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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 3, 2020
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 001-33608
 
lululemon athletica inc.
(Exact name of registrant as specified in its charter)
 
Delaware
20-3842867
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
1818 Cornwall Avenue, Vancouver, British Columbia V6J 1C7
(Address of principal executive offices)

Registrant's telephone number, including area code:
604-732-6124
Former name, former address and former fiscal year, if changed since last report:
N/A
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.005 per share
LULU
Nasdaq Global Select Market
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (of for such shorter period that the registrant was required to submit such files).    Yes No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes No
At June 5, 2020, there were 124,814,503 shares of the registrant's common stock, par value $0.005 per share, outstanding.
Exchangeable and Special Voting Shares:
At June 5, 2020, there were outstanding 5,392,512 exchangeable shares of Lulu Canadian Holding, Inc., a wholly-owned subsidiary of the registrant. Exchangeable shares are exchangeable for an equal number of shares of the registrant's common stock.
In addition, at June 5, 2020, the registrant had outstanding 5,392,512 shares of special voting stock, through which the holders of exchangeable shares of Lulu Canadian Holding, Inc. may exercise their voting rights with respect to the registrant. The special voting stock and the registrant's common stock generally vote together as a single class on all matters on which the common stock is entitled to vote.
 



TABLE OF CONTENTS
 

2


PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
lululemon athletica inc.
CONSOLIDATED BALANCE SHEETS
(Unaudited; Amounts in thousands, except per share amounts)
 
 
May 3,
2020
 
February 2,
2020
ASSETS
Current assets
 
 
 
 
Cash and cash equivalents
 
$
823,006


$
1,093,505

Accounts receivable
 
48,684

 
40,219

Inventories
 
625,849

 
518,513

Prepaid and receivable income taxes
 
89,316

 
85,159

Other prepaid expenses and other current assets
 
107,690

 
70,542

 
 
1,694,545

 
1,807,938

Property and equipment, net
 
659,265

 
671,693

Right-of-use lease assets
 
731,883

 
689,664

Goodwill and intangible assets, net
 
24,044

 
24,423

Deferred income tax assets
 
31,190

 
31,435

Other non-current assets
 
60,859

 
56,201

 
 
$
3,201,786

 
$
3,281,354

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
78,940

 
$
79,997

Accrued inventory liabilities
 
9,860

 
6,344

Accrued compensation and related expenses
 
69,455

 
133,688

Current lease liabilities
 
144,646

 
128,497

Current income taxes payable
 
28,729

 
26,436

Unredeemed gift card liability
 
105,286

 
120,413

Other current liabilities
 
194,580

 
125,043

 
 
631,496

 
620,418

Non-current lease liabilities
 
639,242

 
611,464

Non-current income taxes payable
 
48,226

 
48,226

Deferred income tax liabilities
 
40,764

 
43,432

Other non-current liabilities
 
6,271

 
5,596

 
 
1,365,999

 
1,329,136

Commitments and contingencies
 


 


Stockholders' equity
 
 
 
 
Undesignated preferred stock, $0.01 par value: 5,000 shares authorized; none issued and outstanding
 

 

Exchangeable stock, no par value: 60,000 shares authorized; 5,482 and 6,227 issued and outstanding
 

 

Special voting stock, $0.000005 par value: 60,000 shares authorized; 5,482 and 6,227 issued and outstanding
 

 

Common stock, $0.005 par value: 400,000 shares authorized; 124,717 and 124,122 issued and outstanding
 
624

 
621

Additional paid-in capital
 
334,201

 
355,541

Retained earnings
 
1,786,147

 
1,820,637

Accumulated other comprehensive loss
 
(285,185
)
 
(224,581
)
 
 
1,835,787

 
1,952,218

 
 
$
3,201,786

 
$
3,281,354

See accompanying notes to the unaudited interim consolidated financial statements

3


lululemon athletica inc.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME
(Unaudited; Amounts in thousands, except per share amounts)
 
 
Quarter Ended
 
 
May 3, 2020
 
May 5, 2019
Net revenue
 
$
651,962

 
$
782,315

Cost of goods sold
 
317,560

 
360,595

Gross profit
 
334,402

 
421,720

Selling, general and administrative expenses
 
301,651

 
292,908

Income from operations
 
32,751

 
128,812

Other income (expense), net
 
1,174

 
2,379

Income before income tax expense
 
33,925

 
131,191

Income tax expense
 
5,293

 
34,588

Net income
 
$
28,632

 
$
96,603

 
 
 
 
 
Other comprehensive (loss) income:
 
 
 
 
Foreign currency translation adjustment
 
(60,604
)
 
(15,723
)
Comprehensive (loss) income
 
$
(31,972
)
 
$
80,880

 
 
 
 
 
Basic earnings per share
 
$
0.22

 
$
0.74

Diluted earnings per share
 
$
0.22

 
$
0.74

Basic weighted-average number of shares outstanding
 
130,251

 
130,694

Diluted weighted-average number of shares outstanding
 
130,803

 
131,337

See accompanying notes to the unaudited interim consolidated financial statements
 

4


lululemon athletica inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited; Amounts in thousands)
 
 
Quarter Ended May 3, 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 at February 2, 2020
 
6,227

 
6,227

 
$

 
124,122

 
$
621

 
$
355,541

 
$
1,820,637

 
$
(224,581
)
 
$
1,952,218

Net income
 
 
 
 
 
 
 
 
 
 
 
 
 
28,632

 
 
 
28,632

Foreign currency translation adjustment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(60,604
)
 
(60,604
)
Common stock issued upon exchange of exchangeable shares
 
(745
)
 
(745
)
 

 
745

 
4

 
(4
)
 
 
 
 
 

Stock-based compensation expense
 
 
 
 
 
 
 
 
 
 
 
6,128

 
 
 
 
 
6,128

Common stock issued upon settlement of stock-based compensation
 
 
 
 
 
 
 
371

 
2

 
3,133

 
 
 
 
 
3,135

Shares withheld related to net share settlement of stock-based compensation
 
 
 
 
 
 
 
(152
)
 
(1
)
 
(30,058
)
 
 
 
 
 
(30,059
)
Repurchase of common stock
 
 
 
 
 
 
 
(369
)
 
(2
)
 
(539
)
 
(63,122
)
 
 
 
(63,663
)
Balance at May 3, 2020
 
5,482

 
5,482

 
$

 
124,717

 
$
624

 
$
334,201

 
$
1,786,147

 
$
(285,185
)
 
$
1,835,787



 
 
Quarter Ended May 5, 2019
 
 
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 at February 3, 2019
 
9,332

 
9,332

 
$

 
121,600

 
$
608

 
$
315,285

 
$
1,346,890

 
$
(216,808
)
 
$
1,445,975

Net income
 
 
 
 
 
 
 
 
 
 
 
 
 
96,603

 
 
 
96,603

Foreign currency translation adjustment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(15,723
)
 
(15,723
)
Common stock issued upon exchange of exchangeable shares
 
(1,951
)
 
(1,951
)
 

 
1,951

 
10

 
(10
)
 
 
 
 
 

Stock-based compensation expense
 
 
 
 
 
 
 
 
 
 
 
10,157

 
 
 
 
 
10,157

Common stock issued upon settlement of stock-based compensation
 
 
 
 
 
 
 
464

 
2

 
12,175

 
 
 
 
 
12,177

Shares withheld related to net share settlement of stock-based compensation
 
 
 
 
 
 
 
(115
)
 
(1
)
 
(18,938
)
 
 
 
 
 
(18,939
)
Repurchase of common stock
 
 
 
 
 
 
 
(1,000
)
 
(4
)
 
(1,465
)
 
(162,061
)
 
 
 
(163,530
)
Balance at May 5, 2019
 
7,381

 
7,381

 
$

 
122,900

 
$
615

 
$
317,204

 
$
1,281,432

 
$
(232,531
)
 
$
1,366,720


See accompanying notes to the unaudited interim consolidated financial statements

5


lululemon athletica inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; Amounts in thousands)
 
 
Quarter Ended
 
 
May 3, 2020
 
May 5, 2019
Cash flows from operating activities
 
 
 
 
Net income
 
$
28,632

 
$
96,603

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
43,532

 
32,823

Stock-based compensation expense
 
6,128

 
10,157

Settlement of derivatives not designated in a hedging relationship
 
(5,669
)
 
(4,983
)
Changes in operating assets and liabilities:
 
 
 
 
Inventories
 
(122,810
)
 
(42,856
)
Prepaid and receivable income taxes
 
(4,157
)
 
(32,816
)
Other prepaid expenses and other current and non-current assets
 
(53,358
)
 
(16,164
)
Accounts payable
 
2,222

 
(5,420
)
Accrued inventory liabilities
 
4,016

 
(6,894
)
Accrued compensation and related expenses
 
(60,137
)
 
(32,498
)
Current and non-current income taxes payable
 
3,711

 
(60,533
)
Unredeemed gift card liability
 
(13,640
)
 
(13,641
)
Right-of-use lease assets and current and non-current lease liabilities
 
(16,868
)
 
8,185

Other current and non-current liabilities
 
67,155

 
5,234

Net cash used in operating activities
 
(121,243
)
 
(62,803
)
Cash flows from investing activities
 
 
 
 
Purchase of property and equipment
 
(52,101
)
 
(68,434
)
Settlement of net investment hedges
 
6,475

 
4,657

Other investing activities
 

 
(131
)
Net cash used in investing activities
 
(45,626
)
 
(63,908
)
Cash flows from financing activities
 
 
 
 
Proceeds from settlement of stock-based compensation
 
3,135

 
12,177

Taxes paid related to net share settlement of stock-based compensation
 
(30,059
)
 
(18,939
)
Repurchase of common stock
 
(63,663
)
 
(163,530
)
Net cash used in financing activities
 
(90,587
)
 
(170,292
)
Effect of exchange rate changes on cash and cash equivalents
 
(13,043
)
 
(8,076
)
Decrease in cash and cash equivalents
 
(270,499
)
 
(305,079
)
Cash and cash equivalents, beginning of period
 
$
1,093,505

 
$
881,320

Cash and cash equivalents, end of period
 
$
823,006

 
$
576,241

See accompanying notes to the unaudited interim consolidated financial statements


6


lululemon athletica inc.
INDEX FOR NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL
STATEMENTS


7


lululemon athletica inc.
NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL
STATEMENTS
NOTE 1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Nature of operations
lululemon athletica inc., a Delaware corporation ("lululemon" and, together with its subsidiaries unless the context otherwise requires, the "Company") is engaged in the design, distribution, and retail of healthy lifestyle inspired athletic apparel and accessories. The Company primarily conducts its business through company-operated stores and direct to consumer through e-commerce. It also generates net revenue from outlets, sales from temporary locations, sales to wholesale accounts, license and supply arrangements, and warehouse sales. The Company operates stores in the United States, Canada, the People's Republic of China ("PRC"), Australia, the United Kingdom, Japan, New Zealand, Germany, South Korea, Singapore, France, Malaysia, Sweden, Ireland, the Netherlands, Norway, and Switzerland. There were 489 and 491 company-operated stores in operation as of May 3, 2020 and February 2, 2020, respectively.
COVID-19 Pandemic
The outbreak of a novel strain of coronavirus ("COVID-19") was declared a global pandemic by the World Health Organization in March 2020.
In line with recommendations by public health officials and in accordance with governmental authority orders, the Company took actions to close the majority of its retail locations and to reduce operating hours. In February 2020, the Company temporarily closed all of its retail locations in Mainland China. All of these locations have since reopened. In March 2020, the Company temporarily closed all of its retail locations in North America, Europe, and certain countries in Asia Pacific. Its distribution centers in Columbus, Ohio and Sumner, Washington were temporarily closed for one and two weeks, respectively, during the first quarter of fiscal 2020 due to COVID-19. Subsequent to May 3, 2020, the Company began reopening stores in certain markets in accordance with local government and public health authority guidelines. These stores are operating with precautionary measures in place such as reduced operating hours and maximum occupancy levels. As of June 10, 2020, 295 of its company-operated stores were open. As of June 10, 2020, all of its distribution centers were open.
In response to COVID-19, various government programs have been announced to provide financial relief for affected businesses. The most significant relief measures which the Company qualifies for are the Employee Retention Credit under the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") in the United States, and the Canada Emergency Wage Subsidy ("CEWS") under the COVID-19 Economic Response Plan in Canada. During the first quarter of fiscal 2020, the Company recognized payroll subsidies totaling $14.3 million under these wage subsidy programs and similar plans in other jurisdictions. These subsidies were recorded as a reduction in the associated wage costs which the Company incurred, and were recognized in selling, general and administrative expenses.
The Company also qualifies for and has deferred certain corporate income tax payments and employer payroll tax payments. The most significant is the deferral of $56.8 million of Canadian corporate income tax payments which would otherwise have been paid during the first quarter of fiscal 2020 to the third quarter of fiscal 2020.
The Financial Accounting Standards Board ("FASB") staff issued guidance in April 2020 in relation to accounting for lease concessions made in connection with the effects of COVID-19. In accordance with this guidance, the Company has elected to treat COVID-19-related lease concessions as variable lease payments. The Company is actively negotiating commercially reasonable lease concessions. No significant lease concessions have yet been confirmed.
The temporary store closures as a result of COVID-19 and associated reduction in operating income during the first quarter of fiscal 2020 are considered to be an indicator of impairment and the Company performed an assessment of recoverability for the long-lived assets and right-of-use assets associated with its closed retail locations. The Company recognized an insignificant impairment charge as a result of this analysis.
Inventory is valued at the lower of cost and net realizable value. The Company periodically reviews its inventories and makes provisions as necessary to appropriately value goods that are obsolete, have quality issues, or are damaged. The amount of the provision is equal to the difference between the cost of the inventory and its net realizable value based upon assumptions about product quality, damages, future demand, selling prices, and market conditions. The Company did not recognize any significant additional inventory provisions in the first quarter of fiscal 2020 as a result of this analysis.

8


Revenue is presented net of an allowance for expected returns, which is estimated based on historic return rates, trends, and future expectations. In light of the store closures, the Company has extended its return policy and the increase in the sales return allowances reflects an anticipated delay in returns as a result of retail location closures.
The COVID-19 pandemic has materially impacted the Company's statement of operations. The extent to which COVID-19 continues to impacts the Company's results and financial position will depend on future developments, which are highly uncertain and cannot be predicted, including new information that may emerge concerning the severity of COVID-19 and the actions taken to contain it or treat its impact. Continued proliferation of the virus, or resurgence, may result in further or prolonged closures of its retail locations and distribution centers, reduce operating hours, interrupt the Company's supply chain, cause changes in guest behavior, and reduce discretionary spending. Such factors could result in the impairment of long-lived assets and right-of-use assets and the need for an increased provision against the carrying value of the Company's inventories.
Basis of presentation
The unaudited interim consolidated financial statements as of May 3, 2020 and for the quarters ended May 3, 2020 and May 5, 2019 are presented in United States dollars and have been prepared by the Company under the rules and regulations of the Securities and Exchange Commission ("SEC"). The financial information is presented in accordance with United States generally accepted accounting principles ("GAAP") for interim financial information and, accordingly, does not include all of the information and footnotes required by GAAP for complete financial statements. The financial information as of February 2, 2020 is derived from the Company's audited consolidated financial statements and related notes for the fiscal year ended February 2, 2020, which are included in Item 8 in the Company's fiscal 2019 Annual Report on Form 10-K filed with the SEC on March 26, 2020. These unaudited interim consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented. These unaudited interim consolidated financial statements should be read in conjunction with the Company's consolidated financial statements and related notes included in Item 8 in the Company's fiscal 2019 Annual Report on Form 10-K. Except as disclosed in Note 2 pertaining to the adoption of new accounting pronouncements, there have been no significant changes to the Company's significant accounting policies as described in the Company's fiscal 2019 Annual Report on Form 10-K.
The Company's fiscal year ends on the Sunday closest to January 31 of the following year, typically resulting in a 52-week year, but occasionally giving rise to an additional week, resulting in a 53-week year. Fiscal 2020 will end on January 31, 2021 and will be a 52-week year. Fiscal 2019 was a 52-week year.
The Company's business is affected by the pattern of seasonality common to most retail apparel businesses. Historically, the Company has recognized a significant portion of its operating profit in the fourth fiscal quarter of each year as a result of increased net revenue during the holiday season.
Certain comparative figures have been reclassified to conform to the financial presentation adopted for the current year.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
Recently adopted accounting pronouncements
In June 2016, the FASB issued guidance on ASC 326 "Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments". This guidance changes the impairment model for most financial assets and requires the use of a forward-looking expected loss model rather than incurred losses for instruments measured at amortized cost. Under this model, entities are required to estimate the lifetime expected credit loss on such instruments and record an allowance to offset the amortized cost basis of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset. The Company adopted this update during the first quarter of fiscal 2020 and it did not have a material impact on the Company's consolidated financial statements.
Recently issued accounting pronouncements
In December 2019, the FASB issued guidance on ASC 740, "Income Taxes". The amendments in this update simplify the accounting for income taxes by removing certain exceptions to the general principles in ASC 740. The amendments also improve consistent application and simplify GAAP for other areas of this topic by clarifying and amending existing guidance. This guidance is effective for the Company beginning in its first quarter of fiscal 2021 and early adoption is permitted. The Company is currently evaluating the impact that this new guidance may have on its consolidated financial statements but does not believe it will have a material impact.
In March 2020, the FASB released guidance on ASC 848, "Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting". This update provides optional expedients and exceptions to the current

9


guidance on contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update apply only to contracts and hedging relationships that reference the London Interbank Offered Rate ("LIBOR") or another reference rate expected to be discontinued due to reference rate reform. The guidance was effective upon issuance and generally can be applied to applicable contract modifications through December 31, 2022. The Company is currently evaluating the impact that this new guidance may have on its consolidated financial statements but does not believe it will have a material impact.
NOTE 3. CREDIT FACILITIES
North America revolving credit facility
On June 6, 2018, the Company entered into Amendment No. 1 to its credit agreement. This amended the credit agreement to provide for (i) an increase in the aggregate commitments under the unsecured five-year revolving credit facility to $400.0 million, with an increase of the sub-limits for the issuance of letters of credit and extensions of swing line loans to $50.0 million for each, (ii) an increase in the option, subject to certain conditions as set forth in the credit agreement, to request increases in commitments under the revolving facility from $400.0 million to $600.0 million, and (iii) an extension in the maturity of the revolving facility from December 15, 2021 to June 6, 2023.
In addition, this amendment decreased the applicable margins for LIBOR loans from 1.00%-1.75% to 1.00%-1.50% and for alternate base rate loans from 0.00%-0.75% to 0.00%-0.50%, reduced the commitment fee on average daily unused amounts under the revolving facility from 0.125%-0.200% to 0.10%-0.20%, and reduced fees for unused letters of credit from 1.00%-1.75% to 1.00%-1.50%.
The Company is required to follow certain covenants. As of May 3, 2020, the Company was in compliance with these covenants.
The Company had no borrowings outstanding under this credit facility as of May 3, 2020 and February 2, 2020. As of May 3, 2020, the Company had letters of credit of $1.8 million outstanding.
Mainland China revolving credit facility
In December 2019, the Company entered into an uncommitted and unsecured 130.0 million Chinese Yuan revolving credit facility. The terms are reviewed on an annual basis. The facility includes a revolving loan of up to 100.0 million Chinese Yuan as well as a financial bank guarantee facility of up to 30.0 million Chinese Yuan, or its equivalent in another currency. In U.S. dollars, the uncommitted and unsecured revolving credit facility is equivalent to $18.4 million, the revolving loan is equivalent of up to $14.2 million, and the financial bank guarantee facility is equivalent of up to $4.2 million. Loans are available in Chinese Yuan for a period not to exceed 12 months, and interest accrues on them at a rate equal to 105% of the applicable PBOC Benchmark Lending Rate. Guarantees have a commission equal to 1% per annum of the outstanding amount. The Company is required to follow certain covenants. As of May 3, 2020, the Company was in compliance with these covenants. As of May 3, 2020, there were immaterial borrowings outstanding under this credit facility.
NOTE 4. STOCK-BASED COMPENSATION AND BENEFIT PLANS
Stock-based compensation plans
The Company's eligible employees participate in various stock-based compensation plans, which are provided by the Company directly.
Stock-based compensation expense charged to income for the plans was $6.6 million and $11.0 million for the quarters ended May 3, 2020 and May 5, 2019, respectively. Total unrecognized compensation cost for all stock-based compensation plans was $89.9 million at May 3, 2020, which is expected to be recognized over a weighted-average period of 2.4 years.

10


A summary of the balances of the Company's stock-based compensation plans as of May 3, 2020, and changes during the first quarter 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 at February 2, 2020
 
776

 
$
113.41

 
238

 
$
103.52

 
7

 
$
175.82

 
333

 
$
108.44

 
29

 
$
239.39

Granted
 
214

 
188.84

 
137

 
115.58

 

 

 
112

 
189.30

 

 

Exercised/released
 
42

 
75.26

 
171

 
63.03

 

 

 
159

 
86.02

 

 

Forfeited/expired
 

 

 

 

 

 

 
1

 
137.74

 

 

Balance at May 3, 2020
 
948

 
$
132.05

 
204

 
$
145.55

 
7

 
$
175.82

 
285

 
$
152.27

 
29

 
$
218.69

Exercisable at May 3, 2020
 
270

 
$
96.67

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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 quarter of fiscal 2020:
 
 
Quarter Ended
 May 3, 2020
Expected term
 
3.75 years

Expected volatility
 
39.62
%
Risk-free interest rate
 
0.34
%
Dividend yield
 
%

The Company's performance-based restricted stock units are awarded to eligible employees and entitle the grantee to receive a maximum of two shares of common stock per performance-based restricted stock unit if the Company achieves specified performance goals and the grantee remains employed during the vesting period. The fair value of performance-based restricted stock units is based on the closing price of the Company's common stock on the award date. Expense for performance-based restricted stock units is recognized when it is probable that the performance goal will be achieved.
The grant date fair value of the restricted shares and restricted stock units is based on the closing price of the Company's common stock on the award date. Restricted stock units that are settled in cash or common stock at the election of the employee are remeasured to fair value at the end of each reporting period until settlement. This fair value is based on the closing price of the Company's common stock on the last business day before each period end.
Employee share purchase plan
The Company's board of directors and stockholders approved the Company's Employee Share Purchase Plan ("ESPP") in September 2007. Contributions are made by eligible employees, subject to certain limits defined in the ESPP, and the Company matches one-third of the contribution. The maximum number of shares authorized to be purchased under the ESPP is 6.0 million shares. All shares purchased under the ESPP are purchased in the open market. During the quarter ended May 3, 2020, there were 22.1 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 exceed

11


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 $2.3 million and $2.3 million in the first quarter of fiscal 2020 and fiscal 2019, respectively.
NOTE 5. FAIR VALUE MEASUREMENT
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are made using a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value:
Level 1 - defined as observable inputs such as quoted prices in active markets;
Level 2 - defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and
Level 3 - defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
Assets and liabilities measured at fair value on a recurring basis
The fair value measurement is categorized in its entirety by reference to its lowest level of significant input. As of May 3, 2020 and February 2, 2020, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis:
 
 
May 3, 2020
 
Level 1
 
Level 2
 
Level 3
 
Balance Sheet Classification
 
 
(In thousands)
 
 
Money market funds
 
$
476,607

 
$
476,607

 
$

 
$

 
Cash and cash equivalents
Term deposits
 
132,222

 

 
132,222

 

 
Cash and cash equivalents
Forward currency contract assets
 
23,511

 

 
23,511

 

 
Other prepaid expenses and other current assets
Forward currency contract liabilities
 
23,766

 

 
23,766

 

 
Other current liabilities

 
 
February 2, 2020
 
Level 1
 
Level 2
 
Level 3
 
Balance Sheet Classification
 
 
(In thousands)
 
 
Money market funds
 
$
610,800

 
$
610,800

 
$

 
$

 
Cash and cash equivalents
Term deposits
 
203,360

 

 
203,360

 

 
Cash and cash equivalents
Forward currency contract assets
 
1,735

 

 
1,735

 

 
Other prepaid expenses and other current assets
Forward currency contract liabilities
 
1,920

 

 
1,920

 

 
Other current liabilities

The Company records accounts receivable, accounts payable, and accrued liabilities at cost. The carrying values of these instruments approximate their fair value due to their short-term maturities.
The Company has short-term, highly liquid investments classified as cash equivalents, which are invested in money market funds, Treasury bills, and term deposits. The Company records cash equivalents at their original purchase prices plus interest that has accrued at the stated rate.
The fair values of the forward currency contract assets and liabilities are determined using observable Level 2 inputs, including foreign currency spot exchange rates, forward pricing curves, and interest rates. The fair values consider the credit risk of the Company and its counterparties. The Company's Master International Swap Dealers Association, Inc., Agreements and other similar arrangements allow net settlements under certain conditions. However, the Company records all derivatives on its consolidated balance sheets at fair value and does not offset derivative assets and liabilities.

12


NOTE 6. DERIVATIVE FINANCIAL INSTRUMENTS
Foreign exchange risk
The Company is exposed to risks associated with changes in foreign currency exchange rates and uses derivative financial instruments to manage its exposure to certain of these foreign currency exchange rate risks. The Company does not enter into derivative contracts for speculative or trading purposes.
The Company currently hedges against changes in the Canadian dollar to U.S. dollar exchange rate and changes in the Chinese Yuan to U.S. dollar exchange rate using forward currency contracts.
Net investment hedges
The Company is exposed to foreign exchange gains and losses which arise on translation of its foreign subsidiaries' balance sheets into U.S. dollars. These gains and losses are recorded as a foreign currency translation adjustment in accumulated other comprehensive income or loss within stockholders' equity.
The Company holds a significant portion of its assets in Canada and enters into forward currency contracts designed to hedge a portion of the foreign currency exposure that arises on translation of a Canadian subsidiary into U.S. dollars. These forward currency contracts are designated as net investment hedges. The effective portions of the hedges are reported in accumulated other comprehensive income or loss and will subsequently be reclassified to net earnings in the period in which the hedged investment is either sold or substantially liquidated. Hedge effectiveness is measured using a method based on changes in forward exchange rates. The Company recorded no ineffectiveness from net investment hedges during the first quarter of fiscal 2020.
The Company classifies the cash flows at settlement of its net investment hedges within investing activities in the consolidated statements of cash flows.
Derivatives not designated as hedging instruments
The Company is exposed to gains and losses arising from changes in foreign exchange rates associated with transactions which are undertaken by its subsidiaries in currencies other than their functional currency. Such transactions include intercompany transactions and inventory purchases. These transactions result in the recognition of certain foreign currency denominated monetary assets and liabilities which are remeasured to the quarter-end or settlement date exchange rate. The resulting foreign currency gains and losses are recorded in selling, general and administrative expenses.
During the first quarter of fiscal 2020, the Company entered into certain forward currency contracts designed to economically hedge the foreign exchange revaluation gains and losses that are recognized by its Canadian and Chinese subsidiaries on U.S. dollar denominated monetary assets and liabilities. The Company has not applied hedge accounting to these instruments and the change in fair value of these derivatives is recorded within selling, general and administrative expenses.
The Company classifies the cash flows at settlement of its forward currency contracts which are not designated in hedging relationships within operating activities in the consolidated statements of cash flows.
Quantitative disclosures about derivative financial instruments
The Company presents its derivative assets and derivative liabilities at their gross fair values within other prepaid expenses and other current assets and other current liabilities on the consolidated balance sheets. However, the Company's Master International Swap Dealers Association, Inc., Agreements and other similar arrangements allow net settlements under certain conditions. As of May 3, 2020, there were derivative assets of $23.5 million and derivative liabilities of $23.8 million subject to enforceable netting arrangements.

13


The notional amounts and fair values of forward currency contracts were as follows:
 
 
May 3, 2020
 
February 2, 2020
 
 
Gross Notional
 
Assets
 
Liabilities
 
Gross Notional
 
Assets
 
Liabilities
 
 
(In thousands)
Derivatives designated as net investment hedges:
 
 
 
 
 
 
 
 
 
 
 
 
Forward currency contracts
 
$
461,000

 
$
23,364

 
$

 
$
417,000

 
$
1,583

 
$

Derivatives not designated in a hedging relationship:
 
 
 
 
 
 
 
 
 
 
 
 
Forward currency contracts
 
505,000

 
147

 
23,766

 
460,000

 
152

 
1,920

Net derivatives recognized on consolidated balance sheets:
 
 
 
 
 
 
 
 
 
 
 
 
Forward currency contracts
 
 
 
$
23,511

 
$
23,766

 
 
 
$
1,735

 
$
1,920


The forward currency contracts designated as net investment hedges outstanding as of May 3, 2020 mature on different dates between May 2020 and October 2020.
The forward currency contracts not designated in a hedging relationship outstanding as of May 3, 2020 mature on different dates between May 2020 and October 2020.
The pre-tax gains and losses on foreign exchange forward contracts recorded in accumulated other comprehensive income or loss were as follows:
 
 
Quarter Ended
 
 
May 3, 2020

May 5, 2019
 
 
(In thousands)
Gains (losses) recognized in foreign currency translation adjustment:
 
 
 
 
Derivatives designated as net investment hedges
 
$
28,256

 
$
6,764


No gains or losses have been reclassified from accumulated other comprehensive income or loss into net income for derivative financial instruments in a net investment hedging relationship, as the Company has not sold or liquidated (or substantially liquidated) its hedged subsidiary.
The pre-tax net foreign exchange and derivative gains and losses recorded in the consolidated statement of operations were as follows:
 
 
Quarter Ended
 
 
May 3, 2020
 
May 5, 2019
 
 
(In thousands)
Gains (losses) recognized in selling, general and administrative expenses:
 
 
 
 
Foreign exchange gains
 
$
27,742

 
$
5,697

Derivatives not designated in a hedging relationship
 
(27,520
)
 
(6,631
)
Net foreign exchange and derivative gains (losses)
 
$
222

 
$
(934
)

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.

14


NOTE 7. EARNINGS PER SHARE
The details of the computation of basic and diluted earnings per share are as follows:
 
 
Quarter Ended
 
 
May 3, 2020
 
May 5, 2019
 
 
(In thousands, except per share amounts)
Net income
 
$
28,632

 
$
96,603

Basic weighted-average number of shares outstanding
 
130,251

 
130,694

Assumed conversion of dilutive stock options and awards
 
552

 
643

Diluted weighted-average number of shares outstanding
 
130,803

 
131,337

Basic earnings per share
 
$
0.22

 
$
0.74

Diluted earnings per share
 
$
0.22

 
$
0.74


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 quarters ended May 3, 2020 and May 5, 2019, 97.5 thousand and 75.7 thousand stock options and awards, respectively, were anti-dilutive to earnings per share and therefore have been excluded from the computation of diluted earnings per share.
On January 31, 2019, the Company's board of directors approved a stock repurchase program for up to $500.0 million of the Company's common shares on the open market or in privately negotiated transactions. Common shares repurchased on the open market are at prevailing market prices, including under plans complying with the provisions of Rule 10b5-1 and Rule 10b-18 of the Securities Exchange Act of 1934. The timing and actual number of common shares to be repurchased will depend upon market conditions, eligibility to trade, and other factors, in accordance with Securities and Exchange Commission requirements. As of March 31, 2020, the Company temporarily paused its share repurchase program. As of May 3, 2020, the remaining aggregate value of shares available to be repurchased under this program was $263.6 million.
During the quarters ended May 3, 2020 and May 5, 2019, 0.4 million and 1.0 million shares, respectively, were repurchased under the program at a total cost of $63.7 million and $163.5 million, respectively.
Subsequent to May 3, 2020, and up to June 5, 2020, no shares were repurchased.
NOTE 8. SUPPLEMENTARY FINANCIAL INFORMATION
A summary of certain consolidated balance sheet accounts is as follows:
 
 
May 3,
2020
 
February 2,
2020
 
 
(In thousands)
Inventories:
 
 
 
 
Finished goods
 
$
648,909

 
$
540,580

Provision to reduce inventories to net realizable value
 
(23,060
)
 
(22,067
)
 
 
$
625,849

 
$
518,513



15


 
 
May 3,
2020
 
February 2,
2020
 
 
(In thousands)
Other prepaid expenses and other current assets:
 
 
 
 
Other prepaid expenses
 
$
60,333

 
$
64,568

Forward currency contract assets
 
23,511

 
1,735

Government payroll subsidy receivables
 
13,442

 

Other current assets
 
10,404

 
4,239

 
 
$
107,690

 
$
70,542

Property and equipment, net:
 
 
 
 
Land
 
$
67,545

 
$
71,829

Buildings
 
28,984

 
30,187

Leasehold improvements
 
490,010

 
489,202

Furniture and fixtures
 
108,786

 
109,533

Computer hardware
 
95,250

 
95,399

Computer software
 
339,827

 
336,768

Equipment and vehicles
 
19,302

 
19,521

Work in progress
 
51,445

 
40,930

Property and equipment, gross
 
1,201,149

 
1,193,369

Accumulated depreciation
 
(541,884
)
 
(521,676
)
 
 
$
659,265

 
$
671,693

Other non-current assets:
 
 
 
 
Cloud computing arrangement implementation costs
 
$
31,929

 
$
24,648

Security deposits
 
19,949

 
19,901

Other
 
8,981

 
11,652

 
 
$
60,859

 
$
56,201

Other current liabilities:
 
 
 
 
Accrued duty, freight, and other operating expenses
 
$
76,679

 
$
59,403

Sales return allowances
 
33,962

 
12,897

Deferred revenue
 
27,775

 
12,705

Forward currency contract liabilities
 
23,766

 
1,920

Accrued capital expenditures
 
10,747

 
5,457

Sales tax collected
 
9,485

 
17,370

Accrued rent
 
5,129

 
8,356

Other
 
7,037

 
6,935

 
 
$
194,580

 
$
125,043



16


NOTE 9. SEGMENTED INFORMATION AND DISAGGREGATED NET REVENUE
The Company applies ASC Topic 280, Segment Reporting ("ASC 280"), in determining reportable segments for its financial statement disclosure. The Company reports segments based on the financial information it uses in managing its business. The Company's reportable segments are comprised of company-operated stores and direct to consumer. Direct to consumer represents sales from the Company's e-commerce websites and mobile apps. Outlets, temporary locations, sales to wholesale accounts, license and supply arrangements, and warehouse sale net revenue have been combined into other. During the first quarter of fiscal 2020, the Company reviewed its segment and general corporate expenses and determined certain costs that are more appropriately classified in different categories. Accordingly, comparative figures have been reclassified to conform to the financial presentation adopted for the current year.
 
 
Quarter Ended
 
 
May 3, 2020
 
May 5, 2019
 
 
(In thousands)
Net revenue:
 
 
 
 
Company-operated stores
 
$
259,970

 
$
506,422

Direct to consumer
 
352,039

 
209,844

Other
 
39,953

 
66,049

 
 
$
651,962

 
$
782,315

Segmented income (loss) from operations:
 
 
 
 
Company-operated stores
 
$
(30,154
)
 
$
120,911

Direct to consumer
 
156,947

 
79,337

Other
 
(269
)
 
12,623

 
 
126,524

 
212,871

General corporate expense
 
93,773

 
84,059

Income from operations
 
32,751

 
128,812

Other income (expense), net
 
1,174

 
2,379

Income before income tax expense
 
$
33,925

 
$
131,191

 
 
 
 
 
Capital expenditures:
 
 
 
 
Company-operated stores
 
$
33,819

 
$
38,710

Direct to consumer
 
2,298

 
6,226

Corporate and other
 
15,984

 
23,498

 
 
$
52,101

 
$
68,434

Depreciation and amortization:
 
 
 
 
Company-operated stores
 
$
25,628

 
$
21,060

Direct to consumer
 
2,684

 
2,462

Corporate and other
 
15,220

 
9,301

 
 
$
43,532

 
$
32,823



17


The following table disaggregates the Company's net revenue by geographic area.
 
 
Quarter Ended
 
 
May 3, 2020
 
May 5, 2019
 
 
(In thousands)
United States
 
$
459,352

 
$
553,647

Canada
 
99,497

 
123,645

Outside of North America
 
93,113

 
105,023

 
 
$
651,962

 
$
782,315


The following table disaggregates the Company's net revenue by category.
 
 
Quarter Ended
 
 
May 3, 2020
 
May 5, 2019
 
 
(In thousands)
Women's product
 
$
480,313

 
$
562,983

Men's product
 
129,129

 
170,219

Other categories
 
42,520

 
49,113

 
 
$
651,962

 
$
782,315


NOTE 10. LEGAL PROCEEDINGS AND OTHER CONTINGENCIES
In addition to the legal proceedings described below, the Company is, from time to time, involved in routine legal matters, and audits and inspections by governmental agencies and other third parties which are incidental to the conduct of its business. This includes legal matters such as initiation and defense of proceedings to protect intellectual property rights, personal injury claims, product liability claims, employment claims, and similar matters. The Company believes the ultimate resolution of any such legal proceedings, audits, and inspections will not have a material adverse effect on its consolidated balance sheets, results of operations or cash flows.
On October 9, 2015, certain current and former hourly employees of the Company filed a class action lawsuit in the Supreme Court of New York entitled Rebecca Gathmann-Landini et al v. lululemon USA inc. On December 2, 2015, the case was moved to the United States District Court for the Eastern District of New York. The lawsuit alleges that the Company violated various New York labor codes by failing to pay all earned wages, including overtime compensation. The plaintiffs are seeking an unspecified amount of damages. The Company intends to vigorously defend this matter.
On November 21, 2018, plaintiff David Shabbouei filed in the Delaware Court of Chancery a derivative lawsuit on behalf of the Company against certain of the Company's current and former directors and officers, captioned David Shabbouei v. Laurent Potdevin, et al., 2018-0847-JRS. Plaintiff claims that the defendants breached their fiduciary duties to the Company by allegedly failing to address alleged sexual harassment, gender discrimination, and related conduct at the Company. Plaintiff also claims that the defendants breached their fiduciary duties to the Company and wasted corporate assets with respect to the separation agreement entered into by the Company and Laurent Potdevin in connection with his departure from the Company in February 2018. Plaintiff also further brings an unjust enrichment claim against Mr. Potdevin with respect to the separation agreement. Plaintiff seeks unspecified money damages for the Company for the defendants' alleged breaches of fiduciary duty, waste and unjust enrichment, disgorgement of all profits, benefits and other compensation Mr. Potdevin received as a result of defendants' alleged conduct for the Company, an order directing the Company to implement corporate governance and internal procedures, and an award of plaintiff's attorneys' fees, costs and expenses. On April 2, 2020, the Court granted the motion of the defendants and the Company to dismiss the lawsuit with prejudice.
On March 23, 2020, a former retail employee filed a representative action in the Los Angeles Superior Court alleging violation of the Private Attorney General Act ("PAGA") based on purported California labor code violations including failure to pay wages, failure to pay overtime, failure to provide accurate itemized statements, and failure to provide meal and rest periods. The plaintiff is seeking to recover civil penalties under PAGA. The Company intends to vigorously defend this matter.
On April 9, 2020, Aliign Activation Wear, LLC filed a lawsuit in the United States District Court for the Central District of California alleging federal trademark infringement, false designation of original and unfair competition. The plaintiff is seeking injunctive relief, monetary damages and declaratory relief. The Company intends to vigorously defend this matter.

18


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Some of the statements contained in this Form 10-Q and any documents incorporated herein by reference constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical facts, included or incorporated in this Form 10-Q are forward-looking statements, particularly statements which relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts, such as statements regarding our future financial condition or results of operations, the impact of the COVID-19 pandemic on our business and results of operations, 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.
The forward-looking statements contained in this Form 10-Q reflect our views and assumptions only as of the date of this Form 10-Q and are expressly qualified in their entirety by the cautionary statements included in this Form 10-Q. Except as required by applicable securities law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.
This information should be read in conjunction with the unaudited interim consolidated financial statements and the notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in our fiscal 2019 Annual Report on Form 10-K filed with the SEC on March 26, 2020.
We disclose material non-public information through one or more of the following channels: our investor relations website (http://investor.lululemon.com/), the social media channels identified on our investor relations website, press releases, SEC filings, public conference calls, and webcasts.
Overview
lululemon athletica inc. is principally a designer, distributor, and retailer of healthy lifestyle inspired athletic apparel and accessories. We have a vision to be the experiential brand that ignites a community of people through sweat, grow, and connect, which we call "living the sweatlife." Since our inception, we have fostered a distinctive corporate culture; we promote a set of core values in our business which include taking personal responsibility, nurturing entrepreneurial spirit, acting with honesty and courage, valuing connection, and choosing to have fun. These core values attract passionate and motivated employees who are driven to achieve personal and professional goals, and share our purpose "to elevate the world by unleashing the full potential within every one of us."
Our healthy lifestyle inspired athletic apparel and accessories are marketed under the lululemon brand. We offer a comprehensive line of apparel and accessories for women and men. Our apparel assortment includes items such as pants, shorts, tops, and jackets designed for a healthy lifestyle including athletic activities such as yoga, running, training, and most other sweaty pursuits. We also offer fitness-related accessories.
COVID-19 Pandemic
The outbreak of a novel strain of coronavirus ("COVID-19") was declared a global pandemic by the World Health Organization in March 2020. The spread of COVID-19 has caused public health officials to recommend precautions to mitigate the spread of the virus, especially when congregating in heavily populated areas, such as malls and lifestyle centers. Government authorities in certain markets in which we operate have also issued orders that require the closure of non-essential businesses and people to remain at home.

19


We have taken actions to close retail locations and to reduce operating hours, and we continue to monitor the situation and work closely with local authorities to prioritize the safety of our people and guests. In February 2020, we temporarily closed all of our retail locations in Mainland China. All of these locations have since reopened. In March 2020, we temporarily closed all of our retail locations in North America, Europe, and certain countries in Asia Pacific. Subsequent to May 3, 2020, we began reopening our retail locations in these markets in line with the guidance from local authorities. As of June 10, 2020, 295 of our company-operated stores were open. Our distribution centers in Columbus, Ohio and Sumner, Washington were temporarily closed for one and two weeks, respectively, during the first quarter of fiscal 2020 due to COVID-19. As of June 10, 2020, all of our distribution centers were open.
Our retail locations and distribution centers are operating with precautionary measures in place such as reduced operating hours, physical distancing, enhanced cleaning and sanitation, and maximum occupancy levels. This pandemic has also impacted the operations of our third party logistics providers and our manufacturing and supply partners, including through the closure or reduced capacity of facilities, and operational changes to accommodate physical distancing. As the pandemic progresses, we may face further disruptions or increased operational and logistics costs throughout our supply chain.
There is significant uncertainty regarding the extent and duration of the impact that the COVID-19 pandemic will have on our store operations, the demand for our products, and on our supply chain. It had a material adverse impact on our results of operations for the first quarter of fiscal 2020, and we expect it to continue to impact our results of operations, financial position, and liquidity. The extent to which COVID-19 impacts our results will depend on future developments, which are highly uncertain and cannot be predicted, including new information that may emerge concerning the severity of COVID-19 and the actions taken to contain it or treat its impact.
We remain confident in the long-term growth opportunities and our Power of Three growth plan and believe that we have sufficient cash and cash equivalents, and available capacity under our revolving credit facilities, to meet our liquidity needs. As of May 3, 2020, we had cash and cash equivalents of $823.0 million and the capacity under our committed revolving credit facility was $398.2 million.
Financial Highlights
For the first quarter of fiscal 2020, compared to the first quarter of fiscal 2019:
Net revenue decreased 17% to $652.0 million. On a constant dollar basis, net revenue decreased 16%.
Direct to consumer net revenue increased 68%, or increased 70% on a constant dollar basis.
Gross profit decreased 21% to $334.4 million.
Gross margin decreased 260 basis points to 51.3%.
Income from operations decreased 75% to $32.8 million.
Operating margin decreased 1,150 basis points to 5.0%.
Income tax expense decreased 85% to $5.3 million. Our effective tax rate for the first quarter of fiscal 2020 was 15.6% compared to 26.4% for the first quarter of fiscal 2019.
Diluted earnings per share were $0.22 compared to $0.74 in the first quarter of fiscal 2019.
As the temporary store closures from COVID-19 have resulted in a significant number of stores being removed from our comparable store base, total comparable sales and comparable store sales are not currently representative of the underlying trends of our business. We do not believe these metrics are currently useful to investors in understanding performance, therefore we have not included these metrics in our discussion and analysis of results of operations.
Refer to the non-GAAP reconciliation tables contained in the "Non-GAAP Financial Measures" section of this Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" for reconciliations between constant dollar changes in net revenue and direct to consumer net revenue.

20


Results of Operations
First Quarter Results
The following table summarizes key components of our results of operations for the quarters ended May 3, 2020 and May 5, 2019. The percentages are presented as a percentage of net revenue.
 
 
Quarter Ended
 
 
May 3, 2020
 
May 5, 2019

May 3, 2020
 
May 5, 2019
 
 
(In thousands)
 
(Percentages)
Net revenue
 
$
651,962

 
$
782,315

 
100.0
%
 
100.0
%
Cost of goods sold
 
317,560

 
360,595

 
48.7

 
46.1

Gross profit
 
334,402

 
421,720

 
51.3

 
53.9

Selling, general and administrative expenses
 
301,651

 
292,908

 
46.3

 
37.4

Income from operations
 
32,751

 
128,812

 
5.0

 
16.5

Other income (expense), net
 
1,174

 
2,379

 
0.2

 
0.3

Income before income tax expense
 
33,925

 
131,191

 
5.2

 
16.8

Income tax expense
 
5,293

 
34,588

 
0.8

 
4.4

Net income
 
$
28,632

 
$
96,603

 
4.4
%
 
12.3
%
Net Revenue
Net revenue decreased $130.4 million, or 17%, to $652.0 million for the first quarter of fiscal 2020 from $782.3 million for the first quarter of fiscal 2019. On a constant dollar basis, assuming the average exchange rates for the first quarter of fiscal 2020 remained constant with the average exchange rates for the first quarter of fiscal 2019, net revenue decreased $122.7 million, or 16%.
The decrease in net revenue was primarily due to the impact of COVID-19, including temporary closures of company-operated stores. Decreased company-operated store net revenue as well as a decrease in net revenue from our other locations contributed to the decrease in net revenue. This was partially offset by an increase in direct to consumer net revenue.
Net revenue on a segment basis for the quarters ended May 3, 2020 and May 5, 2019 is summarized below. The percentages are presented as a percentage of total net revenue.
 
 
Quarter Ended
 
 
May 3, 2020
 
May 5, 2019
 
May 3, 2020
 
May 5, 2019
 
 
(In thousands)
 
(Percentages)
Company-operated stores
 
$
259,970

 
$
506,422

 
39.9
%
 
64.7
%
Direct to consumer
 
352,039

 
209,844

 
54.0

 
26.8

Other
 
39,953

 
66,049

 
6.1

 
8.4

Net revenue
 
$
651,962

 
$
782,315

 
100.0
%
 
100.0
%
Company-Operated Stores. Net revenue from our company-operated stores segment decreased $246.5 million, or 49%, to $260.0 million in the first quarter of fiscal 2020 from $506.4 million in the first quarter of fiscal 2019. The decrease in net revenue from our company-operated stores segment was primarily due to the impact of COVID-19. All of our stores in North America, Europe, and certain countries in Asia Pacific were closed for a significant portion of the quarter.
Direct to Consumer. Net revenue from our direct to consumer segment increased $142.2 million, or 68%, to $352.0 million in the first quarter of fiscal 2020 from $209.8 million in the first quarter of fiscal 2019. Direct to consumer net revenue increased 70% on a constant dollar basis. The increase in net revenue from our direct to consumer segment was primarily a result of increased website traffic and improved conversion rates. This was partially offset by a decrease in dollar value per transaction. There was a shift in the way guests shopped in the first quarter of fiscal 2020 as a result of COVID-19, with more guests shopping online instead of in-store, primarily due to temporary store closures.
Other. Net revenue from our other segment decreased $26.1 million, or 40%, to $40.0 million in the first quarter of fiscal 2020 from $66.0 million in the first quarter of fiscal 2019. This decrease was primarily the result of the temporary closures of our other retail locations as a result of COVID-19.

21


Gross Profit
Gross profit decreased $87.3 million, or 21%, to $334.4 million for the first quarter of fiscal 2020 from $421.7 million for the first quarter of fiscal 2019.
Gross profit as a percentage of net revenue, or gross margin, decreased 260 basis points to 51.3% in the first quarter of fiscal 2020 from 53.9% in the first quarter of fiscal 2019. The decrease in gross margin was primarily the result of:
an increase in occupancy and depreciation costs as a percentage of revenue of 330 basis points, primarily due to lower net revenue;
an increase in costs as a percentage of revenue related to our distribution centers of 100 basis points primarily due to lower net revenue; and
an unfavorable impact of foreign exchange rates of 20 basis points.
This was partially offset by an increase in product margin of 180 basis points. The increase in product margin was primarily due to lower product costs, and a favorable mix of higher margin product, partially offset by higher markdowns.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $8.7 million, or 3%, to $301.7 million in the first quarter of fiscal 2020 from $292.9 million in the first quarter of fiscal 2019. The increase in selling, general and administrative expenses was primarily due to:
an increase in head office costs of $7.6 million, comprised of:
an increase in other costs of $18.2 million primarily due to increases in depreciation, information technology costs, brand and community costs, and other head office costs; and
a decrease in employee costs of $10.6 million primarily due to decreased incentive and stock-based compensation expense; and
an increase in costs related to our operating channels of $16.6 million, comprised of:
an increase in variable costs of $10.4 million primarily due to an increase in distribution costs as a result of increased direct to consumer net revenue;
an increase in other costs of $11.6 million primarily due to increased digital marketing expenses;
a decrease in employee costs of $5.4 million primarily due to lower incentive compensation expenses due to temporary store closures as a result of COVID-19; and
The increase in selling, general and administrative expenses was partially offset by $14.3 million of government payroll subsidies which were recognized during the first quarter of fiscal 2020, and by an increase in net foreign exchange and derivative revaluation gains of $1.2 million.
As a percentage of net revenue, selling, general and administrative expenses increased 890 basis points, to 46.3% in the first quarter of fiscal 2020 from 37.4% in the first quarter of fiscal 2019.
Income from Operations
Income from operations decreased $96.1 million, or 75%, to $32.8 million in the first quarter of fiscal 2020 from $128.8 million in the first quarter of fiscal 2019. Operating margin decreased 1,150 basis points to 5.0% compared to 16.5% in the first quarter of fiscal 2019.
On a segment basis, we determine income from operations without taking into account our general corporate expenses. During the first quarter of fiscal 2020, we reviewed our segment and general corporate expenses and determined certain costs that are more appropriately classified in different categories. Accordingly, comparative figures have been reclassified to conform to the financial presentation adopted for the current year.

22


Segmented income (loss) from operations for the quarters ended May 3, 2020 and May 5, 2019 is summarized below. The percentages are presented as a percentage of net revenue of the respective operating segments.
 
 
Quarter Ended
 
 
May 3, 2020
 
May 5, 2019
 
May 3, 2020
 
May 5, 2019
 
 
(In thousands)
 
(Percentage of segment revenue)
Segmented income (loss) from operations:
 
 
 
 
 
 
 
 
Company-operated stores
 
$
(30,154
)
 
$
120,911

 
(11.6
)%
 
23.9
%
Direct to consumer
 
156,947

 
79,337

 
44.6

 
37.8

Other
 
(269
)
 
12,623

 
(0.7
)
 
19.1

 
 
126,524

 
212,871

 
 
 
 
General corporate expense
 
93,773

 
84,059

 
 
 
 
Income from operations
 
$
32,751

 
$
128,812

 
 
 
 
Company-Operated Stores. Income from operations from our company-operated stores segment decreased $151.1 million, or 125%, to a loss of $30.2 million for the first quarter of fiscal 2020 from income of $120.9 million for the first quarter of fiscal 2019. The decrease was primarily the result of decreased gross profit of $177.5 million which was primarily due to temporary store closures resulting from COVID-19, and lower gross margin, which was primarily due to deleverage on occupancy and depreciation costs as a result of lower net revenue. This was partially offset by a decrease in selling, general and administrative expenses, primarily due to decreased store operating expenses including the recognition of government payroll subsidies, and lower credit card fees, distribution costs, and packaging costs primarily as a result of lower net revenue. Additionally, there was a decrease in employee costs, primarily due to lower incentive compensation expenses due to temporary store closures. Income from operations as a percentage of company-operated stores net revenue decreased primarily due to lower gross margin and deleverage on selling, general and administrative expenses.
Direct to Consumer. Income from operations from our direct to consumer segment increased $77.6 million, or 98%, to $156.9 million for the first quarter of fiscal 2020 from $79.3 million for the first quarter of fiscal 2019. The increase was primarily the result of increased gross profit of $103.2 million which was primarily due to increased net revenue as more guests shopped online in the first quarter of fiscal 2020 as a result of COVID-19, and due to higher gross margin. This was partially offset by an increase in selling, general and administrative expenses primarily due to higher variable costs including distribution costs and credit card fees as a result of higher net revenue, as well as higher digital marketing expenses. Income from operations as a percentage of direct to consumer net revenue increased 680 basis points primarily due to higher gross margin and leverage on selling, general and administrative expenses.
Other. Income from operations from our other channels decreased $12.9 million, or 102%, to a loss of $0.3 million for the first quarter of fiscal 2020 from income of $12.6 million for the first quarter of fiscal 2019. The decrease was primarily the result of decreased gross profit of $13.0 million which was primarily due to decreased net revenue, primarily due to temporary store closures resulting from COVID-19. Income from operations as a percentage of other net revenue decreased primarily due to deleverage on selling, general and administrative expenses and lower gross margin.
General Corporate Expense. General corporate expense increased $9.7 million, or 12%, to $93.8 million for the first quarter of fiscal 2020 from $84.1 million for the first quarter of fiscal 2019. This increase was primarily due to increases in depreciation, information technology costs, and as a result of donations made through our Ambassador Relief Fund that provided grants to fitness studio owners impacted by COVID-19. The increase in general corporate expense was partially offset by a decrease in head office employee costs, and an increase in net foreign exchange and derivative revaluation gains of $1.2 million.
Other Income (Expense), Net
Other income, net decreased $1.2 million, or 51%, to $1.2 million for the first quarter of fiscal 2020 from income of $2.4 million for the first quarter of fiscal 2019. The decrease was primarily due to a decrease in net interest income.
Income Tax Expense
Income tax expense decreased $29.3 million, or 85%, to $5.3 million for the first quarter of fiscal 2020 from $34.6 million for the first quarter of fiscal 2019. The effective tax rate for the first quarter of fiscal 2020 was 15.6% compared to 26.4% for the first quarter of fiscal 2019. The decrease in the effective tax rate was primarily due to an increase in tax deductions related to stock-based compensation which, as a result of the lower pre-tax income for the quarter, represented a higher proportion of income before income tax expense and so reduced the overall effective tax rate.

23


Net Income
Net income decreased $68.0 million, or 70%, to $28.6 million for the first quarter of fiscal 2020 from $96.6 million for the first quarter of fiscal 2019. This was primarily due to a decrease in gross profit of $87.3 million, an increase in selling, general and administrative expenses of $8.7 million, and a decrease in other income (expense), net of $1.2 million, partially offset by a decrease in income tax expense of $29.3 million.
Comparable Store Sales and Total Comparable Sales
We separately track comparable store sales, which 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 for at least 30 days. Comparable store sales also exclude sales from direct to consumer and other segments, as well as sales from company-operated stores that we have closed.
Total comparable sales combines comparable store sales and direct to consumer sales. We are evolving towards an omni-channel approach to support the shopping behavior of our guests. This involves country and region specific websites, mobile apps, including mobile apps on in-store devices that allow demand to be fulfilled via our distribution centers, social media, product notification emails, and online order fulfillment through stores.
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.
The comparable sales measures we report may not be equivalent to similarly titled measures reported by other companies.
We typically 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 typically use total comparable sales to evaluate the performance of our business from an omni-channel perspective. We therefore typically believe that investors would similarly find these metrics useful in assessing the performance of our business. However, as the temporary store closures from COVID-19 have resulted in a significant number of stores being removed from our comparable store base, we believe total comparable sales and comparable store sales are not currently representative of the underlying trends of our business. We do not believe these metrics are currently useful to investors in understanding performance, therefore we have not included these metrics in our discussion and analysis of results of operations.
Non-GAAP Financial Measures
Constant dollar changes in net revenue and direct to consumer net revenue are non-GAAP financial measures.
A constant dollar basis assumes the average foreign exchange rates for the period remained constant with the average foreign exchange rates for the same period of the prior year. We provide constant dollar changes in net revenue and direct to consumer net revenue because we use these measures to understand the underlying growth rate of net revenue excluding the impact of changes in foreign exchange rates. We believe that disclosing these measures on a constant dollar basis is useful to investors because it enables them to better understand the level of growth of our business.
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.

24


Constant dollar changes in net revenue and direct to consumer net revenue
The below changes in net revenue show the change compared to the corresponding period in the prior year.
 
 
Quarter Ended
 May 3, 2020
 
 
Net Revenue
 
Direct to Consumer Net Revenue
 
 
(In thousands)
 
(Percentages)
 
(Percentages)
Change
 
$
(130,353
)
 
(17
)%
 
68
%
Adjustments due to foreign exchange rate changes
 
7,674

 
1

 
2

Change in constant dollars
 
$
(122,679
)
 
(16
)%
 
70
%
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 generated in the fourth quarter of our fiscal year. For example, we generated approximately 47% of our full year operating profit during each of the fourth quarters of fiscal 2019 and fiscal 2018.
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 revolving credit facilities. Our primary cash needs are capital expenditures for opening new stores and remodeling or relocating existing stores, making information technology system investments and enhancements, funding working capital requirements, and making other strategic 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, treasury bills, and term deposits.
As of May 3, 2020, our working capital, excluding cash and cash equivalents, was $240.0 million, our cash and cash equivalents were $823.0 million, and our capacity under our committed revolving facility was $398.2 million.
The following table summarizes our net cash flows provided by and used in operating, investing, and financing activities for the periods indicated:
 
 
Quarter Ended
 
 
May 3, 2020
 
May 5, 2019
 
 
(In thousands)
Total cash (used in) provided by:
 
 
 
 
Operating activities
 
$
(121,243
)
 
$
(62,803
)
Investing activities
 
(45,626
)
 
(63,908
)
Financing activities
 
(90,587
)
 
(170,292
)
Effect of exchange rate changes on cash
 
(13,043
)
 
(8,076
)
Decrease in cash and cash equivalents
 
$
(270,499
)
 
$
(305,079
)
Operating Activities
Cash flows used in operating activities consist primarily of net income adjusted for certain items including depreciation and amortization, stock-based compensation expense, and the effect of changes in operating assets and liabilities.
Cash used in operating activities increased $58.4 million, to $121.2 million for the first quarter of fiscal 2020 compared to $62.8 million for the first quarter of fiscal 2019, primarily as a result of a decrease of $68.0 million in net income primarily due to the impact of COVID-19, including temporary closures of company-operated stores. This was partially offset by the following:
an increase of $6.0 million in non-cash expenses primarily related to an increase in depreciation, partially offset by a decrease in stock-based compensation expense; and

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an increase of $3.5 million in changes in operating assets and liabilities, primarily due to the following:
an increase of $92.9 million related to income taxes, primarily due to the deferral of Canadian income tax payments to the third quarter of fiscal 2020 as well as payments for withholding taxes on repatriated foreign earnings in the first quarter of fiscal 2019;
an increase of $61.9 million related to other current and non-current liabilities primarily due to an increase in forward currency contract liabilities as a result of foreign exchange fluctuations, and an increase in the sales return allowance as a result of COVID-19 reducing in-period returns; and
an increase of $7.6 million related to accounts payable.
The increase in changes in operating assets and liabilities was partially offset by the following:
a decrease of $69.0 million related to inventories, primarily due to lower than expected net revenue as a result of the temporary store closures from COVID-19;
a decrease of $37.2 million related to other prepaid expenses and other current and non-current assets, primarily due to an increase in forward currency contract assets as a result of foreign exchange fluctuations;
a decrease of $27.6 million related to accrued compensation related expenses; and
a decrease of $25.1 million related to right-of-use lease assets and current and non-current lease liabilities.
Investing Activities
Cash flows used in investing activities relate to capital expenditures, the settlement of net investment hedges, and other investing activities. The capital expenditures were primarily for opening new company-operated stores, remodeling or relocating certain stores, and ongoing store refurbishment. We also had capital expenditures related to information technology and business systems, related to corporate buildings, and for opening retail locations other than company-operated stores.
Cash used in investing activities decreased $18.3 million to $45.6 million for the first quarter of fiscal 2020 from $63.9 million for the first quarter of fiscal 2019. The decrease was primarily the result of adjusting our investments in light of COVID-19. This included decreasing our corporate capital expenditures on information technology and business systems as well as decreasing our capital expenditures for renovations and relocations of our company-operated stores.
Financing Activities
Cash flows used in financing activities consist primarily of cash used to repurchase shares of our common stock, certain cash flows related to stock-based compensation, and other financing activities.
Cash used in financing activities decreased $79.7 million to $90.6 million for the first quarter of fiscal 2020 compared to $170.3 million for the first quarter of fiscal 2019. The decrease was primarily the result of a decrease in our stock repurchases.
Our cash used in financing activities for the first quarter of fiscal 2020 included $63.7 million to repurchase 0.4 million shares of our common stock compared to $163.5 million to repurchase 1.0 million shares for the first quarter of fiscal 2019. During the first quarter of fiscal 2019, we repurchased 1.0 million shares in a private transaction. We did not purchase any shares in a private transaction during the first quarter of fiscal 2020. The other 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. As of March 31, 2020, we temporarily paused our share repurchase program.
We believe that our cash and cash equivalent balances, cash flows from operations, and borrowings available to us under our revolving credit facilities 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, the continuing impact of COVID-19, as well as the other factors described in Item 1 of Part II of this Quarterly Report on Form 10-Q. In addition, we may make discretionary capital improvements with respect to our stores, distribution facilities, headquarters, or systems, or we may make strategic investments or 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 capital expenditures out of our cash and cash equivalents and cash generated from operations.

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Revolving Credit Facilities
North America revolving credit facility
On December 15, 2016, we entered into a credit agreement for $150.0 million under a committed and unsecured five-year revolving credit facility. Bank of America, N.A., is administrative agent and HSBC Bank Canada is the syndication agent and letter of credit issuer, and the lenders party thereto. Borrowings under the revolving credit facility may be made, in U.S. Dollars, Euros, Canadian Dollars, and in other currencies, subject to the approval of the administrative agent and the lenders. Up to $35.0 million of the revolving credit facility is available for the issuance of letters of credit and up to $25.0 million is available for the issuance of swing line loans. Commitments under the revolving credit facility may be increased by up to $200.0 million, subject to certain conditions, including the approval of the lenders. Borrowings under the agreement may be prepaid and commitments may be reduced or terminated without premium or penalty (other than customary breakage costs). The principal amount outstanding under the credit agreement, if any, will be due and payable in full on December 15, 2021, subject to provisions that permit us to request a limited number of one year extensions annually.
Borrowings made under the revolving credit facility bear interest at a rate per annum equal to, at our option, either (a) a rate based on the rates applicable for deposits on the interbank market for U.S. Dollars or the applicable currency in which the borrowings are made ("LIBOR") or (b) an alternate base rate, plus, in each case, an applicable margin. The applicable margin is determined by reference to a pricing grid, based on the ratio of indebtedness to earnings before interest, tax, depreciation, amortization, and rent ("EBITDAR") and ranges between 1.00%-1.75% for LIBOR loans and 0.00%-0.75% for alternate base rate loans. Additionally, a commitment fee of between 0.125%-0.200%, also determined by reference to the pricing grid, is payable on the average daily unused amounts under the revolving credit facility.
The credit agreement contains negative covenants that, among other things and subject to certain exceptions, limit the ability of our 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.
We are also required to maintain a consolidated rent-adjusted leverage ratio of not greater than 3.50:1.00 and we are not permitted to allow the ratio of consolidated EBITDAR to consolidated interest charges (plus rent) to be less than 2.00:1.00. The credit agreement also contains certain customary representations, warranties, affirmative covenants, and events of default (including, among others, an event of default upon the occurrence of a change of control). If an event of default occurs, the credit agreement may be terminated and the maturity of any outstanding amounts may be accelerated. As of May 3, 2020, we were in compliance with the covenants of the credit facility.
On June 6, 2018, we entered into Amendment No. 1 to the credit agreement. The Amendment amended the credit agreement to provide for (i) an increase in the aggregate commitments under the unsecured five-year revolving credit facility to $400.0 million, with an increase of the sub-limits for the issuance of letters of credit and extensions of swing line loans to $50.0 million for each, (ii) an increase in the option, subject to certain conditions as set forth in the credit agreement, to request increases in commitments under the revolving facility from $400.0 million to $600.0 million and (iii) an extension in the maturity of the revolving facility from December 15, 2021 to June 6, 2023.
In addition, the Amendment decreased the applicable margins for LIBOR loans from 1.00%-1.75% to 1.00%-1.50% and for alternate base rate loans from 0.00%-0.75% to 0.00%-0.50%, reduced the commitment fee on average daily unused amounts under the revolving facility from 0.125%-0.200% to 0.10%-0.20%, and reduced fees for unused letters of credit from 1.00%-1.75% to 1.00%-1.50%.
As of May 3, 2020, aside from letters of credit of $1.8 million, we had no other borrowings outstanding under this credit facility.
Mainland China revolving credit facility
In December 2019, we entered into an uncommitted and unsecured 130.0 million Chinese Yuan revolving credit facility. The terms are reviewed on an annual basis. The facility includes a revolving loan of up to 100.0 million Chinese Yuan as well as a financial bank guarantee facility of up to 30.0 million Chinese Yuan, or its equivalent in another currency. In U.S. dollars, the uncommitted and unsecured revolving credit facility is equivalent to $18.4 million, the revolving loan is equivalent of up to $14.2 million, and the financial bank guarantee facility is equivalent of up to $4.2 million. Loans are available in Chinese Yuan for a period not to exceed 12 months, and interest accrues on them at a rate equal to 105% of the applicable PBOC Benchmark Lending Rate. Guarantees have a commission equal to 1% per annum of the outstanding amount. We are required to follow certain covenants. As of May 3, 2020, we were in compliance with the covenants. As of May 3, 2020, there were immaterial borrowings outstanding under this credit facility.

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Off-Balance Sheet Arrangements
We enter into standby letters of credit to secure certain of our obligations, including leases, taxes, and duties. As of May 3, 2020, letters of credit and letters of guarantee totaling $1.8 million had been issued.
We have not entered into any transactions, agreements or other contractual arrangements to which an entity unconsolidated with us is a party and under which we have (i) any obligation under a guarantee, (ii) any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity, (iii) any obligation under derivative instruments that are indexed to our shares and classified as equity in our consolidated balance sheets, or (iv) any obligation arising out of a variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions. Predicting future events is inherently an imprecise activity and, as such, requires the use of judgment. Actual results may vary from our estimates in amounts that may be material to the financial statements. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact our consolidated financial statements. Our critical accounting policies and estimates are discussed in our fiscal 2019 Annual Report on Form 10-K filed with the SEC on March 26, 2020, and in Notes 12, 5, and 6, included in Item 1 of Part I of this Quarterly Report on Form 10-Q.
Operating Locations
Our company-operated stores by country as of May 3, 2020 and February 2, 2020 are summarized in the table below.
 
 
May 3,
2020
 
February 2,
2020
United States
 
301

 
305

Canada
 
61

 
63

People's Republic of China(1)
 
41

 
38

Australia
 
31

 
31

United Kingdom
 
14

 
14

Japan
 
7

 
7

New Zealand
 
7

 
7

Germany
 
6

 
6

South Korea
 
6

 
5

Singapore
 
4

 
4

France
 
3

 
3

Malaysia
 
2

 
2

Sweden
 
2

 
2

Ireland
 
1

 
1

Netherlands
 
1

 
1

Norway
 
1

 
1

Switzerland
 
1

 
1

Total company-operated stores
 
489

 
491

__________
(1) 
Included within PRC as of May 3, 2020, were seven company-operated stores in the Hong Kong Special Administrative Region, two company-operated stores in the Macao Special Administration Region, and one company-operated store in Taiwan, PRC. As of February 2, 2020, there were six company-operated stores in the Hong Kong Special Administrative Region, two company-operated stores in the Macao Special Administration Region, and one company-operated store in Taiwan, PRC.
As of May 3, 2020, all of our retail locations in North America, Europe, and certain countries in Asia Pacific were temporarily closed as a result of COVID-19.

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Retail locations operated by third parties under license and supply arrangements are not included in the above table. As of May 3, 2020, there were eight licensed locations, including four in Mexico, three in the United Arab Emirates, and one in Qatar.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Risk. The functional currency of our foreign subsidiaries is generally the applicable local currency. Our consolidated financial statements are presented in U.S. dollars. Therefore, the net revenue, expenses, assets, and liabilities of our foreign subsidiaries are translated from their functional currencies into U.S. dollars. Fluctuations in the value of the U.S. dollar affect the reported amounts of net revenue, expenses, assets, and liabilities. Foreign exchange differences which arise on translation of our foreign subsidiaries' balance sheets into U.S. dollars are recorded as a foreign currency translation adjustment in accumulated other comprehensive income or loss within stockholders' equity.
We also have exposure to changes in foreign exchange rates associated with transactions which are undertaken by our subsidiaries in currencies other than their functional currency. Such transactions include intercompany transactions and inventory purchases denominated in currencies other than the functional currency of the purchasing entity. As a result, we have been impacted by changes in exchange rates and may be impacted for the foreseeable future. The potential impact of currency fluctuation increases as our international expansion increases.
As of May 3, 2020, we had certain forward currency contracts outstanding in order to hedge a portion of the foreign currency exposure that arises on translation of a Canadian subsidiary into U.S. dollars. We also had certain forward currency contracts outstanding in an effort to reduce our exposure to the foreign exchange revaluation gains and losses that are recognized by our Canadian and Chinese subsidiaries on U.S. dollar denominated monetary assets and liabilities. Please refer to Note 6 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report for further information, including details of the notional amounts outstanding.
In the future, in an effort to reduce foreign exchange risks, we may enter into further derivative financial instruments including hedging additional currency pairs. We do not, and do not intend to, engage in the practice of trading derivative securities for profit.
We currently generate a significant portion of our net revenue and incur a significant portion of our expenses in Canada. We also hold a significant portion of our net assets in Canada. The reporting currency for our consolidated financial statements is the U.S. dollar. A strengthening of the U.S. dollar against the Canadian dollar results in:
the following impacts to the consolidated statements of operations:
a decrease in our net revenue upon translation of the sales made by our Canadian operations into U.S. dollars for the purposes of consolidation;
a decrease in our selling, general and administrative expenses incurred by our Canadian operations upon translation into U.S. dollars for the purposes of consolidation;
foreign exchange revaluation gains by our Canadian subsidiaries on U.S. dollar denominated monetary assets and liabilities; and
derivative valuation losses on forward currency contracts not designated in a hedging relationship;
the following impacts to the consolidated balance sheets:
a decrease in the foreign currency translation adjustment which arises on the translation of our Canadian subsidiaries' balance sheets into U.S. dollars; and
an increase in the foreign currency translation adjustment from derivative valuation losses on forward currency contracts, entered into as net investment hedges of a Canadian subsidiary.
During the first quarter of fiscal 2020, the change in the relative value of the U.S. dollar against the Canadian dollar resulted in a $74.4 million increase in accumulated other comprehensive loss within stockholders' equity. During the first quarter of fiscal 2019, the change in the relative value of the U.S. dollar against the Canadian dollar resulted in a $16.8 million increase in accumulated other comprehensive loss within stockholders' equity.
A 10% appreciation in the relative value of the U.S. dollar against the Canadian dollar compared to the exchange rates in effect for the first quarter of fiscal 2020 would have resulted in additional income from operations of approximately $1.6 million in the first quarter of fiscal 2020. This assumes a consistent 10% appreciation in the U.S. dollar against the Canadian dollar over the first quarter of fiscal 2020. The timing of changes in the relative value of the U.S. dollar combined with the

29


seasonal nature of our business, can affect the magnitude of the impact that fluctuations in foreign exchange rates have on our income from operations.
Interest Rate Risk. Our committed revolving credit facility provides us with available borrowings in an amount up to $400.0 million in the aggregate. Because our revolving credit facilities bear interest at a variable rate, we will be exposed to market risks relating to changes in interest rates, if we have a meaningful outstanding balance. As of May 3, 2020, aside from letters of credit of $1.8 million, there were immaterial borrowings outstanding under these credit facilities. We currently do not engage in any interest rate hedging activity and currently have no intention to do so. However, in the future, if we have a meaningful outstanding balance under our revolving facility, in an effort to mitigate losses associated with these risks, we may at times enter into derivative financial instruments, although we have not historically done so. These may take the form of forward contracts, option contracts, or interest rate swaps. We do not, and do not intend to, engage in the practice of trading derivative securities for profit.
Our cash and cash equivalent balances are held in the form of cash on hand, bank balances, short-term deposits and treasury bills with original maturities of three months or less, and in money market funds. We do not believe these balances are subject to material interest rate risk.
Credit Risk. We have cash on deposit with various large, reputable financial institutions and have invested in U.S. and Canadian Treasury Bills, and in AAA-rated money market funds. The amount of cash and cash equivalents held with certain financial institutions exceeds government-insured limits. We are also exposed to credit-related losses in the event of nonperformance by the financial institutions that are counterparties to our forward currency contracts. The credit risk amount is our unrealized gains on our derivative instruments, based on foreign currency rates at the time of nonperformance. We have not experienced any losses related to these items, and we believe credit risk to be minimal. We seek to minimize our credit risk by entering into transactions with credit worthy and reputable financial institutions and by monitoring the credit standing of the financial institutions with whom we transact. We seek to limit the amount of exposure with any one counterparty.
Inflation
Inflationary factors such as increases in the cost of our product and overhead costs may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net revenue if the selling prices of our products do not increase with these increased costs.
ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, or the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial and accounting officer, to allow timely decisions to be made regarding required disclosure. We have established a Disclosure Committee, consisting of certain members of management, to assist in this evaluation. The Disclosure Committee meets on a quarterly basis, and as needed.
Our management, including our principal executive officer and principal financial and accounting officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) at May 3, 2020. Based on that evaluation, our principal executive officer and principal financial and accounting officer concluded that, at May 3, 2020, our disclosure controls and procedures were effective.
There were no changes in our internal control over financial reporting during the quarter ended May 3, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In addition to the legal matters described in Note 10 to the unaudited interim consolidated financial statements included in Item 1 of Part I of this report and in our fiscal 2019 Annual Report on Form 10-K, we are, from time to time, involved in routine legal matters incidental to the conduct of our business, including legal matters such as initiation and defense of proceedings to protect intellectual property rights, personal injury claims, product liability claims, employment claims, and similar matters. We believe the ultimate resolution of any such current proceeding will not have a material adverse effect on our continued financial position, results of operations or cash flows.
ITEM 1A. RISK FACTORS
In addition to the other information contained in this Form 10-Q and in our Annual Report on Form 10-K for our 2019 fiscal year, the following risk factors should be considered carefully in evaluating our business. Our business, financial condition, or results of operations could be materially adversely affected by any of these risks. Please note that additional risks not presently known to us or that we currently deem immaterial could also impair our business and operations.
Our success depends on our ability to maintain the value and reputation of our brand.
Our success depends on the value and reputation of the lululemon brand. The lululemon name is integral to our business as well as to the implementation of our strategies for expanding our business. Maintaining, promoting, and positioning our brand will depend largely on the success of our marketing and merchandising efforts and our ability to provide a consistent, high quality product, and guest experience. We rely on social media, as one of our marketing strategies, to have a positive impact on both our brand value and reputation. Our brand and reputation could be adversely affected if we fail to achieve these objectives, if our public image was to be tarnished by negative publicity, which could be amplified by social media, if we fail to deliver innovative and high quality products acceptable to our guests, or if we face or mishandle a product recall. Additionally, while we devote considerable efforts and resources to protecting our intellectual property, if these efforts are not successful the value of our brand may be harmed. Any harm to our brand and reputation could have a material adverse effect on our financial condition.
The current COVID-19 coronavirus pandemic and related government, private sector, and individual consumer responsive actions have and will continue to adversely affect our business operations, store traffic, employee availability, financial condition, liquidity, and cash flow.
The outbreak of the COVID-19 coronavirus disease has been declared a pandemic by the World Health Organization and has spread across the United States, Canada, and many other countries globally. Related government and private sector responsive actions have significantly affected our business operations and will likely continue to do so for the foreseeable future.
The spread of COVID-19 has caused public health officials to recommend precautions to mitigate the spread of the virus, especially when congregating in heavily populated areas, such as malls and lifestyle centers. In February 2020, we temporarily closed all of our retail locations in Mainland China. All of these locations have since reopened. In March 2020, we temporarily closed all of our retail locations in North America, Europe, and certain countries in Asia Pacific. We have started to reopen stores in certain markets with precautionary measures such as limited operating hours and maximum occupancy levels, in line with the guidance from local authorities. There is significant uncertainty around the breadth and duration of our store closures and the restrictions in place once they do reopen.
There is significant uncertainty regarding the pace of stores reopening and what their results of operations will be once they do. We do not know what the duration and severity of potential restrictions on the operations of reopened stores will be. These restrictions could include precautionary measures such as limitations on the number of guests allowed in our stores at a time, minimum distancing requirements, and limited operating hours. A resurgence in COVID-19 cases could cause additional restrictions, including temporarily closing the stores again. An outbreak at one of our locations, even if we follow appropriate precautionary measures, could negatively impact our employees, guests, and brand. There is uncertainty over the impact of COVID-19 on the U.S., Canadian, and global economies, consumer willingness to visit stores, malls, and lifestyle centers, and employee willingness to staff our stores once they reopen. There is also uncertainty regarding potential long-term changes to consumer shopping behavior and preferences and whether consumer demand will recover when stay-at-home restrictions are lifted.

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We may be impacted by other business disruptions related to COVID-19, including disruptions to our sourcing and manufacturing or to our distribution facilities. Both of our distribution centers in the United States have experienced temporary closures due to COVID-19.
The temporary closure of the majority of our retail locations as well as other impacts of COVID-19 have negatively impacted our cash flows from operations and our liquidity. The length and severity of the pandemic, as well as the pace of recovery could negatively impact our liquidity for the foreseeable future. The availability of federal, state, and foreign funding programs is uncertain.
The COVID-19 situation is changing rapidly and the extent to which COVID-19 impacts our results will depend on future developments, which are highly uncertain and cannot be predicted, including new information that may emerge concerning the severity of COVID-19 and the actions taken to contain it or treat its impact.
If any of our products are unacceptable to us or our guests, our business could be harmed.
We have occasionally received, and may in the future receive, shipments of products that fail to comply with our technical specifications or that fail to conform to our quality control standards. We have also received, and may in the future receive, products that are otherwise unacceptable to us or our guests. Under these circumstances, unless we are able to obtain replacement products in a timely manner, we risk the loss of net revenue resulting from the inability to sell those products and related increased administrative and shipping costs. Additionally, if the unacceptability of our products is not discovered until after such products are purchased by our guests, our guests could lose confidence in our products or we could face a product recall and our results of operations could suffer and our business, reputation, and brand could be harmed.
We operate in a highly competitive market and the size and resources of some of our competitors may allow them to compete more effectively than we can, resulting in a loss of our market share and a decrease in our net revenue and profitability.
The market for technical athletic apparel is highly competitive. Competition may result in pricing pressures, reduced profit margins or lost market share, or a failure to grow or maintain our market share, any of which could substantially harm our business and results of operations. We compete directly against wholesalers and direct retailers of athletic apparel, including large, diversified apparel companies with substantial market share and established companies expanding their production and marketing of technical athletic apparel, as well as against retailers specifically focused on women's athletic apparel. We also face competition from wholesalers and direct retailers of traditional commodity athletic apparel, such as cotton T-shirts and sweatshirts. Many of our competitors are large apparel and sporting goods companies with strong worldwide brand recognition. Because of the fragmented nature of the industry, we also compete with other apparel sellers, including those specializing in yoga apparel and other activewear. Many of our competitors have significant competitive advantages, including longer operating histories, larger and broader customer bases, more established relationships with a broader set of suppliers, greater brand recognition and greater financial, research and development, store development, marketing, distribution, and other resources than we do.
Our competitors may be able to achieve and maintain brand awareness and market share more quickly and effectively than we can. In contrast to our grassroots community-based marketing approach, many of our competitors promote their brands through traditional forms of advertising, such as print media and television commercials, and through celebrity endorsements, and have substantial resources to devote to such efforts. Our competitors may also create and maintain brand awareness using traditional forms of advertising more quickly than we can. Our competitors may also be able to increase sales in their new and existing markets faster than we do by emphasizing different distribution channels than we do, such as catalog sales or an extensive franchise network.
In addition, because we hold limited patents and exclusive intellectual property rights in the technology, fabrics or processes underlying our products, our current and future competitors are able to manufacture and sell products with performance characteristics, fabrication techniques, and styling similar to our products.
Our reliance on suppliers to provide fabrics for and to produce our products could cause problems in our supply chain.
We do not manufacture our products or the raw materials for them and rely instead on suppliers. Many of the specialty fabrics used in our products are technically advanced textile products developed and manufactured by third parties and may be available, in the short-term, from only one or a very limited number of sources. We have no long-term contracts with any of our suppliers or manufacturers for the production and supply of our raw materials and products, and we compete with other companies for fabrics, other raw materials, and production. The following statistics are based on cost.
We work with a group of approximately 39 vendors that manufacture our products, five of which produced approximately 56% of our products in fiscal 2019. During fiscal 2019, the largest single manufacturer produced approximately 17% of our

32


products. During fiscal 2019, approximately 33% of our products were manufactured in Vietnam, 16% in Cambodia, 15% in Sri Lanka, and 11% in the PRC, including 2% in Taiwan, PRC.
We work with a group of approximately 76 suppliers to provide the fabrics for our products. In fiscal 2019, approximately 59% of our fabrics were produced by our top five fabric suppliers, and the largest single manufacturer produced approximately 32% of fabric used. During fiscal 2019, approximately 46% of our fabrics originated from Taiwan, PRC, 14% from the rest of the PRC, 19% from Sri Lanka, and the remainder from other regions.
We also source other raw materials which are used in our products, including items such as content labels, elastics, buttons, clasps, and drawcords from suppliers located predominantly in the Asia Pacific region.
We have experienced, and may in the future experience, a significant disruption in the supply of fabrics or raw materials from current sources and we may be unable to locate alternative materials suppliers of comparable quality at an acceptable price, or at all. In addition, if we experience significant increased demand, or if we need to replace an existing supplier or manufacturer, we may be unable to locate additional supplies of fabrics or raw materials or additional manufacturing capacity on terms that are acceptable to us, or at all, or we may be unable to locate any supplier or manufacturer with sufficient capacity to meet our requirements or to fill our orders in a timely manner. Identifying a suitable supplier is an involved process that requires us to become satisfied with its quality control, responsiveness and service, financial stability, and labor and other ethical practices. Even if we are able to expand existing or find new manufacturing or fabric sources, we may encounter delays in production and added costs as a result of the time it takes to train our suppliers and manufacturers in our methods, products, and quality control standards. Our supply of fabric or the manufacturing of our products could be disrupted or delayed by the impact of global health pandemics, including the current COVID-19 coronavirus pandemic, and the related government and private sector responsive actions such as border closures, restrictions on product shipments, and travel restrictions. Delays related to supplier changes could also arise due to an increase in shipping times if new suppliers are located farther away from our markets or from other participants in our supply chain. Any delays, interruption, or increased costs in the supply of fabric or manufacture of our products could have an adverse effect on our ability to meet guest demand for our products and result in lower net revenue and income from operations both in the short and long term.
The operations of many of our suppliers are subject to additional risks that are beyond our control and that could harm our business, financial condition, and results of operations.
Almost all of our suppliers are located outside of North America, and as a result, we are subject to risks associated with doing business abroad, including:
the impact of health conditions, including the current COVID-19 coronavirus pandemic, and related government and private sector responsive actions, and other changes in local economic conditions in countries where our manufacturers, suppliers, or guests are located;
political unrest, terrorism, labor disputes, and economic instability resulting in the disruption of trade from foreign countries in which our products are manufactured;
the imposition of new laws and regulations, including those relating to labor conditions, quality and safety standards, imports, duties, taxes and other charges on imports, as well as trade restrictions and restrictions on currency exchange or the transfer of funds;
reduced protection for intellectual property rights, including trademark protection, in some countries, particularly in the PRC; and
disruptions or delays in shipments whether due to port congestion, labor disputes, product regulations and/or inspections or other factors, natural disasters or health pandemics, or other transportation disruptions.
These and other factors beyond our control could interrupt our suppliers' production in offshore facilities, influence the ability of our suppliers to export our products cost-effectively or at all and inhibit our suppliers' ability to procure certain materials, any of which could harm our business, financial condition, and results of operations.
Our business could be harmed if our suppliers and manufacturers do not comply with our Vendor Code of Ethics or applicable laws.
While we require our suppliers and manufacturers to comply with our Vendor Code of Ethics, which includes labor, health and safety, and environment standards, we do not control their practices. If suppliers or contractors do not comply with these standards or applicable laws or there is negative publicity regarding the production methods of any of our suppliers or manufacturers, even if unfounded or not material to our supply chain, our reputation and sales could be adversely affected, we could be subject to legal liability, or we could be forced to locate alternative suppliers or manufacturing sources.

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