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lululemon athletica inc. - Quarter Report: 2020 August (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 2, 2020
or
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)
Delaware20-3842867
(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)

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
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading symbol(s)Name of each exchange on which registered
Common Stock, par value $0.005 per shareLULUNasdaq Global Select Market
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 ☑ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes ☑ No ☐
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 FilerAccelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
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. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ☐ No ☑
At September 1, 2020, there were 124,920,793 shares of the registrant's common stock, par value $0.005 per share, outstanding.
Exchangeable and Special Voting Shares:
At September 1, 2020, there were outstanding 5,392,512 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 September 1, 2020, the registrant had outstanding 5,392,512 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
 
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Item 2.
Item 3.
Item 4.
Item 1.
Item 1A.
Item 2.
Item 6.
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
lululemon athletica inc.
CONSOLIDATED BALANCE SHEETS
(Unaudited; Amounts in thousands, except per share amounts)
August 2,
2020
February 2,
2020
ASSETS
Current assets
Cash and cash equivalents$522,998 $1,093,505 
Accounts receivable48,922 40,219 
Inventories672,773 518,513 
Prepaid and receivable income taxes125,019 85,159 
Prepaid expenses and other current assets120,043 70,542 
1,489,755 1,807,938 
Property and equipment, net698,514 671,693 
Right-of-use lease assets725,805 689,664 
Goodwill386,593 24,182 
Intangible assets, net84,471 241 
Deferred income tax assets31,591 31,435 
Other non-current assets77,298 56,201 
$3,494,027 $3,281,354 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable$122,767 $79,997 
Accrued inventory liabilities31,675 6,344 
Other accrued liabilities 177,436 112,641 
Accrued compensation and related expenses84,102 133,688 
Current lease liabilities147,941 128,497 
Current income taxes payable75,153 26,436 
Unredeemed gift card liability106,425 120,413 
Other current liabilities17,810 12,402 
763,309 620,418 
Non-current lease liabilities632,646 611,464 
Non-current income taxes payable43,150 48,226 
Deferred income tax liabilities46,901 43,432 
Other non-current liabilities6,919 5,596 
1,492,925 1,329,136 
Commitments and contingencies
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; 5,393 and 6,227 issued and outstanding
  
Special voting stock, $0.000005 par value: 60,000 shares authorized; 5,393 and 6,227 issued and outstanding
  
Common stock, $0.005 par value: 400,000 shares authorized; 124,917 and 124,122 issued and outstanding
625 621 
Additional paid-in capital358,414 355,541 
Retained earnings1,872,948 1,820,637 
Accumulated other comprehensive loss(230,885)(224,581)
2,001,102 1,952,218 
$3,494,027 $3,281,354 
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 EndedTwo Quarters Ended
August 2, 2020August 4, 2019August 2, 2020August 4, 2019
Net revenue$902,942 $883,352 $1,554,904 $1,665,667 
Cost of goods sold413,441 397,556 731,001 758,151 
Gross profit489,501 485,796 823,903 907,516 
Selling, general and administrative expenses352,904 317,814 652,510 610,722 
Amortization of intangible assets724  724  
Acquisition-related expenses11,464  13,509  
Income from operations124,409 167,982 157,160 296,794 
Other income (expense), net(344)1,850 830 4,229 
Income before income tax expense124,065 169,832 157,990 301,023 
Income tax expense37,264 44,842 42,557 79,430 
Net income$86,801 $124,990 $115,433 $221,593 
Other comprehensive income:
Foreign currency translation adjustment54,300 4,514 (6,304)(11,209)
Comprehensive income$141,101 $129,504 $109,129 $210,384 
Basic earnings per share$0.67 $0.96 $0.89 $1.70 
Diluted earnings per share$0.66 $0.96 $0.88 $1.69 
Basic weighted-average number of shares outstanding130,245 130,285 130,248 130,489 
Diluted weighted-average number of shares outstanding130,799 130,783 130,802 131,060 
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)
Quarter Ended August 2, 2020
 Exchangeable StockSpecial Voting StockCommon StockAdditional Paid-in CapitalRetained EarningsAccumulated Other Comprehensive LossTotal
 SharesSharesPar ValueSharesPar Value
Balance at May 3, 20205,482 5,482 $ 124,717 $624 $334,201 $1,786,147 $(285,185)$1,835,787 
Net income86,801 86,801 
Foreign currency translation adjustment54,300 54,300 
Common stock issued upon exchange of exchangeable shares(89)(89) 89    
Stock-based compensation expense15,784 15,784 
Common stock issued upon settlement of stock-based compensation114  9,328 9,328 
Shares withheld related to net share settlement of stock-based compensation(3)1 (899)(898)
Balance at August 2, 20205,393 5,393 $ 124,917 $625 $358,414 $1,872,948 $(230,885)$2,001,102 


Quarter Ended August 4, 2019
 Exchangeable StockSpecial Voting StockCommon StockAdditional Paid-in CapitalRetained EarningsAccumulated Other Comprehensive LossTotal
 SharesSharesPar ValueSharesPar Value
Balance at May 5, 20197,381 7,381 $ 122,900 $615 $317,204 $1,281,432 $(232,531)$1,366,720 
Net income124,990 124,990 
Foreign currency translation adjustment4,514 4,514 
Stock-based compensation expense11,848 11,848 
Common stock issued upon settlement of stock-based compensation33 1 1,336 1,337 
Shares withheld related to net share settlement of stock-based compensation(2) (461)(461)
Repurchase of common stock(10)(1)(12)(1,556)(1,569)
Balance at August 4, 20197,381 7,381 $ 122,921 $615 $329,915 $1,404,866 $(228,017)$1,507,379 

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Two Quarters Ended August 2, 2020
 Exchangeable StockSpecial Voting StockCommon StockAdditional Paid-in CapitalRetained EarningsAccumulated Other Comprehensive LossTotal
 SharesSharesPar ValueSharesPar Value
Balance at February 2, 20206,227 6,227 $ 124,122 $621 $355,541 $1,820,637 $(224,581)$1,952,218 
Net income115,433 115,433 
Foreign currency translation adjustment(6,304)(6,304)
Common stock issued upon exchange of exchangeable shares(834)(834) 834 4 (4) 
Stock-based compensation expense21,912 21,912 
Common stock issued upon settlement of stock-based compensation485 2 12,461 12,463 
Shares withheld related to net share settlement of stock-based compensation(155) (30,957)(30,957)
Repurchase of common stock(369)(2)(539)(63,122)(63,663)
Balance at August 2, 20205,393 5,393 $ 124,917 $625 $358,414 $1,872,948 $(230,885)$2,001,102 

Two Quarters Ended August 4, 2019
 Exchangeable StockSpecial Voting StockCommon StockAdditional Paid-in CapitalRetained EarningsAccumulated Other Comprehensive LossTotal
 SharesSharesPar ValueSharesPar Value
Balance at February 3, 20199,332 9,332 $ 121,600 $608 $315,285 $1,346,890 $(216,808)$1,445,975 
Net income221,593 221,593 
Foreign currency translation adjustment(11,209)(11,209)
Common stock issued upon exchange of exchangeable shares(1,951)(1,951) 1,951 10 (10) 
Stock-based compensation expense22,005 22,005 
Common stock issued upon settlement of stock-based compensation497 3 13,511 13,514 
Shares withheld related to net share settlement of stock-based compensation(117)(1)(19,399)(19,400)
Repurchase of common stock(1,010)(5)(1,477)(163,617)(165,099)
Balance at August 4, 20197,381 7,381 $ 122,921 $615 $329,915 $1,404,866 $(228,017)$1,507,379 

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
August 2, 2020August 4, 2019
Cash flows from operating activities
Net income$115,433 $221,593 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization84,176 70,422 
Stock-based compensation expense21,912 22,005 
Settlement of derivatives not designated in a hedging relationship(13,538)(5,430)
Changes in operating assets and liabilities:
Inventories(138,194)(93,358)
Prepaid and receivable income taxes(39,860)(63,187)
Prepaid expenses and other current and non-current assets(76,811)(45,539)
Accounts payable35,967 15,791 
Accrued inventory liabilities25,322 (7,069)
Other accrued liabilities53,868 3,367 
Accrued compensation and related expenses(49,037)(7,486)
Current and non-current income taxes payable43,926 (55,508)
Unredeemed gift card liability(13,848)(19,413)
Right-of-use lease assets and current and non-current lease liabilities7,388 9,625 
Other current and non-current liabilities3,358 4,229 
Net cash provided by operating activities60,062 50,042 
Cash flows from investing activities
Purchase of property and equipment(104,723)(135,764)
Settlement of net investment hedges10,981 5,062 
Acquisition, net of cash acquired(452,581) 
Other investing activities1,000 (1,267)
Net cash used in investing activities(545,323)(131,969)
Cash flows from financing activities
Proceeds from settlement of stock-based compensation12,463 13,514 
Taxes paid related to net share settlement of stock-based compensation(30,957)(19,400)
Repurchase of common stock(63,663)(165,099)
Net cash used in financing activities(82,157)(170,985)
Effect of exchange rate changes on cash and cash equivalents(3,089)(4,670)
Decrease in cash and cash equivalents(570,507)(257,582)
Cash and cash equivalents, beginning of period$1,093,505 $881,320 
Cash and cash equivalents, end of period$522,998 $623,738 
See accompanying notes to the unaudited interim consolidated financial statements

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

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lululemon athletica inc.
NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL
STATEMENTS
NOTE 1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Nature of operations
lululemon athletica inc., a Delaware corporation ("lululemon" and, together with its subsidiaries unless the context otherwise requires, the "Company") is engaged in the design, distribution, and retail of healthy lifestyle inspired athletic apparel and accessories. 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, and license and supply arrangements. The Company operates stores in the United States, Canada, the People's Republic of China ("PRC"), Australia, the United Kingdom, Japan, Germany, New Zealand, South Korea, Singapore, France, Malaysia, Sweden, Ireland, the Netherlands, Norway, and Switzerland. There were 506 and 491 company-operated stores in operation as of August 2, 2020 and February 2, 2020, respectively.
On July 7, 2020, the Company acquired Curiouser Products Inc., dba MIRROR, ("MIRROR") which has been consolidated from the date of acquisition. MIRROR generates net revenue from the sale of in-home fitness equipment and associated content subscriptions. Please refer to Note 3 for further information.
COVID-19 Pandemic
The outbreak of a novel strain of coronavirus ("COVID-19") was declared a global pandemic by the World Health Organization in March 2020.
In line with recommendations by public health officials and in accordance with governmental authority orders, the Company took actions to temporarily close the majority of its retail locations and to reduce operating hours. In February 2020, the Company temporarily closed all of its retail locations in Mainland China, and in March 2020, the Company temporarily closed all of its retail locations in North America, Europe, and certain countries in Asia Pacific. The stores in Mainland China reopened during the first quarter of fiscal 2020, and stores in other markets began reopening in accordance with local government and public health authority guidelines during the second quarter of fiscal 2020. The Company's stores are operating with restrictive measures in place such as reduced operating hours and limited occupancy levels. As of August 2, 2020, 492 of its company-operated stores were open. The Company's distribution centers in Columbus, Ohio and Sumner, Washington were temporarily closed for one and two weeks, respectively, during the first quarter of fiscal 2020 due to COVID-19.
In response to COVID-19, various government programs have been announced to provide financial relief for affected businesses. The most significant relief measures which the Company qualifies for are the Employee Retention Credit under the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") in the United States, and the Canada Emergency Wage Subsidy ("CEWS") under the COVID-19 Economic Response Plan in Canada. During the first two quarters of fiscal 2020, the Company recognized payroll subsidies totaling $35.5 million under these wage subsidy programs and similar plans in other jurisdictions. These subsidies were recorded as a reduction in the associated wage costs which the Company incurred, and were recognized in selling, general and administrative expenses.
The Company also qualifies for and has deferred certain corporate income tax payments and employer payroll tax payments. The most significant is the deferral of $127.5 million of Canadian corporate income tax payments which would otherwise have been paid during the first and second quarters of fiscal 2020 to the third quarter of fiscal 2020.
The Financial Accounting Standards Board ("FASB") staff issued guidance in April 2020 in relation to accounting for lease concessions made in connection with the effects of COVID-19. In accordance with this guidance, the Company has elected to treat COVID-19-related lease concessions as variable lease payments. The Company is actively negotiating commercially reasonable lease concessions. No significant lease concessions were recognized in the first two quarters of fiscal 2020.
Temporary store closures as a result of COVID-19 and associated reduction in operating income during the first two quarters of fiscal 2020 are considered to be an indicator of impairment and the Company performed an assessment of recoverability for the long-lived assets and right-of-use assets associated with closed retail locations. In the first quarter of fiscal 2020, the Company recognized an insignificant impairment charge as a result of this analysis.
Revenue is presented net of an allowance for expected returns, which is estimated based on historic return rates, trends, considering shifts towards increased online shopping by guests, and future expectations. In light of the store closures, the
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Company has extended its return policy. The increase in the sales return allowance reflects the higher proportion of direct to consumer net revenue and anticipated delays in returns as a result of reduced capacity at retail location and closures.
The COVID-19 pandemic has materially impacted the Company's operations. The extent to which COVID-19 continues to impact the Company's operations, and in turn, its operating results and financial position will depend on future developments, which are highly uncertain and cannot be predicted, including new information that may emerge concerning the severity of COVID-19 and the actions taken to contain it or treat its impact. Continued proliferation of the virus, or resurgence, may result in further or prolonged closures of its retail locations and distribution centers, reduce operating hours, interrupt the Company's supply chain, cause changes in guest behavior, and reduce discretionary spending. Such factors could result in the impairment of long-lived assets and right-of-use assets and the need for an increased provision against the carrying value of the Company's inventories.
Basis of presentation
The unaudited interim consolidated financial statements as of August 2, 2020 and for the quarters and two quarters ended August 2, 2020 and August 4, 2019 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 February 2, 2020 is derived from the Company's audited consolidated financial statements and related notes for the fiscal year ended February 2, 2020, which are included in Item 8 in the Company's fiscal 2019 Annual Report on Form 10-K filed with the SEC on March 26, 2020. 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 2019 Annual Report on Form 10-K. Changes in the significant accounting policies of the Company compared to those described in the Company's fiscal 2019 Annual Report on Form 10-K as a result of the acquisition of MIRROR are described below, and Note 2 sets out the impact of recent accounting pronouncements.
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 2020 will end on January 31, 2021 and will be a 52-week year. Fiscal 2019 was a 52-week year.
The Company's business is affected by the pattern of seasonality common to most retail apparel businesses. Historically, the Company has recognized a significant portion of its operating profit in the fourth fiscal quarter of each year as a result of increased net revenue during the holiday season.
Certain comparative figures have been reclassified to conform to the financial presentation adopted for the current year.
Accounting policies related to the acquisition of MIRROR
Business combinations
The purchase price of an acquisition is measured as the aggregate of the fair value of the consideration transferred including the acquisition-date fair value of the Company's previously held equity interests. The purchase price is allocated to the fair values of the tangible and intangible assets acquired and liabilities assumed, with any excess recorded as goodwill. These fair value determinations require judgment and may involve the use of significant estimates and assumptions. The purchase price allocation may be provisional during a measurement period of up to one year to provide reasonable time to obtain the information necessary to identify and measure the assets acquired and liabilities assumed. Any such measurement period adjustments are recognized in the period in which the adjustment amount is determined. Transaction costs associated with the acquisition are expensed as incurred.
Goodwill and intangible assets
Acquired finite-lived intangible assets are amortized on a straight-line basis over their estimated useful lives, and are reviewed for impairment when events or circumstances indicate that the asset group to which the intangible assets belong might be impaired. The Company revises the estimated remaining useful life of these assets when events or changes in circumstances warrant a revision. If the Company revises the useful life, the unamortized balance is amortized over the remaining useful life on a prospective basis.
Goodwill represents the excess of the aggregate of the consideration transferred over the net assets acquired and liabilities assumed and is tested annually for impairment, or more frequently if there are indicators of impairment.
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Revenue recognition and cost of goods sold
MIRROR generates net revenue from the sale of in-home fitness equipment and associated content subscriptions. Certain in-home fitness contracts contain multiple performance obligations, including hardware and a subscription service commitment. For customer contracts that contain multiple performance obligations the Company accounts for individual performance obligations if they are distinct. The transaction price is allocated to each performance obligation based on its standalone selling price.
The cost of digital content subscription services, including the costs of content creation, studio overhead, and related production departments is recorded in costs of goods sold.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
Recently adopted accounting pronouncements
In June 2016, the FASB issued guidance on ASC 326 "Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments". This guidance changes the impairment model for most financial assets and requires the use of a forward-looking expected loss model rather than incurred losses for instruments measured at amortized cost. Under this model, entities are required to estimate the lifetime expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset. The Company adopted this update during the first quarter of fiscal 2020 and it did not have a material impact on the Company's consolidated financial statements.
Recently issued accounting pronouncements
In December 2019, the FASB issued guidance on ASC 740, "Income Taxes". The amendments in this update simplify the accounting for income taxes by removing certain exceptions to the general principles in ASC 740. The amendments also improve consistent application and simplify GAAP for other areas of this topic by clarifying and amending existing guidance. This guidance is effective for the Company beginning in its first quarter of fiscal 2021 and early adoption is permitted. The Company is currently evaluating the impact that this new guidance may have on its consolidated financial statements but does not believe it will have a material impact.
In March 2020, the FASB released guidance on ASC 848, "Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting". This update provides optional expedients and exceptions to the current guidance on contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update apply only to contracts and hedging relationships that reference the London Interbank Offered Rate ("LIBOR") or another reference rate expected to be discontinued due to reference rate reform. The guidance was effective upon issuance and generally can be applied to applicable contract modifications through December 31, 2022. The Company is currently evaluating the impact that this new guidance may have on its consolidated financial statements but does not believe it will have a material impact.
NOTE 3. ACQUISITION
On July 7, 2020, the Company acquired all of the outstanding shares of MIRROR, an in-home fitness company with an interactive workout platform that features live and on-demand classes. The results of operations, financial position, and cash flows of MIRROR have been included in the Company's consolidated financial statements since the date of acquisition.
The following table summarizes the fair value of the consideration transferred at the date of acquisition, as well as the calculation of goodwill based on the excess of consideration over the provisional fair value of net assets acquired. As part of the transaction, the Company assumed $30.1 million of MIRROR's outstanding debt. This included $15.1 million of external debt that was settled as part of the transaction and $15.0 million of debt previously owed by MIRROR to the Company, which
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represents the effective settlement of a preexisting relationship. The debt was determined to be at market terms and was recognized as a component of the consideration transferred, and no gain or loss was recorded on settlement.
July 7, 2020
(in thousands)
Fair value of consideration transferred:
Cash paid to shareholders$428,261 
Employee options attributed to pre-combination vesting4,569 
Acquired debt settled on acquisition30,122 
Fair value of existing lululemon investment1,782 
464,734 
Less cash and cash equivalents acquired(12,153)
Fair value of consideration transferred, net of cash and cash equivalents acquired$452,581 
Less net assets acquired:
Assets acquired:
Inventories$16,734 
Prepaid expenses and other current assets3,492 
Intangible assets85,000 
Other non-current assets5,648 
$110,874 
Liabilities assumed:
Current liabilities$(13,465)
Current and non-current lease liabilities(3,246)
Net deferred income tax liability(4,074)
$(20,785)
Net assets acquired$90,089 
Goodwill$362,492 
The purchase price allocation remains provisional as the Company is still obtaining all information necessary to finalize the fair value of acquired intangibles, deferred taxes, certain contingencies, and resulting amount of goodwill as of the date of acquisition.
Goodwill relates to benefits expected as a result of the acquisition to MIRROR's business and has been allocated to the MIRROR reporting unit within the Company's other channels. None of the goodwill is expected to be deductible for income tax purposes.
The Company assigned a fair value to and estimated useful lives for the intangible assets acquired as part of the MIRROR business combination. The fair value of the separately identifiable intangible assets, and their estimated useful lives as of the acquisition date were as follows:
Estimated Fair ValueEstimated Useful Life
(In thousands)
Intangible assets:
Brand $26,500 20.0 years
Customer relationships28,000 10.0 years
Technology25,500 7.5 years
Content5,000 5.0 years
$85,000 
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Accounting for business combinations requires significant estimates and assumptions to derive the fair value of acquired assets and liabilities, and in the case of MIRROR, this is with specific reference to acquired intangible assets. The fair value of intangible assets was based upon widely-accepted valuation techniques, including discounted cash flows and relief from royalty and replacement cost methods, depending on the nature of the assets acquired or liabilities assumed. Inherent in each valuation technique are critical assumptions, including future revenue growth rates, gross margin, royalty rates, discount rates, and terminal value assumptions. The recognition of deferred tax assets in relation to the historic net operating losses of MIRROR relied on assumptions and estimates of the future profitability of the Company's US operations.
The Company has not disclosed pro forma information of the combined business as the transaction is not material to revenue or net earnings.
Acquisition-related expenses
In connection with the acquisition, the Company recognized certain acquisition-related expenses which are expensed as incurred. These expenses are recognized within acquisition-related expenses in the consolidated statements of operations include the following amounts:
transaction and integration costs, including fees for advisory and professional services incurred as part of the acquisition and integration costs subsequent to the acquisition;
acquisition-related compensation, including the partial acceleration of vesting of certain stock options, and amounts due to selling shareholders that are contingent upon continuing employment; and
gain recognized on the Company's existing investment in the acquiree as of the acquisition date.
The following table summarizes the acquisition-related expenses recognized during fiscal 2020:
Quarter Ended 
August 2, 2020
Two Quarters Ended 
August 2, 2020
(in thousands)
Acquisition-related expenses:
Transaction and integration costs$7,201 $9,246 
Gain on existing investment(782)(782)
Acquisition-related compensation5,045 5,045 
$11,464 $13,509 
Income tax effects of acquisition-related expenses$(1,967)$(1,967)
In the first two quarters of fiscal 2020, the Company recognized an expense of $2.9 million for the partial acceleration of vesting of certain stock options held by MIRROR employees, and recognized $2.1 million related to deferred consideration.
The Company will recognize a total expense of $57.1 million for deferred consideration which is due to certain continuing MIRROR employees, subject to the continued employment of those individuals through various vesting dates up to three years from the acquisition date. This acquisition-related compensation is expensed over the vesting periods as service is provided, and consists of cash payments, which are included within accrued compensation and related expenses until payments are made, and stock-based compensation awards that have been granted under the Company's 2014 Equity Incentive Plan to replace certain unvested options as of the acquisition date.
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NOTE 4. GOODWILL
The Company's goodwill is assigned to its company-operated stores and other segments. The changes in the carrying amounts of goodwill were as follows:
Goodwill
(In thousands)
Balance as of February 2, 2020$24,182 
MIRROR acquisition362,492 
Effect of foreign currency translation(81)
Balance as of August 2, 2020$386,593 
NOTE 5. INTANGIBLE ASSETS, NET
The carrying value of intangible assets, and their estimated remaining useful lives as of August 2, 2020 were as follows:
August 2,
2020
February 2,
2020
Remaining Useful Life
(In thousands)
Intangible assets, net:
Brand$26,390 $ 19.9 years
Customer relationships27,758  9.9 years
Technology25,211  7.4 years
Content4,917  4.9 years
Other195 241 2.2 years
$84,471 $241 
NOTE 6. CREDIT FACILITIES
North America revolving credit facility
On June 6, 2018, the Company entered into Amendment No. 1 to its credit agreement. This amended 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 decreased 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%, reduced the commitment fee on average daily unused amounts under the revolving facility from 0.125%-0.200% to 0.10%-0.20%, and reduced fees for unused letters of credit from 1.00%-1.75% to 1.00%-1.50%.
The Company is required to follow certain covenants. As of August 2, 2020, the Company was in compliance with these covenants.
The Company had no borrowings outstanding under this credit facility as of August 2, 2020 and February 2, 2020. As of August 2, 2020, the Company had letters of credit of $2.3 million outstanding.
Mainland China revolving credit facility
In December 2019, the Company entered into an uncommitted and unsecured 130.0 million Chinese Yuan revolving credit facility. The terms are reviewed on an annual basis. The facility includes a revolving loan of up to 100.0 million Chinese Yuan as well as a financial bank guarantee facility of up to 30.0 million Chinese Yuan, or its equivalent in another currency. In U.S. dollars, the uncommitted and unsecured revolving credit facility is equivalent to $18.6 million, the revolving loan is equivalent of up to $14.3 million, and the financial bank guarantee facility is equivalent of up to $4.3 million. Loans are available in Chinese Yuan for a period not to exceed 12 months, and interest accrues on them at a rate equal to 105% of the applicable PBOC Benchmark Lending Rate. Guarantees have a commission equal to 1% per annum of the outstanding amount.
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The Company is required to follow certain covenants. As of August 2, 2020, the Company was in compliance with these covenants. As of August 2, 2020, there were no borrowings outstanding under this credit facility.
364-Day revolving credit facility
On June 29, 2020, the Company entered into a 364-day credit agreement providing for a $300.0 million committed and unsecured revolving credit facility. The credit agreement matures on June 28, 2021. Bank of America, N.A., is administrative agent and swing line lender. Borrowings under the credit facility may be prepaid and commitments may be reduced or terminated without premium or penalty (other than customary breakage costs).
Borrowings made under the credit facility bear interest at a rate per annum equal to, at the Company's option, either (1) a rate based on the rates applicable for deposits on the interbank market for U.S. Dollars or the applicable currency in which the borrowings are made (“LIBOR”) or (2) an alternate base rate, plus, in each case, an applicable margin. The applicable margin is determined by reference to a pricing grid, based on the ratio of indebtedness to earnings before interest, tax depreciation, amortization, and rent (“EBITDAR”) and ranges between 1.50%-2.25% for LIBOR loans and 0.50%-1.25% for alternate base rate or Canadian prime rate loans. Additionally, a commitment fee of between 0.25%-0.55%, also determined by reference to the pricing grid, is payable on the average daily unused amounts under the credit facility.
The credit agreement contains negative covenants that, among other things and subject to certain exceptions, limit the ability of the Company's subsidiaries to incur indebtedness, incur liens, undergo fundamental changes, make dispositions of all or substantially all of their assets, alter their businesses and enter into agreements limiting subsidiary dividends and distributions.
The Company is also required to maintain a consolidated rent-adjusted leverage ratio of not greater than 3.50:1.00 and the Company is not permitted to allow the ratio of consolidated EBITDAR to consolidated interest charges (plus rent) to be less than 2.00:1.00. The credit agreement also contains certain customary representations, warranties, affirmative covenants, and events of default (including, among others, an event of default upon the occurrence of a change of control). If an event of default occurs, the credit agreement may be terminated, and the maturity of any outstanding amounts may be accelerated. As of August 2, 2020, the Company was in compliance with the covenants. As of August 2, 2020, there were no borrowings outstanding under this credit facility.
NOTE 7. STOCK-BASED COMPENSATION AND BENEFIT PLANS
Stock-based compensation plans
The Company's eligible employees participate in various stock-based compensation plans, which are provided by the Company directly.
Stock-based compensation expense charged to income for the plans was $24.9 million and $23.5 million for the two quarters ended August 2, 2020 and August 4, 2019, respectively. Total unrecognized compensation cost for all stock-based compensation plans was $95.5 million at August 2, 2020, which is expected to be recognized over a weighted-average period of 2.2 years.
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A summary of the balances of the Company's stock-based compensation plans as of August 2, 2020, and changes during the first two quarters then ended, is presented below:
Stock OptionsPerformance-Based Restricted Stock UnitsRestricted SharesRestricted Stock UnitsRestricted Stock Units
(Liability Accounting)
NumberWeighted-Average Exercise PriceNumberWeighted-Average Grant Date Fair ValueNumberWeighted-Average Grant Date Fair ValueNumberWeighted-Average Grant Date Fair ValueNumberWeighted-Average Fair Value
(In thousands, except per share amounts)
Balance at February 2, 2020776 $113.41 238 $103.52 7 $175.82 333 $108.44 29 $239.39 
Granted233 177.71 136 115.73 4 296.36 119 197.45   
Exercised/released145 85.80 171 63.03 7 175.82 165 86.93   
Forfeited/expired26 158.45 7 158.76   9 156.80   
Balance at August 2, 2020838 $134.68 196 $145.13 4 $296.36 278 $157.64 29 $325.59 
Exercisable at August 2, 2020175 $100.92 
The grant date 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 during the first two quarters of fiscal 2020:
 Two Quarters Ended 
August 2, 2020
Expected term3.61 years
Expected volatility40.03 %
Risk-free interest rate0.32 %
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 grant date 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. Restricted stock units that are settled in cash or common stock at the election of the employee are remeasured to fair value at the end of each reporting period until settlement. This fair value is based on the closing price of the Company's common stock on the last business day before each period end.
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 August 2, 2020, there were 14.9 thousand shares purchased.
Defined contribution pension plans
The Company offers defined contribution pension plans to its eligible employees. 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
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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 $4.5 million and $4.3 million in the first two quarters of fiscal 2020 and fiscal 2019, respectively.
NOTE 8. 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 August 2, 2020 and February 2, 2020, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis:
August 2, 2020Level 1Level 2Level 3Balance Sheet Classification
(In thousands)
Money market funds$179,151 $179,151 $ $ Cash and cash equivalents
Term deposits70,136  70,136  Cash and cash equivalents
Forward currency contract assets6,513  6,513  Prepaid expenses and other current assets
Forward currency contract liabilities6,559  6,559  Other current liabilities
February 2, 2020Level 1Level 2Level 3Balance Sheet Classification
(In thousands)
Money market funds$610,800 $610,800 $ $ Cash and cash equivalents
Term deposits203,360  203,360  Cash and cash equivalents
Forward currency contract assets1,735  1,735  Prepaid expenses and other current assets
Forward currency contract liabilities1,920  1,920  Other current liabilities
The Company records accounts receivable, accounts payable, and accrued liabilities at cost. The carrying values of these instruments approximate their fair value due to their short-term maturities.
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. The Company's Master International Swap Dealers Association, Inc., Agreements and other similar arrangements allow net settlements under certain conditions. However, the Company records all derivatives on its consolidated balance sheets at fair value and does not offset derivative assets and liabilities.
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NOTE 9. 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 and changes in the Chinese Yuan 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 2020.
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 2020, 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 and Chinese 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.
Quantitative disclosures about derivative financial instruments
The Company presents its derivative assets and derivative liabilities at their gross fair values within 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 August 2, 2020, there were derivative assets of $6.5 million and derivative liabilities of $6.6 million subject to enforceable netting arrangements.
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The notional amounts and fair values of forward currency contracts were as follows:
August 2, 2020February 2, 2020
Gross NotionalAssetsLiabilitiesGross NotionalAssetsLiabilities
(In thousands)
Derivatives designated as net investment hedges:
Forward currency contracts$721,000 $ $5,870 $417,000 $1,583 $ 
Derivatives not designated in a hedging relationship:
Forward currency contracts726,000 6,513 689 460,000 152 1,920 
Net derivatives recognized on consolidated balance sheets:
Forward currency contracts$6,513 $6,559 $1,735 $1,920 
The forward currency contracts designated as net investment hedges outstanding as of August 2, 2020 mature on different dates between August 2020 and February 2021.
The forward currency contracts not designated in a hedging relationship outstanding as of August 2, 2020 mature on different dates between August 2020 and January 2021.
The pre-tax gains and losses on foreign exchange forward contracts recorded in accumulated other comprehensive income or loss were as follows:
Quarter EndedTwo Quarters Ended
August 2, 2020August 4, 2019August 2, 2020August 4, 2019
(In thousands)
Gains (losses) recognized in foreign currency translation adjustment:
Derivatives designated as net investment hedges$(24,728)$(4,822)$3,528 $1,941 
No gains or losses have been reclassified from accumulated other comprehensive income or loss into net income for derivative financial instruments in a net investment hedging relationship, as the Company has not sold or liquidated (or substantially liquidated) its hedged subsidiary.
The pre-tax net foreign exchange and derivative gains and losses recorded in the consolidated statement of operations were as follows:
Quarter EndedTwo Quarters Ended
August 2, 2020August 4, 2019August 2, 2020August 4, 2019
(In thousands)
Gains (losses) recognized in selling, general and administrative expenses:
Foreign exchange gains (losses)$(23,867)$(4,452)$3,874 $1,245 
Derivatives not designated in a hedging relationship21,574 5,121 (5,946)(1,510)
Net foreign exchange and derivative gains (losses) $(2,293)$669 $(2,072)$(265)
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.
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NOTE 10. EARNINGS PER SHARE
The details of the computation of basic and diluted earnings per share are as follows:
Quarter EndedTwo Quarters Ended
August 2, 2020August 4, 2019August 2, 2020August 4, 2019
(In thousands, except per share amounts)
Net income$86,801 $124,990 $115,433 $221,593 
Basic weighted-average number of shares outstanding130,245 130,285 130,248 130,489 
Assumed conversion of dilutive stock options and awards554 498 554 571 
Diluted weighted-average number of shares outstanding130,799 130,783 130,802 131,060 
Basic earnings per share$0.67 $0.96 $0.89 $1.70 
Diluted earnings per share$0.66 $0.96 $0.88 $1.69 
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 August 2, 2020 and August 4, 2019, 58.2 thousand and 75.1 thousand 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 January 31, 2019, the Company's board of directors approved a stock repurchase program for up to $500.0 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. As of March 31, 2020, the Company temporarily paused its share repurchase program. As of August 2, 2020, the remaining aggregate value of shares available to be repurchased under this program was $263.6 million.
During the two quarters ended August 2, 2020 and August 4, 2019, 0.4 million and 1.0 million shares, respectively, were repurchased under the program at a total cost of $63.7 million and $165.1 million, respectively.
Subsequent to August 2, 2020, and up to September 1, 2020, no shares were repurchased.
NOTE 11. SUPPLEMENTARY FINANCIAL INFORMATION
A summary of certain consolidated balance sheet accounts is as follows:
August 2,
2020
February 2,
2020
(In thousands)
Inventories:
Finished goods$700,034 $540,580 
Provision to reduce inventories to net realizable value(27,261)(22,067)
$672,773 $518,513 
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August 2,
2020
February 2,
2020
(In thousands)
Prepaid expenses and other current assets:
Prepaid expenses$70,753 $64,568 
Forward currency contract assets6,513 1,735 
Government payroll subsidy receivables32,700  
Other current assets10,077 4,239 
$120,043 $70,542 
Property and equipment, net:
Land$70,843 $71,829 
Buildings29,910 30,187 
Leasehold improvements535,033 489,202 
Furniture and fixtures111,565 109,533 
Computer hardware102,263 95,399 
Computer software368,195 336,768 
Equipment and vehicles15,137 19,521 
Work in progress58,429 40,930 
Property and equipment, gross1,291,375 1,193,369 
Accumulated depreciation(592,861)(521,676)
$698,514 $671,693 
Other non-current assets:
Cloud computing arrangement implementation costs$45,999 $24,648 
Security deposits21,858 19,901 
Other9,441 11,652 
$77,298 $56,201 
Other accrued liabilities
Accrued duty, freight, and other operating expenses$93,658 $59,403 
Sales return allowances30,093 12,897 
Sales tax collected19,301 17,370 
Accrued capital expenditures13,624 5,457 
Forward currency contract liabilities6,559 1,920 
Accrued rent6,117 8,356 
Other8,084 7,238 
$177,436 $112,641 
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NOTE 12. SEGMENTED INFORMATION AND DISAGGREGATED NET REVENUE
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. Other net revenue includes revenue from outlets, temporary locations, sales to wholesale accounts, license and supply arrangements, and the sale of in-home fitness equipment and associated content subscriptions. During the first quarter of fiscal 2020, the Company reviewed its segment and general corporate expenses and determined certain costs that are more appropriately classified in different categories. Accordingly, comparative figures have been reclassified to conform to the financial presentation adopted for the current year.
Quarter EndedTwo Quarters Ended
August 2, 2020August 4, 2019August 2, 2020August 4, 2019
(In thousands)
Net revenue:
Company-operated stores$287,201 $583,756 $547,171 $1,090,178 
Direct to consumer554,302 217,636 906,341 427,480 
Other61,439 81,960 101,392 148,009 
$902,942 $883,352 $1,554,904 $1,665,667 
Segmented income (loss) from operations:
Company-operated stores$(5,293)$154,316 $(35,447)$275,227 
Direct to consumer237,595 86,618 394,542 165,955 
Other2,587 16,418 2,318 29,041 
234,889 257,352 361,413 470,223 
General corporate expense98,292 89,370 190,020 173,429 
Amortization of intangible assets724  724  
Acquisition-related expenses11,464  13,509  
Income from operations124,409 167,982 157,160 296,794 
Other income (expense), net(344)1,850 830 4,229 
Income before income tax expense$124,065 $169,832 $157,990 $301,023 
Capital expenditures:
Company-operated stores$27,316 $42,026 $61,135 $80,736 
Direct to consumer9,781 7,584 12,079 13,810 
Corporate and other15,525 17,720 31,509 41,218 
$52,622 $67,330 $104,723 $135,764 
Depreciation and amortization:
Company-operated stores$21,963 $23,712 $47,591 $44,772 
Direct to consumer2,928 2,970 5,612 5,432 
Corporate and other15,753 10,917 30,973 20,218 
$40,644 $37,599 $84,176 $70,422 
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The following table disaggregates the Company's net revenue by geographic area.
Quarter EndedTwo Quarters Ended
August 2, 2020August 4, 2019August 2, 2020August 4, 2019
(In thousands)
United States$595,918 $621,843 $1,055,270 $1,175,490 
Canada147,658 145,605 247,155 269,250 
Outside of North America159,366 115,904 252,479 220,927 
$902,942 $883,352 $1,554,904 $1,665,667 
The following table disaggregates the Company's net revenue by category.
Quarter EndedTwo Quarters Ended
August 2, 2020August 4, 2019August 2, 2020August 4, 2019
(In thousands)
Women's product$649,310 $616,197 $1,129,623 $1,179,180 
Men's product191,019 212,727 320,148 382,946 
Other categories62,613 54,428 105,133 103,541 
$902,942 $883,352 $1,554,904 $1,665,667 
NOTE 13. LEGAL PROCEEDINGS AND OTHER CONTINGENCIES
In addition to the legal proceedings described below, the Company is, from time to time, involved in routine legal matters, and audits and inspections by governmental agencies and other third parties which are incidental to the conduct of its business. This includes 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 legal proceedings, audits, and inspections 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 March 23, 2020, a former retail employee filed a representative action in the Los Angeles Superior Court alleging violation of the Private Attorney General Act ("PAGA") based on purported California labor code violations including failure to pay wages, failure to pay overtime, failure to provide accurate itemized statements, and failure to provide meal and rest periods. The plaintiff is seeking to recover civil penalties under PAGA. The Company intends to vigorously defend this matter.
On April 9, 2020, Aliign Activation Wear, LLC filed a lawsuit in the United States District Court for the Central District of California alleging federal trademark infringement, false designation of origin and unfair competition. The plaintiff is seeking injunctive relief, monetary damages and declaratory relief. The Company intends to vigorously defend this matter.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Some of the statements contained in this Form 10-Q and any documents incorporated herein by reference constitute forward-looking statements within the meaning of 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, the impact of the COVID-19 pandemic on our business and results of operations, expectations related to our acquisition of MIRROR, 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.
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The forward-looking statements contained in this Form 10-Q and any documents incorporated herein by reference reflect our current views about future events and are subject to risks, uncertainties, assumptions, and changes in circumstances that may cause events or our actual activities or results to differ significantly from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, actions, levels of activity, performance, or achievements. Readers are cautioned not to place undue reliance on these forward-looking statements. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements, including, but not limited to, those factors described in "Risk Factors" and elsewhere in this report.
The forward-looking statements contained in this Form 10-Q reflect our views and assumptions only as of the date of this Form 10-Q and are expressly qualified in their entirety by the cautionary statements included in this Form 10-Q. Except as required by applicable securities law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.
This information should be read in conjunction with the unaudited interim consolidated financial statements and the notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in our fiscal 2019 Annual Report on Form 10-K filed with the SEC on March 26, 2020.
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 vision to be the experiential brand that ignites a community of people through sweat, grow, and connect, which we call "living the sweatlife." 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 "to elevate the world by unleashing the full potential within every one of us."
Our healthy lifestyle inspired athletic apparel and accessories are marketed under the lululemon brand. We offer a comprehensive line of apparel and accessories for women and men. Our apparel assortment includes items such as pants, shorts, tops, and jackets designed for a healthy lifestyle including athletic activities such as yoga, running, training, and most other sweaty pursuits. We also offer fitness-related accessories.
During the second quarter of fiscal 2020, we acquired Curiouser Products Inc., dba MIRROR, for a purchase price of approximately $500.0 million, of which approximately $57.1 million is due to certain continuing employees subject to their continued employment through various vesting dates up to three years after the closing date of the transaction. MIRROR is a leading in-home fitness company with an interactive workout platform that features live and on-demand classes. The acquisition of MIRROR will bolster our digital sweatlife offerings and bring immersive and personalized in-home sweat, and mindfulness solutions to new and existing lululemon guests.
COVID-19 Pandemic
The outbreak of a novel strain of coronavirus ("COVID-19") was declared a global pandemic by the World Health Organization in March 2020. The spread of COVID-19 has caused public health officials to impose restrictions and to recommend precautions to mitigate the spread of the virus, especially when congregating in heavily populated areas, such as malls and lifestyle centers.
We have taken actions to temporarily close retail locations and to reduce operating hours, and we continue to monitor the situation and work closely with local authorities to prioritize the safety of our people and guests. In February 2020, we temporarily closed all of our retail locations in Mainland China. In March 2020, we temporarily closed all of our retail locations in North America, Europe, and certain countries in Asia Pacific. The stores in Mainland China reopened during the first quarter of fiscal 2020, and stores in other markets began reopening in accordance with local government and public health authority guidelines during the second quarter of fiscal 2020. As of August 2, 2020, 492 of our company-operated stores were open. Our distribution centers in Columbus, Ohio and Sumner, Washington were temporarily closed for one and two weeks, respectively, during the first quarter of fiscal 2020 due to COVID-19. As of August 2, 2020, all of our distribution centers were open.
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Our retail locations and distribution centers are operating with restrictive and precautionary measures in place such as reduced operating hours, physical distancing, enhanced cleaning and sanitation, and limited occupancy levels. This pandemic has also impacted the operations of our third party logistics providers and our manufacturing and supply partners, including through the closure or reduced capacity of facilities, and operational changes to accommodate physical distancing. As the pandemic continues, we may face further disruptions or increased operational and logistics costs throughout our supply chain.
There is significant uncertainty regarding the extent and duration of the impact that the COVID-19 pandemic will have on our store operations, the demand for our products, and on our supply chain. It had a material adverse impact on our results of operations for the first two quarters of fiscal 2020, and we expect it to continue to impact our results of operations, financial position, and liquidity. The extent to which COVID-19 impacts our results will depend on future developments, which are highly uncertain and cannot be predicted, including new information that may emerge concerning the severity of COVID-19 and the actions taken to contain it or treat its impact.
We remain confident in the long-term growth opportunities and our Power of Three growth plan and believe that we have sufficient cash and cash equivalents, and available capacity under our revolving credit facilities, to meet our liquidity needs. As of August 2, 2020, we had cash and cash equivalents of $523.0 million and the capacity under our committed revolving credit facilities was $697.7 million.
Financial Highlights
For the second quarter of fiscal 2020, compared to the second quarter of fiscal 2019:
Net revenue increased 2% to $902.9 million. On a constant dollar basis, net revenue increased 3%.
Company-operated stores net revenue decreased 51% to $287.2 million.
Direct to consumer net revenue increased 155% to $554.3 million, or increased 157% on a constant dollar basis. We held an online warehouse sale during the second quarter of fiscal 2020 which generated net revenue of $43.3 million.
Gross profit increased 1% to $489.5 million.
Gross margin decreased 80 basis points to 54.2%.
Acquisition-related expenses of $11.5 million were recognized.
Income from operations decreased 26% to $124.4 million.
Operating margin decreased 520 basis points to 13.8%.
Income tax expense decreased 17% to $37.3 million. Our effective tax rate for the second quarter of fiscal 2020 was 30.0% compared to 26.4% for the second quarter of fiscal 2019.
Diluted earnings per share were $0.66 compared to $0.96 in the second quarter of fiscal 2019. This includes $9.5 million of after-tax costs related to the MIRROR acquisition, which reduced diluted earnings per share by $0.08 for the second quarter of fiscal 2020.
As the temporary store closures from COVID-19 have resulted in a significant number of stores being removed from our comparable store base, total comparable sales and comparable store sales are not currently representative of the underlying trends of our business. We do not believe these metrics are currently useful to investors in understanding performance, therefore we have not included these metrics in our discussion and analysis of results of operations.
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 and direct to consumer net revenue and the most directly comparable measures calculated in accordance with GAAP.
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Results of Operations
Second Quarter Results
The following table summarizes key components of our results of operations for the quarters ended August 2, 2020 and August 4, 2019. The percentages are presented as a percentage of net revenue.
 Quarter Ended
 August 2, 2020August 4, 2019August 2, 2020August 4, 2019
 (In thousands)(Percentages)
Net revenue$902,942 $883,352 100.0 %100.0 %
Cost of goods sold413,441 397,556 45.8 45.0 
Gross profit489,501 485,796 54.2 55.0 
Selling, general and administrative expenses352,904 317,814 39.1 36.0 
Amortization of intangible assets724  0.1  
Acquisition-related expenses11,464  1.3  
Income from operations124,409 167,982 13.8 19.0 
Other income (expense), net(344)1,850  0.2 
Income before income tax expense124,065 169,832 13.7 19.2 
Income tax expense37,264 44,842 4.1 5.1 
Net income$86,801 $124,990 9.6 %14.1 %
Net Revenue
Net revenue increased $19.6 million, or 2%, to $902.9 million for the second quarter of fiscal 2020 from $883.4 million for the second quarter of fiscal 2019. On a constant dollar basis, assuming the average exchange rates for the second quarter of fiscal 2020 remained constant with the average exchange rates for the second quarter of fiscal 2019, net revenue increased $26.6 million, or 3%.
The increase in net revenue was primarily due to increased direct to consumer net revenue. This was partially offset by a decrease in company-operated store revenue, as well as a decrease in net revenue from our other channels driven by temporary retail location closures as well as reduced operating hours and limited guest occupancy levels as a result of COVID-19.
Net revenue on a segment basis for the quarters ended August 2, 2020 and August 4, 2019 is summarized below. The percentages are presented as a percentage of total net revenue.
 Quarter Ended
 August 2, 2020August 4, 2019August 2, 2020August 4, 2019
 (In thousands)(Percentages)
Company-operated stores$287,201 $583,756 31.8 %66.1 %
Direct to consumer554,302 217,636 61.4 24.6 
Other61,439 81,960 6.8 9.3 
Net revenue$902,942 $883,352 100.0 %100.0 %
Company-Operated Stores. Net revenue from our company-operated stores segment decreased $296.6 million, or 51%, to $287.2 million in the second quarter of fiscal 2020 from $583.8 million in the second quarter of fiscal 2019. The decrease in net revenue from our company-operated stores segment was primarily due to the impact of COVID-19, including temporary store closures, reduced operating hours, and occupancy restrictions.
Direct to Consumer. Net revenue from our direct to consumer segment increased $336.7 million, or 155%, to $554.3 million in the second quarter of fiscal 2020 from $217.6 million in the second quarter of fiscal 2019. Direct to consumer net revenue increased 157% on a constant dollar basis. The increase in net revenue from our direct to consumer segment was primarily a result of increased website traffic and improved conversion rates. This was partially offset by a decrease in dollar value per transaction. The shift in the way guests are shopping continued in the second quarter of fiscal 2020 as a result of COVID-19, with more guests shopping online instead of in-store. During the second quarter of fiscal 2020, we held an online warehouse sale in the United States and Canada which generated net revenue of $43.3 million. We did not hold any warehouse sales during the second quarter of fiscal 2019.
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Other. Net revenue from our other segment decreased $20.5 million, or 25%, to $61.4 million in the second quarter of fiscal 2020 from $82.0 million in the second quarter of fiscal 2019. This decrease was primarily the result of COVID-19, including temporary location closures, reduced operating hours, and occupancy restrictions.
Gross Profit
Gross profit increased $3.7 million, or less than 1%, to $489.5 million for the second quarter of fiscal 2020 from $485.8 million for the second quarter of fiscal 2019.
Gross profit as a percentage of net revenue, or gross margin, decreased 80 basis points to 54.2% in the second quarter of fiscal 2020 from 55.0% in the second quarter of fiscal 2019. The decrease in gross margin was primarily the result of:
an increase in costs as a percentage of revenue related to our distribution centers of 130 basis points; and
an unfavorable impact of foreign exchange rates of 20 basis points.
This was partially offset by a decrease in costs related to our product departments as a percentage of revenue of 40 basis points, and a decrease in depreciation and occupancy costs as a percentage of revenue of 30 basis points. Product margin was consistent with the second quarter of fiscal 2019 primarily due to lower product costs and product mix, offset by higher markdowns.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $35.1 million, or 11%, to $352.9 million in the second quarter of fiscal 2020 from $317.8 million in the second quarter of fiscal 2019. The increase in selling, general and administrative expenses was primarily due to:
an increase in costs related to our operating channels of $38.7 million, comprised of:
an increase in variable costs of $36.9 million primarily due to an increase in distribution costs as a result of increased direct to consumer net revenue;
an increase in other costs of $19.2 million primarily due to increased digital marketing expenses; and
a decrease in employee costs of $17.4 million primarily due to lower incentive compensation expenses in our company-operated store and other channels;
an increase in head office costs of $14.3 million, comprised of:
an increase of $15.8 million primarily due to increases in information technology costs, professional fees, and depreciation; and
a decrease in employee costs of $1.5 million primarily due to decreased travel and decreased incentive compensation expense, partially offset by increased salaries and wages expense as a result of headcount growth, and stock-based compensation expense; and
an increase in net foreign exchange and derivative revaluation losses of $3.0 million.
The increase in selling, general and administrative expenses was partially offset by $20.9 million of government payroll subsidies which were recognized during the second quarter of fiscal 2020.
As a percentage of net revenue, selling, general and administrative expenses increased 310 basis points, to 39.1% in the second quarter of fiscal 2020 from 36.0% in the second quarter of fiscal 2019.
Amortization of intangible assets
Amortization of intangible assets was $0.7 million in the second quarter of fiscal 2020. This was primarily the result of the recognition of intangible assets of $85.0 million in the second quarter of fiscal 2020 as a result of our acquisition of MIRROR. We did not recognize an expense for the amortization of intangible assets in the second quarter of fiscal 2019.
Acquisition-related expenses
As a result of our acquisition of MIRROR in the second quarter of fiscal 2020, we recognized acquisition-related expenses of $11.5 million in the second quarter of fiscal 2020. This included transaction and integration related costs of $7.2 million for advisory and professional services, and integration costs subsequent to the acquisition. This also included acquisition-related compensation of $5.0 million for the partial acceleration of vesting of certain options and deferred
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consideration due to certain continuing MIRROR employees. Acquisition-related expenses were partially offset by a $0.8 million gain recognized on our existing investment. We did not have acquisition-related expenses in the second quarter of fiscal 2019. Please refer to Note 3 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report for further information.
Income from Operations
Income from operations decreased $43.6 million, or 26%, to $124.4 million in the second quarter of fiscal 2020 from $168.0 million in the second quarter of fiscal 2019. Operating margin decreased 520 basis points to 13.8% compared to 19.0% in the second quarter of fiscal 2019.
On a segment basis, we determine income from operations without taking into account our general corporate expenses. During the first quarter of fiscal 2020, we reviewed our segment and general corporate expenses and determined certain costs that are more appropriately classified in different categories. Accordingly, comparative figures have been reclassified to conform to the financial presentation adopted for the current year.
Segmented income (loss) from operations for the quarters ended August 2, 2020 and August 4, 2019 is summarized below. The percentages are presented as a percentage of net revenue of the respective operating segments.
 Quarter Ended
 August 2, 2020August 4, 2019August 2, 2020August 4, 2019
 (In thousands)(Percentage of segment revenue)
Segmented income (loss) from operations:
Company-operated stores$(5,293)$154,316 (1.8)%26.4 %
Direct to consumer237,595 86,618 42.9 39.8 
Other2,587 16,418 4.2 20.0 
234,889 257,352 
General corporate expense98,292 89,370 
Amortization of intangible assets724  
Acquisition-related expenses11,464  
Income from operations$124,409 $167,982 
Company-Operated Stores. Income from operations from our company-operated stores segment decreased $159.6 million, or 103%, to a loss of $5.3 million for the second quarter of fiscal 2020 from income of $154.3 million for the second quarter of fiscal 2019. The decrease was primarily the result of decreased gross profit of $209.3 million which was primarily due to lower net revenue as a result of the impact of COVID-19 restrictions, and lower gross margin, which was primarily due to deleverage on occupancy and depreciation costs as a result of lower net revenue. This was partially offset by a decrease in selling, general and administrative expenses, primarily due to decreased store operating expenses including lower incentive compensation, credit card fees, packaging costs, and distribution costs primarily as a result of lower net revenue, and due to the recognition of government payroll subsidies and lower community costs. Income from operations as a percentage of company-operated stores net revenue decreased primarily due to lower gross margin and deleverage on selling, general and administrative expenses.
Direct to Consumer. Income from operations from our direct to consumer segment increased $151.0 million, or 174%, to $237.6 million for the second quarter of fiscal 2020 from $86.6 million for the second quarter of fiscal 2019. The increase was primarily the result of increased gross profit of $222.2 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 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 310 basis points primarily due to leverage on selling, general and administrative expenses and higher gross margin.
Other. Income from operations from our other channels decreased $13.8 million, or 84%, to $2.6 million for the second quarter of fiscal 2020 from $16.4 million for the second quarter of fiscal 2019. The decrease was primarily the result of decreased gross profit of $9.2 million which was primarily due to decreased net revenue. This was partially offset by an increase in selling, general and administrative expenses primarily due to an increase in marketing costs, partially offset by decreased operating expenses including lower incentive compensation, credit card fees, packaging costs, and distribution costs primarily as a result of lower net revenue. Income from operations as a percentage of other net revenue decreased primarily due to deleverage on selling, general and administrative expenses.
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General Corporate Expense. General corporate expense increased $8.9 million, or 10%, to $98.3 million for the second quarter of fiscal 2020 from $89.4 million for the second quarter of fiscal 2019. This increase was primarily due to increases in depreciation, information technology costs, and professional fees, and an increase in net foreign exchange and derivative revaluation losses of $3.0 million. The increase in general corporate expense was partially offset by a decrease in incentive compensation and the recognition of government payroll subsidies.
Other Income (Expense), Net
Other income, net decreased $2.2 million, or 119%, to an expense of $0.3 million for the second quarter of fiscal 2020 from income of $1.9 million for the second quarter of fiscal 2019. The decrease was primarily due to a decrease in net interest income.
Income Tax Expense
Income tax expense decreased $7.6 million, or 17%, to $37.3 million for the second quarter of fiscal 2020 from $44.8 million for the second quarter of fiscal 2019. The effective tax rate for the second quarter of fiscal 2020 was 30.0% compared to 26.4% for the second quarter of fiscal 2019.
The increase in the effective tax rate was due to certain non-deductible expenses related to the MIRROR acquisition which increased the effective tax rate by 110 basis points, and due to new regulations which resulted in additional foreign tax credits being recognized in the second quarter of fiscal 2019.
Net Income
Net income decreased $38.2 million, or 31%, to $86.8 million for the second quarter of fiscal 2020 from $125.0 million for the second quarter of fiscal 2019. This was primarily due to an increase in selling, general and administrative expenses of $35.1 million, acquisition-related expenses of $11.5 million, amortization of intangible assets of $0.7 million, and a decrease in other income (expense), net of $2.2 million, partially offset by an increase in gross profit of $3.7 million, and a decrease in income tax expense of $7.6 million.
First Two Quarters Results
The following table summarizes key components of our results of operations for the first two quarters ended August 2, 2020 and August 4, 2019. The percentages are presented as a percentage of net revenue.
 Two Quarters Ended
 August 2, 2020August 4, 2019August 2, 2020August 4, 2019
 (In thousands)(Percentages)
Net revenue$1,554,904 $1,665,667 100.0 %100.0 %
Cost of goods sold731,001 758,151 47.0 45.5 
Gross profit823,903 907,516 53.0 54.5 
Selling, general and administrative expenses652,510 610,722 42.0 36.7 
Amortization of intangible assets724    
Acquisition-related expenses13,509  0.9  
Income from operations157,160 296,794 10.1 17.8 
Other income (expense), net830 4,229 0.1 0.3 
Income before income tax expense157,990 301,023 10.2 18.1 
Income tax expense42,557 79,430 2.7 4.8 
Net income$115,433 $221,593 7.4 %13.3 %
Net Revenue
Net revenue decreased $110.8 million, or 7%, to $1.555 billion for the first two quarters of fiscal 2020 from $1.666 billion for the first two quarters of fiscal 2019. On a constant dollar basis, assuming the average exchange rates for the first two quarters of fiscal 2020 remained constant with the average exchange rates for the first two quarters of fiscal 2019, net revenue decreased $96.1 million, or 6%.
The decrease in net revenue was primarily due to a decrease in company-operated store net revenue as well as a decrease in net revenue from our other locations driven by temporary retail location closures as well as reduced operating hours and
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limited guest occupancy levels as a result of COVID-19. This was partially offset by an increase in direct to consumer net revenue.
Net revenue on a segment basis for the first two quarters ended August 2, 2020 and August 4, 2019 is summarized below. The percentages are presented as a percentage of total net revenue.
 Two Quarters Ended
 August 2, 2020August 4, 2019August 2, 2020August 4, 2019
 (In thousands)(Percentages)
Company-operated stores$547,171 $1,090,178 35.2 %65.4 %
Direct to consumer906,341 427,480 58.3 25.7 
Other101,392 148,009 6.5 8.9 
Net revenue$1,554,904 $1,665,667 100.0 %100.0 %
Company-Operated Stores. Net revenue from our company-operated stores segment decreased $543.0 million, or 50%, to $547.2 million in the first two quarters of fiscal 2020 from $1.090 billion in the first two quarters of fiscal 2019. The decrease in net revenue from our company-operated stores segment was primarily due to the impact of COVID-19. All of our stores in North America, Europe, and certain countries in Asia Pacific were temporarily closed for a significant portion of the first two quarters of fiscal 2020. Since re-opening our company-operated store net revenues have been impacted by COVID-19 restrictions including reduced operating hours and occupancy limits.
Direct to Consumer. Net revenue from our direct to consumer segment increased $478.9 million, or 112%, to $906.3 million in the first two quarters of fiscal 2020 from $427.5 million in the first two quarters of fiscal 2019. Direct to consumer net revenue increased 114% on a constant dollar basis. The increase in net revenue from our direct to consumer segment was primarily a result of increased website traffic and improved conversion rates. This was partially offset by a decrease in dollar value per transaction. There was a shift in the way guests shopped in the first two quarters of fiscal 2020 as a result of COVID-19, with more guests shopping online instead of in-store. During the second quarter of fiscal 2020, we held an online warehouse sale in the United States and Canada which generated net revenue of $43.3 million. We did not hold any warehouse sales during the first two quarters of fiscal 2019.
Other. Net revenue from our other segment decreased $46.6 million, or 31%, to $101.4 million in the first two quarters of fiscal 2020 from $148.0 million in the first two quarters of fiscal 2019. This decrease was primarily the result of COVID-19, including temporary location closures, reduced operating hours, and occupancy restrictions.
Gross Profit
Gross profit decreased $83.6 million, or 9%, to $823.9 million for the first two quarters of fiscal 2020 from $907.5 million for the first two quarters of fiscal 2019.
Gross profit as a percentage of net revenue, or gross margin, decreased 150 basis points, to 53.0% in the first two quarters of fiscal 2020 from 54.5% in the first two quarters of fiscal 2019. The decrease in gross margin was primarily the result of:
an increase in occupancy and depreciation costs as a percentage of revenue of 120 basis points;
an increase in costs as a percentage of revenue related to our distribution centers of 110 basis points; and
an unfavorable impact of foreign exchange rates of 20 basis points.
This was partially offset by an increase in product margin of 80 basis points primarily due to lower product costs, and a favorable mix of higher margin product, partially offset by higher markdowns, and a decrease in costs related to our product departments as a percentage of revenue of 20 basis points.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $41.8 million, or 7%, to $652.5 million in the first two quarters of fiscal 2020 from $610.7 million in the first two quarters of fiscal 2019. The increase in selling, general and administrative expenses was primarily due to:
an increase in costs related to our operating channels of $55.2 million, comprised of:
an increase in variable costs of $47.3 million primarily due to an increase in distribution costs as a result of increased direct to consumer net revenue;
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an increase in other costs of $30.6 million primarily due to increased digital marketing expenses; and
a decrease in employee costs of $22.7 million primarily due to lower incentive compensation expenses in our company-operated store and other channels;
an increase in head office costs of $20.0 million, comprised of:
an increase of $32.1 million primarily due to increases in information technology costs, depreciation, and brand and community costs; and
a decrease in employee costs of $12.1 million primarily due to decreased incentive compensation expense and decreased travel, partially offset by increased salaries and wages expense as a result of headcount growth; and
an increase in net foreign exchange and derivative revaluation losses of $1.8 million.
The increase in selling, general and administrative expenses was partially offset by $35.2 million of government payroll subsidies which were recognized during the first two quarters of fiscal 2020.
As a percentage of net revenue, selling, general and administrative expenses increased 530 basis points, to 42.0% in the first two quarters of fiscal 2020 from 36.7% in the first two quarters of fiscal 2019.
Amortization of intangible assets
Amortization of intangible assets was $0.7 million in the first two quarters of fiscal 2020. This was primarily the result of the recognition of intangible assets of $85.0 million in the second quarter of fiscal 2020 as a result of our acquisition of MIRROR. We did not recognize an expense for the amortization intangible assets in the first two quarters of fiscal 2019.
Acquisition-related expenses
As a result of our acquisition of MIRROR in the second quarter of fiscal 2020, we recognized acquisition-related expenses of $13.5 million in the first two quarters of fiscal 2020. This included transaction and integration related costs of $9.2 million for advisory and professional services, and integration costs subsequent to the acquisition. This also included acquisition-related compensation of $5.0 million for the partial acceleration of vesting of certain options and deferred consideration to certain continuing MIRROR employees. Acquisition-related expenses were partially offset by a $0.8 million gain recognized on our existing investment. We did not have acquisition-related expenses in the first two quarters of fiscal 2019. Please refer to Note 3 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report for further information.
Income from Operations
Income from operations decreased $139.6 million, or 47%, to $157.2 million in the first two quarters of fiscal 2020 from $296.8 million in the first two quarters of fiscal 2019. Operating margin decreased 770 basis points to 10.1% compared to 17.8% in the first two quarters of fiscal 2019.
On a segment basis, we determine income from operations without taking into account our general corporate expenses. During the first quarter of fiscal 2020, we reviewed our segment and general corporate expenses and determined certain costs that are more appropriately classified in different categories. Accordingly, comparative figures have been reclassified to conform to the financial presentation adopted for the current year.
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Segmented income (loss) from operations for the first two quarters ended August 2, 2020 and August 4, 2019 is summarized below. The percentages are presented as a percentage of net revenue of the respective operating segments.
 Two Quarters Ended
 August 2, 2020August 4, 2019August 2, 2020