Edgar Filing: lululemon athletica inc.

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 29, 2018



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

For the transition period from to

Commission file number 001-33608

lululemon athletica inc.

(Exact name of registrant as specified in its charter)



Delaware	20-3842867
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

1818 Cornwall Avenue Vancouver, British Columbia	V6J 1C7
(Address of principal executive offices)	(Zip Code)

Registrant's telephone number, including area code:

604-732-6124

Former name, former address and former fiscal year, if changed since last report:

N/A

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (of for such shorter period that the registrant was required to submit and post such files). Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	þ	Accelerated filer	o
Non-accelerated filer	o (Do not check if a smaller reporting company)	Smaller reporting company	o
Emerging growth company	o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

At August 27, 2018, there were 122,594,553 shares of the registrant's common stock, par value $0.005 per share, outstanding.

Exchangeable and Special Voting Shares:

At August 27, 2018, there were outstanding 9,776,421 exchangeable shares of Lulu Canadian Holding, Inc., a wholly-owned subsidiary of the registrant. Exchangeable shares are exchangeable for an equal number of shares of the registrant's common stock.

In addition, at August 27, 2018, the registrant had outstanding 9,776,421 shares of special voting stock, through which the holders of exchangeable shares of Lulu Canadian Holding, Inc. may exercise their voting rights with respect to the registrant. The special voting stock and the registrant's common stock generally vote together as a single class on all matters on which the common stock is entitled to vote.

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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	20
Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	36
Item 4.	CONTROLS AND PROCEDURES	38

PART II. OTHER INFORMATION

Item 1.	LEGAL PROCEEDINGS	39
Item 1A.	RISK FACTORS	39
Item 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	48
Item 6.	EXHIBITS	49

SIGNATURES		50

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PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

lululemon athletica inc.

CONSOLIDATED BALANCE SHEETS

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



	July 29, 2018			January 28, 2018
ASSETS
Current assets
Cash and cash equivalents	$	777,841		$	990,501
Accounts receivable	23,535			19,173
Inventories	392,672			329,562
Prepaid and receivable income taxes	62,203			48,948
Other prepaid expenses and other current assets	51,786			48,098
	1,308,037			1,436,282
Property and equipment, net	487,546			473,642
Goodwill and intangible assets, net	24,255			24,679
Deferred income tax assets	28,345			32,491
Other non-current assets	32,974			31,389
	$	1,881,157		$	1,998,483
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable	$	110,523		$	24,646
Accrued inventory liabilities	12,597			13,027
Accrued compensation and related expenses	62,794			70,141
Current income taxes payable	3,021			15,700
Unredeemed gift card liability	64,420			82,668
Revolving credit facility	100,000			—
Other current liabilities	95,806			86,416
	449,161			292,598
Non-current income taxes payable	44,078			48,268
Deferred income tax liabilities	1,582			1,336
Other non-current liabilities	66,121			59,321
	560,942			401,523
Stockholders' equity
Undesignated preferred stock, $0.01 par value: 5,000 shares authorized; none issued and outstanding	—			—
Exchangeable stock, no par value: 60,000 shares authorized; 9,776 and 9,781 issued and outstanding	—			—
Special voting stock, $0.000005 par value: 60,000 shares authorized; 9,776 and 9,781 issued and outstanding	—			—
Common stock, $0.005 par value: 400,000 shares authorized; 122,656 and 125,650 issued and outstanding	613			628
Additional paid-in capital	299,702			284,253
Retained earnings	1,224,044			1,455,002
Accumulated other comprehensive loss	(204,144		)	(142,923		)
	1,320,215			1,596,960
	$	1,881,157		$	1,998,483

See accompanying notes to the unaudited interim consolidated financial statements

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lululemon athletica inc.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

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



	Quarter Ended					Two Quarters Ended
	July 29, 2018			July 30, 2017		July 29, 2018			July 30, 2017
Net revenue	$	723,500		$	581,054	$	1,373,206		$	1,101,361
Cost of goods sold	327,306			283,632		632,279			547,044
Gross profit	396,194			297,422		740,927			554,317
Selling, general and administrative expenses	261,986			225,524		502,414			424,665
Asset impairment and restructuring costs	—			3,186		—			15,517
Income from operations	134,208			68,712		238,513			114,135
Other income (expense), net	1,591			812		4,509			1,719
Income before income tax expense	135,799			69,524		243,022			115,854
Income tax expense	40,029			20,813		72,099			35,897
Net income	$	95,770		$	48,711	$	170,923		$	79,957

Other comprehensive (loss) income:
Foreign currency translation adjustment	(18,249		)	72,854		(61,221		)	41,079
Comprehensive income	$	77,521		$	121,565	$	109,702		$	121,036

Basic earnings per share	$	0.71		$	0.36	$	1.27		$	0.59
Diluted earnings per share	$	0.71		$	0.36	$	1.26		$	0.58
Basic weighted-average number of shares outstanding	133,986			136,171		134,744			136,604
Diluted weighted-average number of shares outstanding	134,530			136,303		135,230			136,747

See accompanying notes to the unaudited interim consolidated financial statements

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lululemon athletica inc.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Unaudited; Amounts in thousands)



	Exchangeable Stock		Special Voting Stock				Common Stock					Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total
	Shares		Shares		Par Value		Shares		Par Value			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total
Balance at January 28, 2018	9,781		9,781		$	—	125,650		$	628		$	284,253		$	1,455,002		$	(142,923	)	$	1,596,960
Net income															170,923						170,923
Foreign currency translation adjustment																		(61,221		)	(61,221		)
Common stock issued upon exchange of exchangeable shares	(5	)	(5	)	—		5		—			—									—
Stock-based compensation expense												13,048									13,048
Common stock issued upon settlement of stock-based compensation							437		2			13,750									13,752
Shares withheld related to net share settlement of stock-based compensation							(81	)	—			(7,001		)							(7,001		)
Repurchase of common stock							(3,355	)	(17		)	(4,348		)	(401,881		)				(406,246		)
Balance at July 29, 2018	9,776		9,776		$	—	122,656		$	613		$	299,702		$	1,224,044		$	(204,144	)	$	1,320,215

See accompanying notes to the unaudited interim consolidated financial statements

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lululemon athletica inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; Amounts in thousands)



	Two Quarters Ended
	July 29, 2018			July 30, 2017
Cash flows from operating activities
Net income	$	170,923		$	79,957
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	55,429			51,569
Deferred income taxes	2,464			(12,746		)
Stock-based compensation expense	13,048			8,710
Asset impairment for ivivva restructuring	—			11,593
Settlement of derivatives not designated in a hedging relationship	(1,807		)	—
Changes in operating assets and liabilities:
Inventories	(73,065		)	(10,041		)
Prepaid and receivable income taxes	(13,255		)	15,029
Other prepaid expenses and other current and non-current assets	(7,724		)	(20,376		)
Accounts payable	86,885			(6,784		)
Accrued inventory liabilities	615			9,571
Accrued compensation and related expenses	(4,926		)	(8,970		)
Current income taxes payable	(11,828		)	(25,310		)
Unredeemed gift card liability	(17,043		)	(15,192		)
Non-current income taxes payable	(4,190		)	—
Other current and non-current liabilities	14,500			25,028
Net cash provided by operating activities	210,026			102,038
Cash flows from investing activities
Purchase of property and equipment	(84,007		)	(49,889		)
Settlement of net investment hedges	(4,514		)	—
Other investing activities	(771		)	—
Net cash used in investing activities	(89,292		)	(49,889		)
Cash flows from financing activities
Proceeds from settlement of stock-based compensation	13,752			915
Taxes paid related to net share settlement of stock-based compensation	(7,001		)	(2,024		)
Repurchase of common stock	(406,246		)	(90,801		)
Net increase in revolving credit facility	100,000			—
Other financing activities	(744		)	—
Net cash used in financing activities	(300,239		)	(91,910		)
Effect of exchange rate changes on cash and cash equivalents	(33,155		)	26,127
Decrease in cash and cash equivalents	(212,660		)	(13,634		)
Cash and cash equivalents, beginning of period	$	990,501		$	734,846
Cash and cash equivalents, end of period	$	777,841		$	721,212

See accompanying notes to the unaudited interim consolidated financial statements

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lululemon athletica inc.

INDEX FOR NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL

STATEMENTS



Note 1	Nature of Operations and Basis of Presentation	8
Note 2	Recent Accounting Pronouncements	8
Note 3	Credit Facility	10
Note 4	Stock-Based Compensation and Benefit Plans	10
Note 5	Fair Value Measurement	12
Note 6	Derivative Financial Instruments	13
Note 7	Asset Impairment and Restructuring	15
Note 8	Income Taxes	16
Note 9	Earnings Per Share	17
Note 10	Supplementary Financial Information	17
Note 11	Segment Reporting	19
Note 12	Legal Proceedings	20
Note 13	Subsequent Event	20

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lululemon athletica inc.

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL

STATEMENTS

NOTE 1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION

Nature of operations

lululemon athletica inc., a Delaware corporation ("lululemon" and, together with its subsidiaries unless the context otherwise requires, the "Company") is engaged in the design, distribution, and retail of healthy lifestyle inspired athletic apparel. The Company primarily conducts its business through company-operated stores and direct to consumer through e-commerce. It also generates net revenue from outlets, sales from temporary locations, sales to wholesale accounts, showrooms, warehouse sales, and license and supply arrangements. The Company operates stores in the United States, Canada, Australia, China, the United Kingdom, New Zealand, Germany, Japan, South Korea, Singapore, Ireland, Sweden, and Switzerland. There were 415 and 404 company-operated stores in operation as of July 29, 2018 and January 28, 2018, respectively.

Basis of presentation

The unaudited interim consolidated financial statements as of July 29, 2018 and for the quarters and two quarters ended July 29, 2018 and July 30, 2017 are presented in United States dollars and have been prepared by the Company under the rules and regulations of the Securities and Exchange Commission ("SEC"). The financial information is presented in accordance with United States generally accepted accounting principles ("GAAP") for interim financial information and, accordingly, does not include all of the information and footnotes required by GAAP for complete financial statements. The financial information as of January 28, 2018 is derived from the Company's audited consolidated financial statements and related notes for the fiscal year ended January 28, 2018, which are included in Item 8 in the Company's fiscal 2017 Annual Report on Form 10-K filed with the SEC on March 27, 2018. These unaudited interim consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented. These unaudited interim consolidated financial statements should be read in conjunction with the Company's consolidated financial statements and related notes included in Item 8 in the Company's fiscal 2017 Annual Report on Form 10-K.

The Company's fiscal year ends on the Sunday closest to January 31 of the following year, typically resulting in a 52-week year, but occasionally giving rise to an additional week, resulting in a 53-week year. Fiscal 2018 will end on February 3, 2019 and will be a 53-week year.

The Company's business is affected by the pattern of seasonality common to most retail apparel businesses. Historically, the Company has recognized a significant portion of its operating profit in the fourth fiscal quarter of each year as a result of increased net revenue during the holiday season.

Certain comparative figures have been reclassified to conform to the financial presentation adopted for the current year.

NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS

Recently adopted accounting pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers ("ASC 606") which supersedes the revenue recognition requirements in ASC 605 Revenue Recognition. This ASU requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

The Company adopted ASC 606 on January 29, 2018 on a modified retrospective basis. There were no changes to the consolidated statement of operations as a result of the adoption, and the timing and amount of its revenue recognition remained substantially unchanged under this new guidance. Under the provisions of ASC 606, the Company is now required to present its provision for sales returns on a gross basis, rather than a net basis. The Company's liability for sales return refunds is recognized within other current liabilities, and the Company now presents an asset for the value of inventory which is expected to be returned within other current assets on the consolidated balance sheets. Under the modified retrospective approach, the comparative prior period information has not been restated for this change.

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The effect of adoption of ASC 606 on the Company's consolidated balance sheet as of July 29, 2018 was as follows:



	July 29, 2018
	As Reported		Adjustment for ASC 606			Balances Without Adoption of ASC 606
	(In thousands)
Other prepaid expenses and other current assets	$	51,786	$	(2,751	)	$	49,035
Current assets	1,308,037		(2,751		)	1,305,286
Total assets	1,881,157		(2,751		)	1,878,406

Other current liabilities	95,806		2,751			98,557
Current liabilities	449,161		2,751			451,912
Total liabilities	560,942		2,751			563,693

In May 2017, the FASB amended ASC 718, Stock Compensation, to reduce diversity in practice and to clarify when a change to the terms or conditions of a share-based payment award must be accounted for as a modification and will result in fewer changes to the terms of an award being accounted for as modifications. The new guidance was effective beginning in the first quarter of fiscal 2018 and will apply on a prospective basis. The Company does not expect it to have a material impact on its consolidated financial statements.

Accounting policies as a result of recently adopted accounting pronouncements

Revenue recognition

Net revenue is comprised of company-operated store net revenue, direct to consumer net revenue through websites and mobile apps, including mobile apps on in-store devices that allow demand to be fulfilled via the Company's distribution centers, and other net revenue, which includes revenue from outlets, temporary locations, sales to wholesale accounts, showrooms, warehouse sales, and license and supply arrangement net revenue, which consists of royalties as well as sales of the Company's products to licensees. All revenue is reported net of sales taxes collected from customers on behalf of taxing authorities.

Revenue is recognized when performance obligations are satisfied through the transfer of control of promised goods to the Company's customers. Control transfers once a customer has the ability to direct the use of, and obtain substantially all of the benefits from, the product. This includes the transfer of legal title, physical possession, the risks and rewards of ownership, and customer acceptance. Revenue from company-operated stores and other retail locations is recognized at the point of sale. Direct to consumer revenue and sales to wholesale accounts are recognized upon receipt by the customer.

Revenue is presented net of an allowance for estimated returns, which is based on historic experience. The Company's liability for sales return refunds is recognized within other current liabilities, and an asset for the value of inventory which is expected to be returned is recognized within other prepaid expenses and other current assets on the consolidated balance sheets.

Shipping fees billed to customers are recorded as revenue, and shipping costs are recognized within selling, general and administrative expenses in the same period the related revenue is recognized.

Proceeds from the sale of gift cards are initially deferred and recognized within unredeemed gift card liability on the consolidated balance sheets, and are recognized as revenue when tendered for payment. Based on historical experience, and to the extent there is no requirement to remit unclaimed card balances to government agencies, an estimate of the gift card balances that will never be redeemed is recognized as revenue in proportion to gift cards which have been redeemed.

Recently issued accounting pronouncements

In February 2016, the FASB issued ASC 842, Leases ("ASC 842") to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. Under the new guidance, lessees are required to recognize a lease liability, which represents the discounted obligation to make future minimum lease payments, and a corresponding right-of-use asset on the balance sheet for most leases. This guidance will be effective for the Company beginning in its first quarter of fiscal 2019, with early application permitted. The Company will adopt ASC 842 in its first quarter of fiscal 2019. The new guidance can be applied using either a modified retrospective approach at the beginning of the earliest period presented, or at the beginning of the period in which it is adopted, rather than at the beginning of the earliest comparative period presented. The Company is continuing to evaluate the method of adoption.

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The Company expects to apply the transition package of three practical expedients which allow companies not to reassess whether agreements contain leases, the classification of leases, and the capitalization of initial direct costs. The Company expects to make an accounting policy election to recognize lease expense for leases with a term of 12 months or less on a straight-line basis over the lease term and recognize no right of use asset or lease liability for those leases.

The Company is in the process of implementing new lease accounting software and continues to evaluate the impact this standard will have on its consolidated financial statements, disclosures, and internal controls. It is expected that the primary financial statement impact upon adoption will be the recognition, on a discounted basis, of the Company's minimum commitments under noncancelable operating leases as right of use assets and obligations on the consolidated balance sheets. It is expected that this will result in a significant increase in assets and liabilities on the consolidated balance sheets.

In August 2017, the FASB amended ASC 815, Derivatives and Hedging to more closely align hedge accounting with companies' risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. It will make more financial and nonfinancial hedging strategies eligible for hedge accounting. It also amends the presentation and disclosure requirements and changes how companies assess effectiveness. This guidance will be effective for the Company beginning in its first quarter of fiscal 2019, with early application permitted. The Company is currently evaluating the impact that this new guidance may have on its consolidated financial statements.

In January 2018, the FASB released guidance on the accounting for the global intangible low-taxed income ("GILTI") provisions of the tax bill H.R.1, commonly known as the U.S. Tax Cuts and Jobs Act ("U.S. tax reform"). The GILTI provisions impose a tax on foreign subsidiary earnings in excess of a deemed return on the foreign subsidiary's tangible assets. The guidance indicates that an accounting policy election can be made to treat the GILTI tax as either a current tax in the period in which it is incurred or as a deferred tax. The Company has not yet made its accounting policy election but will do so during the one-year measurement period as allowed by the SEC. In accordance with the FASB guidance, until an accounting policy election is made, any taxes related to the GILTI provisions will be treated as a current income tax expense in the period incurred.

In February 2018, the FASB amended ASC 220, Income Statement—Reporting Comprehensive Income. ASC 740, Income Taxes, requires that the effect of a change in tax laws or rates on deferred tax assets and liabilities be included in income from continuing operations. In situations in which the tax effects of a transaction were initially recognized directly in other comprehensive income, this results in "stranded" amounts in accumulated other comprehensive income related to the income tax rate differential. The amendments to ASC 220 allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the enactment of the U.S. tax reform. The guidance in the ASU is effective for the Company beginning in its first quarter of fiscal 2019 with early adoption permitted. The Company does not expect to elect to reclassify "stranded" amounts from accumulated other comprehensive income to retained earnings.

NOTE 3. CREDIT FACILITY

On June 6, 2018, the Company entered into Amendment No. 1 to its credit agreement. This amends the credit agreement to provide for (i) an increase in the aggregate commitments under the unsecured five-year revolving credit facility to $400.0 million, with an increase of the sub-limits for the issuance of letters of credit and extensions of swing line loans to $50.0 million for each, (ii) an increase in the option, subject to certain conditions as set forth in the credit agreement, to request increases in commitments under the revolving facility from $400.0 million to $600.0 million, and (iii) an extension in the maturity of the revolving facility from December 15, 2021 to June 6, 2023.

In addition, this amendment decreases the applicable margins for LIBOR loans from 1.00%-1.75% to 1.00%-1.50% and for alternate base rate loans from 0.00%-0.75% to 0.00%-0.50%, reduces the commitment fee on average daily unused amounts under the revolving facility from 0.125%-0.200% to 0.10%-0.20%, and reduces fees for unused letters of credit from 1.00%-1.75% to 1.00%-1.50%.

As of July 29, 2018, the Company had borrowings of $100.0 million outstanding under this credit facility, as well as letters of credit of $1.3 million. The weighted-average interest rate on funds borrowed as of July 29, 2018 was 3.32%. The Company had no borrowings outstanding under this credit facility as of January 28, 2018.

NOTE 4. STOCK-BASED COMPENSATION AND BENEFIT PLANS

Stock-based compensation plans

The Company's eligible employees participate in various stock-based compensation plans, which are provided by the Company directly.

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Stock-based compensation expense charged to income for the plans was $13.0 million and $8.7 million for the two quarters ended July 29, 2018 and July 30, 2017, respectively. Total unrecognized compensation cost for all stock-based compensation plans was $59.2 million at July 29, 2018, which is expected to be recognized over a weighted-average period of 2.3 years.

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

A summary of the Company's stock option, performance-based restricted stock unit, restricted share, and restricted stock unit activity as of July 29, 2018, and changes during the first two quarters then ended, is presented below:



	Stock Options			Performance-Based Restricted Stock Units			Restricted Shares			Restricted Stock Units
	Number	Weighted-Average Exercise Price		Number	Weighted-Average Grant Date Fair Value		Number	Weighted-Average Grant Date Fair Value		Number	Weighted-Average Grant Date Fair Value
	(In thousands, except per share amounts)
Balance at January 28, 2018	1,117	$	56.44	329	$	60.42	21	$	52.45	427	$	57.54
Granted	308	86.99		85	87.19		6	124.19		248	87.18
Exercised/released	245	56.20		39	63.04		21	52.45		145	59.37
Forfeited/expired	277	58.49		127	61.35		—	—		40	64.58
Balance at July 29, 2018	903	$	66.31	248	$	68.72	6	$	124.19	490	$	71.45
Exercisable at July 29, 2018	186	$	56.47

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



	Two Quarters Ended July 29, 2018
Expected term	3.75 years
Expected volatility	36.88	%
Risk-free interest rate	2.46	%
Dividend yield	—	%

The Company's performance-based restricted stock units are awarded to eligible employees and entitle the grantee to receive a maximum of two shares of common stock per performance-based restricted stock unit if the Company achieves specified performance goals and the grantee remains employed during the vesting period. The fair value of performance-based restricted stock units is based on the closing price of the Company's common stock on the award date. Expense for performance-based restricted stock units is recognized when it is probable that the performance goal will be achieved.

The fair value of the restricted shares and restricted stock units is based on the closing price of the Company's common stock on the award date.

Employee share purchase plan

The Company's board of directors and stockholders approved the Company's Employee Share Purchase Plan ("ESPP") in September 2007. Contributions are made by eligible employees, subject to certain limits defined in the ESPP, and the Company matches one-third of the contribution. The maximum number of shares authorized to be purchased under the ESPP is 6.0 million shares. All shares purchased under the ESPP are purchased in the open market. During the quarter ended July 29, 2018, there were 23.8 thousand shares purchased.

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Defined contribution pension plans

During the second quarter of fiscal 2016, the Company began offering defined contribution pension plans to its eligible employees in Canada and the United States. Participating employees may elect to defer and contribute a portion of their eligible compensation to a plan up to limits stated in the plan documents, not to exceed the dollar amounts set by applicable laws. The Company matches 50% to 75% of the contribution depending on the participant's length of service, and the contribution is subject to a two year vesting period. The Company's net expense for the defined contribution plans was $3.1 million and $2.7 million in the first two quarters of fiscal 2018 and fiscal 2017, respectively.

NOTE 5. FAIR VALUE MEASUREMENT

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are made using a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value:


•	Level 1 - defined as observable inputs such as quoted prices in active markets;


•	Level 2 - defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and


•	Level 3 - defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

Assets and liabilities measured at fair value on a recurring basis

The fair value measurement is categorized in its entirety by reference to its lowest level of significant input. As of July 29, 2018 and January 28, 2018, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis:



	July 29, 2018		Level 1		Level 2		Level 3		Balance Sheet Classification
	(In thousands)
Money market funds	$	143,478	$	143,478	$	—	$	—	Cash and cash equivalents
Term deposits	337,818		—		337,818		—		Cash and cash equivalents
Net forward currency contract assets	3,254		—		3,254		—		Other prepaid expenses and other current assets
Net forward currency contract liabilities	5,891		—		5,891		—		Other current liabilities



	January 28, 2018		Level 1		Level 2		Level 3		Balance Sheet Classification
	(In thousands)
Term deposits	$	258,238	$	—	$	258,238	$	—	Cash and cash equivalents
Net forward currency contract assets	7,889		—		7,889		—		Other prepaid expenses and other current assets
Net forward currency contract liabilities	8,771		—		8,771		—		Other current liabilities

The Company records accounts receivable, accounts payable, accrued liabilities, and borrowings under the revolving credit facility at cost. The carrying values of these instruments approximate their fair value due to their short-term maturities.

The Company has short-term, highly liquid investments classified as cash equivalents, which are invested in money market funds, Treasury bills, and term deposits. The Company records cash equivalents at their original purchase prices plus interest that has accrued at the stated rate.

The fair values of the forward currency contract assets and liabilities are determined using observable Level 2 inputs, including foreign currency spot exchange rates, forward pricing curves, and interest rates. The fair values consider the credit risk of the Company and its counterparties. They are presented at their gross fair values. However, the Company's Master International Swap Dealers Association, Inc., Agreements and other similar arrangements allow net settlements under certain conditions.

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Assets and liabilities measured at fair value on a non-recurring basis

In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company has impaired certain long-lived assets and recorded them at their estimated fair value on a non-recurring basis. The fair value of these long-lived assets was determined using Level 3 inputs, principally the present value of the estimated future cash flows expected from their use and eventual disposition. Please refer to Note 7 of these unaudited interim consolidated financial statements for further details regarding the impairment of long-lived assets as a result of the ivivva restructuring.

The Company has also recorded certain lease termination liabilities at fair value on a non-recurring basis, determined using Level 3 inputs based on remaining lease rentals and reduced by estimated sublease income. As of July 29, 2018 and January 28, 2018, the Company had lease termination liabilities of $3.2 million and $6.4 million, respectively. This was primarily as a result of the ivivva restructuring.

NOTE 6. DERIVATIVE FINANCIAL INSTRUMENTS

Foreign exchange risk

The Company is exposed to risks associated with changes in foreign currency exchange rates and uses derivative financial instruments to manage its exposure to certain of these foreign currency exchange rate risks. The Company does not enter into derivative contracts for speculative or trading purposes.

The Company currently hedges against changes in the Canadian dollar to U.S. dollar exchange rate using forward currency contracts.

Net investment hedges

The Company is exposed to foreign exchange gains and losses which arise on translation of its foreign subsidiaries' balance sheets into U.S. dollars. These gains and losses are recorded as a foreign currency translation adjustment in accumulated other comprehensive income or loss within stockholders' equity.

The Company holds a significant portion of its assets in Canada and enters into forward currency contracts designed to hedge a portion of the foreign currency exposure that arises on translation of a Canadian subsidiary into U.S. dollars. These forward currency contracts are designated as net investment hedges. The effective portions of the hedges are reported in accumulated other comprehensive income or loss and will subsequently be reclassified to net earnings in the period in which the hedged investment is either sold or substantially liquidated. Hedge effectiveness is measured using a method based on changes in forward exchange rates. The Company recorded no ineffectiveness from net investment hedges during the first two quarters of fiscal 2018.

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

Derivatives not designated as hedging instruments

The Company is exposed to gains and losses arising from changes in foreign exchange rates associated with transactions which are undertaken by its subsidiaries in currencies other than their functional currency. Such transactions include intercompany transactions and inventory purchases. These transactions result in the recognition of certain foreign currency denominated monetary assets and liabilities which are remeasured to the quarter-end or settlement date exchange rate. The resulting foreign currency gains and losses are recorded in selling, general and administrative expenses.

During the first two quarters of fiscal 2018, the Company entered into certain forward currency contracts designed to economically hedge the foreign exchange revaluation gains and losses that are recognized by its Canadian subsidiaries on U.S. dollar denominated monetary assets and liabilities. The Company has not applied hedge accounting to these instruments and the change in fair value of these derivatives is recorded within selling, general and administrative expenses.

The Company classifies the cash flows at settlement of its forward currency contracts which are not designated in hedging relationships within operating activities in the consolidated statements of cash flows.

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Outstanding notional amounts

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



	July 29, 2018		July 30, 2017
	(In thousands)
Derivatives designated as net investment hedges	$	339,000	$	78,000
Derivatives not designated in a hedging relationship	321,000		65,000

The forward currency contracts designated as net investment hedges mature on different dates between August 2018 and January 2019.

The forward currency contracts not designated in a hedging relationship mature on different dates between August 2018 and January 2019.

Quantitative disclosures about derivative financial instruments

The Company presents its derivative assets and derivative liabilities at their gross fair values within other prepaid expenses and other current assets and other current liabilities on the consolidated balance sheets. However, the Company's Master International Swap Dealers Association, Inc., Agreements and other similar arrangements allow net settlements under certain conditions. As of July 29, 2018, there were derivative assets of $3.3 million and derivative liabilities of $5.9 million subject to enforceable netting arrangements.

The fair values of forward currency contracts were as follows:



	July 29, 2018		July 30, 2017
	(In thousands)
Net forward currency contract assets, recognized within other prepaid expenses and other current assets:
Derivatives designated as net investment hedges	$	3,254	$	—
Derivatives not designated in a hedging relationship	—		5,937
Net forward currency contract liabilities, recognized within other current liabilities:
Derivatives designated as net investment hedges	—		7,068
Derivatives not designated in a hedging relationship	5,891		—

The pre-tax gains and losses on foreign exchange forward contracts recorded in accumulated other comprehensive income are as follows:



	Quarter Ended					Two Quarters Ended
	July 29, 2018		July 30, 2017			July 29, 2018		July 30, 2017
	(In thousands)
Gains (losses) recognized in foreign currency translation adjustment:
Derivatives designated as net investment hedges	$	5,721	$	(8,925	)	$	16,538	$	(8,925	)

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

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The pre-tax net foreign exchange and derivative gains and losses recorded in the consolidated statement of operations are as follows:



	Quarter Ended						Two Quarters Ended
	July 29, 2018			July 30, 2017			July 29, 2018			July 30, 2017
	(In thousands)
Gains (losses) recognized in selling, general and administrative expenses:
Foreign exchange gains (losses)	$	2,960		$	(9,303	)	$	12,605		$	(3,511	)
Derivatives not designated in a hedging relationship	(5,539		)	7,634			(15,587		)	7,634
Net foreign exchange and derivative (losses) gains	$	(2,579	)	$	(1,669	)	$	(2,982	)	$	4,123

Credit risk

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to the forward currency contracts. The credit risk amount is the Company's unrealized gains on its derivative instruments, based on foreign currency rates at the time of nonperformance.

The Company's forward currency contracts are entered into with large, reputable financial institutions that are monitored by the Company for counterparty risk.

The Company's derivative contracts contain certain credit risk-related contingent features. Under certain circumstances, including an event of default, bankruptcy, termination, and cross default under the Company's revolving credit facility, the Company may be required to make immediate payment for outstanding liabilities under its derivative contracts.

NOTE 7. ASSET IMPAIRMENT AND RESTRUCTURING

During fiscal 2017, the Company restructured its ivivva operations. On August 20, 2017, the Company closed 48 of its 55 ivivva branded company-operated stores and all other ivivva branded temporary locations. As a result of this restructuring, the Company recognized aggregate pre-tax charges of $47.2 million during fiscal 2017, inclusive of $23.2 million recognized during the first two quarters of fiscal 2017.

A summary of the pre-tax charges recognized in connection with the Company's restructuring of its ivivva operations is as follows:



	Quarter Ended					Two Quarters Ended
	July 29, 2018		July 30, 2017			July 29, 2018		July 30, 2017
	(In thousands)
Costs recorded in cost of goods sold:
Provision to reduce inventories to net realizable value	$	—	$	962		$	—	$	2,904
Expected loss on committed inventory purchases	—		(941		)	—		2,536
Accelerated depreciation	—		2,223			—		2,223
	—		2,244			—		7,663
Costs recorded in operating expenses:
Impairment of property and equipment	—		—			—		11,593
Employee related costs	—		2,458			—		3,196
Lease termination and other restructuring costs	—		728			—		728
Asset impairment and restructuring costs	—		3,186			—		15,517
Restructuring and related costs	$	—	$	5,430		$	—	$	23,180

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

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Costs recorded in cost of goods sold

During the first two quarters of fiscal 2017, the Company recognized expenses of $7.7 million in cost of goods sold as a result of the restructuring of its ivivva operations. This included $2.9 million to reduce inventories to their estimated net realizable value, and $2.5 million for the losses the Company expected to incur on certain inventory and fabric purchase commitments.

During the second quarter of fiscal 2017, the Company took delivery of inventory that it had previously committed to purchase. As a result, there was a reduction in the Company's liability for expected losses on committed inventory purchases and a corresponding increase in its provision to reduce inventories to net realizable value.

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

Costs recorded in operating expenses

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

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

During the first two quarters of fiscal 2017, the Company recognized employee related expenses as a result of the restructuring of $3.2 million as well as lease termination and other restructuring costs of $0.7 million.

NOTE 8. INCOME TAXES

The U.S. tax reform was enacted on December 22, 2017 and introduced significant changes to U.S. income tax laws. The U.S. tax reform reduced the U.S. federal income tax rate from 35% to 21%, introduced a shift to a territorial tax system and changed how foreign earnings are subject to U.S. tax, and imposed a mandatory one-time transition tax on the deemed repatriation of accumulated undistributed earnings of foreign subsidiaries. The U.S. tax reform also introduced new taxes on certain foreign-sourced earnings and certain related-party payments, which are referred to as the GILTI tax and the base erosion anti-abuse tax. Accounting for the income tax effects of the U.S. tax reform is complex and requires significant judgement and estimates in the interpretation and calculations of its provisions.

The SEC issued Staff Accounting Bulletin 118 ("SAB 118") which allows companies to record provisional estimates of the impacts of the U.S. tax reform within a one year measurement period. As disclosed in Note 14 to the audited consolidated financial statements included in Item 8 of the Company's fiscal 2017 Annual Report on Form 10-K filed with the SEC on March 27, 2018, the Company recorded certain provisional amounts in the fourth quarter of fiscal 2017 and expects the accounting for the income tax effects of the U.S. tax reform to be completed in fiscal 2018.

As the Company completes its analysis of the U.S. tax reform it may make adjustments to the provisional amounts recognized during fiscal 2017, and will incorporate any additional interpretations or guidance that may be issued. The Company may also identify additional effects not reflected as of July 29, 2018. Any such adjustments may materially impact the provision for income taxes and the effective income tax rate in the period in which the adjustments are made.

As of July 29, 2018, no deferred income tax liabilities have been recognized on any of the undistributed earnings of the Company's foreign subsidiaries as these earnings were indefinitely reinvested outside of the United States. The Company is continuing to evaluate the impact that the U.S. tax reform will have upon the taxes which may become payable upon repatriation, its reinvestment plans, and the most efficient means of deploying its capital resources globally. As this analysis has not yet been completed, it is possible that amounts determined to be indefinitely reinvested outside of the U.S. may ultimately be repatriated, resulting in additional tax liabilities being recognized.

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NOTE 9. EARNINGS PER SHARE

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



	Quarter Ended				Two Quarters Ended
	July 29, 2018		July 30, 2017		July 29, 2018		July 30, 2017
	(In thousands, except per share amounts)
Net income	$	95,770	$	48,711	$	170,923	$	79,957
Basic weighted-average number of shares outstanding	133,986		136,171		134,744		136,604
Assumed conversion of dilutive stock options and awards	544		132		486		143
Diluted weighted-average number of shares outstanding	134,530		136,303		135,230		136,747
Basic earnings per share	$	0.71	$	0.36	$	1.27	$	0.59
Diluted earnings per share	$	0.71	$	0.36	$	1.26	$	0.58

The Company's calculation of weighted-average shares includes the common stock of the Company as well as the exchangeable shares. Exchangeable shares are the equivalent of common shares in all material respects. All classes of stock have, in effect, the same rights and share equally in undistributed net income. For the two quarters ended July 29, 2018 and July 30, 2017, 48.5 thousand and 0.2 million stock options and awards, respectively, were anti-dilutive to earnings per share and therefore have been excluded from the computation of diluted earnings per share.

On December 1, 2016, the Company's board of directors approved a program to repurchase shares of the Company's common stock up to an aggregate value of $100.0 million. This stock repurchase program was completed during the third quarter of fiscal 2017.

On November 29, 2017, the Company's board of directors approved a stock repurchase program for up to $200.0 million. On June 6, 2018, the board of directors approved an increase to this stock repurchase program, authorizing the repurchase of up to a total of $600.0 million of the Company's common shares on the open market or in privately negotiated transactions. Common shares repurchased on the open market are at prevailing market prices, including under plans complying with the provisions of Rule 10b5-1 and Rule 10b-18 of the Securities Exchange Act of 1934. The timing and actual number of common shares to be repurchased will depend upon market conditions, eligibility to trade, and other factors, in accordance with Securities and Exchange Commission requirements, and the repurchase program is expected to be completed by November 2019. As of July 29, 2018, the remaining aggregate value of shares available to be repurchased under this program was $192.8 million.

During the two quarters ended July 29, 2018 and July 30, 2017, 3.4 million and 1.7 million shares, respectively, were repurchased under the program at a total cost of $406.2 million and $90.8 million, respectively.

Subsequent to July 29, 2018, and up to August 27, 2018, 0.1 million shares were repurchased at a total cost of $7.9 million.

NOTE 10. SUPPLEMENTARY FINANCIAL INFORMATION

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



	July 29, 2018			January 28, 2018
	(In thousands)
Inventories:
Finished goods	$	411,801		$	344,695
Provision to reduce inventories to net realizable value	(19,129		)	(15,133		)
	$	392,672		$	329,562

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	July 29, 2018			January 28, 2018
	(In thousands)
Property and equipment, net:
Land	$	78,829		$	83,048
Buildings	38,100			39,278
Leasehold improvements	313,062			301,449
Furniture and fixtures	94,270			91,778
Computer hardware	64,060			61,734
Computer software	181,909			173,997
Equipment and vehicles	14,993			14,806
Work in progress	78,503			51,260
Property and equipment, gross	863,726			817,350
Accumulated depreciation	(376,180		)	(343,708		)
	$	487,546		$	473,642
Goodwill and intangible assets, net:
Goodwill	$	25,496		$	25,496
Changes in foreign currency exchange rates	(1,241		)	(890		)
	24,255			24,606
Intangible assets, net	—			73
	$	24,255		$	24,679
Other non-current assets:
Security deposits	$	13,869		$	11,599
Deferred lease assets	8,908			10,458
Other	10,197			9,332
	$	32,974		$	31,389
Other current liabilities:
Accrued duty, freight, and other operating expenses	$	44,808		$	33,695
Sales tax collected	13,205			11,811
Sales return allowance	8,911			6,293
Accrued rent	6,234			7,074
Forward currency contract liabilities	5,891			8,771
Accrued capital expenditures	4,671			5,714
Lease termination liabilities	3,219			6,427
Other	8,867			6,631
	$	95,806		$	86,416
Other non-current liabilities:
Deferred lease liabilities	$	30,061		$	27,186
Tenant inducements	30,510			26,250
Other	5,550			5,885
	$	66,121		$	59,321

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NOTE 11. SEGMENT REPORTING

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



	Quarter Ended				Two Quarters Ended
	July 29, 2018		July 30, 2017		July 29, 2018		July 30, 2017
	(In thousands)
Net revenue:
Company-operated stores	$	486,368	$	413,944	$	919,499	$	793,043
Direct to consumer	167,405		113,049		325,248		210,272
Other	69,727		54,061		128,459		98,046
	$	723,500	$	581,054	$	1,373,206	$	1,101,361
Segmented income from operations:
Company-operated stores	$	125,868	$	92,609	$	225,155	$	170,139
Direct to consumer	67,033		38,748		129,300		72,846
Other	13,094		6,952		24,317		9,760
	205,995		138,309		378,772		252,745
General corporate expense	71,787		64,167		140,259		115,430
Restructuring and related costs	—		5,430		—		23,180
Income from operations	134,208		68,712		238,513		114,135
Other income (expense), net	1,591		812		4,509		1,719
Income before income tax expense	$	135,799	$	69,524	$	243,022	$	115,854

Capital expenditures:
Company-operated stores	$	27,765	$	16,634	$	47,001	$	23,802
Direct to consumer	593		6,861		1,314		8,841
Corporate and other	21,335		6,515		35,692		17,246
	$	49,693	$	30,010	$	84,007	$	49,889
Depreciation and amortization:
Company-operated stores	$	18,489	$	15,881	$	35,571	$	31,081
Direct to consumer	2,302		4,353		4,901		6,347
Corporate and other	7,865		8,172		14,957		14,141
	$	28,656	$	28,406	$	55,429	$	51,569

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

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The following table disaggregates the Company's net revenue by geographic area. The economic conditions in these areas could affect the amount and timing of the Company's net revenue and cash flows.



	Quarter Ended				Two Quarters Ended
	July 29, 2018		July 30, 2017		July 29, 2018		July 30, 2017
	(In thousands)
United States	$	512,413	$	413,634	$	974,683	$	793,101
Canada	124,278		108,446		236,427		200,092
Outside of North America	86,809		58,974		162,096		108,168
	$	723,500	$	581,054	$	1,373,206	$	1,101,361

NOTE 12. LEGAL PROCEEDINGS

In addition to the legal matters described below, the Company is, from time to time, involved in routine legal matters incidental to the conduct of its business, including legal matters such as initiation and defense of proceedings to protect intellectual property rights, personal injury claims, product liability claims, employment claims, and similar matters. The Company believes the ultimate resolution of any such current proceeding will not have a material adverse effect on its consolidated balance sheets, results of operations or cash flows.

On October 9, 2015, certain current and former hourly employees of the Company filed a class action lawsuit in the Supreme Court of New York entitled Rebecca Gathmann-Landini et al v. lululemon USA inc. On December 2, 2015, the case was moved to the United States District Court for the Eastern District of New York. The lawsuit alleges that the Company violated various New York labor codes by failing to pay all earned wages, including overtime compensation. The plaintiffs are seeking an unspecified amount of damages. The Company intends to vigorously defend this matter.

On December 20, 2017, former lululemon employee Shayla Famouri filed a lawsuit in Los Angeles Superior Court against the Company and a former employee of the Company. The plaintiff alleges claims for sexual assault and battery, sexual harassment, retaliation, creating a hostile work environment and related claims. The complaint seeks damages in the amount of $3.0 million, as well as non-monetary relief such as policy change and an apology. The Company intends to vigorously defend this matter.

NOTE 13. SUBSEQUENT EVENT

The Company evaluates events or transactions that occur after the balance sheet date through to the date which the financial statements are issued, for potential recognition or disclosure in its consolidated financial statements in accordance with ASC Topic 855, Subsequent Events.

On August 13, 2018, the Company repaid the $100.0 million outstanding on its revolving credit facility.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Some of the statements contained in this Form 10-Q and any documents incorporated herein by reference constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical facts, included or incorporated in this Form 10-Q are forward-looking statements, particularly statements which relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts, such as statements regarding our future financial condition or results of operations, our prospects and strategies for future growth, the development and introduction of new products, and the implementation of our marketing and branding strategies. In many cases, you can identify forward-looking statements by terms such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "intends," "predicts," "potential" or the negative of these terms or other comparable terminology.

The forward-looking statements contained in this Form 10-Q and any documents incorporated herein by reference reflect our current views about future events and are subject to risks, uncertainties, assumptions, and changes in circumstances that may cause events or our actual activities or results to differ significantly from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, actions, levels of activity, performance, or achievements. Readers are cautioned not to place undue reliance on these forward-looking statements. A number of important factors could cause actual results to differ

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materially from those indicated by the forward-looking statements, including, but not limited to, those factors described in "Risk Factors" and elsewhere in this report.

The forward-looking statements contained in this Form 10-Q reflect our views and assumptions only as of the date of this Form 10-Q and are expressly qualified in their entirety by the cautionary statements included in this Form 10-Q. Except as required by applicable securities law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

This information should be read in conjunction with the unaudited interim consolidated financial statements and the notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in our fiscal 2017 Annual Report on Form 10-K filed with the SEC on March 27, 2018.

We disclose material non-public information through one or more of the following channels: our investor relations website (http://investor.lululemon.com/), the social media channels identified on our investor relations website, press releases, SEC filings, public conference calls, and webcasts.

Overview

lululemon athletica inc. is principally a designer, distributor, and retailer of healthy lifestyle inspired athletic apparel and accessories. We have a mission to create transformational products and experiences which enable people to live a life they love, and have developed a brand for those pursuing an active, mindful lifestyle. Since our inception, we have fostered a distinctive corporate culture; we promote a set of core values in our business which include taking personal responsibility, nurturing entrepreneurial spirit, acting with honesty and courage, valuing connection, and choosing to have fun. These core values attract passionate and motivated employees who are driven to achieve personal and professional goals, and share our purpose of "elevating the world through the power of practice."

Our healthy lifestyle inspired athletic apparel and accessories are marketed under the lululemon and ivivva brand names. We offer a comprehensive line of apparel and accessories for women, men, and female youth. Our apparel assortment includes items such as pants, shorts, tops, and jackets designed for a healthy lifestyle and athletic activities such as yoga, running, training, and most other sweaty pursuits. We also offer fitness-related accessories, including items such as bags, socks, underwear, yoga mats and equipment, and water bottles.

During fiscal 2017, we restructured our ivivva operations. On August 20, 2017, we closed 48 of our 55 ivivva branded company-operated stores and all other ivivva branded temporary locations.

Financial Highlights

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

For the second quarter of fiscal 2018, compared to the second quarter of fiscal 2017:


•	Net revenue increased 25% to $723.5 million. On a constant dollar basis, net revenue increased 24%.


•	Total comparable sales, which includes comparable store sales and direct to consumer, increased 20%. On a constant dollar basis, total comparable sales increased 19%.


–	Comparable store sales increased 10%, or increased 10% on a constant dollar basis.


–	Direct to consumer net revenue increased 48%, or increased 47% on a constant dollar basis.


•	Gross profit increased 33% to $396.2 million. It increased 32% compared to adjusted gross profit for the second quarter of fiscal 2017.


•	Gross margin increased 360 basis points to 54.8%. It increased 320 basis points compared to adjusted gross margin for the second quarter of fiscal 2017.


•	Income from operations increased 95% to $134.2 million. It increased 81% compared to adjusted income from operations for the second quarter of fiscal 2017.


•	Operating margin increased 670 basis points to 18.5%. It increased 570 basis points compared to adjusted operating margin for the second quarter of fiscal 2017.

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•	Income tax expense increased 92% to $40.0 million. Our effective tax rate for the second quarter of fiscal 2018 was 29.5% compared to 29.9% for the second quarter of fiscal 2017. The adjusted effective tax rate was 29.6% in the second quarter of fiscal 2017.


•	Diluted earnings per share were $0.71 compared to $0.36 in the second quarter of fiscal 2017. Adjusted diluted earnings per share were $0.39 for the second quarter of fiscal 2017.

Refer to the non-GAAP reconciliation tables contained in the "Non-GAAP Financial Measures" section of this "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" for reconciliations between constant dollar changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue, and adjusted gross profit, gross margin, income from operations, operating margin, income tax expense, effective tax rates, and diluted earnings per share, and the most directly comparable measures calculated in accordance with GAAP.

Results of Operations

Second Quarter Results

The following table summarizes key components of our results of operations for the quarters ended July 29, 2018 and July 30, 2017. The percentages are presented as a percentage of net revenue.



	Quarter Ended
	July 29, 2018		July 30, 2017		July 29, 2018		July 30, 2017
	(In thousands)				(Percentages)
Net revenue	$	723,500	$	581,054	100.0	%	100.0	%
Cost of goods sold	327,306		283,632		45.2		48.8
Gross profit	396,194		297,422		54.8		51.2
Selling, general and administrative expenses	261,986		225,524		36.2		38.8
Asset impairment and restructuring costs	—		3,186		—		0.6
Income from operations	134,208		68,712		18.5		11.8
Other income (expense), net	1,591		812		0.2		0.2
Income before income tax expense	135,799		69,524		18.8		12.0
Income tax expense	40,029		20,813		5.5		3.6
Net income	$	95,770	$	48,711	13.2	%	8.4	%

Net Revenue

Net revenue increased $142.4 million, or 25%, to $723.5 million for the second quarter of fiscal 2018 from $581.1 million for the second quarter of fiscal 2017. On a constant dollar basis, assuming the average exchange rates for the second quarter of fiscal 2018 remained constant with the average exchange rates for the second quarter of fiscal 2017, net revenue increased $139.7 million, or 24%.

The increase in net revenue was primarily due to increased direct to consumer net revenue, net revenue generated by new company-operated stores, and an increase in comparable store sales. Total comparable sales, which includes comparable store sales and direct to consumer, increased 20% in the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017. Total comparable sales increased 19% on a constant dollar basis.

Net revenue on a segment basis for the quarters ended July 29, 2018 and July 30, 2017 is summarized below. The percentages are presented as a percentage of total net revenue.



	Quarter Ended
	July 29, 2018		July 30, 2017		July 29, 2018		July 30, 2017
	(In thousands)				(Percentages)
Company-operated stores	$	486,368	$	413,944	67.2	%	71.2	%
Direct to consumer	167,405		113,049		23.1		19.5
Other	69,727		54,061		9.6		9.3
Net revenue	$	723,500	$	581,054	100.0	%	100.0	%

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Company-Operated Stores. Net revenue from our company-operated stores segment increased $72.4 million, or 17%, to $486.4 million in the second quarter of fiscal 2018 from $413.9 million in the second quarter of fiscal 2017. The following contributed to the increase in net revenue from our company-operated stores segment:

•

Net revenue from company-operated stores we opened or significantly expanded subsequent to July 30, 2017, and therefore not included in comparable store sales, contributed $50.6 million to the increase. We opened 42 net new lululemon branded company-operated stores since the second quarter of fiscal 2017, including 22 stores in North America, 12 stores in Asia, six stores in Europe, and two stores in Australia/New Zealand.

•

A comparable store sales increase of 10% in the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017 resulted in a $35.7 million increase to net revenue. Comparable store sales increased 10%, or $34.6 million on a constant dollar basis. The increase in comparable store sales was primarily a result of increased store traffic, and due to improved conversion rates and increased dollar value per transaction.

These increases in net revenue were partially offset by the closure of 48 of our ivivva branded company-operated stores as part of the restructuring of our ivivva operations. These closures reduced our net revenue from company-operated stores for the second quarter of fiscal 2018 by $13.8 million compared to the second quarter of fiscal 2017.

Direct to Consumer. Net revenue from our direct to consumer segment increased $54.4 million, or 48%, to $167.4 million in the second quarter of fiscal 2018 from $113.0 million in the second quarter of fiscal 2017. Direct to consumer net revenue increased 47% on a constant dollar basis. This was primarily a result of increased website traffic and improved conversion rates, and due to increased dollar value per transaction. During the second quarter of fiscal 2017, we held an online warehouse sale in the United States and Canada which generated net revenue of $12.3 million. We did not hold any online warehouse sales during the second quarter of fiscal 2018.

Other. Net revenue from our other segment increased $15.7 million, or 29%, to $69.7 million in the second quarter of fiscal 2018 from $54.1 million in the second quarter of fiscal 2017. This increase was primarily the result of an increased number of outlets and temporary locations, including seasonal stores, open during the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017. There was also an increase in net revenue at existing outlets during the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017. The increase in net revenue from our other segment was partially offset by lower net revenue from showrooms, primarily due to a decreased number of showrooms open during the second quarter of fiscal 2018 compared to the second quarter of fiscal 2017.

Gross Profit

Gross profit increased $98.8 million, or 33%, to $396.2 million for the second quarter of fiscal 2018 from $297.4 million for the second quarter of fiscal 2017.

Gross profit as a percentage of net revenue, or gross margin, increased 360 basis points to 54.8% in the second quarter of fiscal 2018 from 51.2% in the second quarter of fiscal 2017. The increase in gross margin was primarily the result of:


•	an increase in product margin of 260 basis points, which was primarily due to lower product costs, a favorable mix of higher margin product, and lower markdowns;


•	a decrease in occupancy and depreciation costs as a percentage of revenue of 70 basis points;


•	a favorable impact of foreign exchange rates of 20 basis points; and


•	the costs incurred in the second quarter of fiscal 2017 in connection with the restructuring of our ivivva operations, which reduced gross margin in that quarter by 40 basis points.

This was partially offset by an increase in fixed costs as a percentage of revenue related to our product and supply chain departments of 30 basis points.

During the second quarter of fiscal 2017, as a result of the restructuring of our ivivva operations, we recognized costs totaling $2.2 million within costs of goods sold, as outlined in Note 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report. Excluding these charges from the comparatives for the second quarter of fiscal 2017, gross profit increased 32% and gross margin increased 320 basis points.

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Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $36.5 million, or 16%, to $262.0 million in the second quarter of fiscal 2018 from $225.5 million in the second quarter of fiscal 2017. The increase in selling, general and administrative expenses was primarily due to:


•	an increase in costs related to our operating channels of $29.7 million, comprised of:


–	an increase in employee costs of $14.6 million primarily from a growth in labor hours and benefits, mainly associated with new company-operated stores and other new operating locations, and due to higher retail bonus expenses;


–	an increase in variable costs of $9.0 million primarily due to an increase in distribution costs, credit card fees, and packaging costs as a result of increased net revenue; and


–	an increase in other costs of $6.1 million primarily due to an increase in digital marketing expenses, brand and community costs, and other costs associated with our operating locations;


•	an increase in head office costs of $5.9 million, comprised of:


–	an increase in employee costs of $3.6 million primarily due to additional employees to support the growth in our business; and


–	an increase in other costs of $2.2 million primarily due to increases in brand and community costs, information technology costs, and other head office costs; and

•

an increase in net foreign exchange and derivative revaluation losses of $0.9 million. There were net foreign exchange and derivative revaluation losses of $2.6 million in the second quarter of fiscal 2018 compared to net foreign exchange and derivative revaluation losses of $1.7 million in the second quarter of fiscal 2017. The net foreign exchange gains and losses primarily relate to the revaluation of U.S. dollar denominated monetary assets and liabilities held by Canadian subsidiaries. During the second quarter of fiscal 2017, we began entering into forward currency contracts designed to economically hedge these foreign exchange revaluation gains and losses.

As a percentage of net revenue, selling, general and administrative expenses decreased 260 basis points, to 36.2% in the second quarter of fiscal 2018 from 38.8% in the second quarter of fiscal 2017.

Asset Impairment and Restructuring Costs

During the second quarter of fiscal 2017, we incurred asset impairment and restructuring costs totaling $3.2 million in connection with the restructuring of our ivivva operations. This included employee related costs of $2.5 million and lease termination and other restructuring costs of $0.7 million. Please refer to Note 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report.

We did not have any asset impairment and restructuring costs in the second quarter of fiscal 2018.

Income from Operations

Income from operations increased $65.5 million, or 95%, to $134.2 million in the second quarter of fiscal 2018 from $68.7 million in the second quarter of fiscal 2017. Operating margin increased 670 basis points to 18.5% compared to 11.8% in the second quarter of fiscal 2017.

In connection with the restructuring of our ivivva operations, we recognized pre-tax costs totaling $5.4 million in the second quarter of fiscal 2017. This included costs of $2.2 million recognized in cost of goods sold, and asset impairment and restructuring costs totaling $3.2 million. Excluding these charges from the comparatives for the second quarter of fiscal 2017, income from operations increased 81% and operating margin increased 570 basis points.

On a segment basis, we determine income from operations without taking into account our general corporate expenses and the costs we incurred in connection with the restructuring of our ivivva operations. In the first quarter of fiscal 2018, we reviewed our general corporate expenses and determined certain costs which were previously classified as general corporate expenses are more appropriately classified within our direct to consumer segment. Accordingly, comparative figures have been reclassified to conform to the financial presentation adopted for the current year.

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Segmented income from operations for the quarters ended July 29, 2018 and July 30, 2017 is summarized below. The percentages are presented as a percentage of net revenue of the respective operating segments.



	Quarter Ended
	July 29, 2018		July 30, 2017		July 29, 2018		July 30, 2017
	(In thousands)				(Percentage of segment revenue)
Segmented income from operations:
Company-operated stores	$	125,868	$	92,609	25.9	%	22.4	%
Direct to consumer	67,033		38,748		40.0		34.3
Other	13,094		6,952		18.8		12.9
	205,995		138,309
General corporate expense	71,787		64,167
Restructuring and related costs	—		5,430
Income from operations	$	134,208	$	68,712

Company-Operated Stores. Income from operations from our company-operated stores segment increased $33.3 million, or 36%, to $125.9 million for the second quarter of fiscal 2018 from $92.6 million for the second quarter of fiscal 2017. The increase was primarily the result of increased gross profit of $46.3 million which was primarily due to increased net revenue and higher gross margin. This was partially offset by an increase in selling, general and administrative expenses, primarily due to an increase in store employee costs, increased store operating expenses including higher credit card fees, distribution costs and packaging costs as a result of higher net revenues, and due to increased brand and community costs. Income from operations as a percentage of company-operated stores net revenue increased 350 basis points due to higher gross margin and leverage on selling, general and administrative expenses.

Direct to Consumer. Income from operations from our direct to consumer segment increased $28.3 million, or 73%, to $67.0 million for the second quarter of fiscal 2018 from $38.8 million for the second quarter of fiscal 2017. The increase was primarily the result of increased gross profit of $39.5 million which was primarily due to increased net revenue and higher gross margin. This was partially offset by an increase in selling, general and administrative expenses primarily due to higher variable costs including distribution costs, credit card fees, and packaging costs as a result of higher net revenue, as well as higher digital marketing expenses. Income from operations as a percentage of direct to consumer net revenue increased 570 basis points due to higher gross margin and leverage on selling, general and administrative expenses.

Other. Other income from operations increased $6.1 million, or 88%, to $13.1 million for the second quarter of fiscal 2018 from $7.0 million for the second quarter of fiscal 2017. The increase was primarily the result of increased gross profit of $10.8 million which was primarily due to increased net revenue and higher gross margin. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses, primarily due to increased employee costs and due to increased operating expenses including higher credit card fees and distribution costs as a result of higher net revenues. Income from operations as a percentage of other net revenue increased 590 basis points due to higher gross margin and leverage on selling, general and administrative expenses.

General Corporate Expense. General corporate expense increased $7.6 million, or 12%, to $71.8 million for the second quarter of fiscal 2018 from $64.2 million for the second quarter of fiscal 2017. This increase was primarily due to increases in head office employee costs, increased information technology costs, increased brand and community costs, and an increase in net foreign exchange and derivative revaluation losses of $0.9 million. There were net foreign exchange and derivative revaluation losses of $2.6 million in the second quarter of fiscal 2018 compared to net foreign exchange and derivative revaluation losses of $1.7 million in the second quarter of fiscal 2017. The net foreign exchange gains and losses primarily relate to the revaluation of U.S. dollar denominated monetary assets and liabilities held by Canadian subsidiaries, and the derivatives are designed to economically hedge these gains and losses.

Other Income (Expense), Net

Other income, net increased $0.8 million, or 96%, to $1.6 million for the second quarter of fiscal 2018 from income of $0.8 million for the second quarter of fiscal 2017. The increase was primarily due to an increase in net interest income, primarily due to higher rates of return on our cash and cash equivalents, including money market funds, treasury bills, and term deposits, and due to an increase in cash and cash equivalents in the second quarter of fiscal 2018 compared to second quarter of fiscal 2017. This was partially offset by an increase in net interest expense primarily related to borrowings on our revolving credit facility during the second quarter of fiscal 2018.

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Income Tax Expense

Income tax expense increased $19.2 million, or 92%, to $40.0 million for the second quarter of fiscal 2018 from $20.8 million for the second quarter of fiscal 2017.

During the second quarter of fiscal 2017, we recognized a net income tax recovery of $1.4 million on the costs recognized in connection with the ivivva restructuring. Please refer to Note 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report.

The U.S. Tax Cuts and Jobs Act ("U.S. tax reform") was enacted on December 22, 2017 and introduced significant changes to U.S. income tax law. We recorded certain provisional amounts in the fourth quarter of fiscal 2017 and expect the accounting for the income tax effects of the U.S. tax reform to be completed in fiscal 2018. Please refer to Note 8 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report. We recognized a provisional income tax expense relating to the global intangible low-taxed income ("GILTI") tax in our effective tax rate for fiscal 2018. The results for the second quarter of fiscal 2018 did not include any discrete items related to the U.S. tax reform.

The effective tax rate for the second quarter of fiscal 2018 was 29.5% compared to 29.9% for the second quarter of fiscal 2017. Excluding the costs and related tax recoveries which were recognized in connection with the ivivva restructuring, the adjusted effective tax rate was 29.6% for the second quarter of fiscal 2017. The decrease in the effective tax rate for the second quarter of fiscal 2018 compared to the adjusted effective tax rate for the second quarter of fiscal 2017 was primarily due to the lower U.S. federal income tax rate as a result of the U.S. tax reform, partially offset by the provisional income tax expense relating to the GILTI tax and other adjustments following the finalization of certain income tax returns.

Net Income

Net income increased $47.1 million, or 97%, to $95.8 million for the second quarter of fiscal 2018 from $48.7 million for the second quarter of fiscal 2017. This was primarily due to an increase in gross profit of $98.8 million, a reduction in asset impairment and restructuring costs of $3.2 million, and an increase in other income (expense), net of $0.8 million, partially offset by an increase in selling, general and administrative expenses of $36.5 million and an increase in income tax expense of $19.2 million.

First Two Quarters Results

The following table summarizes key components of our results of operations for the first two quarters ended July 29, 2018 and July 30, 2017. The percentages are presented as a percentage of net revenue.



	Two Quarters Ended
	July 29, 2018		July 30, 2017		July 29, 2018		July 30, 2017
	(In thousands)				(Percentages)
Net revenue	$	1,373,206	$	1,101,361	100.0	%	100.0	%
Cost of goods sold	632,279		547,044		46.0		49.7
Gross profit	740,927		554,317		54.0		50.3
Selling, general and administrative expenses	502,414		424,665		36.6		38.6
Asset impairment and restructuring costs	—		15,517		—		1.3
Income from operations	238,513		114,135		17.4		10.4
Other income (expense), net	4,509		1,719		0.3		0.1
Income before income tax expense	243,022		115,854		17.7		10.5
Income tax expense	72,099		35,897		5.3		3.2
Net income	$	170,923	$	79,957	12.4	%	7.3	%

Net Revenue

Net revenue increased $271.8 million, or 25%, to $1.373 billion for the first two quarters of fiscal 2018 from $1.101 billion for the first two quarters of fiscal 2017. On a constant dollar basis, assuming the average exchange rates for the first two quarters of fiscal 2018 remained constant with the average exchange rates for the first two quarters of fiscal 2017, net revenue increased $260.0 million, or 24%.

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sales and direct to consumer, increased 20% in the first two quarters of fiscal 2018 compared to the first two quarters of fiscal 2017. Total comparable sales increased 19% on a constant dollar basis.

Net revenue on a segment basis for the first two quarters ended July 29, 2018 and July 30, 2017 is summarized below. The percentages are presented as a percentage of total net revenue.



	Two Quarters Ended
	July 29, 2018		July 30, 2017		July 29, 2018		July 30, 2017
	(In thousands)				(Percentages)
Company-operated stores	$	919,499	$	793,043	67.0	%	72.0	%
Direct to consumer	325,248		210,272		23.7		19.1
Other	128,459		98,046		9.3		8.9
Net revenue	$	1,373,206	$	1,101,361	100.0	%	100.0	%

Company-Operated Stores. Net revenue from our company-operated stores segment increased $126.5 million, or 16%, to $919.5 million in the first two quarters of fiscal 2018 from $793.0 million in the first two quarters of fiscal 2017. The following contributed to the increase in net revenue from our company-operated stores segment:

•

Net revenue from company-operated stores we opened or significantly expanded subsequent to July 30, 2017, and therefore not included in comparable store sales, contributed $93.2 million to the increase. We opened 42 net new lululemon branded company-operated stores since the second quarter of fiscal 2017, including 22 stores in North America, 12 stores in Asia, six stores in Europe, and two stores in Australia/New Zealand.


•	A comparable store sales increase of 9% in the first two quarters of fiscal 2018 compared to the first two quarters of fiscal 2017 resulted in a $58.6 million increase to net revenue. Comparable store sales increased 8%, or $53.1 million on a constant dollar basis. The increase in comparable store sales was primarily a result of increased store traffic and improved conversion rates.

These increases in net revenue were partially offset by the closure of 48 of our ivivva branded company-operated stores as part of the restructuring of our ivivva operations. These closures reduced our net revenue from company-operated stores for the first two quarters of fiscal 2018 by $25.4 million compared to the first two quarters of fiscal 2017.

Direct to Consumer. Net revenue from our direct to consumer segment increased $115.0 million, or 55%, to $325.2 million in the first two quarters of fiscal 2018 from $210.3 million in the first two quarters of fiscal 2017. Direct to consumer net revenue increased 53% on a constant dollar basis. This was primarily a result of increased website traffic and increased conversion rates. During the second quarter of fiscal 2017, we held an online warehouse sale in the United States and Canada which generated net revenue of $12.3 million. We did not hold any online warehouse sales during the first two quarters of fiscal 2018.

Other. Net revenue from our other segment increased $30.4 million, or 31%, to $128.5 million in the first two quarters of fiscal 2018 from $98.0 million in the first two quarters of fiscal 2017. This increase was primarily the result of an increased number of outlets and temporary locations, including seasonal stores, open during the first two quarters of fiscal 2018 compared to the first two quarters of fiscal 2017. There was also an increase in net revenue at existing outlets during the first two quarters of fiscal 2018 compared to the first two quarters of fiscal 2017. The increase in net revenue from our other segment was partially offset by lower net revenue from showrooms, primarily due to a decreased number of showrooms open during the first two quarters of fiscal 2018 compared to the first two quarters of fiscal 2017.

Gross Profit

Gross profit increased $186.6 million, or 34%, to $740.9 million for the first two quarters of fiscal 2018 from $554.3 million for the first two quarters of fiscal 2017.

Gross profit as a percentage of net revenue, or gross margin, increased 370 basis points, to 54.0% in the first two quarters of fiscal 2018 from 50.3% in the first two quarters of fiscal 2017. The increase in gross margin was primarily the result of:


•	an increase in product margin of 190 basis points, which was primarily due to lower product costs, a favorable mix of higher margin product, lower markdowns, and lower inventory provision expense;


•	a decrease in occupancy and depreciation costs as a percentage of revenue of 80 basis points;


•	a favorable impact of foreign exchange rates of 30 basis points; and

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•	the costs incurred in the first two quarters of fiscal 2017 in connection with the restructuring of our ivivva operations, which reduced gross margin in that quarter by 70 basis points.

During the first two quarters of fiscal 2018, as a result of the restructuring of our ivivva operations, we recognized costs totaling $7.7 million within costs of goods sold, as outlined in Note 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report. Excluding these charges from the comparatives for the second quarter of fiscal 2017, gross profit increased 32% and gross margin increased 300 basis points.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $77.7 million, or 18%, to $502.4 million in the first two quarters of fiscal 2018 from $424.7 million in the first two quarters of fiscal 2017. The increase in selling, general and administrative expenses was primarily due to:


•	an increase in costs related to our operating channels of $52.2 million, comprised of:


–	an increase in employee costs of $22.5 million, primarily from a growth in labor hours and benefits, mainly associated with new company-operated stores and other new operating locations, and due to higher retail bonus expenses;


–	an increase in variable costs of $17.7 million, primarily due to an increase in distribution costs, credit card fees, and packaging costs as a result of increased net revenue; and


–	an increase in other costs of $12.1 million, primarily due to an increase in digital marketing expenses, brand and community costs, and other costs associated with our operating locations; and


•	an increase in head office costs of $18.4 million, comprised of:


–	an increase in employee costs of $12.7 million primarily due to additional employees to support the growth in our business; and


–	an increase in other costs of $5.7 million primarily due to an increase in brand and community costs, depreciation, and information technology related costs, partially offset by a decrease in professional fees.

The increase in selling, general and administrative expenses was partially offset by an increase in net foreign exchange and derivative revaluation losses of $7.1 million. There were net foreign exchange and derivative revaluation losses of $3.0 million in the first two quarters of fiscal 2018 compared to net foreign exchange and derivative revaluation gains of $4.1 million in the first two quarters of fiscal 2017. The net foreign exchange gains and losses primarily relate to the revaluation of U.S. dollar denominated monetary assets and liabilities held by Canadian subsidiaries. During the second quarter of fiscal 2017, we began entering into forward currency contracts designed to economically hedge these foreign exchange revaluation gains and losses.

As a percentage of net revenue, selling, general and administrative expenses decreased 200 basis points, to 36.6% in the first two quarters of fiscal 2018 from 38.6% in the first two quarters of fiscal 2017.

Asset Impairment and Restructuring Costs

During the first two quarters of fiscal 2017, we incurred asset impairment and restructuring costs totaling $15.5 million in connection with the restructuring of our ivivva operations. This included long-lived asset impairment charges of $11.6 million, employee related costs of $3.2 million, and lease termination and other restructuring costs of $0.7 million. Please refer to Note 7 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report.

We did not have any asset impairment and restructuring costs in the first two quarters of fiscal 2018.

Income from Operations

Income from operations increased $124.4 million, or 109%, to $238.5 million in the first two quarters of fiscal 2018 from $114.1 million in the first two quarters of fiscal 2017. Operating margin increased 700 basis points to 17.4% compared to 10.4% in the first two quarters of fiscal 2017.

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 included costs of $7.7 million recognized in cost of goods sold, and asset impairment and restructuring costs totaling $15.5 million. Excluding these charges from the comparatives for the first two quarters of fiscal 2017, income from operations increased 74% and operating margin increased 490 basis points.

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