the first two quarters of fiscal 2016.

Gross Profit

Gross profit increased $61.0 million, or 12%, to $554.3 million for the first two quarters of fiscal 2017 from $493.3 million for the first two quarters of fiscal 2016. Gross profit as a percentage of net revenue, or gross margin, was 50.3% in the first two quarters of fiscal 2017 compared to 48.8% in the first two quarters of fiscal 2016.

Gross margin increased by 150 basis points, to 50.3% in the first two quarters of fiscal 2017 from 48.8% in the first two quarters of fiscal 2016. The increase in gross margin was primarily the result of an increase in product margin of 320 basis points which was primarily due to a favorable mix of higher margin product and lower product costs, partially offset by higher markdowns.

This was partially offset by costs incurred in connection with the restructuring of our ivivva operations of 70 basis points, an increase in occupancy and depreciation costs of 50 basis points, and an increase in costs related to our product and supply chain departments of 50 basis points.

During the first two quarters of fiscal 2017, as a result of the restructuring of our ivivva operations, we recognized costs totaling $7.7 million within costs of goods sold, as outlined in Note 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 14% to $562.0 million and adjusted gross margin increased 220 basis points to 51.0% compared to the first two quarters of fiscal 2016.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $62.9 million, or 17%, to $424.7 million in the first two quarters of fiscal 2017 from $361.7 million in the first two 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 $38.0 million, comprised of:


–	an increase in employee costs of $19.2 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 $3.1 million, primarily due to an increase in credit card fees and distribution costs, partially offset by a decrease in total packaging costs; and


–	an increase in other costs of $15.7 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 $37.5 million, comprised of:


–	an increase in employee costs of $11.3 million primarily due to additional employees to support the growth in our business; and


–	an increase in other costs of $26.2 million primarily due to a global brand campaign, increases in other brand and community costs, professional fees, information technology related costs, and depreciation.

The increase in selling, general and administrative expenses was partially offset by an increase in net foreign exchange and derivative revaluation gains of $12.6 million. There were net foreign exchange and derivative revaluation gains of $4.1 million in the first two quarters of fiscal 2017 compared to net foreign exchange revaluation losses of $8.5 million in the first two 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. During the second quarter of fiscal 2017 we entered into certain forward currency contracts designed to hedge against changes in the Canadian dollar to U.S. dollar exchange rate. See Note 5 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report.

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As a percentage of net revenue, selling, general and administrative expenses increased 280 basis points, to 38.6% in the first two quarters of fiscal 2017 from 35.8% in the first two 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 $15.5 million in the first two quarters of fiscal 2017. This includes long-lived asset impairment charges of $11.6 million, employee related costs of $3.2 million, and lease termination and other restructuring costs of $0.7 million. We did not have asset impairment and restructuring costs in the first two 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 decreased $17.4 million, or 13%, to $114.1 million in the first two quarters of fiscal 2017 from $131.5 million in the first two quarters of fiscal 2016. Operating margin decreased 260 basis points to 10.4% compared to 13.0% in the first two quarters of fiscal 2016.

In connection with the restructuring of our ivivva operations, we recognized pre-tax costs totaling $23.2 million in the first two quarters of fiscal 2017. This includes long-lived asset impairment and restructuring costs of $15.5 million, inventory write downs of $2.9 million, anticipated losses related to firm inventory purchase commitments of $2.5 million, and accelerated depreciation charges of $2.2 million. Excluding these charges, adjusted income from operations increased by 4% to $137.3 million and adjusted operating margin decreased by 50 basis points to 12.5%.

Segmented income from operations for the first two quarters ended July 30, 2017 and July 31, 2016 is summarized below. The percentages are presented as a percentage of net revenue of the respective operating segments.



	Two Quarters Ended
	July 30, 2017		July 31, 2016		July 30, 2017		July 31, 2016
	(In thousands)				(Percentages)
Company-operated stores	$	170,139	$	153,564	21.5	%	20.7	%
Direct to consumer	75,566		71,152		35.9		38.5
Other	9,760		6,720		10.0		7.9
Segmented income from operations	255,465		231,436
General corporate expense	118,150		99,888
Restructuring and related costs	23,180		—
Income from operations	$	114,135	$	131,548

Company-Operated Stores. Income from operations from our company-operated stores segment increased $16.6 million, or 11%, to $170.1 million for the first two quarters of fiscal 2017 from $153.6 million for the first two quarters of fiscal 2016. The increase was primarily the result of increased gross profit of $40.8 million which was primarily due to increased net revenue from new stores and higher gross margin. The increase in gross margin was primarily due to a favorable mix of higher margin product, lower product costs, and improved average retail prices. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses, including increased store employee costs and increased operating expenses associated with new stores. Income from operations as a percentage of company-operated stores net revenue increased by 80 basis points. The increase in gross margin was partially offset by deleverage of selling, general and administrative expenses.

Direct to Consumer. Income from operations from our direct to consumer segment increased $4.4 million, or 6%, to $75.6 million for the first two quarters of fiscal 2017 from $71.2 million for the first two quarters of fiscal 2016. The increase was primarily the result of increased gross profit of $19.3 million as a result of increased net revenue and higher gross margin. Direct to consumer net revenue increased due to increased website traffic, partially offset by lower conversion rates and a decrease in dollar value per transaction. 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 two quarters of fiscal 2016. 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 distribution and credit card fees as a result of higher net revenue. Income from operations as a percentage of direct to consumer net revenue d

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ecreased by 260 basis points primarily due to deleverage of selling, general and administrative expenses, partially offset by increased gross margin.

Other. Other income from operations increased $3.0 million, or 45%, to $9.8 million for the first two quarters of fiscal 2017 from $6.7 million for the first two quarters of fiscal 2016. The increase was primarily the result of increased gross profit of $8.6 million which was primarily due to increased net revenue at existing outlets, an increased number of outlets and temporary locations, 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, and increased operating expenses associated with new locations and higher net revenues. Income from operations as a percentage of other net revenue increased by 210 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 increased $18.3 million, or 18%, to $118.2 million for the first two quarters of fiscal 2017 from $99.9 million for the first two 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, information technology related costs, and depreciation. These increases were partially offset by an increase in net foreign exchange and derivative revaluation gains of $12.6 million. There were net foreign exchange and derivative revaluation gains of $4.1 million in the first two quarters of fiscal 2017 compared to net foreign exchange losses of $8.5 million in the first two 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.

Other Income (Expense), Net

Other income, net increased $1.6 million to $1.7 million for the first two quarters of fiscal 2017 from income of $0.1 million for the first two quarters of fiscal 2016. The increase was primarily due to net interest expense of $1.5 million which was recorded in the first two 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 $3.2 million, or 10%, to $35.9 million for the first two quarters of fiscal 2017 from $32.7 million for the first two quarters of fiscal 2016.

The first two quarters of fiscal 2017 and fiscal 2016 included certain tax adjustments which resulted in net income tax recoveries of $6.1 million and $7.6 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 two quarters of fiscal 2017 relates to the tax effect of the costs recognized in connection with the ivivva restructuring, the tax recovery recognized in the first two quarters of fiscal 2016 relates to our transfer pricing arrangements and taxes on repatriation of foreign earnings.

The effective tax rate for the first two quarters of fiscal 2017 was 31.0% compared to 24.8% for the first two quarters of fiscal 2016. The adjusted effective tax rate was 30.2% for the first two quarters of fiscal 2017 compared to 30.2% for the first two quarters of fiscal 2016.

Net Income

Net income decreased $19.0 million, or 19%, to $80.0 million for the first two quarters of fiscal 2017 from $99.0 million for the first two quarters of fiscal 2016. This was primarily due to an increase in selling, general and administrative expenses of $62.9 million, long-lived asset impairment and restructuring costs of $15.5 million, and an increase in income tax expense of $3.2 million, partially offset by an increase in gross profit of $61.0 million, and an increase in other income (expense), net of $1.6 million.

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, wholesale accounts, temporary locations, warehouse sales, license and supply arrangements, and sales from company-operated stores that we have closed.

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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, direct to consumer net revenue, and direct to consumer net revenue excluding the online warehouse sale, 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, direct to consumer net revenue, and direct to consumer net revenue excluding the online warehouse sale 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, direct to consumer net revenue, and direct to consumer net revenue excluding the online warehouse sale show the change compared to the corresponding period in the prior year.

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Constant dollar changes in net revenue, total comparable sales, comparable store sales, direct to consumer net revenue, and direct to consumer net revenue excluding the online warehouse sale



	Quarter Ended July 30, 2017				Two Quarters Ended July 30, 2017
	(In thousands)		(Percentages)		(In thousands)		(Percentages)
Change in net revenue	$	66,534	13	%	$	91,325	9	%
Adjustments due to foreign exchange rate changes	2,351		—		3,831		—
Change in net revenue in constant dollars	$	68,885	13	%	$	95,156	9	%



	Quarter Ended July 30, 2017				Two Quarters Ended July 30, 2017
	(In thousands)		(Percentages)		(In thousands)			(Percentages)
Change in comparable store sales²	$	3,689	2	%	$	(2,482	)	—	%
Adjustments due to foreign exchange rate changes	1,168		—		1,694			—
Change in comparable store sales in constant dollars²	$	4,857	2	%	$	(788	)	—	%



	Quarter Ended July 30, 2017		Two Quarters Ended July 30, 2017
	(Percentages)
Change in direct to consumer net revenue	29	%	14	%
Adjustments due to foreign exchange rate changes	1		—
Change in direct to consumer net revenue in constant dollars	30	%	14	%



	Quarter Ended July 30, 2017		Two Quarters Ended July 30, 2017
	(Percentages)
Change in direct to consumer net revenue excluding the online warehouse sale	15	%	7	%
Adjustments due to foreign exchange rate changes	1		1
Change in direct to consumer net revenue excluding the online warehouse sale in constant dollars	16	%	8	%

__________

¹Total comparable sales includes comparable store sales and direct to consumer sales.

²Comparable store sales reflects 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.

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Adjusted financial measures

The following tables reconcile adjusted financial measures with the most directly comparable measures calculated in accordance with GAAP. The amounts are in thousands, except for the per share amounts.



	Quarter Ended July 30, 2017									Quarter Ended July 31, 2016
	GAAP Results			Adjustments			Adjusted Results (Non-GAAP)			GAAP Results			Adjustments			Adjusted Results (Non-GAAP)
Gross profit¹	$	297,422		$	2,244		$	299,666		$	254,161		$	—		$	254,161
Gross margin¹	51.2		%	0.4		%	51.6		%	49.4		%	—		%	49.4		%
Income from operations^1,2	68,712			5,430			74,142			73,959			—			73,959
Operating margin^1,2	11.8		%	1.0		%	12.8		%	14.4		%	—		%	14.4		%
Income before income tax expense^1,2,3	69,524			5,430			74,954			74,537			270			74,807
Income tax expense^3,4	20,813			1,390			22,203			20,912			1,926			22,838
Effective tax rate^3,4	29.9		%	(0.3		)%	29.6		%	28.1		%	2.4		%	30.5		%
Diluted earnings per share^1,2,3,4	$	0.36		$	0.03		$	0.39		$	0.39		$	(0.01	)	$	0.38



	Two Quarters Ended July 30, 2017						Two Quarters Ended July 31, 2016
	GAAP Results		Adjustments		Adjusted Results (Non-GAAP)		GAAP Results	Adjustments	Adjusted Results (Non-GAAP)
Gross profit¹	$	554,317	$	7,663	$	561,980