Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion summarizes our consolidated operating results, financial condition, and liquidity during the three-year period ending January 31, 2016. Our 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 2015, fiscal 2014, and fiscal 2013 were 52 week years. The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K.

This discussion and analysis contains forward-looking statements based on current expectations that involve risks, uncertainties and assumptions, such as our plans, objectives, expectations, and intentions set forth in the "Special Note Regarding Forward-Looking Statements." Our actual results and the timing of events may differ materially from those anticipated in these forward looking statements as a result of various factors, including those set forth in the "Item 1A. Risk Factors" section and elsewhere in this Annual Report on Form 10-K.

Overview

Fiscal 2015 was a year in which we made significant progress on our strategic priorities that positions us well for long term profitable growth.

We strengthened our leadership by filling key executive positions during the year and now have in place a complete, experienced, and culturally aligned management team to drive our strategic priorities towards our 10 year vision.

We reignited our product engine starting with our first global product launch, our new women's pant lines, that brought together the best of product innovation and education. We also reorganized our design and merchandising teams, resulting in a singular creative voice for our women's and men's product with a renewed focus on design and innovation.

We made key investments in our website, omni-channel capabilities, supply chain, and information technology infrastructure. These are foundational investments that will support and enable our long term growth.

In addition to continuing our expansion in the United States, we opened company-operated stores for the first time in Germany and Hong Kong and opened additional stores in Singapore and the United Kingdom. We also opened showrooms in new markets in France, Korea, Malaysia, Sweden, and Switzerland. As of January 31, 2016, we operated 20 showrooms in 10 different countries in Asia and Europe. In addition, our licensee in the Middle East opened two licensed stores in the United Arab Emirates during fiscal 2015.

In fiscal 2016, our top priority will be first to strengthen and grow our women's category, specifically with a renewed focus on our tops. For men's, we will continue to focus on product design, while also adding more dedicated square footage through store expansions. To further grow our direct to consumer segment, we will make investments in customer relationship management, analytics, and digital marketing, while also launching our new North America website in the first half of fiscal 2016. In international markets, we will focus our efforts in key cities, while expanding into new markets where we've seen strong traction from our showroom performance. Our final priority is operational excellence, where we are investing in developing a scalable and world-class supply chain and operational infrastructure that we expect to be a key enabler of our long term growth.

Financial Highlights

•	Our net revenue increased from $1.8 billion in fiscal 2014 to $2.1 billion in fiscal 2015, representing an annual growth rate of 15%. Our increase in net revenue from fiscal 2014 to fiscal 2015 resulted primarily from the addition of 61 net new company-operated stores and the growth of our direct to consumer segment.

•	Total comparable sales, which includes comparable store sales and direct to consumer, increased 5% in fiscal 2015 and increased by 10% on a constant dollar basis.

•

Company-operated stores accounted for 73.6% of total net revenue in fiscal 2015, 75.0% of total net revenue in fiscal 2014 and 77.3% of total net revenue in fiscal 2013. Comparable store sales increased by 4% on a constant dollar basis for fiscal 2015 primarily as the result of increased traffic which resulted in an increase in the number of transactions, and due to higher average unit retail prices.

•

Our direct to consumer segment is an increasingly substantial part of our growth strategy, and now represents 19.5% of our net revenue compared to 17.9% in fiscal 2014 and 16.5% in fiscal 2013. Direct to consumer net revenue increased 30% on a constant dollar basis primarily as the result of an increase in the number of transactions which was driven by increased traffic and higher conversion rates.

•

Gross profit for fiscal 2015 increased by 9% to $997.2 million, from $914.2 million in fiscal 2014. As a percentage of net revenue, gross profit decreased to 48.4% compared to 50.9% in fiscal 2014. The decrease in the gross margin was primarily due to an increase in fixed costs, such as occupancy and depreciation, an unfavorable impact of foreign exchange rates, and an increase in markdowns and discounts.

•	Income from operations for fiscal 2015 decreased by 2% to $369.1 million, from $376.0 million in fiscal 2014. The decrease in income from operations was a result of an increase in selling, general and administrative expenses, partially offset by an increase in gross profit. As a percentage of net revenue, income from operations decreased to 17.9% compared to 20.9% of net revenue in fiscal 2014.

•

Income tax expense for fiscal 2015 decreased by 29% to $102.4 million, from $144.1 million in fiscal 2014. Our effective tax rate for fiscal 2015 was 27.8% compared to 37.6% for fiscal 2014. Fiscal 2015 included a net income tax recovery of $7.4 million related to our transfer pricing arrangements and estimated taxes associated with the repatriation of foreign earnings. In addition, fiscal 2015 included a related net interest expense of $3.5 million recorded in other (expense) income, net. Fiscal 2014 included an income tax expense of $33.7 million related to the repatriation of foreign earnings used to fund our share repurchase program. Our effective tax rate excluding these adjustments would have been 29.5% for fiscal 2015 compared to 28.8% for fiscal 2014.

•	Diluted earnings per share for fiscal 2015 were $1.89, compared to $1.66 in fiscal 2014. Excluding certain tax and related interest adjustments, diluted earnings per share were $1.86 for fiscal 2015 and $1.89 for fiscal 2014.

Refer to the non-GAAP reconciliation tables contained in the "Results of Operations" section of this "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for reconciliations of constant dollar total comparable sales, constant dollar comparable store sales, constant dollar changes in direct to consumer net revenue, the effective tax rate excluding certain tax and related interest adjustments, and diluted earnings per share excluding certain tax and related interest adjustments to measures calculated in accordance with United States generally accepted accounting principles ("GAAP").

General

Net revenue is comprised of company-operated store sales, direct to consumer sales through www.lululemon.com, www.ivivva.com, and other country and region specific websites, and other net revenue, which includes outlet sales, showroom sales, sales to wholesale accounts, warehouse sales, sales from temporary locations, and license and supply arrangement net revenue, which consists of royalties as well as sales of our products to licensees.

Cost of goods sold includes the cost of purchased merchandise, including freight, duty, and nonrefundable taxes incurred in delivering the goods to our distribution centers. It also includes occupancy costs and depreciation expense for our company-operated store locations, all costs incurred in operating our distribution centers and production, design, distribution, and merchandise departments, hemming, shrink, and inventory provision expense. The primary drivers of the costs of individual products are the costs of raw materials and labor in the countries where we source our merchandise.

Selling, general and administrative expenses consist of all operating costs not otherwise included in cost of goods sold. We expect selling, general and administrative expenses to increase in fiscal 2016 as we incur additional operating expenses to support our store and direct to consumer growth, while also making strategic investments to support the long term growth of the business.

Income tax expense depends on the statutory tax rates in the countries where we sell our products and the proportion of taxable income earned in those jurisdictions. To the extent the relative proportion of taxable income in the jurisdictions fluctuates, so will our effective tax rate. We also anticipate that, in the future, we may start to sell our products through retail locations located in countries in which we have not yet operated, in which case, we would become subject to taxation based on the foreign statutory rates in the countries where these sales take place and our effective tax rate could fluctuate accordingly.

Results of Operations

The following tables summarize key components of our results of operations for the periods indicated, both in dollars and as a percentage of net revenue:

		Fiscal Year Ended
		January 31, 2016				February 1, 2015				February 2, 2014
		(In thousands)
Consolidated statements of operations:
Net revenue		$	2,060,523			$	1,797,213			$	1,591,188
Cost of goods sold		1,063,357				883,033				751,112
Gross profit		997,166				914,180				840,076
Selling, general and administrative expenses		628,090				538,147				448,718
Income from operations		369,076				376,033				391,358
Other (expense) income, net		(581		)		7,102				5,768
Income before income tax expense		368,495				383,135				397,126
Income tax expense		102,448				144,102				117,579
Net income		$	266,047			$	239,033			$	279,547

		Fiscal Year Ended
		January 31, 2016			February 1, 2015			February 2, 2014
		(% of net revenue)
Net revenue		100.0	%		100.0	%		100.0	%
Cost of goods sold		51.6			49.1			47.2
Gross profit		48.4			50.9			52.8
Selling, general and administrative expenses		30.5			30.0			28.2
Income from operations		17.9			20.9			24.6
Other (expense) income, net		—			0.4			0.4
Income before income tax expense		17.9			21.3			25.0
Income tax expense		5.0			8.0			7.4
Net income		12.9	%		13.3	%		17.6	%

Comparison of Fiscal 2015 to Fiscal 2014

Net Revenue

Net revenue increased $263.3 million, or 15%, to $2.061 billion in fiscal 2015 from $1.797 billion in fiscal 2014. Assuming the average exchange rates in fiscal 2015 remained constant with the average exchange rates in fiscal 2014, our net revenue would have increased $352.2 million, or 20%.

The net revenue increase was primarily driven by sales from new stores and the growth of our direct to consumer segment. Total comparable sales, which includes comparable store sales and direct to consumer, increased 5% in fiscal 2015 compared to fiscal 2014. Excluding the effect of foreign currency fluctuations, total comparable sales would have increased by 10%.

Our net revenue on a segment basis for fiscal 2015 and fiscal 2014 is summarized below. Net revenue is expressed in dollar amounts. The percentages are presented as a percentage of total net revenue.

		Fiscal Years Ended January 31, 2016 and February 1, 2015
		2015				2014				2015			2014
		(In thousands)								(Percentages)
Company-operated stores		$	1,516,323			$	1,348,225			73.6	%		75.0	%
Direct to consumer		401,525				321,180				19.5			17.9
Other		142,675				127,808				6.9			7.1
Net revenue		$	2,060,523			$	1,797,213			100.0	%		100.0	%

Company-operated Stores. Net revenue from our company-operated stores segment increased $168.1 million, or 12%, to $1.516 billion in fiscal 2015 from $1.348 billion in fiscal 2014.

During fiscal 2015 we opened 61 net new stores, which included 49 stores in the United States, three stores in Canada, four stores in the United Kingdom, two stores in Hong Kong, and one store in each of Germany, Puerto Rico, and Singapore.

The increase in net revenue from our company-operated stores segment resulted from an increase of $175.4 million from non-comparable stores, which includes sales from new stores that have not been open for 12 months and sales from stores which have been significantly expanded. The increase in net revenue was partially offset by a decrease of $7.3 million from comparable store sales.

Comparable store sales decreased by less than 1% in fiscal 2015 compared to fiscal 2014. Excluding the effect of foreign currency fluctuations, comparable store sales would have increased 4%, or $48.8 million, in fiscal 2015. Comparable store sales, excluding the effect of foreign currency fluctuations, increased primarily as the result of increased traffic which resulted in an increase in the number of transactions, and due to higher average unit retail prices.

Direct to Consumer. Net revenue from our direct to consumer segment increased $80.3 million, or 25%, to $401.5 million in fiscal 2015 from $321.2 million in fiscal 2014. Excluding the effect of foreign exchange fluctuations, direct to consumer net revenue would have increased 30%. The increase in net revenue from our direct to consumer segment was primarily the result of an increase in the number of transactions which was driven by increased traffic and higher conversion rates on our e-commerce websites.

Other. Net revenue from our other segment increased $14.9 million, or 12%, to $142.7 million in fiscal 2015 from $127.8 million in fiscal 2014. This increase was primarily the result of an increased number of outlets and an increased number of warehouse sales held during fiscal 2015 compared to fiscal 2014. This was partially offset by fewer temporary locations open during fiscal 2015 compared to fiscal 2014.

Gross Profit

Gross profit increased $83.0 million, or 9%, to $997.2 million in fiscal 2015 from $914.2 million in fiscal 2014.

Gross profit, as a percentage of net revenue, or gross margin, decreased 250 basis points, to 48.4% in fiscal 2015 from 50.9% in fiscal 2014. The decrease in gross margin was primarily the result of:

•	an increase in fixed costs, such as occupancy costs and depreciation, relative to the increase in net revenue, of 90 basis points;

•	an unfavorable impact of foreign exchange rates on product costs which contributed to a decrease in gross margin of 90 basis points; and

•	a decrease in product margin of 70 basis points, primarily due to an increase in markdowns and discounts, as well as other product related costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $89.9 million, or 17%, to $628.1 million in fiscal 2015 from $538.1 million in fiscal 2014. The increase in selling, general and administrative expenses was principally comprised of:

•	an increase in employee costs for our operating locations of $36.8 million, primarily from a growth in labor hours and bonuses, mainly associated with new company-operated stores;

•	an increase in head office costs other than employee costs of $18.7 million primarily as a result of increased professional fees, including supply chain consulting costs, increased brand and community costs, and increased depreciation;

•	an increase in variable costs such as distribution costs, credit card fees, and packaging of $14.6 million primarily as a result of new company-operated stores as well as increased sales volume from our direct to consumer segment;

•	an increase in head office employee costs of $14.5 million to support the growth in our business; and

•	an increase in other costs of $10.9 million for our operating channels such as repairs and maintenance costs, digital marketing expenses, and store community costs.

The increase in selling, general and administrative expenses was partially offset by an increase in net foreign exchange revaluation gains of $5.6 million.

As a percentage of net revenue, selling, general and administrative expenses increased 50 basis points, to 30.5% in fiscal 2015 from 30.0% in fiscal 2014.

We expect selling, general and administrative expenses to increase in fiscal 2016 as we incur additional operating expenses to support our store and direct to consumer growth, while also making strategic investments to support the long term growth of our business.

Income from Operations

Income from operations decreased $7.0 million, or 2%, to $369.1 million in fiscal 2015 from $376.0 million in fiscal 2014. The decrease was a result of increased selling, general and administrative costs of $89.9 million, partially offset by increased gross profit of $83.0 million.

On a segment basis, we determine income from operations without taking into account our general corporate expenses.

Income from operations before general corporate expenses for fiscal 2015 and fiscal 2014 is summarized below and is expressed in dollar amounts. The percentages are presented as a percentage of net revenue of the respective operating segments.

		Fiscal Years Ended January 31, 2016 and February 1, 2015
		2015				2014				2015			2014
		(In thousands)								(Percentages)
Company-operated stores		$	346,802			$	356,589			22.9	%		26.4	%
Direct to consumer		166,418				132,877				41.4			41.4
Other		5,826				9,499				4.1			7.4
Income from operations before general corporate expense		519,046				498,965
General corporate expense		149,970				122,932
Income from operations		$	369,076			$	376,033

Company-operated Stores. Income from operations from our company-operated stores segment decreased $9.8 million, or 3%, to $346.8 million for fiscal 2015 from $356.6 million for fiscal 2014 primarily due to an increase in selling, general and administrative expenses related to employee costs as well as operating expenses associated with new stores, partially offset by an increase of $41.0 million in gross profit from increased sales. Income from operations as a percentage of company-operated stores net revenue decreased by 350 basis points primarily due to lower gross margin resulting from an increase in fixed costs relative to the increase in net revenue, unfavorable foreign exchange rates, and an increase in markdowns and discounts, as well as increased selling, general and administrative expenses as a percentage of net revenue.

Direct to Consumer. Income from operations from our direct to consumer segment increased $33.5 million, or 25%, to $166.4 million in fiscal 2015 from $132.9 million in fiscal 2014. The increase was primarily the result of increased gross profit of $39.8 million primarily due to increased net revenue resulting from an increase in the number of transactions which was driven by increased traffic and higher conversion rates, partially offset by increased selling, general and administrative expenses. Income from operations as a percentage of direct to consumer net revenue was 41.4% in each of fiscal 2015 and fiscal 2014.

Other. Income from operations from our other segment decreased $3.7 million, or 39%, to $5.8 million in fiscal 2015 from $9.5 million in fiscal 2014. Income from operations as a percentage of other net revenue decreased by 330 basis points primarily due to an increased proportion of outlet and warehouse sales within our other segment net revenue in fiscal 2015 compared to fiscal 2014 that carry a lower gross margin.

General Corporate Expense. General corporate expense increased $27.0 million, or 22%, to $150.0 million in fiscal 2015 from $122.9 million in fiscal 2014. This increase was primarily due to increased head office employee costs, professional fees, including increased professional fees related to supply chain consulting costs, and brand and community costs to support the growth of our business. The increase in general corporate expenses was partially offset by an increase in net foreign exchange revaluation gains of $5.6 million. General corporate expenses are expected to continue to increase in future years as we grow our overall business and require increased efforts at our head office to support our company-operated stores, direct to consumer and other segments.

Other (Expense) Income, Net

There was net other expense of $0.6 million in fiscal 2015 compared to net other income of $7.1 million in fiscal 2014. This was primarily the result of less interest earned on our decreased cash and cash equivalents in fiscal 2015 compared to fiscal 2014 as well as a net interest expense of $3.5 million related to certain tax adjustments that are outlined in Note 15 to the audited consolidated financial statements included in Item 8 of Part II of this report.

Income Tax Expense

Income tax expense decreased $41.7 million, or 29%, to $102.4 million in fiscal 2015 from $144.1 million in fiscal 2014. Our effective tax rate for fiscal 2015 was 27.8% compared to 37.6% for fiscal 2014. Fiscal 2015 included certain tax adjustments which resulted in a net recovery of $7.4 million as outlined in Note 15 to the audited consolidated financial statements included in Item 8 of Part II of this report. Fiscal 2014 included a tax expense of $33.7 million to provide for U.S. income and applicable foreign withholding taxes on dividends of $473.7 million which were distributed during fiscal 2014 from foreign subsidiaries to the U.S. parent entity to fund our share repurchase program. Our effective tax rate excluding these adjustments would have been 29.5% for fiscal 2015 compared to 28.8% for fiscal 2014.

Net Income

Net income increased $27.0 million, or 11%, to $266.0 million in fiscal 2015 from $239.0 million in fiscal 2014. The increase in net income in fiscal 2015 was primarily due to a $83.0 million increase in gross profit resulting from new stores and the growth of our direct to consumer segment and a decrease of $41.7 million in income tax expense, partially offset by an increase of $89.9 million in selling, general and administrative expenses and a $7.7 million increase in other (expense) income, net.

Comparison of Fiscal 2014 to Fiscal 2013

Net Revenue

Net revenue increased $206.0 million, or 13%, to $1.797 billion in fiscal 2014 from $1.591 billion in fiscal 2013. Assuming the average exchange rates in fiscal 2014 remained constant with the average exchange rates in fiscal 2013, our net revenue would have increased $241.7 million, or 15%.

The net revenue increase was driven by sales from new stores and the growth of our direct to consumer segment. Total comparable sales, which includes comparable store sales and direct to consumer, increased 1% in fiscal 2014 compared to fiscal 2013. Excluding the effect of foreign currency fluctuations, total comparable sales would have increased by 3%.

Our net revenue on a segment basis for fiscal 2014 and fiscal 2013 is summarized below. Net revenue is expressed in dollar amounts. The percentages are presented as a percentage of total net revenue.

		Fiscal Years Ended February 1, 2015 and February 2, 2014
		2014				2013				2014			2013
		(In thousands)								(Percentages)
Company-operated stores		$	1,348,225			$	1,228,999			75.0	%		77.3	%
Direct to consumer		321,180				263,083				17.9			16.5
Other		127,808				99,106				7.1			6.2
Net revenue		$	1,797,213			$	1,591,188			100.0	%		100.0	%

Company-operated Stores. Net revenue from our company-operated stores segment increased $119.2 million, or 10%, to $1.348 billion in fiscal 2014 from $1.229 billion in fiscal 2013. Net revenue from company-operated stores we opened during fiscal 2014, and during fiscal 2013 prior to sales from such stores becoming part of our comparable stores base, contributed $162.0 million of the increase. Net new store openings in fiscal 2014 included 40 stores in the United States, including eight ivivva branded stores, three stores in Canada, including two ivivva branded stores, one store in Australia, one store in New

Zealand, two stores in the United Kingdom, and one store in Singapore. The increase in net revenue from our company-operated stores segment was partially offset by a comparable store sales decrease of 3% in fiscal 2014 compared to fiscal 2013 which resulted in a $42.8 million decrease to net revenue, including the effect of foreign currency fluctuations. Excluding the effect of foreign currency fluctuations, comparable store sales would have decreased 1%, or $19.1 million, in fiscal 2014. Comparable store sales have decreased, primarily as the result of lower conversion rates and lower units purchased per transaction.

Direct to Consumer. Net revenue from our direct to consumer segment increased $58.1 million, or 22%, to $321.2 million in fiscal 2014 from $263.1 million in fiscal 2013. Excluding the effect of foreign exchange fluctuations, direct to consumer net revenue would have increased 24%. The increase in net revenue from our direct to consumer segment was a result of increasing traffic on our e-commerce websites.

Other. Net revenue from our other segment increased $28.7 million, or 29%, to $127.8 million in fiscal 2014 from $99.1 million in fiscal 2013. The increase in net revenue from our other segment was primarily due to increased sales from our outlets, showrooms, and temporary locations. We continue to employ our other segment strategy to increase interest in our product in markets where we may not have company-operated stores.

Gross Profit

Gross profit increased $74.1 million, or 9%, to $914.2 million in fiscal 2014 from $840.1 million in fiscal 2013. Increased net revenue resulted in an increased gross profit. A $17.5 million inventory provision related to the pull-back of black Luon pants was recorded in cost of sales during fiscal 2013.

Gross profit, as a percentage of net revenue, or gross margin, decreased 190 basis points, to 50.9% in fiscal 2014 from 52.8% in fiscal 2013. The decrease in gross margin resulted primarily from:

•	a decrease of 210 basis points due to product mix, increased product costs, and increased air freight costs;

•	an increase in expenses related to our product and supply chain departments, relative to the increase in net revenue, of 70 basis points;

•	an increase in fixed costs, such as occupancy costs and depreciation, relative to the increase in net revenue, of 40 basis points; and

•	an unfavorable impact of foreign exchange rates on product costs which contributed to a decrease in gross margin of 40 basis points.

The decrease in gross margin was partially offset by a decrease in provision for inventories, charged to cost of sales, of 110 basis points related to the pull-back of black Luon pants which was recorded in the first quarter of fiscal 2013. A decrease in markdowns of 60 basis points driven by high sell-through of seasonal items also partially offset the decrease in gross margin.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $89.4 million, or 20%, to $538.1 million in fiscal 2014 from $448.7 million in fiscal 2013. The increase in selling, general and administrative expenses was principally comprised of:

•	an increase in employee costs of $40.2 million as there were increases in hourly wages and a growth in labor hours associated with new company-operated stores, outlets, showrooms, and other;

•	an increase in variable store costs of $5.7 million from new company-operated stores, outlets, showrooms, and other;

•	an increase in variable costs such as distribution costs, credit card fees and packaging related to our direct to consumer segment of $6.0 million as a result of increased sales volume;

•	an increase in administrative costs related to our direct to consumer segment of $4.4 million associated with the growth in this channel and increased head count to support it;

•	an increase in head office employee costs of $5.7 million from increased head count in order to position us for long-term growth, partially offset by decreased stock-based compensation;

•	an increase in other head office costs of $5.2 million as a result of the overall growth of our business and investment in strategic initiatives and projects;

•	an increase in other costs, including occupancy costs not included in cost of goods sold, of $11.4 million; and

•	a decrease in net foreign exchange gains of $10.8 million.

As a percentage of net revenue, selling, general and administrative expenses increased 180 basis points, to 30.0% in fiscal 2014 from 28.2% in fiscal 2013.

We expect selling, general and administrative expenses to increase throughout fiscal 2015 as we add administrative and sales personnel and increase our infrastructure to support the growth in our store base.

Income from Operations

Income from operations decreased $15.3 million, or 4%, to $376.0 million in fiscal 2014 from $391.4 million in fiscal 2013. The decrease was a result of increased selling, general and administrative costs of $89.4 million, partially offset by increased gross profit of $74.1 million. The increase in selling, general and administrative costs was primarily driven by the increase in our business.

On a segment basis, we determine income from operations without taking into account our general corporate expenses.

Income from operations before general corporate expenses for fiscal 2014 and fiscal 2013 is summarized below and is expressed in dollar amounts. The percentages are presented as a percentage of net revenue of the respective operating segments.

		Fiscal Years Ended February 1, 2015 and February 2, 2014
		2014				2013				2014			2013
		(In thousands)								(Percentages)
Company-operated stores		$	356,589			$	372,267			26.4	%		30.3	%
Direct to consumer		132,877				109,999				41.4			41.8
Other		9,499				13,994				7.4			14.1
Income from operations before general corporate expense		498,965				496,260
General corporate expense		122,932				104,902
Income from operations		$	376,033			$	391,358

Company-operated Stores. Income from operations from our company-operated stores segment decreased $15.7 million, or 4%, to $356.6 million for fiscal 2014 from $372.3 million for fiscal 2013 primarily due to an increase in selling, general and administrative expenses related to employee costs as well as operating expenses associated with new stores, partially offset by an increase of $31.2 million in gross profit from increased sales. Income from operations as a percentage of company-operated stores net revenue decreased by 390 basis points primarily due to higher selling, general and administrative expenses as a percentage of net revenue as well as lower gross margin resulting from product mix, increased product costs, and increased air freight costs.

Direct to Consumer. Income from operations from our direct to consumer segment increased $22.9 million, or 21%, to $132.9 million in fiscal 2014 from $110.0 million in fiscal 2013. The increase was primarily the result of increased gross profit of $33.1 million primarily due to increased net revenue resulting from increased traffic, partially offset by increased selling, general and administrative expenses related to our long-term strategy for developing this channel. Income from operations as a percentage of direct to consumer net revenue decreased to 41.4% in fiscal 2014 from 41.8% in fiscal 2013.

Other. Income from operations from our other segment decreased $4.5 million, or 32%, to $9.5 million in fiscal 2014 from $14.0 million in fiscal 2013. Income from operations as a percentage of other net revenue decreased by 670 basis points primarily due to an increased number of showrooms in new international markets which have a higher cost structure than North America. We continue to employ our other segment strategy to increase interest in our product in markets we have not otherwise entered with company-operated stores.

General Corporate Expense. General corporate expense increased $18.0 million, or 17%, to $122.9 million in fiscal 2014 from $104.9 million in fiscal 2013. This increase was primarily due to a $10.8 million decrease in net foreign exchange gains, primarily from our Canadian operating entity. An increase in expenses related to our head office growth of $7.2 million, which was largely related to additional costs incurred to support the growth of our business, including increased professional fees related to investment in strategic initiatives and projects. General corporate expenses are expected to continue to increase in future years as we grow our overall business and require increased efforts at our head office to support our company-operated stores, direct to consumer, and other segments.

Other (Expense) Income, Net

There was net other income of $7.1 million in fiscal 2014 compared to net other income of $5.8 million in fiscal 2013. This was primarily the result of increased interest earned on cash and cash equivalents.

Income Tax Expense

Income tax expense increased $26.5 million, or 23%, to $144.1 million in fiscal 2014 from $117.6 million in fiscal 2013. In fiscal 2014, our effective tax rate was 37.6% compared to 29.6% in fiscal 2013. The increase in our effective tax rate was a result of a tax expense of $33.7 million recorded during fiscal 2014 to provide for U.S. income and applicable foreign withholding taxes on dividends of $473.7 million which were distributed during fiscal 2014 from foreign subsidiaries to the U.S. parent entity to fund the share repurchase program.

Net Income

Net income decreased $40.5 million, or 15%, to $239.0 million in fiscal 2014 from $279.5 million in fiscal 2013. The decrease in net income in fiscal 2014 was primarily due to an increase of $89.4 million in selling, general and administrative expenses, and an increase of $26.5 million in income tax expense, partially offset by a $1.3 million increase in net other income, and a $74.1 million increase in gross profit resulting from new stores and the growth of our direct to consumer segment.

Comparable Sales

We separately track comparable store sales, which reflect net revenue at company-operated stores that have been open for at least 12 months. Net revenue from a store is included in comparable store sales beginning with the first month for which the store has a full month of comparable prior year sales. Non-comparable store sales include sales from new stores that have not been open for 12 months or from stores which have been significantly expanded. Also included in non-comparable stores sales are sales from direct to consumer, outlets, showrooms, wholesale accounts, warehouse sales, temporary locations, license and supply arrangements, and sales from company-operated stores which we have closed. Total comparable sales combines comparable store sales and direct to consumer sales. By measuring the change in year-over-year net revenue in stores that have been open for 12 months or more as well as the change in direct to consumer sales, total comparable sales allows us to evaluate our sales performance eliminating the impact of newly opened stores.

We began to report total comparable sales in fiscal 2013, which combines comparable store sales and direct to consumer sales, excluding the 53rd week of sales from fiscal 2012. Our direct to consumer segment represents a growing portion of our net revenue as the shopping behavior of our guests evolves. Our approach to our guests supports this as it involves country and region specific websites, mobile/tablet devices in stores, social networks, and product notification emails. We therefore believe that reporting total comparable sales with comparable store sales and direct to consumer sales combined provides a more relevant metric.

Various factors affect comparable sales, including:

•	the location of new stores relative to existing stores;

•	consumer preferences, buying trends and overall economic trends;

•	our ability to anticipate and respond effectively to customer preferences for technical athletic apparel;

•	competition;

•	changes in our merchandise mix;

•	pricing;

•	the timing of our releases of new merchandise and promotional events;

•	the effectiveness of our grassroots marketing efforts;

•	the level of customer service that we provide in our stores and on our websites;

•	our ability to source and distribute products efficiently; and

•	the number of stores we open, close (including for temporary renovations) and expand in any period.

Opening new stores is an important part of our growth strategy. Accordingly, total comparable sales has limited utility for assessing the success of our growth strategy insofar as comparable sales do not reflect the performance of stores open less than 12 months.

Non-GAAP Financial Measures

Net revenue changes in constant dollars, total comparable sales in constant dollars, comparable store sales in constant dollars, changes in direct to consumer net revenue in constant dollars, the effective tax rate excluding certain tax and related interest adjustments, and diluted earnings per share excluding certain tax adjustments are non-GAAP performance measures.

We provide constant dollar changes in net revenue, total comparable sales, comparable store sales, and changes in direct to consumer net revenue because we use these measures to understand the underlying growth rate of net revenue excluding the impact of changes in foreign exchange rates, which are not under management's control. We believe that disclosing these measures on a constant dollar basis is useful to investors because it enables them to better understand the level of growth of our business.

We disclose the tax rate and diluted earnings per share excluding certain tax and related interest adjustments because of their comparability to our historical information as well as our diluted earnings per share guidance, which we believe is useful to investors.

The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. A reconciliation of the non-GAAP financial measures follows, which includes more detail on the GAAP financial measure that is most directly comparable to each non-GAAP financial measure, and the related reconciliations between these financial measures.

The below performance measures show the dollar and percentage change compared to the corresponding period in the prior year.

Constant dollar changes in net revenue

		Fiscal Year Ended January 31, 2016							Fiscal Year Ended February 1, 2015
		(In thousands)				(Percentage)			(In thousands)				(Percentage)
Net revenue increase		$	263,310			15	%		$	206,024			13	%
Adjustments due to foreign exchange rate changes		88,877				5			35,656				2
Net revenue increase in constant dollars		$	352,187			20	%		$	241,680			15	%

Constant dollar total comparable sales

		Fiscal Year Ended
		January 31, 2016			February 1, 2015
Total comparable sales		5	%		1	%
Adjustments due to foreign exchange rate changes		5			2
Total comparable sales in constant dollars		10	%		3	%

Constant dollar comparable store sales

		Fiscal Year Ended January 31, 2016							Fiscal Year Ended February 1, 2015
		(In thousands)				(Percentage)			(In thousands)				(Percentage)
Comparable store sales		$	(7,335	)		—	%		$	(42,801	)		(3	)%
Adjustments due to foreign exchange rate changes		56,106				4			23,712				2
Comparable store sales in constant dollars		$	48,771			4	%		$	(19,089	)		(1	)%

Constant dollar changes in direct to consumer net revenue

		Fiscal Year Ended
		January 31, 2016			February 1, 2015
Increase in direct to consumer net revenue		25	%		22	%
Adjustments due to foreign exchange rate changes		5			2
Increase in direct to consumer net revenue in constant dollars		30	%		24	%

Effective tax rate, excluding tax and related interest adjustments

		Fiscal Year Ended
		January 31, 2016			February 1, 2015
Effective tax rate		27.8	%		37.6	%
Tax and related interest adjustments1		1.7			(8.8	)
Effective tax rate, excluding tax and related interest adjustments		29.5	%		28.8	%

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1Please refer to Note 15 to the audited consolidated financial statements included in Item 8 of Part II of this report for an explanation as to the nature of these items.

Diluted earnings per share, excluding tax and related interest adjustments

		Fiscal Year Ended
		January 31, 2016				February 1, 2015
Diluted earnings per share		$	1.89			$	1.66
Tax and related interest adjustments1		(0.03		)		0.23
Diluted earnings per share, excluding tax and related interest adjustments		$	1.86			$	1.89

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1Please refer to Note 15 to the audited consolidated financial statements included in Item 8 of Part II of this report for an explanation as to the nature of these items.

Liquidity and Capital Resources

Our primary sources of liquidity are our current balances of cash and cash equivalents and cash flows from operations. Our primary cash needs are capital expenditures for opening new stores and remodeling or relocating existing stores, making information technology system enhancements, funding working capital requirements, and making other strategic capital investments both in North America and internationally. We may also use cash to repurchase shares of our common stock. Cash and cash equivalents in excess of our needs are held in interest bearing accounts with financial institutions.

As of January 31, 2016, our working capital (excluding cash and cash equivalents) was $190.1 million and our cash and cash equivalents were $501.5 million.

The following table summarizes our net cash flows provided by and used in operating, investing and financing activities for the periods indicated:

		Fiscal Year Ended
		January 31, 2016				February 1, 2015				February 2, 2014
		(In thousands)
Total cash provided by (used in):
Operating activities		$	298,740			$	314,449			$	278,339
Investing activities		(143,487		)		(119,733		)		(106,408		)
Financing activities		(273,693		)		(149,077		)		8,907
Effect of exchange rate changes		(44,557		)		(79,809		)		(72,368		)
(Decrease) increase in cash and cash equivalents		$	(162,997	)		$	(34,170	)		$	108,470

Operating Activities

Cash flows provided by operating activities consist primarily of net income adjusted for certain items not affecting cash and the effect of changes in operating assets and liabilities.

In fiscal 2015, cash provided by operating activities decreased $15.7 million, to $298.7 million compared to cash provided by operating activities of $314.4 million in fiscal 2014. The decrease was primarily a result of an increase in inventory purchases and an increase in prepaid and receivable income taxes. This was partially offset by an increase in net income, changes in other operating assets and liabilities, and the change in items not affecting cash. The change in items not affecting

cash was primarily due to an increase in depreciation related to our increased number of stores and a reduction in net deferred income tax assets.

Inventory increased during fiscal 2015 primarily due to the opening of new stores, increased inventory levels to support the sales growth in our company-operated stores and direct to consumer segments, and the timing of product deliveries.

Prepaid and receivable income taxes increased during fiscal 2015 primarily as a result of certain tax adjustments as outlined in Note 15 to the audited consolidated financial statements included in Item 8 of Part II of this report. These adjustments resulted in an income tax receivable in the United States and an increase in income taxes payable in Canada.

In fiscal 2014, cash provided by operating activities increased $36.1 million, to $314.4 million compared to cash provided by operating activities of $278.3 million in fiscal 2013. The increase was primarily a result of an increase in income taxes payable, a change in items not affecting cash, and an increase in accrued compensation and related benefits. This was partially offset by a decrease in net income, and changes in other operating assets and liabilities.

The increase in income taxes payable in fiscal 2014 compared to fiscal 2013 was primarily the result of taxes due on the dividends of $473.7 million which were distributed during fiscal 2014 by foreign subsidiaries to the U.S. parent entity to fund the share repurchase program.

Investing Activities

Cash flows used in investing activities relate entirely to capital expenditures. Cash used in investing activities increased $23.8 million, to $143.5 million in fiscal 2015 from $119.7 million in fiscal 2014. Cash used in investing activities increased $13.3 million, to $119.7 million in fiscal 2014 from $106.4 million in fiscal 2013.

Capital expenditures for our company-operated stores segment were $85.8 million in fiscal 2015 which included $49.2 million to open 62 company-operated stores, $76.9 million in fiscal 2014 which included $38.1 million to open 49 company-operated stores, and $60.2 million in fiscal 2013 which included $31.3 million to open 45 new company-operated stores. The remaining capital expenditures for our company-operated stores segment in each period were primarily for the remodeling or relocation of certain stores, and ongoing store refurbishment.

Capital expenditures for our direct to consumer segment were $8.3 million, $10.0 million, and $6.0 million in fiscal 2015, fiscal 2014, and fiscal 2013, respectively. The capital expenditures for our direct to consumer segment in each period were primarily related to website enhancements as well as country and region specific website launches.

Capital expenditures related to corporate activities and other were $49.4 million, $32.9 million, and $40.2 million in fiscal 2015, fiscal 2014, and fiscal 2013, respectively. The capital expenditures in each period for corporate activities and other were for investments in information technology and business systems, improvements at our head office and other corporate buildings, and for capital expenditures related to opening retail locations other than company-operated stores.

Capital expenditures are expected to range between $150 million and $155 million in fiscal 2016.

Financing Activities

Cash flows used in or provided by financing activities consist primarily of cash used to repurchase shares of our common stock and certain cash flows related to stock-based compensation.

Cash used in financing activities increased $124.6 million, to $273.7 million in fiscal 2015 from $149.1 million in fiscal 2014. Cash used in financing activities increased $158.0 million, to cash used of $149.1 million in fiscal 2014 from cash provided of $8.9 million in fiscal 2013. The primary cause of these increases in cash used in financing activities was our stock repurchase program which began in the second quarter of fiscal 2014. During fiscal 2015 we repurchased 5.0 million shares for a total cost of $274.2 million, and in fiscal 2014 we repurchased 3.7 million shares for a total cost of $147.4 million.

We believe that our cash and cash equivalent balances, cash generated from operations, and borrowings available to us under our revolving credit facility will be adequate to meet our liquidity needs and capital expenditure requirements for at least the next 12 months. Our cash from operations may be negatively impacted by a decrease in demand for our products as well as the other factors described in "Item 1A. Risk Factors". In addition, we may make discretionary capital improvements with respect to our stores, distribution facilities, headquarters, or systems, which we would expect to fund through the use of cash, issuance of debt or equity securities or other external financing sources to the extent we were unable to fund such capital expenditures out of our cash and cash equivalents and cash generated from operations.

Revolving Credit Facility

In November 2015, we renewed our unsecured demand revolving credit facilities with HSBC Bank Canada and Bank of America, N.A., Canada Branch for a one year period. The credit facilities provide us with available borrowings in a total amount of $15.0 million. Borrowings under the credit facilities must be repaid in full on demand and are available by way of U.S. or Canadian denominated advances, letters of credit or depository bills. Advances denominated in U.S. dollars bear interest on the outstanding balance at a rate equal to U.S. LIBOR plus 100 basis points or the U.S. prime rate, at our option. Advances denominated in Canadian dollars bear interest on the outstanding balance at a rate equal to the CDOR Rate plus 100 basis points or the Canadian prime rate, at our option. Borrowings drawn down under standby letters of credit bear a fee of 100 basis points and borrowings drawn down under commercial letters of credit bear the banks' standard pricing. We are also required to pay a quarterly commitment fee of 10 basis points on the unused portion of the facility. Our wholly-owned subsidiary, lululemon usa inc., has provided a guarantee to the bank counter-parties under the facilities. The revolving credit facilities are unsecured, with a negative pledge on assets subject to permitted encumbrances, and no financial covenants. As of January 31, 2016, aside from letters of credit of $1.6 million, we had no other borrowings outstanding under these credit facilities.

Contractual Obligations and Commitments

Leases. We lease certain store and other retail locations, distribution centers, offices, and equipment under non-cancelable operating leases. Our leases generally have initial terms of between five and 10 years, and generally can be extended only in five-year increments, if at all. Our leases expire at various dates between one and 15 years, excluding extensions at our option. A substantial number of our leases include renewal options and certain of our leases include rent escalation clauses, rent holidays and leasehold rental incentives, none of which are reflected in the table below. Most of our leases for store premises also include contingent rental payments based on sales, the impact of which also are not reflected in the table below.

Product purchase obligations. The amounts listed for product purchase obligations in the table below represent agreements (including open purchase orders) to purchase products in the ordinary course of business that are enforceable and legally binding and that specify all significant terms. In some cases, prices are subject to change throughout the production process. The reported amounts exclude product purchase liabilities included in accounts payable and accrued inventory liabilities as of January 31, 2016.

The following table summarizes our contractual arrangements as of January 31, 2016, and the timing and effect that such commitments are expected to have on our liquidity and cash flows in future periods:

		Payments Due by Fiscal Year
		Total				2016				2017				2018				2019				2020				Thereafter
		(In thousands)
Operating leases (minimum rent)		$	515,821			$	107,456			$	102,071			$	88,193			$	75,845			$	52,881			$	89,375
Product purchase obligations		$	159,730			$	159,730			$	—			$	—			$	—			$	—			$	—

Off-Balance Sheet Arrangements

We enter into standby letters of credit to secure certain of our obligations, including leases, taxes and duties. As of January 31, 2016, letters of credit and letters of guarantee totaling $1.6 million had been issued.

We have not entered into any transactions, agreements or other contractual arrangements to which an entity unconsolidated with us is a party and under which we have (i) any obligation under a guarantee, (ii) any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity, (iii) any obligation under derivative instruments that are indexed to our shares and classified as equity in our consolidated balance sheets, or (iv) any obligation arising out of a variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions. Predicting future events is inherently an imprecise activity and, as such, requires the use of judgment. Actual results may vary from our estimates in amounts that may be material to the financial statements. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact our consolidated financial statements.

We believe that the following critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements:

Revenue Recognition. Net revenue is recognized net of sales taxes, discounts, and an estimated allowance for sales returns. Sales to customers through company-operated stores and other physical locations are recognized at the point of sale, net of an estimated allowance for sales returns. Direct to consumer sales are recognized once delivery has occurred and collection is reasonably assured, net of an estimated allowance for sales returns. Other net revenue includes outlet sales, showroom sales, sales to wholesale accounts, warehouse sales, sales from temporary locations, and license and supply arrangement net revenue, which consists of royalties as well as sales of our product to licensees. Revenue is recognized when these sales occur and amounts billed to customers for shipping and handling are recognized at the time of shipment. Employee discounts are classified as a reduction of net revenue.

Our estimated allowance for sales returns is a subjective critical estimate that has a direct impact on reported net revenue. This allowance is calculated based on a history of actual returns, estimated future returns and any significant future known or anticipated events. Consideration of these factors results in an estimated allowance for sales returns. Our standard terms for retail sales limit returns to approximately 14 days after the sale of the merchandise, however we accept returns after 14 days where the product fails to meet our guests' quality expectations.

Revenue from our gift cards is recognized when tendered for payment, or upon redemption. Outstanding customer balances are included in "Unredeemed gift card liability" on the consolidated balance sheets. There are no expiration dates on our gift cards, and we do not charge any service fees that cause a decrement to customer balances.

While we will continue to honor all gift cards presented for payment, we may determine the likelihood of redemption to be remote for certain card balances due to, among other things, long periods of inactivity. In these circumstances, to the extent we determine there is no requirement for remitting card balances to government agencies under unclaimed property laws, card balances may be recognized in the consolidated statements of operations in net revenue. The amount recognized is an estimate, based on historical customer redemption rates.

Inventory. Inventory is valued at the lower of cost and market. We periodically review our inventories and make provisions as necessary to appropriately value obsolete and damaged goods. The amount of the provision is equal to the difference between the cost of the inventory and its net realizable value based upon assumptions about future demands, selling prices, and market conditions. If changes in market conditions result in reductions in the estimated net realizable value of our inventory below our previous estimate, we would increase our reserve in the period in which we made such a determination. In addition, we provide for inventory shrinkage as a percentage of sales, based on historical trends from actual physical inventories. Inventory shrinkage estimates are made to reduce the inventory value for lost or stolen items. We perform physical inventory counts throughout the year and adjust the shrink provision accordingly.

Property and Equipment. Property and equipment are recorded at cost less accumulated depreciation. Buildings are depreciated on a straight-line basis over the expected useful life of the asset, which we estimate to be 20 years. Leasehold improvements are depreciated on a straight-line basis over the lesser of the length of the lease and the estimated useful life of the assets, up to a maximum of five years. All other property and equipment is depreciated using the declining balance method as follows:

Furniture and fixtures		20	%
Computer hardware and software		30	%
Equipment and vehicles		30	%

Changes in circumstances (such as technological advances) can result in differences between the actual and estimated useful lives. In those cases where we determine that the useful life of a long-lived asset should be shortened, we increase depreciation expense over the remaining useful life to depreciate the asset's net book value to its salvage value.

Long-Lived Assets. Long-lived assets, including intangible assets with finite useful lives are evaluated for impairment when the occurrence of events or changes in circumstances indicates that the carrying value of the assets may not be recoverable as measured by comparing their net book value to the undiscounted estimated future cash flows generated by their use and eventual disposition. Impaired assets are recorded at fair value, determined principally by the present value of the estimated future cash flows expected from their use and eventual disposition.

Income Taxes. Deferred income tax assets and liabilities are determined based on the temporary differences between the carrying amounts and the tax basis of assets and liabilities, and for tax losses, tax credit carry forwards, and other tax attributes, using the enacted tax rates that are to be in effect when these differences are expected to reverse.

Deferred income tax liabilities are provided for U.S. income taxes on the undistributed earnings of foreign subsidiaries, unless those earnings can be distributed on a tax-free basis or if the earnings are indefinitely reinvested. We determine on a regular basis the amount of undistributed earnings that will be indefinitely reinvested in our non-U.S. operations. This assessment is based on the cash flow projections and operational and fiscal objectives of each of our U.S. and foreign subsidiaries. Such estimates are inherently imprecise since many assumptions used in the projections are subject to revision. The possibility exists that amounts determined to be indefinitely reinvested outside of the U.S. may ultimately be repatriated.

U.S. income and foreign withholding taxes have not been provided on approximately $425.2 million of cumulative undistributed earnings of a Canadian subsidiary as of January 31, 2016. These earnings are indefinitely reinvested outside of the United States. Income taxes of approximately $16.6 million would be incurred if these earnings were repatriated to the United States.

As of January 31, 2016, we had cash and cash equivalents of $437.5 million outside of the United States. As described in Note 15 to the audited consolidated financial statements included in Item 8 of Part II of this report, we intend to distribute $156.0 million from a Canadian subsidiary to the U.S. parent entity to finance the payment of an intercompany debt. We have recognized a deferred tax liability of $7.8 million to provide for U.S. income and applicable foreign withholding taxes on this expected distribution. With the exception of this amount, we do not intend to repatriate these funds to the United States.

We evaluate our tax filing positions and recognize the largest amount of tax benefit that is considered more likely than not to be sustained upon examination by the relevant taxing authorities based on the technical merits of the position. This determination requires the use of significant judgment. Income tax expense is adjusted in the period in which an uncertain tax position is effectively settled, the statute of limitations expires, facts or circumstances change, tax laws change, or new information becomes available.

Our intercompany transfer pricing policies are currently subject to audits by various foreign tax jurisdictions. Although we believe that our intercompany transfer pricing policies and tax positions are reasonable, the final outcomes of tax audits or potential tax disputes may be materially different from that which is reflected in our income tax provisions and accruals.

Goodwill and Intangible Assets. Intangible assets are recorded at cost. Reacquired franchise rights are amortized on a straight-line basis over their estimated useful lives of 10 years. Goodwill represents the excess of the purchase price over the fair market value of identifiable net assets acquired and is not amortized. Goodwill is tested for impairment annually or more frequently when an event or circumstance indicates that goodwill might be impaired. Goodwill impairment testing requires us to estimate the fair value of our reporting units. We generally base our measurement of the fair value on the present value of future cash flows. Our significant estimates in the discounted cash flows model include the discount rate and long-term rates of growth. We use our best estimates and judgment based on available evidence in conducting the impairment testing.

Stock-Based Compensation. We account for stock-based compensation using the fair value method. The fair value of awards granted is estimated at the date of grant and is recognized as employee compensation expense on a straight-line basis over the requisite service period. For awards with service and/or performance conditions, the amount of compensation expense recognized is based on the number of awards that are expected to vest.

The estimation of the number of stock awards that will ultimately vest requires judgment, and to the extent actual results differ from our estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider several factors when estimating the number of awards which are expected to vest, including, future profit forecasts, types of awards, size of option holder group, and anticipated employee retention. Actual results may differ substantially from these estimates.

The calculation of the grant-date fair value of stock options requires us to make certain estimates and assumptions, including, stock price volatility, and the expected life of the options. We evaluate and revise these estimates and assumptions as necessary, to reflect market conditions and our historical experience. The expected term of the options is based upon historical experience of similar awards, giving consideration to expectations of future employee behavior. Expected volatility is based upon the historical volatility of our common stock for the period corresponding with the expected term of the options. In the future, the expected volatility and expected term may change which could substantially change the grant-date fair value of future awards of stock options and, ultimately, the expense we record.

Contingencies. In the ordinary course of business, we are involved in legal proceedings regarding contractual and employment relationships and a variety of other matters. We record contingent liabilities resulting from claims against us, when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third-party claimants and courts.