lululemon athletica inc. 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Some of the statements contained in this Form 10-Q and any documents incorporated herein by reference constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical facts, included or incorporated in this Form 10-Q are forward-looking statements, particularly statements which relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts, such as statements regarding our future financial condition or results of operations, our prospects and strategies for future growth, the development and introduction of new products, and the implementation of our marketing and branding strategies. In many cases, you can identify forward-looking statements by terms such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "intends," "predicts," "potential" or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Form 10-Q and any documents incorporated herein by reference reflect our current views about future events and are subject to risks, uncertainties, assumptions, and changes in circumstances that may cause events or our actual activities or results to differ significantly from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, actions, levels of activity, performance, or achievements. Readers are cautioned not to place undue reliance on these forward-looking statements. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements, including, but not limited to, those factors described in "Risk Factors" and elsewhere in this report. 20 Table of Contents The forward-looking statements contained in this Form 10-Q reflect our views and assumptions only as of the date of this Form 10-Q and are expressly qualified in their entirety by the cautionary statements included in this Form 10-Q. Except as required by applicable securities law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. This information should be read in conjunction with the unaudited interim consolidated financial statements and the notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in our fiscal 2022 Annual Report on Form 10-K filed with the SEC on March 28, 2023. Fiscal 2023 and fiscal 2022 are referred to as "2023," and "2022," respectively. The first three quarters of 2023 and 2022 ended on October 29, 2023 and October 30, 2022, respectively. Components of management's discussion and analysis of financial condition and results of operations include: • Overview • Financial Highlights and Market Conditions and Trends • Quarter-to-Date Results of Operations • Year-to-Date Results of Operations • Comparable Store Sales and Total Comparable Sales • Non-GAAP Financial Measures • Seasonality • Liquidity and Capital Resources • Critical Accounting Policies and Estimates • Operating Locations We disclose material non-public information through one or more of the following channels: our investor relations website (http://corporate.lululemon.com/investors), the social media channels identified on our investor relations website, press releases, SEC filings, public conference calls, and webcasts. Overview lululemon athletica inc. is principally a designer, distributor, and retailer of technical athletic apparel, footwear, and accessories. We have a vision to create transformative products and experiences that build meaningful connections, unlocking greater possibility and wellbeing for all. Since our inception, we have fostered a distinctive corporate culture; we promote a set of core values in our business which include taking personal responsibility, acting with courage, valuing connection and inclusion, and choosing to have fun. These core values attract passionate and motivated employees who are driven to achieve personal and professional goals, and share our purpose "to elevate human potential by helping people feel their best." We offer a comprehensive line of performance apparel, footwear, and accessories marketed under the lululemon brand. Our apparel assortment includes items such as pants, shorts, tops, and jackets designed for a healthy lifestyle including athletic activities such as yoga, running, training, and most other activities. We also offer apparel designed for being on the move and fitness-inspired accessories. We expect to continue to broaden our merchandise offerings through expansion across these product areas. Financial Highlights The summary below compares the third quarter of 2023 to the third quarter of 2022, and provides both GAAP and non-GAAP financial measures. The adjusted financial measures for 2023 exclude $72.1 million of post-tax asset impairment and other charges recognized in relation to lululemon Studio. • Net revenue increased 19% to $2.2 billion. • Total comparable sales increased 13%, or 14% on a constant dollar basis. – Comparable store sales increased 9%. – Direct to consumer net revenue increased 18%, or 19% on a constant dollar basis. • Gross profit increased 21% to $1.3 billion. Adjusted gross profit increased 23% to $1.3 billion. • Gross margin increased 110 basis points to 57.0%. Adjusted gross margin increased 220 basis points to 58.1%. 21 Table of Contents • Income from operations decreased 4% to $338.1 million. Adjusted income from operations increased 24% to $436.3 million. • Operating margin decreased 370 basis points to 15.3%. Adjusted operating margin increased 80 basis points to 19.8%. • Income tax expense increased 2% to $99.2 million. Our effective tax rate for the third quarter of 2023 was 28.5% compared to 27.6% for the third quarter of 2022. The adjusted effective tax rate was 28.1% for the third quarter of 2023. • We have contracted with Peloton Interactive, Inc. to be the exclusive digital fitness content provider for the lululemon Studio Mirror and will no longer produce our own digital fitness content. While we will continue to provide services and support to existing lululemon Studio subscribers, we have ceased selling the Mirror hardware. We recognized post-tax inventory provisions, asset impairments, and restructuring costs related to lululemon Studio totaling $72.1 million during the third quarter of 2023. • Diluted earnings per share were $1.96 compared to $2.00 in the third quarter of 2022. Adjusted diluted earnings per share were $2.53 in the third quarter of 2023. Refer to the non-GAAP reconciliation tables contained in the "Non-GAAP Financial Measures" section of this "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" for reconciliations between the above adjusted non-GAAP financial measures and the most directly comparable measures calculated in accordance with GAAP. Market Conditions and Trends Macroeconomic conditions, supply chain disruption, and the COVID-19 pandemic have impacted our business and operating costs. Certain trends are expected to continue throughout 2023, with the impact varying by market. Macroeconomic Conditions Macroeconomic conditions, including foreign currency fluctuations, have impacted our financial results. Foreign currency fluctuations reduced the growth of our net revenue by $82.2 million when comparing the first three quarters of 2023 to the first three quarters of 2022, primarily due to the overall appreciation of the US dollar. We expect that future exchange rate volatility will impact our results. We have also experienced increased wage rates when comparing the first three quarters of 2023 to the first three quarters of 2022. Guest traffic in our company-operated stores and online increased during the first three quarters of 2023, compared to the first three quarters of 2022. Consumer purchasing behaviors may be impacted by current economic conditions including inflation, higher interest rates, and other macroeconomic factors which may have an adverse effect on our future operating margins. Supply chain disruption In 2021 and 2022 we experienced supply chain disruption, including delays in inbound delivery of our products as well as in manufacturing. This supply chain disruption caused us to use higher cost modes of transport, including increasing our use of air freight. We saw an improvement in the supply chain disruption during the second half of 2022 and during the first three quarters of 2023, including reductions in freight costs and reductions in our levels of air freight usage. During the first three quarters of 2023 compared to the first three quarters of 2022, our product margin increased by 320 basis points excluding the impact of the lululemon Studio inventory provision, primarily due to lower freight costs from rate reductions and reduced air freight usage. We expect that the reduction in freight costs for the fourth quarter of 2023 will be less significant than in the first three quarters of 2023. COVID-19 Pandemic Most of our retail locations were open throughout the first three quarters of 2023 and 2022, with certain locations temporarily closed due to COVID-19 resurgences during the first quarter of 2022, including certain company-operated stores and our third party distribution center in the People's Republic of China ("PRC"). Net revenue from the PRC increased 64% in the first three quarters of 2023 compared to the first three quarters of 2022, with improvements in COVID-19 trading conditions contributing to this increase. 22 Table of Contents Quarter-to-Date Results of Operations: Third Quarter Results The following table summarizes key components of our results of operations for the periods indicated: Third Quarter 2023 2022 2023 2022 (In thousands) (Percentage of net revenue) Net revenue $ 2,204,218 $ 1,856,889 100.0 % 100.0 % Cost of goods sold 947,554 818,037 43.0 44.1 Gross profit 1,256,664 1,038,852 57.0 55.9 Selling, general and administrative expenses 842,795 684,236 38.2 36.8 Impairment of assets and restructuring costs 74,501 — 3.4 — Amortization of intangible assets 1,253 2,189 0.1 0.1 Income from operations 338,115 352,427 15.3 19.0 Other income (expense), net 9,842 331 0.4 — Income before income tax expense 347,957 352,758 15.8 19.0 Income tax expense 99,243 97,288 4.5 5.2 Net income $ 248,714 $ 255,470 11.3 % 13.8 % Net Revenue Net revenue increased $347.3 million, or 19%, to $2.2 billion for the third quarter of 2023 from $1.9 billion for the third quarter of 2022. On a constant dollar basis, assuming the average foreign currency exchange rates for the third quarter of 2023 remained constant with the average foreign currency exchange rates for the third quarter of 2022, net revenue increased $358.4 million, or 19%. The increase in net revenue was primarily due to increased company-operated store net revenue, including from new company-operated stores and increased comparable store sales, as well as due to increased direct to consumer net revenue. Other net revenue also increased. Total comparable sales, which includes comparable store sales and direct to consumer net revenue, increased 13% for the third quarter of 2023 compared to the third quarter of 2022. Total comparable sales increased 14% on a constant dollar basis. Net revenue for the third quarter of 2023 and 2022 is summarized below. Third Quarter 2023 2022 2023 2022 Year over year change (In thousands) (Percentage of net revenue) (In thousands) (Percentage) Company-operated stores $ 1,073,973 $ 903,060 48.7 % 48.6 % $ 170,913 18.9 % Direct to consumer 908,127 767,351 41.2 41.3 140,776 18.3 Other 222,118 186,478 10.1 10.0 35,640 19.1 Net revenue $ 2,204,218 $ 1,856,889 100.0 % 100.0 % $ 347,329 18.7 % Company-Operated Stores. The increase in net revenue from our company-operated stores was driven by net revenue from company-operated stores that we opened or significantly expanded since the third quarter of 2022 which contributed $108.2 million to the increase. We have opened 63 net new company-operated stores since the third quarter of 2022, including 32 stores in Asia Pacific, 28 stores in North America, and three stores in Europe. The increase in net revenue from our company-operated stores was also driven by increased comparable store sales. Comparable store sales increased 9%, or 9% on a constant dollar basis. The increase in comparable store sales was primarily a result of increased store traffic, partially offset by a decrease in conversion rates and a lower dollar value per transaction. Direct to Consumer. Direct to consumer net revenue increased 18%, or 19% on a constant dollar basis. The increase in net revenue from our direct to consumer segment was primarily a result of increased traffic and a higher dollar value per transaction, partially offset by a decrease in conversion rates. 23 Table of Contents Other. The increase in other net revenue was primarily due to increased outlet sales, sales to wholesale accounts, and license and supply arrangement revenue. The increase in net revenue was partially offset by a decrease in net revenue from our temporary locations, which had fewer locations open compared to the prior year, and a decrease in lululemon Studio net revenue. Gross Profit Third Quarter 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Gross profit $ 1,256,664 $ 1,038,852 $ 217,812 21.0 % Gross margin 57.0 % 55.9 % 110 basis points As a result of our decision to cease selling the lululemon Studio Mirror, we recognized an inventory obsolescence provision of $23.7 million during the third quarter of 2023. This reduced gross margin by 110 basis points. Please refer to Note 3. Impairment of Assets and Restructuring Costs included in Item 1 of Part I of this report. Gross margin increased 110 basis points, or increased 220 basis points on an adjusted basis. The 220 basis point increase in adjusted gross margin was primarily the result of: • a net increase in product margin of 250 basis points, primarily due to lower freight costs from rate reductions and reduced air freight usage as well as lower duty costs, modestly offset by higher inventory provisions, shrink, and damages in the current year. The increase in adjusted gross margin was partially offset by an increase in occupancy costs as a percentage of net revenue of 20 basis points and an unfavorable impact of foreign currency exchange rates of 10 basis points. Selling, General and Administrative Expenses Third Quarter 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Selling, general and administrative expenses $ 842,795 $ 684,236 $ 158,559 23.2 % Selling, general and administrative expenses as a percentage of net revenue 38.2 % 36.8 % 140 basis points The increase in selling, general and administrative expenses was primarily due to: • an increase in head office costs of $89.4 million, comprised of: – an increase in brand and community costs of $36.3 million primarily due to increased marketing expenses; – an increase in employee costs of $26.9 million primarily due to increased salaries and wages expense as well as increased benefits costs, stock-based compensation, and incentive compensation, primarily as a result of headcount growth and increased wage rates; – an increase in other head office costs of $11.2 million, primarily due to increased professional fees; – an increase in technology costs, including cloud computing amortization, of $8.2 million; and – an increase in depreciation of $6.8 million. • an increase in costs related to our operating channels of $75.6 million, comprised of: – an increase in employee costs of $34.2 million primarily due to increased salaries and wages expense, benefit costs, and incentive compensation in our company-operated stores channel, primarily from the growth in our business and increased wage rates; – an increase in other operating costs of $18.8 million primarily due to increased depreciation, repairs and maintenance costs, and technology costs; 24 Table of Contents – an increase in variable costs of $15.2 million primarily due to increased credit card fees, distribution costs, and packaging costs primarily as a result of increased net revenue; and – an increase in brand and community costs of $7.4 million primarily due to increased digital marketing expenses related to our direct to consumer channel. The increase in selling, general and administrative expenses was partially offset by a decrease in net foreign currency exchange and derivative revaluation losses of $6.4 million. Impairment of Assets and Restructuring Costs Third Quarter 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Impairment of assets and restructuring costs $ 74,501 $ — $ 74,501 n/a During the third quarter of 2023, we recognized certain asset impairments and restructuring costs related to lululemon Studio. Please refer to Note 3. Impairment of Assets and Restructuring Costs included in Item 1 of Part I of this report for further information. Amortization of Intangible Assets Third Quarter 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Amortization of intangible assets $ 1,253 $ 2,189 $ (936) (42.8) % The amortization of intangible assets was primarily the result of the amortization of intangible assets recognized upon the acquisition of MIRROR, which we rebranded as lululemon Studio. Income from Operations On a segment basis, we determine income from operations without taking into account our general corporate expenses and certain other expenses. Segmented income from operations is summarized below. Third Quarter 2023 2022 2023 2022 Year over year change (In thousands) (Percentage of net revenue of respective operating segment) (In thousands) (Percentage) Segmented income from operations: Company-operated stores $ 310,510 $ 242,733 28.9 % 26.9 % $ 67,777 27.9 % Direct to consumer 384,393 321,742 42.3 41.9 62,651 19.5 Other 53,527 24,911 24.1 13.4 28,616 114.9 $ 748,430 $ 589,386 $ 159,044 27.0 % General corporate expense 310,852 234,770 76,082 32.4 lululemon Studio obsolescence provision 23,709 — 23,709 n/a Impairment of assets and restructuring costs 74,501 — 74,501 n/a Amortization of intangible assets 1,253 2,189 (936) (42.8) Income from operations $ 338,115 $ 352,427 $ (14,312) (4.1) % Operating margin 15.3 % 19.0 % (370) basis points Company-Operated Stores . The increase in income from operations from our company-operated stores was primarily the result of increased gross profit of $114.5 million, driven by increased net revenue and higher gross margin. The increase in gross margin was primarily due to higher product margin driven by lower freight costs and lower markdowns, partially offset by higher inventory provisions, shrink, and damages. The increase in gross margin was partially offset by an unfavorable impact of foreign currency exchange rates, deleverage in occupancy costs, and deleverage in costs from our product teams. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses, primarily due to 25 Table of Contents higher employee and operating costs. Employee costs increased primarily due to higher salaries and wages expense, benefit costs, and incentive compensation as a result of the growth in our business and increased wage rates. Store operating costs increased primarily due to increases in credit card fees and packaging costs, as a result of higher net revenue, as well as increased repairs and maintenance. Income from operations as a percentage of company-operated store net revenue increased due to higher gross margin, partially offset by deleverage on selling, general and administrative expenses. Direct to Consumer. The increase in income from operations from our direct to consumer segment was primarily the result of increased gross profit of $105.5 million, driven by increased net revenue and higher gross margin. The increase in gross margin was primarily due to higher product margin driven by lower freight costs, partially offset by higher markdowns and inventory provisions. The increase in gross margin was partially offset by an unfavorable impact of foreign currency exchange rates and deleverage in costs from our product teams and distribution centers. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses, primarily due to higher digital marketing expenses, higher variable operating costs including distribution costs, credit card fees, and packaging costs as a result of higher net revenue, as well as higher depreciation costs and technology costs. Income from operations as a percentage of direct to consumer net revenue increased primarily due to higher gross margin, partially offset by deleverage on selling, general and administrative expenses. Other. The increase in income from operations from our other channels was primarily the result of increased gross profit of $21.6 million, driven by increased net revenue and higher gross margin. The increase in income from operations from our other channels was partially offset by an increase in selling, general and administrative expenses primarily due to increased salaries and wages expense and increased repairs and maintenance, partially offset by reduced lululemon Studio marketing expenses. Income from operations as a percentage of other net revenue increased primarily due to leverage on selling, general and administrative expenses and higher gross margin. General Corporate Expense. The increase in general corporate expense was primarily due to increased brand and community costs, as well as increased employee costs, primarily from headcount growth and increased wage rates, professional fees, technology costs, and depreciation. The increase in general corporate expense was partially offset by a decrease in net foreign currency exchange and derivative revaluation losses of $6.4 million. Other Income (Expense), Net Third Quarter 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Other income (expense), net $ 9,842 $ 331 $ 9,511 n/a The increase in other income, net was primarily due to an increase in interest income as a result of higher interest rates and higher cash balances. Income Tax Expense Third Quarter 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Income tax expense $ 99,243 $ 97,288 $ 1,955 2.0 % Effective tax rate 28.5 % 27.6 % 90 basis points The increase in the effective tax rate was primarily due to the accrual of withholding taxes on unremitted foreign earnings and a lower tax rate on certain inventory provisions, asset impairments, and restructuring costs recognized in relation to lululemon Studio which increased the effective tax rate in the third quarter of 2023 by 40 basis points. This was partially offset by a reduction in non-deductible expenses in international jurisdictions and an increase in tax benefits related to stock-based compensation. Excluding certain inventory provisions, asset impairments, and restructuring costs recognized in relation to lululemon Studio in 2023, and their tax effects, our adjusted effective tax rate was 28.1% for the third quarter of 2023. 26 Table of Contents Net Income Third Quarter 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Net income $ 248,714 $ 255,470 $ (6,756) (2.6) % The decrease in net income was primarily due to an increase in selling, general and administrative expenses of $158.6 million, asset impairment and restructuring costs recognized in relation to lululemon Studio in the third quarter of 2023 of $74.5 million, and an increase in income tax expense of $2.0 million, partially offset by an increase in gross profit of $217.8 million and an increase in other income (expense), net of $9.5 million. Excluding certain inventory provisions, asset impairments, and restructuring costs recognized in relation to lululemon Studio in 2023, and their tax effects, adjusted net income increased $65.4 million or 26%. Year-to-Date Results of Operations: First Three Quarters Results The following table summarizes key components of our results of operations for the periods indicated: First Three Quarters 2023 2022 2023 2022 (In thousands) (Percentage of net revenue) Net revenue $ 6,414,175 $ 5,338,680 100.0 % 100.0 % Cost of goods sold 2,708,195 2,373,959 42.2 44.5 Gross profit 3,705,980 2,964,721 57.8 55.5 Selling, general and administrative expenses 2,407,683 1,954,340 37.5 36.6 Impairment of assets and restructuring costs 74,501 — 1.2 — Amortization of intangible assets 5,010 6,579 0.1 0.1 Gain on disposal of assets — (10,180) — (0.2) Income from operations 1,218,786 1,013,982 19.0 19.0 Other income (expense), net 25,229 454 0.4 — Income before income tax expense 1,244,015 1,014,436 19.4 19.0 Income tax expense 363,293 279,447 5.7 5.2 Net income $ 880,722 $ 734,989 13.7 % 13.8 % Net Revenue Net revenue increased $1.1 billion, or 20%, to $6.4 billion for the first three quarters of 2023 from $5.3 billion for the first three quarters of 2022. On a constant dollar basis, assuming the average foreign currency exchange rates for the first three quarters of 2023 remained constant with the average foreign currency exchange rates for the first three quarters of 2022, net revenue increased $1.2 billion, or 22%. The increase in net revenue was primarily due to increased company-operated store net revenue, including from new company-operated stores and increased comparable store sales, as well as due to increased direct to consumer net revenue. Other net revenue also increased. Total comparable sales, which includes comparable store sales and direct to consumer net revenue, increased 13% for the first three quarters of 2023 compared to the first three quarters of 2022. Total comparable sales increased 14% on a constant dollar basis. 27 Table of Contents Net revenue for the first three quarters of 2023 and 2022 is summarized below. First Three Quarters 2023 2022 2023 2022 Year over year change (In thousands) (Percentage of net revenue) (In thousands) (Percentage) Company-operated stores $ 3,128,999 $ 2,537,741 48.8 % 47.5 % $ 591,258 23.3 % Direct to consumer 2,636,742 2,264,029 41.1 42.4 372,713 16.5 Other 648,434 536,910 10.1 10.1 111,524 20.8 Net revenue $ 6,414,175 $ 5,338,680 100.0 % 100.0 % $ 1,075,495 20.1 % Company-Operated Stores . The increase in net revenue from our company-operated stores was driven by net revenue from company-operated stores that we opened or significantly expanded since the third quarter of 2022 which contributed $387.1 million to the increase. We have opened 63 net new company-operated stores since the third quarter of 2022, including 32 stores in Asia Pacific, 28 stores in North America, and three stores in Europe. The increase in net revenue from our company-operated stores was also driven by increased comparable store sales. Comparable store sales increased 10%, or 11% on a constant dollar basis. The increase in comparable store sales was primarily a result of increased store traffic, partially offset by a decrease in conversion rates and a lower dollar value per transaction. Direct to Consumer. Direct to consumer net revenue increased 16%, or 18% on a constant dollar basis. The increase in net revenue from our direct to consumer segment was primarily a result of increased traffic, partially offset by a decrease in conversion rates and a lower dollar value per transaction. Other. The increase in other net revenue was primarily due to increased outlet sales, sales to wholesale accounts, and license and supply arrangement revenue. The increase in net revenue was partially offset by a decrease in net revenue from our temporary locations, which had fewer locations open compared to the prior year, and a decrease in lululemon Studio net revenue. Gross Profit First Three Quarters 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Gross profit $ 3,705,980 $ 2,964,721 $ 741,259 25.0 % Gross margin 57.8 % 55.5 % 230 basis points As a result of our decision to cease selling the lululemon Studio Mirror, we recognized an inventory obsolescence provision of $23.7 million during the third quarter of 2023. This reduced gross margin by 30 basis points. Please refer to Note 3. Impairment of Assets and Restructuring Costs included in Item 1 of Part I of this report. Gross margin increased 230 basis points, or increased 260 basis points on an adjusted basis. The 260 basis point increase in adjusted gross margin was primarily the result of: • a net increase in product margin of 320 basis points, primarily due to lower freight costs from rate reductions and reduced air freight usage as well as lower duty costs, modestly offset by higher inventory provisions and damages in the current year. The increase in adjusted gross margin was partially offset by: • an unfavorable impact of foreign currency exchange rates of 30 basis points; • an increase in costs related to our distribution centers and product departments as a percentage of net revenue of 20 basis points; and • an increase in occupancy costs as a percentage of net revenue of 10 basis points. 28 Table of Contents Selling, General and Administrative Expenses First Three Quarters 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Selling, general and administrative expenses $ 2,407,683 $ 1,954,340 $ 453,343 23.2 % Selling, general and administrative expenses as a percentage of net revenue 37.5 % 36.6 % 90 basis points The increase in selling, general and administrative expenses was primarily due to: • an increase in head office costs of $258.0 million, comprised of: – an increase in employee costs of $90.1 million primarily due to increased salaries and wages expense as well as increased incentive compensation, benefit costs, and stock-based compensation; primarily as a result of headcount growth and increased wage rates; – an increase in brand and community costs of $73.2 million primarily due to increased marketing expenses as well as increased charitable donations; – an increase in depreciation of $34.1 million; – an increase in technology costs, including cloud computing amortization, of $32.1 million; and – an increase in other head office costs of $28.5 million, primarily due to increased professional fees. • an increase in costs related to our operating channels of $213.1 million, comprised of: – an increase in employee costs of $109.7 million primarily due to increased salaries and wages expense, incentive compensation, and benefit costs in our company-operated stores channel, primarily from the growth in our business and increased wage rates; – an increase in other operating costs of $45.3 million primarily due to increased depreciation costs, technology costs, and repairs and maintenance costs; – an increase in variable costs of $39.5 million primarily due to increased credit card fees, distribution costs, and packaging costs, primarily as a result of increased net revenue; and – an increase in brand and community costs of $18.6 million primarily due to increased digital marketing expenses related to our direct to consumer channel. The increase in selling, general and administrative expenses was partially offset by a decrease in net foreign currency exchange and derivative revaluation losses of $17.8 million. Impairment of Assets and Restructuring Costs First Three Quarters 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Impairment of assets and restructuring costs $ 74,501 $ — $ 74,501 n/a During the third quarter of 2023, we recognized certain asset impairments and restructuring costs related to lululemon Studio. Please refer to Note 3. Impairment of Assets and Restructuring Costs included in Item 1 of Part I of this report for further information. 29 Table of Contents Amortization of Intangible Assets First Three Quarters 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Amortization of intangible assets $ 5,010 $ 6,579 $ (1,569) (23.8) % The amortization of intangible assets was primarily the result of the amortization of intangible assets recognized upon the acquisition of MIRROR, which we rebranded as lululemon Studio. Gain on Disposal of Assets First Three Quarters 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Gain on disposal of assets $ — $ (10,180) $ 10,180 (100.0) % During the second quarter of 2022, we completed the sale of an administrative office building, which resulted in a pre-tax gain of $10.2 million. Income from Operations On a segment basis, we determine income from operations without taking into account our general corporate expenses and certain other expenses. Segmented income from operations is summarized below. First Three Quarters 2023 2022 2023 2022 Year over year change (In thousands) (Percentage of net revenue of respective operating segment) (In thousands) (Percentage) Segmented income from operations: Company-operated stores $ 910,021 $ 660,246 29.1 % 26.0 % $ 249,775 37.8 % Direct to consumer 1,137,716 933,272 43.1 41.2 204,444 21.9 Other 146,293 74,064 22.6 13.8 72,229 97.5 $ 2,194,030 $ 1,667,582 $ 526,448 31.6 % General corporate expense 872,024 657,201 214,823 32.7 lululemon Studio obsolescence provision 23,709 — 23,709 n/a Impairment of assets and restructuring costs 74,501 — 74,501 n/a Amortization of intangible assets 5,010 6,579 (1,569) (23.8) Gain on disposal of assets — (10,180) 10,180 (100.0) Income from operations $ 1,218,786 $ 1,013,982 $ 204,804 20.2 % Operating margin 19.0 % 19.0 % 0 basis points Company-Operated Stores. The increase in income from operations from our company-operated stores was primarily the result of increased gross profit of $396.0 million, driven by increased net revenue and higher gross margin. The increase in gross margin was primarily due to higher product margin driven by lower freight costs and lower markdowns, partially offset by higher inventory provisions, shrink, and damages. The increase in gross margin was also due to leverage on depreciation costs, partially offset by an unfavorable impact of foreign currency exchange rates and deleverage in costs from our product teams. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses, primarily due to higher employee and operating costs. Employee costs increased primarily due to higher salaries and wages expense, incentive compensation, and benefit costs as a result of the growth in our business and increased wage rates. Store operating costs increased primarily due to increases in credit card fees and packaging costs as a result of higher net revenue, as well as increased repairs and maintenance. Income from operations as a percentage of company-operated store net revenue increased due to higher gross margin, partially offset by deleverage on selling, general and administrative expenses. Direct to Consumer. The increase in income from operations from our direct to consumer segment was primarily the result of increased gross profit of $311.3 million, driven by increased net revenue and higher gross margin. The increase in 30 Table of Contents gross margin was primarily due to higher product margin driven by lower freight costs, partially offset by higher markdowns and higher inventory provisions and damages. The increase in gross margin was partially offset by an unfavorable impact of foreign currency exchange rates and deleverage in costs from our product teams and distribution centers. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses primarily due to higher digital marketing expenses, higher variable operating costs including distribution costs, credit card fees, and packaging costs as a result of higher net revenue, as well as higher depreciation costs and higher technology costs. Income from operations as a percentage of direct to consumer net revenue increased primarily due to higher gross margin, partially offset by deleverage on selling, general and administrative expenses. Other. The increase in income from operations from our other channels was primarily the result of increased gross profit of $57.7 million, driven by increased net revenue and higher gross margin. The increase in income from operations from our other channels was partially offset by an increase in selling, general and administrative expenses driven by higher salaries and wages expense, higher repairs and maintenance, and professional fees, partially offset by reduced lululemon Studio marketing expenses. Income from operations as a percentage of other net revenue increased primarily due to leverage on selling, general and administrative expenses and higher gross margin. General Corporate Expense. The increase in general corporate expense was primarily due to increased employee costs, primarily from headcount growth and increased wage rates, as well as increased brand and community costs, depreciation, technology costs, and professional fees. The increase in general corporate expense was partially offset by a decrease in net foreign currency exchange and derivative revaluation losses of $17.8 million. Other Income (Expense), Net First Three Quarters 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Other income (expense), net $ 25,229 $ 454 $ 24,775 n/a The increase in other income, net was primarily due to an increase in interest income as a result of higher interest rates and higher cash balances. Income Tax Expense First Three Quarters 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Income tax expense $ 363,293 $ 279,447 $ 83,846 30.0 % Effective tax rate 29.2 % 27.5 % 170 basis points The increase in the effective tax rate was primarily due to the accrual of withholding taxes on unremitted foreign earnings, adjustments upon the filing of income tax returns, and a lower tax rate on certain inventory provisions, asset impairments, and restructuring costs recognized in relation to lululemon Studio which increased the effective tax rate in the first three quarters of 2023 by 20 basis points. A lower tax rate on the capital gain on the sale of an administrative building reduced our effective tax rate in the first three quarters of 2022 by 20 basis points. The increase in the effective tax rate was partially offset by a reduction in non-deductible expenses in international jurisdictions. Excluding certain inventory provisions, asset impairments, and restructuring costs recognized in relation to lululemon Studio in 2023, and the gain on sale of an administrative building in 2022, and their tax effects, our adjusted effective tax rates were 29.0% and 27.7% for the first three quarters of 2023 and 2022, respectively. 31 Table of Contents Net Income First Three Quarters 2023 2022 Year over year change (In thousands) (In thousands) (Percentage) Net income $ 880,722 $ 734,989 $ 145,733 19.8 % The increase in net income was primarily due to an increase in gross profit of $741.3 million and an increase in other income (expense), net of $24.8 million, partially offset by an increase in selling, general and administrative expenses of $453.3 million, an increase in income tax expense of $83.8 million, asset impairment and restructuring costs recognized in relation to lululemon Studio in 2023 of $74.5 million, and a gain on disposal of assets of $10.2 million in the prior year. Excluding certain inventory provisions, asset impairments, and restructuring costs recognized in relation to lululemon Studio in 2023, and the gain on sale of an administrative building in 2022, and their tax effects, adjusted net income increased $226.4 million or 31%. Comparable Store Sales and Total Comparable Sales We use comparable store sales to assess the performance of our existing stores as it allows us to monitor the performance of our business without the impact of recently opened or expanded stores. We use total comparable sales to evaluate the performance of our business from an omni-channel perspective. We believe investors would similarly find these metrics useful in assessing the performance of our business. Comparable store sales reflect net revenue from company-operated stores that have been open, or open after being significantly expanded, for at least 12 full fiscal months. Net revenue from a store is included in comparable store sales beginning with the first fiscal month for which the store has a full fiscal month of sales in the prior year. Comparable store sales exclude sales from new stores that have not been open for at least 12 full fiscal months, from stores which have not been in their significantly expanded space for at least 12 full fiscal months, and from stores which have been temporarily relocated for renovations or temporarily closed. Comparable store sales also exclude sales from direct to consumer and our other operations, as well as sales from company-operated stores that have closed. Total comparable sales combines comparable store sales and direct to consumer net revenue. In fiscal years with 53 weeks, the 53rd week of net revenue is excluded from the calculation of comparable sales. In the year following a 53 week year, the prior year period is shifted by one week to compare similar calendar weeks. Opening new stores and expanding existing stores is an important part of our growth strategy. Accordingly, total comparable sales is just one way of assessing the success of our growth strategy insofar as comparable sales do not reflect the performance of stores opened, or significantly expanded, within the last 12 full fiscal months. The comparable sales measures we report may not be equivalent to similarly titled measures reported by other companies. Non-GAAP Financial Measures Constant dollar changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue are non-GAAP financial measures. A constant dollar basis assumes the average foreign currency exchange rates for the period remained constant with the average foreign currency exchange rates for the same period of the prior year. We provide constant dollar changes in our results to help investors understand the underlying growth rate of net revenue excluding the impact of changes in foreign currency exchange rates. Adjusted gross profit, gross margin, income from operations, operating margin, income tax expense, effective tax rates, net income, and diluted earnings per share exclude certain inventory provisions, asset impairments, and restructuring costs recognized in relation to lululemon Studio, the gain on disposal of assets for the sale of an administrative office building, and the related income tax effects of these items. We believe these adjusted financial measures are useful to investors as they provide supplemental information that enable evaluation of the underlying trend in our operating performance, and enable a comparison to our historical financial information. Further, due to the finite and discrete nature of these items, we do not consider them to be normal operating expenses that are necessary to run our business, or impairments or disposal gains that are expected to arise in the normal course of our operations. Management uses these adjusted financial measures and constant currency metrics internally when reviewing and assessing financial performance. 32 Table of Contents The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or with greater prominence to, the financial information prepared and presented in accordance with GAAP. A reconciliation of the non-GAAP financial measures follows, which includes more detail on the GAAP financial measure that is most directly comparable to each non-GAAP financial measure, and the related reconciliations between these financial measures. Our non-GAAP financial measures may be calculated differently from, and therefore may not be directly comparable to, similarly titled measures reported by other companies. Constant Dollar Changes in Net Revenue The below changes in net revenue show the change compared to the corresponding period in the prior year. Third Quarter 2023 First Three Quarters 2023 Net Revenue Net Revenue (In thousands) (Percentage) (In thousands) (Percentage) Change $ 347,329 19 % $ 1,075,495 20 % Adjustments due to foreign currency exchange rate changes 11,098 — 82,201 2 % Change in constant dollars $ 358,427 19 % $ 1,157,696 22 % Constant Dollar Changes in Total Comparable Sales, Comparable Store Sales, and Direct to Consumer Net Revenue The below changes in total comparable sales, comparable store sales, and direct to consumer net revenue show the change compared to the corresponding period in the prior year. Third Quarter 2023 First Three Quarters 2023 Total Comparable Sales (1),(2) Comparable Store Sales (2) Direct to Consumer Net Revenue Total Comparable Sales (1),(2) Comparable Store Sales (2) Direct to Consumer Net Revenue Change 13 % 9 % 18 % 13 % 10 % 16 % Adjustments due to foreign currency exchange rate changes 1 — 1 1 1 2 Change in constant dollars 14 % 9 % 19 % 14 % 11 % 18 % __________ (1) Total comparable sales includes comparable store sales and direct to consumer net revenue. (2) Comparable store sales reflects net revenue from company-operated stores that have been open for at least 12 full fiscal months, or open for at least 12 full fiscal months after being significantly expanded. 33 Table of Contents Adjusted financial measures The following tables reconcile adjusted financial measures with the most directly comparable measures calculated in accordance with GAAP. The 2023 adjustments relate to certain inventory provisions, asset impairments, and restructuring costs recognized in relation to lululemon Studio and their related tax effects. The 2022 adjustments relate to the gain on sale of an administrative office building and its related tax effects. Please refer to Note 3. Impairment of Assets and Restructuring Costs and Note 4. Gain on Disposal of Assets included in Item 1 of Part I of this report for further information on the nature of these amounts. Third Quarter 2023 Gross Profit Gross Margin Income from Operations Operating Margin Income Tax Expense Effective Tax Rate Net Income Diluted Earnings Per Share (In thousands, except per share amounts) GAAP results $ 1,256,664 57.0 % $ 338,115 15.3 % $ 99,243 28.5 % $ 248,714 $ 1.96 lululemon Studio charges: lululemon Studio obsolescence provision 23,709 1.1 23,709 1.1 23,709 0.19 Impairment of assets 44,186 2.0 44,186 0.35 Restructuring costs 30,315 1.4 30,315 0.24 Tax effect of the above 26,085 (0.4) (26,085) (0.21) 23,709 1.1 98,210 4.5 26,085 (0.4) 72,125 0.57 Adjusted results (non-GAAP) $ 1,280,373 58.1 % $ 436,325 19.8 % $ 125,328 28.1 % $ 320,839 $ 2.53 First Three Quarters 2023 Gross Profit Gross Margin Income from Operations Operating Margin Income Tax Expense Effective Tax Rate Net Income Diluted Earnings Per Share (In thousands, except per share amounts) GAAP results $ 3,705,980 57.8 % $ 1,218,786 19.0 % $ 363,293 29.2 % $ 880,722 $ 6.92 lululemon Studio charges: lululemon Studio obsolescence provision 23,709 0.3 23,709 0.3 23,709 0.19 Impairment of assets 44,186 0.7 44,186 0.35 Restructuring costs 30,315 0.5 30,315 0.24 Tax effect of the above 26,085 (0.2) (26,085) (0.21) 23,709 0.3 98,210 1.5 26,085 (0.2) 72,125 0.57 Adjusted results (non-GAAP) $ 3,729,689 58.1 % $ 1,316,996 20.5 % $ 389,378 29.0 % $ 952,847 $ 7.49 34 Table of Contents First Three Quarters 2022 Income from Operations Operating Margin Income Tax Expense Effective Tax Rate Net Income Diluted Earnings Per Share (In thousands, except per share amounts) GAAP results $ 1,013,982 19.0 % $ 279,447 27.5 % $ 734,989 $ 5.74 Gain on disposal of assets (10,180) (0.2) (10,180) (0.08) Tax effect of the above (1,661) 0.2 1,661 0.01 Adjusted results (non-GAAP) $ 1,003,802 18.8 % $ 277,786 27.7 % $ 726,470 $ 5.67 Seasonality Our business is affected by the general seasonal trends common to the retail apparel industry. Our annual net revenue is weighted more heavily toward our fourth fiscal quarter, reflecting our historical strength in sales during the holiday season, while our operating expenses are more equally distributed throughout the year. As a result, a substantial portion of our operating profits are typically generated in the fourth quarter of our fiscal year. For example, we generated approximately 44% of our full year operating profit during the fourth quarter of 2021. Our operating profits in 2022 were not weighted towards our fourth quarter primarily due to the impairment of goodwill and other assets recognized in relation to lululemon Studio during that quarter. Liquidity and Capital Resources Our primary sources of liquidity are our current balances of cash and cash equivalents, cash flows from operations, and capacity under our committed revolving credit facility, including to fund short-term working capital requirements. Our primary cash needs are capital expenditures for opening new stores and remodeling or relocating existing stores, investing in our distribution centers, investing in technology and making 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 well as in money market funds and term deposits. The following table summarizes our net cash flows provided by and used in operating, investing, and financing activities for the periods indicated: First Three Quarters 2023 2022 Year over year change (In thousands) Total cash provided by (used in): Operating activities $ 912,066 $ (79,801) $ 991,867 Investing activities (445,325) (386,862) (58,463) Financing activities (510,583) (399,428) (111,155) Effect of foreign currency exchange rate changes on cash and cash equivalents (19,887) (41,156) 21,269 Increase (decrease) in cash and cash equivalents $ (63,729) $ (907,247) $ 843,518 Operating Activities The increase in cash provided by operating activities was primarily as a result of: • an increase in cash flows from the changes in operating assets and liabilities of $613.9 million, primarily driven by changes in inventories, prepaid expenses and other current assets, and accounts payable, partially offset by changes in income taxes; • changes in adjusting items of $232.2 million, primarily driven by certain inventory provisions, asset impairments, and restructuring costs recognized in relation to lululemon Studio, as well as increased depreciation and higher cash inflows related to derivatives; and • increased net income of $145.7 million. 35 Table of Contents Investing Activities The increase in cash used in investing activities was primarily due to increased capital expenditures and the settlement of net investment hedges. The increase in capital expenditures was primarily due to investment in our distribution centers as well as technology infrastructure and digital investments, partially offset by a slight decrease in company-operated store expenditures. Financing Activities The increase in cash used in financing activities was primarily the result of an increase in our stock repurchases. During the first three quarters of 2023, 1.4 million shares were repurchased at a total cost including commissions and excise taxes of $504.6 million. During the first three quarters of 2022, 1.2 million shares were repurchased at a total cost including commissions of $375.0 million. The common stock was repurchased in the open market 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, with the timing and actual number of shares repurchased depending upon market conditions, eligibility to trade, and other factors. Liquidity Outlook We believe that our cash and cash equivalent balances, cash generated from operations, and borrowings available to us under our committed 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, or we may repurchase shares under an approved stock repurchase program, 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 expenditures out of our cash and cash equivalents and cash generated from operations. The following table includes certain measures of our liquidity: October 29, 2023 (In thousands) Cash and cash equivalents $ 1,091,138 Working capital excluding cash and cash equivalents (1) 825,647 Capacity under committed revolving credit facility 393,361 _________ (1) Working capital is calculated as current assets of $3.4 billion less current liabilities of $1.4 billion. We enter into standby letters of credit and guarantee to secure certain of our obligations, including leases, taxes, and duties. As of October 29, 2023, letters of credit and guarantee totaling $10.0 million had been issued, including $6.6 million under our committed revolving credit facility. Our committed North America credit facility provides for $400.0 million in commitments under an unsecured five-year revolving credit facility. The credit facility has a maturity date of December 14, 2026, subject to extension under certain circumstances. As of October 29, 2023, aside from letters of credit and guarantee of $6.6 million, we had no other borrowings outstanding under this credit facility. Further information regarding our credit facilities and associated covenants is outlined in Note 5. Revolving Credit Facilities and Supply Chain Financing Program included in Item 1 of Part I of this report. The timing and cost of our inventory purchases will vary depending on a variety of factors such as revenue growth, assortment and purchasing decisions, product costs including freight and duty, and the availability of production capacity and speed. Our inventory balance as of October 29, 2023 was $1.7 billion, a decrease of 4% from October 30, 2022. 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 significant 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 36 Table of Contents 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. Our critical accounting policies, estimates, and judgements are discussed within "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our 2022 Annual Report on Form 10-K filed with the SEC on March 28, 2023. Operating Locations Our company-operated stores by country as of October 29, 2023 and January 29, 2023 are summarized in the table below. Number of company-operated stores by country (market) October 29, 2023 January 29, 2023 United States 361 350 People's Republic of China (1) 133 117 Canada 70 69 Australia 32 32 United Kingdom 20 20 South Korea 18 16 Germany 9 10 New Zealand 8 8 Singapore 7 8 Japan 7 7 France 5 4 Ireland 4 4 Spain 3 3 Malaysia 2 2 Sweden 2 2 Netherlands 2 1 Norway 1 1 Switzerland 1 1 Thailand 1 — Total company-operated stores 686 655 __________ (1) PRC included 114 stores in China Mainland, nine stores in Hong Kong Special Administrative Region, eight stores in Taiwan, and two stores in Macao Special Administration Region, as of October 29, 2023. As of January 29, 2023, there were 99 stores in China Mainland, nine stores in Hong Kong Special Administrative Region, seven stores in Taiwan, and two stores in Macao Special Administration Region. Retail locations operated by third parties under license and supply arrangements are not included in the above table. As of October 29, 2023, there were 38 licensed locations, including 18 in Mexico, six in the United Arab Emirates, six in Saudi Arabia, three in Qatar, three in Kuwait, and two in Israel.