lululemon athletica inc. 10-Q

ITEM 1. FINANCIAL STATEMENTS lululemon athletica inc. CONSOLIDATED BALANCE SHEETS (Unaudited; Amounts in thousands, except per share amounts) October 31, 2021 January 31, 2021 ASSETS Current assets Cash and cash equivalents $ 993,591 $ 1,150,517 Accounts receivable 75,343 62,399 Inventories 943,900 647,230 Prepaid and receivable income taxes 140,582 139,126 Prepaid expenses and other current assets 157,878 125,107 2,311,294 2,124,379 Property and equipment, net 876,489 745,687 Right-of-use lease assets 789,381 734,835 Goodwill 387,065 386,877 Intangible assets, net 73,494 80,080 Deferred income tax assets 6,804 6,731 Other non-current assets 127,480 106,626 $ 4,572,007 $ 4,185,215 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Accounts payable $ 227,067 $ 172,246 Accrued inventory liabilities 10,038 14,956 Other accrued liabilities 314,394 211,911 Accrued compensation and related expenses 181,863 130,171 Current lease liabilities 175,445 166,091 Current income taxes payable 43,199 8,357 Unredeemed gift card liability 137,656 155,848 Other current liabilities 28,358 23,598 1,118,020 883,178 Non-current lease liabilities 684,460 632,590 Non-current income taxes payable 38,073 43,150 Deferred income tax liabilities 60,374 58,755 Other non-current liabilities 12,625 8,976 1,913,552 1,626,649 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; 5,203 and 5,203 issued and outstanding — — Special voting stock, $ 0.000005 par value: 60,000 shares authorized; 5,203 and 5,203 issued and outstanding — — Common stock, $ 0.005 par value: 400,000 shares authorized; 124,135 and 125,150 issued and outstanding 621 626 Additional paid-in capital 406,413 388,667 Retained earnings 2,398,186 2,346,428 Accumulated other comprehensive loss ( 146,765 ) ( 177,155 ) 2,658,455 2,558,566 $ 4,572,007 $ 4,185,215 See accompanying notes to the unaudited interim consolidated financial statements 3 Table of Contents lululemon athletica inc. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (Unaudited; Amounts in thousands, except per share amounts) Quarter Ended Three Quarters Ended October 31, 2021 November 1, 2020 October 31, 2021 November 1, 2020 Net revenue $ 1,450,421 $ 1,117,426 $ 4,127,504 $ 2,672,330 Cost of goods sold 621,028 490,072 1,755,111 1,221,073 Gross profit 829,393 627,354 2,372,393 1,451,257 Selling, general and administrative expenses 545,124 411,708 1,583,075 1,064,172 Amortization of intangible assets 2,195 2,195 6,585 2,965 Acquisition-related expenses 24,127 8,531 39,934 22,040 Income from operations 257,947 204,920 742,799 362,080 Other income (expense), net 15 ( 580 ) 338 250 Income before income tax expense 257,962 204,340 743,137 362,330 Income tax expense 70,174 60,697 202,319 103,254 Net income $ 187,788 $ 143,643 $ 540,818 $ 259,076 Other comprehensive income (loss): Foreign currency translation adjustment 10,274 2,269 30,390 ( 4,035 ) Comprehensive income $ 198,062 $ 145,912 $ 571,208 $ 255,041 Basic earnings per share $ 1.45 $ 1.10 $ 4.16 $ 1.99 Diluted earnings per share $ 1.44 $ 1.10 $ 4.14 $ 1.98 Basic weighted-average number of shares outstanding 129,684 130,318 130,019 130,271 Diluted weighted-average number of shares outstanding 130,189 130,924 130,557 130,842 See accompanying notes to the unaudited interim consolidated financial statements 4 Table of Contents lululemon athletica inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited; Amounts in thousands) Quarter Ended October 31, 2021 Exchangeable Stock Special Voting Stock Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Loss Total Shares Shares Par Value Shares Par Value Balance as of August 1, 2021 5,203 5,203 $ — 124,644 $ 623 $ 381,737 $ 2,445,845 $ ( 157,039 ) $ 2,671,166 Net income 187,788 187,788 Foreign currency translation adjustment 10,274 10,274 Stock-based compensation expense 21,657 21,657 Common stock issued upon settlement of stock-based compensation 83 — 7,907 7,907 Shares withheld related to net share settlement of stock-based compensation ( 9 ) — ( 3,914 ) ( 3,914 ) Repurchase of common stock ( 583 ) ( 2 ) ( 974 ) ( 235,447 ) ( 236,423 ) Balance as of October 31, 2021 5,203 5,203 $ — 124,135 $ 621 $ 406,413 $ 2,398,186 $ ( 146,765 ) $ 2,658,455 Quarter Ended November 1, 2020 Exchangeable Stock Special Voting Stock Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Loss Total Shares Shares Par Value Shares Par Value Balance as of August 2, 2020 5,393 5,393 $ — 124,917 $ 625 $ 358,414 $ 1,872,948 $ ( 230,885 ) $ 2,001,102 Net income 143,643 143,643 Foreign currency translation adjustment 2,269 2,269 Common stock issued upon exchange of exchangeable shares ( 177 ) ( 177 ) — 177 1 ( 1 ) — Stock-based compensation expense 15,186 15,186 Common stock issued upon settlement of stock-based compensation 30 1 1,678 1,679 Shares withheld related to net share settlement of stock-based compensation ( 3 ) ( 1 ) ( 925 ) ( 926 ) Balance as of November 1, 2020 5,216 5,216 $ — 125,121 $ 626 $ 374,352 $ 2,016,591 $ ( 228,616 ) $ 2,162,953 5 Table of Contents Three Quarters Ended October 31, 2021 Exchangeable Stock Special Voting Stock Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Loss Total Shares Shares Par Value Shares Par Value Balance as of January 31, 2021 5,203 5,203 $ — 125,150 $ 626 $ 388,667 $ 2,346,428 $ ( 177,155 ) $ 2,558,566 Net income 540,818 540,818 Foreign currency translation adjustment 30,390 30,390 Stock-based compensation expense 51,878 51,878 Common stock issued upon settlement of stock-based compensation 495 2 17,618 17,620 Shares withheld related to net share settlement of stock-based compensation ( 152 ) ( 1 ) ( 49,480 ) ( 49,481 ) Repurchase of common stock ( 1,358 ) ( 6 ) ( 2,270 ) ( 489,060 ) ( 491,336 ) Balance as of October 31, 2021 5,203 5,203 $ — 124,135 $ 621 $ 406,413 $ 2,398,186 $ ( 146,765 ) $ 2,658,455 Three Quarters Ended November 1, 2020 Exchangeable Stock Special Voting Stock Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Loss Total Shares Shares Par Value Shares Par Value Balance as of February 2, 2020 6,227 6,227 $ — 124,122 $ 621 $ 355,541 $ 1,820,637 $ ( 224,581 ) $ 1,952,218 Net income 259,076 259,076 Foreign currency translation adjustment ( 4,035 ) ( 4,035 ) Common stock issued upon exchange of exchangeable shares ( 1,011 ) ( 1,011 ) — 1,011 5 ( 5 ) — Stock-based compensation expense 37,098 37,098 Common stock issued upon settlement of stock-based compensation 515 3 14,139 14,142 Shares withheld related to net share settlement of stock-based compensation ( 158 ) ( 1 ) ( 31,882 ) ( 31,883 ) Repurchase of common stock ( 369 ) ( 2 ) ( 539 ) ( 63,122 ) ( 63,663 ) Balance as of November 1, 2020 5,216 5,216 $ — 125,121 $ 626 $ 374,352 $ 2,016,591 $ ( 228,616 ) $ 2,162,953 See accompanying notes to the unaudited interim consolidated financial statements 6 Table of Contents lululemon athletica inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited; Amounts in thousands) Three Quarters Ended October 31, 2021 November 1, 2020 Cash flows from operating activities Net income $ 540,818 $ 259,076 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 162,086 133,209 Stock-based compensation expense 51,878 37,098 Settlement of derivatives not designated in a hedging relationship 30,427 ( 9,841 ) Changes in operating assets and liabilities: Inventories ( 288,821 ) ( 234,154 ) Prepaid and receivable income taxes ( 883 ) ( 83,113 ) Prepaid expenses and other current assets ( 43,395 ) ( 66,778 ) Other non-current assets ( 8,792 ) ( 36,419 ) Accounts payable 50,903 73,596 Accrued inventory liabilities ( 5,253 ) 4,240 Other accrued liabilities 93,132 69,496 Accrued compensation and related expenses 50,437 ( 37,077 ) Current and non-current income taxes payable 29,862 ( 25,611 ) Unredeemed gift card liability ( 18,969 ) ( 15,624 ) Right-of-use lease assets and current and non-current lease liabilities 6,318 6,577 Other current and non-current liabilities 8,376 10,729 Net cash provided by operating activities 658,124 85,404 Cash flows from investing activities Purchase of property and equipment ( 266,991 ) ( 170,830 ) Settlement of net investment hedges ( 36,447 ) 5,867 Acquisition, net of cash acquired — ( 452,581 ) Other investing activities ( 10,000 ) 1,000 Net cash used in investing activities ( 313,438 ) ( 616,544 ) Cash flows from financing activities Proceeds from settlement of stock-based compensation 17,620 14,142 Shares withheld related to net share settlement of stock-based compensation ( 49,481 ) ( 31,883 ) Repurchase of common stock ( 491,336 ) ( 63,663 ) Net cash used in financing activities ( 523,197 ) ( 81,404 ) Effect of foreign currency exchange rate changes on cash and cash equivalents 21,585 620 Decrease in cash and cash equivalents ( 156,926 ) ( 611,924 ) Cash and cash equivalents, beginning of period $ 1,150,517 $ 1,093,505 Cash and cash equivalents, end of period $ 993,591 $ 481,581 See accompanying notes to the unaudited interim consolidated financial statements 7 Table of Contents lululemon athletica inc. INDEX FOR NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS Note 1 Nature of Operations and Basis of Presentation 9 Note 2 Recent Accounting Pronouncements 10 Note 3 Acquisition 10 Note 4 Revolving Credit Facilities 11 Note 5 Stock-Based Compensation and Benefit Plans 11 Note 6 Fair Value Measurement 13 Note 7 Derivative Financial Instruments 14 Note 8 Earnings Per Share 16 Note 9 Supplementary Financial Information 16 Note 10 Segmented Information 18 Note 11 Net Revenue by Geography and Category 18 Note 12 Legal Proceedings and Other Contingencies 19 8 Table of Contents lululemon athletica inc. NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Operations and Basis of Presentation Nature of operations lululemon athletica inc., a Delaware corporation, ("lululemon" and, together with its subsidiaries unless the context otherwise requires, the "Company") is engaged in the design, distribution, and retail of healthy lifestyle inspired athletic apparel and accessories, which are sold through a chain of company-operated stores, direct to consumer through e-commerce, 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, South Korea, Germany, New Zealand, Japan, Singapore, France, Malaysia, Sweden, Ireland, the Netherlands, Norway, and Switzerland. There were 552 and 521 company-operated stores as of October 31, 2021 and January 31, 2021, 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. Acquisition for further information. COVID-19 Pandemic The outbreak of a novel strain of coronavirus ("COVID-19") caused governments and public health officials to impose restrictions and recommend precautions to mitigate the spread of the virus. The Company temporarily closed almost all of its retail locations for a significant portion of the first two quarters of fiscal 2020. While most of the Company's retail locations were open throughout the first three quarters of fiscal 2021, certain locations were temporarily closed based on government and health authority guidance. During the third quarter and first three quarters of fiscal 2020, the Company recognized $ 1.4 million and $ 37.0 million, respectively, of government payroll subsidies as a reduction in selling, general, and administrative expenses. These subsidies partially offset the wages paid to employees while its retail locations were temporarily closed due to COVID-19. The Company did not recognize any payroll subsidies in the first three quarters of fiscal 2021. Basis of presentation The unaudited interim consolidated financial statements as of October 31, 2021 and for the quarters and three quarters ended October 31, 2021 and November 1, 2020 are presented in U.S. dollars and have been prepared by the Company under the rules and regulations of the Securities and Exchange Commission ("SEC"). The financial information is presented in accordance with United States generally accepted accounting principles ("GAAP") for interim financial information and, accordingly, does not include all of the information and footnotes required by GAAP for complete financial statements. The financial information as of January 31, 2021 is derived from the Company's audited consolidated financial statements and related notes for the fiscal year ended January 31, 2021, which are included in Item 8 in the Company's fiscal 2020 Annual Report on Form 10-K filed with the SEC on March 30, 2021. 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 2020 Annual Report on Form 10-K. Note 2. Recent Accounting Pronouncements 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 2021 will end on January 30, 2022 and will be a 52-week year. Fiscal 2020 was a 52-week year and ended on January 31, 2021. Fiscal 2021 and fiscal 2020 are referred to as "2021," and "2020," respectively. The first three quarters of 2021 and 2020 ended on October 31, 2021 and November 1, 2020, respectively. 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. 9 Table of Contents Note 2. Recent Accounting Pronouncements Recently adopted 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 make simplifications in other areas of this topic by clarifying and amending existing guidance. The Company adopted this update during the first quarter of 2021 and it did not have a material impact on the Company's consolidated financial statements. Recently issued accounting pronouncements The Company considers the applicability and impact of all Accounting Standard Updates ("ASUs"). Recently issued ASUs were assessed and determined to be either not applicable or are expected to have minimal impact on its consolidated financial position or results of operations. 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 fair value of the consideration paid, net of cash acquired, was $ 452.6 million. This resulted in the recognition of intangible assets of $ 85.0 million and goodwill of $ 362.5 million. The purchase price allocation was finalized as of January 31, 2021 with no measurement period adjustments. 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: • acquisition-related compensation, including the partial acceleration of vesting of certain stock options, amounts due to selling shareholders and MIRROR employees that are contingent upon continuing employment; • transaction and integration costs, including fees for advisory and professional services incurred as part of the acquisition and integration costs subsequent to the acquisition; 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: Third Quarter First Three Quarters 2021 2020 2021 2020 (in thousands) Acquisition-related expenses: Transaction and integration costs $ 328 $ 1,017 $ 1,859 $ 10,263 Gain on existing investment — — — ( 782 ) Acquisition-related compensation 23,799 7,514 38,075 12,559 $ 24,127 $ 8,531 $ 39,934 $ 22,040 Income tax effects of acquisition-related expenses $ ( 611 ) $ ( 896 ) $ ( 1,417 ) $ ( 2,862 ) In connection with the acquisition, $ 2.9 million was recognized on the acquisition date for the partial acceleration of vesting of certain stock options held by MIRROR employees, and $ 57.1 million of consideration was deferred up to three years from the acquisition, subject to the continued employment of the recipients through various vesting dates. This acquisition-related compensation is expensed over the vesting periods as service is provided. 10 Table of Contents In September 2021, MIRROR's Chief Executive Officer transitioned into an advisory role with the Company. The remaining deferred consideration payable to this individual will be paid in July 2022. Due to the reduction in this individual's responsibilities, the compensation expense has been accelerated and was recognized in full during the third quarter of 2021. Note 4. Revolving Credit Facilities North America revolving credit facility During 2016, the Company obtained a $ 150.0 million committed and unsecured five-year revolving credit facility with major financial institutions. During 2018, the Company amended the credit agreement to provide for: i. an increase in the aggregate commitments under the 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, to request increases in commitments from $ 400.0 million to $ 600.0 million; and iii. an extension in the maturity of the facility from December 15, 2021 to June 6, 2023. Borrowings under the facility may be made in U.S. Dollars, Euros, Canadian Dollars, and in other currencies, subject to the lenders' approval. As of October 31, 2021, aside from letters of credit of $ 3.1 million, there were no other borrowings outstanding under this facility. Borrowings under the facility bear interest at a rate equal to, at the Company's option, either (a) rates based on deposits on the interbank market for U.S. Dollars or the applicable currency in which the borrowings are made ("LIBOR") or (b) an alternate base rate, plus, an applicable margin 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 1.00 %- 1.50 % for LIBOR loans and 0.00 %- 0.50 % for alternate base rate loans. Additionally, a commitment fee of between 0.10 %- 0.20 % is payable on the average unused amounts under the revolving credit facility, and fees of 1.00 %- 1.50 % are payable on unused letters of credit. 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 3.5 :1 and to maintain the ratio of consolidated EBITDAR to consolidated interest charges (plus rent) below 2 :1. 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). As of October 31, 2021, the Company was in compliance with the covenants of the credit facility. Mainland China revolving credit facility In December 2019, the Company entered into an uncommitted and unsecured 130.0 million Chinese Yuan revolving credit facility with terms that are reviewed on an annual basis. The credit facility was increased to 230.0 million Chinese Yuan during 2020. It is comprised of a revolving loan of up to 200.0 million Chinese Yuan and a financial guarantee facility of up to 30.0 million Chinese Yuan, or its equivalent in another currency. Loans are available for a period not to exceed 12 months, at an interest rate equal to the loan prime rate plus a spread of 0.5175 %. The Company is required to follow certain covenants. As of October 31, 2021, the Company was in compliance with the covenants and, aside from letters of credit of 3.5 million Chinese Yuan, there were no borrowings or guarantees outstanding under this credit facility. Note 5. Stock-Based Compensation and Benefit Plans Stock-based compensation plans The Company's eligible employees participate in various stock-based compensation plans, provided directly by the Company. Stock-based compensation expense charged to income for the plans was $ 49.6 million and $ 41.9 million for the first three quarters of 2021 and 2020, respectively. Total unrecognized compensation cost for all stock-based compensation plans was $ 108.9 million as of October 31, 2021, which is expected to be recognized over a weighted-average period of 2.1 years. 11 Table of Contents A summary of the balances of the Company's stock-based compensation plans as of October 31, 2021, and changes during the first three quarters then ended, is presented below: Stock Options Performance-Based Restricted Stock Units Restricted Shares Restricted Stock Units Restricted Stock Units (Liability Accounting) Number Weighted-Average Exercise Price Number Weighted-Average Grant Date Fair Value Number Weighted-Average Grant Date Fair Value Number Weighted-Average Grant Date Fair Value Number Weighted-Average Fair Value (In thousands, except per share amounts) Balance as of January 31, 2021 804 $ 139.27 199 $ 149.20 4 $ 299.09 275 $ 166.50 15 $ 328.68 Granted 191 308.96 136 181.56 4 327.22 120 327.82 — — Exercised/released 169 104.42 166 100.89 4 299.09 142 138.58 15 397.83 Forfeited/expired 28 195.67 5 212.34 — — 17 231.34 — — Balance as of October 31, 2021 798 $ 185.23 164 $ 222.98 4 $ 327.22 236 $ 260.76 — $ — Exercisable as of October 31, 2021 258 $ 126.62 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. 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 three quarters of 2021: First Three Quarters 2021 Expected term 3.75 years Expected volatility 39.32 % Risk-free interest rate 0.50 % Dividend yield — % 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 third quarter of 2021, there were 16.1 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 12 Table of Contents exceed the dollar amounts set by applicable laws. The Company matches 50 % to 75 % of the contribution depending on the participant's length of service, and the contribution is subject to a two year vesting period. The Company's net expense for the defined contribution plans was $ 8.8 million and $ 6.7 million in the first three quarters of 2021 and 2020, respectively. Note 6. 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 October 31, 2021 and January 31, 2021, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis: October 31, 2021 Level 1 Level 2 Level 3 Balance Sheet Classification (In thousands) Money market funds $ 416,778 $ 416,778 $ — $ — Cash and cash equivalents Term deposits 219,367 — 219,367 — Cash and cash equivalents Forward currency contract assets 6,429 — 6,429 — Prepaid expenses and other current assets Forward currency contract liabilities 7,869 — 7,869 — Other current liabilities January 31, 2021 Level 1 Level 2 Level 3 Balance Sheet Classification (In thousands) Money market funds $ 671,817 $ 671,817 $ — $ — Cash and cash equivalents Term deposits 183,015 — 183,015 — Cash and cash equivalents Forward currency contract assets 17,364 — 17,364 — Prepaid expenses and other current assets Forward currency contract liabilities 18,767 — 18,767 — Other current liabilities The Company records cash, 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. 13 Table of Contents Note 7. Derivative Financial Instruments Foreign currency 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 and Chinese Yuan to the U.S. dollar exchange rate and changes in the Euro and Australian dollar to the Canadian dollar exchange rate using forward currency contracts. Net investment hedges The Company is exposed to foreign currency exchange gains and losses which arise on translation of its international 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 Company assesses hedge effectiveness based on changes in forward rates. The Company recorded no ineffectiveness from net investment hedges during the first three quarters of 2021. 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 currency 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 foreign currency exchange rate. The resulting foreign currency gains and losses are recorded in selling, general and administrative expenses. During the first three quarters of 2021, the Company entered into certain forward currency contracts designed to economically hedge the foreign currency exchange revaluation gains and losses that are recognized by its Canadian and Chinese subsidiaries on specific monetary assets and liabilities denominated in currencies other than the functional currency of the entity. 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 October 31, 2021, there were derivative assets of $ 6.4 million and derivative liabilities of $ 7.9 million subject to enforceable netting arrangements. 14 Table of Contents The notional amounts and fair values of forward currency contracts were as follows: October 31, 2021 January 31, 2021 Gross Notional Assets Liabilities Gross Notional Assets Liabilities (In thousands) Derivatives designated as net investment hedges: Forward currency contracts $ 1,185,000 $ — $ 6,472 $ 985,000 $ — $ 18,099 Derivatives not designated in a hedging relationship: Forward currency contracts 1,297,026 6,429 1,397 1,055,000 17,364 668 Net derivatives recognized on consolidated balance sheets: Forward currency contracts $ 6,429 $ 7,869 $ 17,364 $ 18,767 The forward currency contracts designated as net investment hedges outstanding as of October 31, 2021 mature on different dates between November 2021 and May 2022. The forward currency contracts not designated in a hedging relationship outstanding as of October 31, 2021 mature on different dates between November 2021 and May 2022. The pre-tax gains and losses on foreign currency exchange forward contracts recorded in accumulated other comprehensive income or loss were as follows: Third Quarter First Three Quarters 2021 2020 2021 2020 (In thousands) Gains (losses) recognized in foreign currency translation adjustment: Derivatives designated as net investment hedges $ ( 9,766 ) $ ( 7,391 ) $ ( 24,822 ) $ ( 3,863 ) 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 currency exchange and derivative gains and losses recorded in the consolidated statement of operations were as follows: Third Quarter First Three Quarters 2021 2020 2021 2020 (In thousands) Gains (losses) recognized in selling, general and administrative expenses: Foreign currency exchange gains (losses) $ ( 8,161 ) $ ( 3,627 ) $ ( 28,296 ) $ 247 Derivatives not designated in a hedging relationship 6,511 3,823 18,758 ( 2,123 ) Net foreign currency exchange and derivative gains (losses) $ ( 1,650 ) $ 195 $ ( 9,538 ) $ ( 1,876 ) 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. 15 Table of Contents Note 8. Earnings Per Share The details of the computation of basic and diluted earnings per share are as follows: Third Quarter First Three Quarters 2021 2020 2021 2020 (In thousands, except per share amounts) Net income $ 187,788 $ 143,643 $ 540,818 $ 259,076 Basic weighted-average number of shares outstanding 129,684 130,318 130,019 130,271 Assumed conversion of dilutive stock options and awards 505 606 538 571 Diluted weighted-average number of shares outstanding 130,189 130,924 130,557 130,842 Basic earnings per share $ 1.45 $ 1.10 $ 4.16 $ 1.99 Diluted earnings per share $ 1.44 $ 1.10 $ 4.14 $ 1.98 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 first three quarters of 2021 and 2020, 48.0 thousand and 40.2 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. On December 1, 2020, the Company's board of directors approved an increase in the remaining authorization of the existing stock repurchase program from $ 263.6 million to $ 500.0 million, and on October 1, 2021, it approved an increase in the remaining authorization from $ 141.2 million to $ 641.2 million. The repurchase plan has no time limit and does not require the repurchase of a minimum number of shares. 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 October 31, 2021, the remaining authorized value of shares available to be repurchased under this program was $ 508.7 million. During the first three quarters of 2021 and 2020, 1.4 million and 0.4 million shares, respectively, were repurchased under the program at a total cost of $ 491.3 million and $ 63.7 million, respectively. Subsequent to October 31, 2021, and up to December 2, 2021, 46.5 thousand shares were repurchased at a total cost of $ 21.5 million. Note 9. Supplementary Financial Information A summary of certain consolidated balance sheet accounts is as follows: October 31, 2021 January 31, 2021 (In thousands) Inventories: Inventories, at cost $ 989,137 $ 678,200 Provision to reduce inventories to net realizable value ( 45,237 ) ( 30,970 ) $ 943,900 $ 647,230 16 Table of Contents October 31, 2021 January 31, 2021 (In thousands) Prepaid expenses and other current assets: Prepaid expenses $ 131,852 $ 82,164 Forward currency contract assets 6,429 17,364 Other current assets 19,597 25,579 $ 157,878 $ 125,107 Property and equipment, net: Land $ 76,527 $ 74,261 Buildings 31,506 30,870 Leasehold improvements 652,988 583,305 Furniture and fixtures 121,990 117,334 Computer hardware 131,427 116,239 Computer software 511,971 427,313 Equipment and vehicles 17,916 17,105 Work in progress 149,471 69,847 Property and equipment, gross 1,693,796 1,436,274 Accumulated depreciation ( 817,307 ) ( 690,587 ) $ 876,489 $ 745,687 Other non-current assets: Cloud computing arrangement implementation costs $ 84,934 $ 74,631 Security deposits 24,017 23,154 Other 18,529 8,841 $ 127,480 $ 106,626 Other accrued liabilities Accrued freight and other operating expenses $ 187,773 $ 97,335 Accrued duty 24,871 17,404 Sales return allowances 30,414 32,560 Sales tax collected 17,583 15,246 Accrued capital expenditures 16,564 8,653 Forward currency contract liabilities 7,869 18,766 Accrued rent 13,909 8,559 Other 15,411 13,388 $ 314,394 $ 211,911 17 Table of Contents Note 10. Segmented Information The Company's segments are based on the financial information it uses in managing its business and comprise two reportable segments: (i) company-operated stores and (ii) direct to consumer. The remainder of its operations which includes outlets, temporary locations, sales to wholesale accounts, license and supply arrangements, and MIRROR are included within Other. Third Quarter First Three Quarters 2021 2020 2021 2020 (In thousands) Net revenue: Company-operated stores $ 707,160 $ 511,756 $ 1,938,864 $ 1,058,927 Direct to consumer 586,525 478,263 1,729,040 1,384,604 Other 156,736 127,407 459,600 228,799 $ 1,450,421 $ 1,117,426 $ 4,127,504 $ 2,672,330 Segmented income from operations: Company-operated stores $ 180,700 $ 111,780 $ 464,844 $ 76,333 Direct to consumer 257,050 209,610 754,231 604,152 Other 27,450 1,304 64,196 3,622 465,200 322,694 1,283,271 684,107 General corporate expense 180,931 107,048 493,953 297,022 Amortization of intangible assets 2,195 2,195 6,585 2,965 Acquisition-related expenses 24,127 8,531 39,934 22,040 Income from operations 257,947 204,920 742,799 362,080 Other income (expense), net 15 ( 580 ) 338 250 Income before income tax expense $ 257,962 $ 204,340 $ 743,137 $ 362,330 Capital expenditures: Company-operated stores $ 65,665 $ 37,946 $ 112,886 $ 99,081 Direct to consumer 19,163 13,671 62,646 25,750 Corporate and other 37,669 14,490 91,459 45,999 $ 122,497 $ 66,107 $ 266,991 $ 170,830 Depreciation and amortization: Company-operated stores $ 30,135 $ 26,334 $ 85,239 $ 73,925 Direct to consumer 8,084 4,103 20,668 9,715 Corporate and other 19,744 18,596 56,179 49,569 $ 57,963 $ 49,033 $ 162,086 $ 133,209 Note 11. Net Revenue by Geography and Category The following table disaggregates the Company's net revenue by geographic area. Third Quarter First Three Quarters 2021 2020 2021 2020 (In thousands) United States $ 982,238 $ 775,576 $ 2,828,144 $ 1,830,845 Canada 244,061 181,376 628,292 428,531 Outside of North America 224,122 160,474 671,068 412,954 $ 1,450,421 $ 1,117,426 $ 4,127,504 $ 2,672,330 The following table disaggregates the Company's net revenue by category. During the fourth quarter of 2020, the Company determined that a portion of certain sales returns which had been recorded within Other categories were more 18 Table of Contents appropriately classified within Women's product and Men's product. Accordingly, comparative figures have been reclassified to conform to the current presentation. Third Quarter First Three Quarters 2021 2020 2021 2020 (In thousands) Women's product $ 984,952 $ 787,402 $ 2,803,548 $ 1,912,227 Men's product 343,263 238,051 980,633 556,823 Other categories 122,206 91,973 343,323 203,280 $ 1,450,421 $ 1,117,426 $ 4,127,504 $ 2,672,330 Note 12. 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. The Company has recognized immaterial provisions related to the expected outcome of legal proceedings. In April 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 obtained summary judgment that the Company did not infringe upon any of the plaintiff's rights and the district court entered judgment in the Company's favor on all claims. The plaintiff has filed a Notice of Appeal with the United States Court of Appeals for the Ninth Circuit. The Company intends to defend its win at the appellate level. In April 2021, DISH Technologies L.L.C., and Sling TV L.L.C. (DISH) filed a complaint in the United States District Court for the District of Delaware and, along with DISH DBS Corporation, also with the United States International Trade Commission (ITC) under Section 337 of the Tariff Act of 1930 against the Company and its Curiouser Products subsidiary (MIRROR), along with ICON Health & Fitness, Inc., FreeMotion Fitness, Inc., NordicTrack, Inc., and Peloton Interactive, Inc., alleging infringement of various patents related to fitness devices containing internet-streaming enabled video displays. In the ITC complaint, DISH seeks an exclusion order barring the importation of MIRROR fitness devices, streaming components and systems containing components that infringe one or more of the asserted patents as well as a cease and desist order preventing the Company from carrying out commercial activities within the United States related to those products. In the District of Delaware complaint, DISH is seeking an order permanently enjoining the Company from infringing the asserted patents, an award of damages for the infringement of the asserted patents, and an award of damages for lost sales. The ITC investigation is ongoing and the Delaware litigation remains stayed pending resolution to the ITC investigation. The Company intends to vigorously defend this matter.