lululemon athletica, inc.
lululemon athletica inc. (Form: 10-Q, Received: 12/12/2013 08:46:22)
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 3, 2013
or
o
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.)
 
 
400-1818 Cornwall Avenue,
Vancouver, British Columbia
V6J 1C7
(Address of principal executive offices)
(Zip Code)
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
 
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
þ
Accelerated filer
  
o
Non-accelerated filer
o  (Do not check if a smaller reporting company)
Smaller reporting company
  
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o No þ
At December 9, 2013 , there were 115,223,687 shares of the registrant’s common stock, par value $0.005 per share, outstanding.
Exchangeable and Special Voting Shares:
At December 9, 2013 , there were outstanding 29,982,922 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 December 9, 2013 , the registrant had outstanding 29,982,922 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 vo ting 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

TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 6.
 
 

2

Table of Contents

PART I
FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
lululemon athletica inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS  
 
 
November 3,
2013
 
February 3,
2013
 
 
(Unaudited)
 
 
 
 
(Amounts in thousands, except per share amounts)
ASSETS
Current assets
 
 
 
 
Cash and cash equivalents
 
$
600,745

 
$
590,179

Accounts receivable
 
12,105

 
6,351

Inventories
 
206,154

 
155,222

Prepaid expenses and other current assets
 
61,587

 
35,301

 
 
880,591

 
787,053

Property and equipment, net
 
243,626

 
214,639

Goodwill and intangible assets, net
 
28,991

 
30,201

Deferred income taxes
 
16,103

 
15,033

Other non-current assets
 
5,243

 
4,152

 
 
$
1,174,554

 
$
1,051,078

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
4,783

 
$
1,045

Accrued liabilities
 
38,221

 
30,032

Accrued compensation and related expenses
 
26,829

 
27,530

Income taxes payable
 
991

 
39,637

Unredeemed gift card liability
 
23,790

 
35,113

 
 
94,614

 
133,357

Non-current liabilities
 
37,180

 
30,422

 
 
131,794

 
163,779

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, issued and outstanding 29,983 and 32,065
 

 

Special voting stock, $0.000005 par value, 60,000 shares authorized, issued and outstanding 29,983 and 32,065
 

 

Common stock, $0.005 par value, 400,000 shares authorized, issued and outstanding 115,223 and 112,371
 
576

 
562

Additional paid-in capital
 
242,465

 
221,372

Retained earnings
 
814,130

 
644,275

Accumulated other comprehensive (loss) income
 
(14,411
)
 
21,090

 
 
1,042,760

 
887,299

 
 
$
1,174,554

 
$
1,051,078

See accompanying notes to the interim consolidated financial statements


3


lululemon athletica inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
 
 
 
Thirteen Weeks Ended November 3, 2013
 
Thirteen Weeks Ended 
 October 28, 2012
 
Thirty-Nine Weeks Ended November 3, 2013
 
Thirty-Nine Weeks Ended October 28, 2012
 
 
(Unaudited)
 
 
(Amounts in thousands, except per share amounts)
Net revenue
 
$
379,900

 
$
316,537

 
$
1,070,195

 
$
884,869

Cost of goods sold
 
175,294

 
141,237

 
508,909

 
396,550

Gross profit
 
204,606

 
175,300

 
561,286

 
488,319

Selling, general and administrative expenses
 
112,270

 
94,689

 
324,075

 
264,455

Income from operations
 
92,336

 
80,611

 
237,211

 
223,864

Other income (expense), net
 
1,453

 
1,424

 
4,249

 
3,500

Income before provision for income taxes
 
93,789

 
82,035

 
241,460

 
227,364

Provision for income taxes
 
27,678

 
24,655

 
71,605

 
65,308

Net income
 
66,111

 
57,380

 
169,855

 
162,056

Net income attributable to non-controlling interest
 

 
64

 

 
875

Net income attributable to lululemon athletica inc.
 
$
66,111

 
$
57,316

 
$
169,855

 
$
161,181

Basic earnings per share
 
$
0.46

 
$
0.40

 
$
1.17

 
$
1.12

Diluted earnings per share
 
$
0.45

 
$
0.39

 
$
1.16

 
$
1.11

Basic weighted-average number of shares outstanding
 
145,120

 
144,057

 
144,806

 
143,903

Diluted weighted-average number of shares outstanding
 
146,014

 
145,748

 
145,967

 
145,750

Other comprehensive income:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
(9,153
)
 
2,642

 
(35,501
)
 
(381
)
Comprehensive income
 
$
56,958

 
$
59,958

 
$
134,354

 
$
160,800

See accompanying notes to the interim consolidated financial statements


4


lululemon athletica inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
 
 
 
Exchangeable
Stock
 
Special Voting
Stock
 
Common
Stock
 
 
 
 
 
 
 
 
 
 
Shares
 
Par
Value
 
Shares
 
Par
Value
 
Shares
 
Par
Value
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
 
 
(Unaudited)
(Amounts in thousands)
Balance at February 3, 2013
 
32,065

 
$

 
32,065

 
$

 
112,371

 
$
562

 
$
221,372

 
$
644,275

 
$
21,090

 
$
887,299

Net income attributable to lululemon athletica inc.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
169,855

 
 
 
169,855

Foreign currency translation adjustment
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(35,501
)
 
(35,501
)
Stock-based compensation
 
 
 
 
 
 
 
 
 
 
 
 
 
12,453

 
 
 
 
 
12,453

Excess tax benefit from stock-based compensation
 
 
 
 
 
 
 
 
 
 
 
 
 
6,453

 
 
 
 
 
6,453

Common stock issued upon exchange of exchangeable shares
 
(2,082
)
 

 
(2,082
)
 

 
2,082

 
10

 
(10
)
 
 
 
 
 

Restricted share issuance
 
 
 
 
 
 
 
 
 
15

 

 

 
 
 
 
 

Stock options exercised
 
 
 
 
 
 
 
 
 
647

 
3

 
7,475

 
 
 
 
 
7,478

Common stock issued upon settlement of performance-based restricted stock units
 
 
 
 
 
 
 
 
 
191

 
1

 
(1
)
 
 
 
 
 

Shares withheld related to net share settlement of performance-based restricted stock units
 
 
 
 
 
 
 
 
 
(83
)
 

 
(5,277
)
 
 
 
 
 
(5,277
)
Balance at November 3, 2013
 
29,983

 
$

 
29,983

 
$

 
115,223

 
$
576

 
$
242,465

 
$
814,130

 
$
(14,411
)
 
$
1,042,760

See accompanying notes to the interim consolidated financial statements


5


lululemon athletica inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
 
Thirty-Nine Weeks Ended 
 November 3, 2013
 
Thirty-Nine Weeks Ended 
 October 28, 2012
 
 
(Unaudited)
(Amounts in thousands)
Cash flows from operating activities
 
 
 
 
Net income
 
$
169,855

 
$
162,056

Items not affecting cash
 
 
 
 
Provision for inventories
 
18,316

 
724

Depreciation and amortization
 
36,723

 
30,962

Stock-based compensation
 
12,453

 
11,828

Excess tax benefits from stock-based compensation
 
(6,453
)
 
(7,172
)
Other, including net changes in other non-cash balances
 
 
 
 
Prepaid tax installments
 
(12,124
)
 
(9,315
)
Other prepaid expenses and other current assets
 
(14,645
)
 
(6,965
)
Inventories
 
(72,052
)
 
(61,262
)
Accounts payable
 
3,728

 
(7,958
)
Accrued liabilities
 
7,230

 
11,048

Sales tax collected
 
270

 
(7,573
)
Income taxes payable
 
(40,272
)
 
(1,858
)
Accrued compensation and related expenses
 
(1,474
)
 
(663
)
Other non-cash balances
 
(6,749
)
 
(612
)
Net cash provided by operating activities
 
94,806

 
113,240

Cash flows from investing activities
 
 
 
 
Purchase of property and equipment
 
(71,945
)
 
(72,041
)
Net cash used in investing activities
 
(71,945
)
 
(72,041
)
Cash flows from financing activities
 
 
 
 
Proceeds from exercise of stock options
 
7,478

 
6,978

Excess tax benefits from stock-based compensation
 
6,453

 
7,172

Purchase of non-controlling interest
 

 
(26,013
)
Taxes paid related to net share settlement of equity awards
 
(5,277
)
 

Net cash provided by (used in) financing activities
 
8,654

 
(11,863
)
Effect of exchange rate changes on cash
 
(20,949
)
 
650

Increase in cash and cash equivalents
 
10,566

 
29,986

Cash and cash equivalents, beginning of period
 
$
590,179

 
$
409,437

Cash and cash equivalents, end of period
 
$
600,745

 
$
439,423

See accompanying notes to the interim consolidated financial statements


6


lululemon athletica inc. and Subsidiaries
NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL
STATEMENTS
(Amounts in thousands, except per share and store count information, unless otherwise indicated)
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, manufacture and distribution of healthy lifestyle inspired athletic apparel, which is sold through a chain of corporate-owned and operated retail stores, direct to consumer through e-commerce and through a network of wholesale accounts. The Company’s primary markets are the United States, Canada, Australia, and New Zealand, where 166 , 53 , 25 and three corporate-owned stores were in operation as of November 3, 2013 , respectively. There were a total of 247 and 211 corporate-owned stores in operation as of November 3, 2013 and February 3, 2013 , respectively.
Basis of presentation
The unaudited interim consolidated financial statements as of November 3, 2013 and for the thirty-nine weeks ended November 3, 2013 and October 28, 2012 are presented using the United States dollar and have been prepared by the Company under the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the financial information is presented in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and, accordingly, do not include all of the information and footnotes required by GAAP for complete financial statements. The financial information as of February 3, 2013 is derived from the Company’s audited consolidated financial statements and notes for the fiscal year ended February 3, 2013 , included in Item 8 in the fiscal 2012 Annual Report on Form 10-K filed with the SEC on March 21, 2013 . 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 the Company’s 2012 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 2013 is a 52 week year, and will end on February 2, 2014 while fiscal 2012 was a 53 week year, and ended on February 3, 2013 .
The Company’s business is affected by the pattern of seasonality common to most retail apparel businesses. The results for the periods presented are not necessarily indicative of future financial results.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
In January 2013, the FASB amended ASC Topic 210 Balance Sheet (“ASC 210”) to clarify the scope of the required enhanced disclosures that will enable financial statement users to evaluate the effect or potential effect of netting arrangements on a company’s financial position, including the effect or potential effect of rights of setoff associated within scope assets and liabilities. The amendment requires enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (i) offset in accordance with ASC 210-20-45 or ASC 815-10-45 or (ii) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with ASC 210-20-45 or ASC 815-10-45. This guidance is effective for annual periods beginning on or after January 1, 2013. The Company adopted the amendment in the first quarter of fiscal 2013 with no material impact on the Company’s consolidated financial statements.
NOTE 3. STOCK-BASED COMPENSATION
Share option plans
The Company’s 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 $12,453 and $11,828 for the thirty-nine weeks ended November 3, 2013 and October 28, 2012 , respectively. Total unrecognized compensation cost for all stock-based compensation plans was $23,886 at November 3, 2013 , which is expected to be recognized over a weighted-average period of 2.1  years.

7


Company stock options, performance-based restricted stock units and restricted shares
A summary of the Company’s stock option, performance-based restricted stock unit and restricted share activity as of November 3, 2013 and changes during the thirty-nine week period then ended is presented below:
 
 
 
Number of
Stock
Options
 
Weighted-
Average
Exercise
Price
 
Number of
Performance-Based Restricted Stock
Units
 
Weighted-
Average
Grant
Fair Value
 
Number of
Restricted
Shares
 
Weighted-
Average
Grant
Fair Value
Balance at February 3, 2013
 
1,377

 
$
19.51

 
491

 
$
45.47

 
16

 
$
63.97

Granted
 
97

 
66.34

 
267

 
52.61

 
17

 
64.30

Exercised
 
647

 
11.56

 
191

 
20.74

 
16

 
63.97

Forfeited
 
52

 
24.83

 
24

 
60.98

 
2

 
64.30

Balance at November 3, 2013
 
775

 
$
31.67

 
543

 
$
57.01

 
15

 
$
64.30

Exercisable at November 3, 2013
 
364

 
$
16.51

 

 
$

 

 
$

The Company’s performance-based restricted stock units are awarded to eligible employees and entitle the grantee to receive a maximum of 1.5  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 share units is recognized when it is probable that the performance goal will be achieved.
Employee stock purchase plan
The Company’s Board of Directors and stockholders approved the Company’s Employee Share Purchase Plan (“ESPP”) in September 2007. The ESPP allows for the purchase of common stock of the Company by all eligible employees at a 25% discount from fair market value subject to certain limits as defined in the ESPP. The maximum number of shares available under the ESPP is 6,000  shares. During the thirteen weeks ended November 3, 2013 , there were 23  shares purchased under the ESPP, which were funded by the Company through open market purchases.
NOTE 4. EARNINGS PER SHARE
The details of the computation of basic and diluted earnings per share are as follows:
 
 
 
Thirteen Weeks Ended November 3, 2013
 
Thirteen Weeks Ended October 28, 2012
 
Thirty-Nine Weeks Ended November 3, 2013
 
Thirty-Nine Weeks Ended October 28, 2012
Net income attributable to lululemon athletica inc.
 
$
66,111

 
$
57,316

 
$
169,855

 
$
161,181

Basic weighted-average number of shares outstanding
 
145,120

 
144,057

 
144,806

 
143,903

Effect of stock options assume exercised
 
894

 
1,691

 
1,161

 
1,847

Diluted weighted-average number of shares outstanding
 
146,014

 
145,748

 
145,967

 
145,750

Basic earnings per share
 
$
0.46

 
$
0.40

 
$
1.17

 
$
1.12

Diluted earnings per share
 
$
0.45

 
$
0.39

 
$
1.16

 
$
1.11


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 thirty-nine weeks ended November 3, 2013 and October 28, 2012 , 63 and 53 stock options, respectively, were anti-dilutive to earnings and therefore have been excluded from the computation of diluted earnings per share.

8


NOTE 5. INVENTORIES
 
 
November 3,
2013
 
February 3,
2013
Finished goods
 
$
232,270

 
$
163,008

Raw materials
 
568

 
583

Provision to reduce inventory to market value
 
(26,684
)
 
(8,369
)
 
 
$
206,154

 
$
155,222

The Company’s calculation of provision to reduce inventory to market value includes a $17,469 charge to cost of sales in the thirty-nine weeks ended November 3, 2013, related to the pull-back of black luon pants in corporate-owned stores, direct to consumer and other sales channels, as well as inventory held in its warehouse facilities.

9


NOTE 6. SUPPLEMENTARY FINANCIAL INFORMATION
A summary of certain balance sheet accounts is as follows:
 
 
 
November 3,
2013
 
February 3,
2013
Prepaid expenses and other current assets:
 
 
 
 
Prepaid tax installments
 
$
40,398

 
$
21,821

Prepaid expenses
 
21,189

 
13,480

 
 
$
61,587

 
$
35,301

Property and equipment:
 
 
 
 
Land
 
$
69,773

 
$
72,679

Buildings
 
10,554

 
10,969

Leasehold improvements
 
140,927

 
109,233

Furniture and fixtures
 
38,872

 
30,907

Computer hardware and software
 
96,687

 
81,099

Equipment and vehicles
 
1,487

 
1,486

Accumulated amortization and depreciation
 
(114,674
)
 
(91,734
)
 
 
$
243,626

 
$
214,639

Goodwill and intangible assets:
 
 
 
 
Goodwill
 
$
23,609

 
$
23,609

Changes in foreign currency exchange rates
 
879

 
2,451

 
 
24,488

 
26,060

Reacquired franchise rights
 
10,630

 
10,630

Accumulated amortization
 
(8,490
)
 
(8,076
)
Changes in foreign currency exchange rates
 
2,363

 
1,587

 
 
4,503

 
4,141

 
 
$
28,991

 
$
30,201

Accrued liabilities:
 
 
 
 
Inventory purchases
 
$
12,837

 
$
7,633

Sales tax collected
 
8,909

 
8,501

Accrued rent
 
5,093

 
5,688

Other
 
11,382

 
8,210

 
 
$
38,221

 
$
30,032

Non-current liabilities:
 
 
 
 
Deferred lease liability
 
$
17,921

 
$
16,785

Tenant inducements
 
19,259

 
13,637

 
 
$
37,180

 
$
30,422

NOTE 7. LEGAL PROCEEDINGS
On October 25, 2013, plaintiff Laborers’ District Council Industry Pension Fund filed a books-and-records action entitled Laborers’ District Council Construction Industry Pension Fund v. lululemon athletica inc., No. 9039 (Del. Ch.) under 7 Del. C. Sec. 220 based on a demand letter it sent to the Company on or around August 8, 2013 to request certain lululemon records relating to the March 2013 sheer luon issue, the Company's announcement that its CEO intends to resign, and certain stock trades executed by the Chairman of the Company’s board of directors prior to the Company's announcement regarding its CEO. The Company moved to dismiss the complaint on November 11, 2013, and the motion remains pending. The Company believes there is no merit to this action and the Company intends to continue to defend vigorously.
On August 12, 2103 and August 23, 2013, plaintiffs Thomas Canty and Tammy Federman filed shareholder derivative actions entitled Canty v. Day , et al., No. 13-CV-5629 (S.D.N.Y.) and Federman v. Day, et al., No. 13-CV-5977 (S.D.N.Y.).

10


Plaintiffs allege that they are acting on behalf of the Company and name as defendants current and former directors and certain officers of the Company. The complaint challenges certain public disclosures and conduct relating to the March 2013 sheer luon issue, the Company's announcement that its CEO intends to resign, and certain stock trades executed by certain defendants prior to the Company's announcement regarding its CEO. The plaintiffs have designated the Canty complaint as their operative complaint and allege violations of Section 14(a) of the Securities Exchange Act and for breach of fiduciary duty, unjust enrichment, abuse of control, and gross mismanagement. The Defendants believe there is no merit to this suit and the Defendants intend to defend vigorously.
On July 2, 2013, plaintiff Houssam Alkhoury filed a putative shareholder class action entitled Alkhoury v. lululemon athletica inc., et al., No. 13-CV-4596 (S.D.N.Y.) against lululemon, a certain director and a certain officer of the Company (collectively, “Defendants”). On September 3, 2013, plaintiff Houssam Alkhoury and putative plaintiff Louisiana Sheriffs' Pension & Relief Fund moved to be appointed as lead plaintiff in the lawsuit. On October 1, 2013, the Court appointed Louisiana Sheriffs' Pension & Relief Fund as Lead Plaintiff and on November 1, Lead Plaintiff filed a consolidated class action complaint on behalf of a proposed class of purchasers of lululemon stock between September 7, 2012 through June 11, 2013 (the “Complaint”). In its Complaint, Lead Plaintiff asserts causes of action under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 against Defendants based on certain public disclosures made by the Company relating to its product quality and the March 2013 sheer luon issue. The Company believes there is no merit to this suit and the Company intends to defend vigorously.
On May 3, 2013, plaintiff Hallandale Beach Police Officers and Firefighters Personnel Retirement Fund filed a books-and-records action entitled Hallandale Beach Police Officers and Firefighters' Personnel Retirement Fund v. lululemon athletica inc., No. 8522 (Del. Ch.). under 7 Del. C. Sec. 220 based on a demand letter it sent to the Company on April 17, 2013 to request certain lululemon records relating to the March 2013 sheer luon issue and recent revisions to the Company's executive bonus plan. The Company moved to dismiss the complaint on May 28, 2013. On June 14, 2013, plaintiff sent a supplemental demand letter that requested additional records from the Company relating to the Company's announcement that its CEO intends to resign, and certain stock trades executed by the Company's Chairman prior to the Company's announcement regarding its CEO. On July 1, 2013, plaintiff filed an amended complaint to incorporate allegations relating to the June 14, 2013 supplemental demand letter. The Company moved to dismiss the amended complaint on August 15, 2013, and in response to this filing, plaintiffs served the Company with a new demand letter and then filed a second amended complaint on November 4, 2013. The Company believes there is no merit to this action and the Company intends to continue to defend vigorously.


11


NOTE 8. SEGMENT REPORTING
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 corporate-owned stores, direct to consumer and other. Direct to consumer includes sales from the Company’s e-commerce websites. Sales to wholesale accounts, showrooms sales and outlet sales have been combined into other. The Company has reviewed the classification of its expenses amongst its reportable segments and has updated the classification of some of these expenses. Accordingly, all prior year comparable information has been reclassified to conform to the current year classification. Information for these segments is detailed in the table below:
 
 
 
Thirteen Weeks Ended 
 November 3, 2013
 
Thirteen Weeks Ended 
 October 28, 2012
 
Thirty-Nine Weeks Ended 
 November 3, 2013
 
Thirty-Nine Weeks Ended 
 October 28, 2012
Net revenue:
 
 
 
 
 
 
 
 
Corporate-owned stores
 
$
290,666

 
$
252,046

 
$
833,792

 
$
712,149

Direct to consumer
 
61,954

 
45,122

 
165,304

 
118,991

Other
 
27,280

 
19,369

 
71,099

 
53,729

 
 
$
379,900

 
$
316,537

 
$
1,070,195

 
$
884,869

Income from operations before general corporate expense:
 
 
 
 
 
 
 
 
Corporate-owned stores
 
$
89,676

 
$
84,438

 
$
244,915

 
$
242,045

Direct to consumer
 
27,980

 
19,167

 
68,999

 
51,644

Other
 
4,597

 
4,278

 
12,755

 
11,597

 
 
122,253

 
107,883

 
326,669

 
305,286

General corporate expense
 
29,917

 
27,272

 
89,458

 
81,422

Income from operations
 
92,336

 
80,611

 
237,211

 
223,864

Other income (expense), net
 
1,453

 
1,424

 
4,249

 
3,500

Income before provision for income taxes
 
$
93,789

 
$
82,035

 
$
241,460

 
$
227,364

Capital expenditures:
 
 
 
 
 
 
 
 
Corporate-owned stores
 
$
17,576

 
$
23,103

 
$
44,016

 
$
52,573

Direct to consumer
 
1,051

 
1,733

 
3,814

 
2,564

Corporate
 
9,305

 
8,159

 
24,115

 
16,904

 
 
$
27,932

 
$
32,995

 
$
71,945

 
$
72,041

Depreciation:
 

 

 
 
 
 
Corporate-owned stores
 
$
7,847

 
$
7,826

 
$
22,850

 
$
20,957

Direct to consumer
 
1,190

 
639

 
3,303

 
2,296

Corporate
 
3,879

 
3,036

 
10,570

 
7,709

 
 
$
12,916

 
$
11,501

 
$
36,723

 
$
30,962


12


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 Section 27A of the Securities Act of 1933 and the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, included or incorporated in this Form 10-Q are forward-looking statements, particularly statements which relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts, such as statements regarding our future financial condition or results of operations, our prospects and strategies for future growth, the development and introduction of new products, and the implementation of our marketing and branding strategies. In many cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “intends,” “predicts,” “potential” or the negative of these terms or other comparable terminology.
The forward-looking statements contained in this Form 10-Q and any documents incorporated herein by reference reflect our current views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause events or our actual activities or results to differ significantly from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, actions, levels of activity, performance or achievements. Readers are cautioned not to place undue reliance on these forward-looking statements. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements, including, but not limited to, those factors described in “Risk Factors” and elsewhere in this report.
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.
Our fiscal year ends on the Sunday closest to January 31 of the following year, typically resulting in a 52 week year, but occasionally giving rise to an additional week, resulting in a 53 week year. Fiscal 2013 is a 52 week year, and will end on February 2, 2014 while fiscal 2012 was a 53 week year, and ended on February 3, 2013 .
We will 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
Our results for the first three quarters of fiscal 2013 demonstrate our organization’s solid foundation. We remain committed to our brand and core values, which we believe drove year over year revenue growth across most of our selling channels. We believe our strong cash flow generation, solid balance sheet and healthy liquidity provide us with the financial flexibility to execute the initiatives which will continue to lead to quality growth.
In mid-March 2013, we determined that certain shipments of women’s black luon bottoms received from our factories and available in our stores from March 1, 2013, did not meet our specifications. As we became aware of this issue, we pulled what we believe to be all of the affected items from our stores, showrooms and e-commerce sites and began working with our supplier to replace the fabric and with our other manufacturers to replace these items as quickly as possible. The lost revenue in the remaining seven weeks of the first quarter of fiscal 2013 and in the second quarter of fiscal 2013, as well as additional costs incurred and the write down of affected product on hand from this issue have negatively impacted our results from operations in the first three quarters of fiscal 2013. During the first quarter of fiscal 2013 we recorded a $17.5 million inventory provision for the affected luon.
We believe the pull-back of black luon pants reiterates our quality standards. Our brand is recognized as premium in our offerings of women and men’s run and yoga assortment, as well as a leader in technical fabrics and functionality. Delivering quality to our customers is a critical factor in our market place differentiation and we believe removing items that do not meet our standards is key to maintaining our brand reputation. We have continued to invest in new and legacy information technology systems to develop new capabilities to support our vertical retail strategy.
Throughout the first three quarters of fiscal 2013 , we were able to grow our e-commerce business which has further increased our brand awareness and has made our product available in new markets, including those outside of North America. While the pull-back of black luon pants from our e-commerce sites negatively affected sales, net revenue from our direct to consumer channel increased 39% and represented 15.5% of total revenue in the first three quarters of fisca l 2013 compared to

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13.4% of total revenue in the same period of the prior year. Continuing increases in traffic on our e-commerce website lead us to believe that there is potential for our direct to consumer segment to become an increasingly substantial part of our business and we plan to continue to commit a significant portion of our resources to further developing this channel.
We increased our store base through execution of our real estate strategy, when and where we saw opportunities for success. For example, we have opened 46 net new corporate-owned stores in North America and Australia since the third quarter of fiscal 2012 . Where we find opportunities for growth through opening showrooms, or other community presence efforts, we expect to expand our store base and therefore our business. Our growth strategy relies on positive comparable store sales and expansion in North America, particularly in the United States. We also believe that international growth is an opportunity and are expanding our foothold in markets by establishing local community connections, distributing to strategic sales partners and opening showrooms where we believe our guests are shopping.
Operating Segment Overview
lululemon is a designer and retailer of technical athletic apparel operating primarily in North America and Australia. Our yoga-inspired apparel is marketed under the lululemon athletica and ivivva athletica brand names. We offer a comprehensive line of apparel and accessories including pants, shorts, tops and jackets designed for athletic pursuits such as yoga, running and general fitness, and dance-inspired apparel for female youth. As of November 3, 2013 , our branded apparel was principally sold through 247 corporate-owned stores that are located in the United States, Canada, Australia and New Zealand and via our e-commerce websites included in our direct to consumer sales channel. We believe our vertical retail strategy allows us to interact more directly with and gain insights from our customers while providing us with greater control of our brand. In the thirteen week period ended November 3, 2013 , 65% of our net revenue was derived from the sales of our products in the United States, 30% of our net revenue was derived from sales of our products in Canada, and 5% of our net revenue was derived from sales of our products outside of North America. In the thirteen week period ended October 28, 2012 , 60% of our net revenue was derived from the sales of our products in the United States, 35% of our net revenue was derived from sales of our products in Canada, and 5% of our net revenue was derived from sales of our products outside of North America.
Our net revenue increased from $1.0 billion in fiscal 2011 to $1.4 billion in fiscal 2012, representing an annual growth rate of 37%. Our net revenue also increased from $316.5 million in the third quarter of fiscal 2012 to $379.9 million in third quarter of fiscal 2013 , representing a 20% increase, and comparable store sales increased 2% . Our ability to open new stores and grow sales in existing stores has been driven by increasing demand for our technical athletic apparel and a growing recognition of the lululemon athletica brand. We believe our superior products, strategic store locations, inviting store environment and distinctive corporate culture are responsible for our strong financial performance.

We have three reportable segments: corporate-owned stores, direct to consumer and other. We report our segments based on the financial information we use in managing our businesses. While we receive financial information for each corporate-owned store, we have aggregated all of the corporate-owned stores into one reportable segment due to the similarities in the economic and other characteristics of these stores. Our direct to consumer segment accounted for 16.3% of our net revenue in third quarter of fiscal 2013 , compared to 14.3% in the third quarter of fiscal 2012 . Our other segment, consisting of sales to wholesale accounts, sales from company-operated showrooms, warehouse sales and outlets, accounted for less than 10% of our net revenue in the third quarters of fiscal 2013 and fiscal 2012 .

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Results of Operations
Thirteen Week Results
The following table summarizes key components of our results of operations for the thirteen weeks ended November 3, 2013 and October 28, 2012 . The operating results are expressed in dollar amounts as well as relevant percentages, presented as a percentage of net revenue.
 
 
Thirteen Weeks Ended November 3, 2013 and October 28, 2012
 
 
2013
 
2012
 
2013
 
2012
 
 
(In thousands)
 
(Percentages)
Net revenue
 
$
379,900

 
$
316,537

 
100.0
 
100.0
Cost of goods sold
 
175,294

 
141,237

 
46.1
 
44.6
Gross profit
 
204,606

 
175,300

 
53.9
 
55.4
Selling, general and administrative expenses
 
112,270

 
94,689

 
29.6
 
29.9
Income from operations
 
92,336

 
80,611

 
24.3
 
25.5
Other income (expense), net
 
1,453

 
1,424

 
0.4
 
0.4
Income before provision for income taxes
 
93,789

 
82,035

 
24.7
 
25.9
Provision for income taxes
 
27,678

 
24,655

 
7.3
 
7.8
Net income
 
66,111

 
57,380

 
17.4
 
18.1
Net income attributable to non-controlling interest
 

 
64

 
 
Net income attributable to lululemon athletica inc.
 
$
66,111

 
$
57,316

 
17.4
 
18.1
Net Revenue
Net revenue increased $63.4  million, or 20% , to $379.9 million for the third quarter of fiscal 2013 from $316.5  million for the third quarter of fiscal 2012 . Assuming the average exchange rates for the third quarter of fiscal 2013 remained constant with the average exchange rates for the third quarter of fiscal 2012 , our net revenue would have increased $70.9 million , or 22% .
The net revenue increase was driven by sales from new stores opened, the growth of our e-commerce website sales included in our direct to consumer segment, and increased sales at locations in our comparable stores base. We believe the constant dollar increase in comparable store sales was driven primarily by the strength of our existing product lines, successful introduction of new products and increasing recognition of the lululemon athletica brand name, especially at our U.S. stores.

Our net revenue on a segment basis for the thirteen weeks ended November 3, 2013 and October 28, 2012 is expressed in dollar amounts as well as relevant percentages, presented as a percentage of total net revenue below.
 
 
Thirteen Weeks Ended November 3, 2013 and October 28, 2012
 
 
2013
 
2012
 
2013
 
2012
 
 
(In thousands)
 
(Percentages)
Corporate-owned stores
 
$
290,666

 
$
252,046

 
76.5

 
79.6

Direct to consumer
 
61,954

 
45,122

 
16.3

 
14.3

Other
 
27,280

 
19,369

 
7.2

 
6.1

Net revenue
 
$
379,900

 
$
316,537

 
100.0

 
100.0

Corporate-Owned Stores.  Net revenue from our corporate-owned stores segment increased $38.6 million , or 15% , to $290.7 million in the third quarter of fiscal 2013 from $252.0 million in the third quarter of fiscal 2012 . The following contributed to the increase in net revenue from our corporate-owned stores segment:
Comparable store sales increase of 2% in the third quarter of fiscal 2013 resulted in a $5.3 million increase to net revenue, including the effect of foreign currency fluctuations. Excluding the effect of foreign currency fluctuations, comparable store sales would have increased 5% , or $10.6 million , in the third quarter of fiscal 2013 ; and

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Net revenue from corporate-owned stores we opened subsequent to October 28, 2012 , and therefore not included in the comparable store sales growth, contributed $33.3 million of the increase . Net new store openings since the third quarter of fiscal 2012 included 39 stores in the United States, three stores in Canada, three stores in Australia and one store in New Zealand.
Direct to Consumer.  Net revenue from our direct to consumer segment increased $16.8 million , or 37% , to $62.0 million in the third quarter of fiscal 2013 from $45.1 million in the third quarter of fiscal 2012 . The increase in net revenue was primarily the result of increasing traffic on our e-commerce websites.
Other.  Net revenue from our other segment increased $7.9 million , or 41% , to $27.3 million in the third quarter of fiscal 2013 from $19.4 million in the third quarter of fiscal 2012 . This increase was primarily the result of four new outlets opened since the third quarter of fiscal 2012 as well as increased net revenues from existing outlets. Increased revenue from our showrooms also contributed to the increase in net revenue from our other segment. We operate our other segment to increase interest in our product in markets we have not otherwise entered with corporate-owned stores.
Gross Profit
Gross profit increased $29.3 million , or 17% , to $204.6 million for the third quarter of fiscal 2013 from $175.3 million for the third quarter of fiscal 2012 . Increased net revenues were partially offset by increased cost of goods sold.
The increase in gross profit was also partially offset by increases in fixed costs, such as occupancy costs and depreciation, and increased costs related to our production, design, distribution and merchandising departments.
Gross profit as a percentage of net revenue, or gross margin, decreased by 150  basis points, to 53.9% in the third quarter of fiscal 2013 from 55.4% in the third quarter of fiscal 2012 . This was primarily a result of a decrease in product margin of 220 basis points due to an increase in product costs as well as increased air freight costs from higher usage.
The decrease in gross margin was partially offset by leverage on fixed costs, such as depreciation and occupancy costs, and a decrease in expenses related to our product and supply chain departments, relative to the increase in net revenue, which together contributed to an increase in gross margin of 70 basis points.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $17.6 million , or 19% , to $112.3 million in the third quarter of fiscal 2013 from $94.7 million in the third quarter of fiscal 2012 . The increase in selling, general and administrative expenses was principally comprised of:
an increase in employee costs of $6.1 million as we experienced natural growth in labor hours associated with new and existing corporate-owned stores, outlets, showrooms and other, as well as an increase in wages as we invested in our employees;
an increase in variable store costs of $2.0 million as a result of increased sales volume from new and existing corporate-owned stores, outlets, showrooms and other;
an increase in head office employee costs of $3.3 million from increased head count incurred in order to position us for long-term growth;
an increase in other head office costs of $2.9 million as a result of the overall growth of our business and investment in strategic initiatives and projects;
an increase in variable costs such as distribution costs, credit card fees and packaging related to our direct to consumer segment of $0.9 million as a result of increased sales volume;
an increase in administrative costs related to our direct to consumer segment of $1.0 million associated with the growth in this channel and increased head count to support it; and
an increase in other costs, including occupancy costs and depreciation not included in cost of goods sold, of $1.4 million as a result of the expansion of our business.
As a percentage of net revenue, selling, general and administrative expenses decreased 30 basis points, to 29.6% from 29.9% .

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Income from Operations
Income from operations increased $11.7 million , or 15% , to $92.3 million in the third quarter of fiscal 2013 from $80.6 million in the third quarter of fiscal 2012 . The increase was a result of increased gross profit of $29.3 million , partially offset by increased selling, general and administrative costs of $17.6 million . The increase in selling, general and administrative costs was driven principally by the overall growth of our business.
On a segment basis, we determine income from operations without taking into account our general corporate expenses. We have reviewed our classification of our expenses amongst our reportable segments and have updated the classification of some of these expenses. Accordingly, all prior year comparable information has been reclassified to conform to the current year classification.

Income from operations before general corporate expenses for the thirteen weeks ended November 3, 2013 and October 28, 2012 is expressed in dollar amounts as well as percentages, presented as a percentage of net revenue of the respective operating segments below.
 
 
Thirteen Weeks Ended November 3, 2013 and October 28, 2012
 
 
2013
 
2012
 
2013
 
2012
 
 
(In thousands)
 
(Percentages)
Corporate-owned stores
 
$
89,676

 
$
84,438

 
30.9
 
33.5
Direct to consumer
 
27,980

 
19,167

 
45.2
 
42.5
Other
 
4,597

 
4,278

 
16.9
 
22.1
Income from operations before general corporate expense
 
122,253

 
107,883

 
 
 
 
General corporate expense
 
29,917

 
27,272

 
 
 
 
Income from operations
 
$
92,336

 
$
80,611

 
 
 
 
Corporate-Owned Stores.  Income from operations from our corporate-owned stores segment increased $5.2 million , or 6% , to $89.7 million for the third quarter of fiscal 2013 from $84.4 million for the third quarter of fiscal 2012 primarily due to an increase in gross profit of $15.7 million from increased sales, partially offset by an increase in selling, general and administrative expenses related to employee costs as well as operating expenses associated with new stores and net revenue growth at existing stores. Income from operations as a percentage of corporate-owned stores revenue decreased by 260 basis points primarily from a decrease in gross margin due to an increase in product costs as well as increased freight costs from higher usage.
Direct to Consumer.  Income from operations from our direct to consumer segment increased $8.8 million , or 46% , to $28.0 million for the third quarter of fiscal 2013 from $19.2 million for the third quarter of fiscal 2012 . This increase was primarily the result of increased gross profit of $10.9 million primarily due to increased revenue resulting from increased traffic, offset by increased selling, general and administrative expenses related to our long-term strategy for developing this channel. Income from operations as a percentage of direct to consumer revenue increased by 270 basis points primarily due to increased revenue resulting from higher traffic.
Other.  Income from operations from our other segment increased $0.3 million , or 7% , to $4.6 million for the third quarter of fiscal 2013 from $4.3 million for the third quarter of fiscal 2012 . Gross profit related to our other segment increased $2.8 million in the third quarter of fiscal 2013 from the third quarter of fiscal 2012 . Income from operations as a percentage of other revenue decreased by 520 basis points primarily due to increased selling, general and administrative expenses.
General Corporate Expense.  General corporate expense increased $2.6 million , or 10% , to $29.9 million for the third quarter of fiscal 2013 from $27.3 million for the third quarter of fiscal 2012 . This was primarily due to increased head office employee costs, as well as other head office costs as a result of the overall growth of our business and investment in strategic initiatives and projects. The increase in general corporate expense was partially offset by a $1.8 million foreign exchange gain in our Canadian operating entity.
Other Income (Expense), Net
Other income (expense), net, remained flat compared to the third quarter of fiscal 2012, and was $1.5 million for the third quarter of fiscal 2013 .

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Provision for Income Taxes
Provision for income taxes increased $3.0 million , or 12% , to $27.7 million in the third quarter of fiscal 2013 from $24.7 million in the third quarter of fiscal 2012 . In the third quarter of fiscal 2013 , our effective tax rate was 29.5% compared to 30.1% in the third quarter of fiscal 2012 . The tax rate for the third quarter of fiscal 2013 reflects the ongoing impact of the revised intercompany pricing agreements.

Net Income
Net income increased $8.8 million to $66.1 million for the third quarter of fiscal 2013 from $57.3 million for the third quarter of fiscal 2012 . The increase in net income was a result of an increase in gross profit of $29.3 million , offset by an increase in selling, general and administrative expenses of $17.6 million and an increase in provision for income taxes of $3.0 million .
Thirty-Nine Week Results
The following table summarizes key components of our results of operations for the thirty-nine week periods ended November 3, 2013 and October 28, 2012 . The operating results are expressed in dollar amounts as well as relevant percentages, presented as a percentage of net revenue.
 
 
Thirty-Nine Week November 3, 2013 and October 28, 2012
 
 
2013
 
2012
 
2013
 
2012
 
 
(In thousands)
 
(Percentages)
Net revenue
 
$
1,070,195

 
$
884,869

 
100.0
 
100.0
Cost of goods sold
 
$
508,909

 
$
396,550

 
47.6
 
44.8
Gross profit
 
$
561,286

 
$
488,319

 
52.4
 
55.2
Selling, general and administrative expenses
 
$
324,075

 
$
264,455

 
30.2
 
29.9
Income from operations
 
$
237,211

 
$
223,864

 
22.2
 
25.3
Other income (expense), net
 
$
4,249

 
$
3,500

 
0.4
 
0.4
Income before provision for income taxes
 
$
241,460

 
$
227,364

 
22.6
 
25.7
Provision for income taxes
 
$
71,605

 
$
65,308

 
6.7
 
7.4
Net income
 
$
169,855

 
$
162,056

 
15.9
 
18.3
Net income attributable to non-controlling interest
 

 
875

 
 
0.1
Net income attributable to lululemon athletica inc.
 
$
169,855

 
$
161,181

 
15.9
 
18.2
Net Revenue
Net revenue increased $185.3 million , or 21% , to $1,070.2 million for the first three quarters of fiscal 2013 from $884.9 million for the first three quarters of fiscal 2012 . Assuming the average exchange rates for the first three quarters of fiscal 2013 remained constant with average exchange rates for the first three quarters of fiscal 2012 , our net revenue would have increased $198.0 million , or 22% , for the first three quarters of fiscal 2013 .
The net revenue increase was driven by increased sales at locations in our comparable stores base, sales from new stores opened and the growth of our e-commerce website sales included in our direct to consumer segment. We believe the constant dollar increase in comparable store sales was driven primarily by the strength of our existing product lines, our successful introduction of new products and increasing recognition of the lululemon athletica brand name, especially at our U.S. stores.
 Our net revenue on a segment basis for the thirty-nine week periods ended November 3, 2013 and October 28, 2012 is expressed in dollar amounts as well as relevant percentages, presented as a percentage of total net revenue below.
 
 
Thirty-Nine Week November 3, 2013 and October 28, 2012
 
 
2013
 
2012
 
2013
 
2012
 
 
(In thousands)
 
(Percentages)
Corporate-owned stores
 
$
833,792

 
$
712,149

 
77.9
 
80.5
Direct to consumer
 
165,304

 
118,991

 
15.5
 
13.4
Other
 
71,099

 
53,729

 
6.6
 
6.1
Net revenue
 
$
1,070,195

 
$
884,869

 
100.0
 
100.0

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Corporate-Owned Stores.  Net revenue from our corporate-owned stores segment increased $121.6 million , or 17% , to $833.8 million in the first three quarters of fiscal 2013 from $712.1 million in the first three quarters of fiscal 2012 . The following contributed to the increase in net revenue from our corporate-owned stores segment:
Comparable store sales increase of 5% in the first three quarters of fiscal 2013 resulted in a $35.1 million increase to net revenue, including the effect of foreign currency fluctuations. Excluding the effect of foreign currency fluctuations, comparable store sales increased 7% , or $44.2 million , in the first three quarters of fiscal 2013 ; and
Net revenue from corporate-owned stores we opened subsequent to October 28, 2012 , and therefore not included in the comparable store sales growth, contributed $86.5 million of the increase. Net new store openings since the third quarter of fiscal 2012 included 39 stores in the United States, three stores in Canada, three stores in Australia and one store in New Zealand.
Direct to consumer.  Net revenue from our direct to consumer segment increased $46.3 million , or 39% , to $165.3 million in the first three quarters of fiscal 2013 from $119.0 million in the first three quarters of fiscal 2012 . The increase in net revenue was primarily the result of increasing traffic on our e-commerce websites.
Other.  Net revenue from our other segment increased $17.4 million , or 32% , to $71.1 million in the first three quarters of fiscal 2013 from $53.7 million in the first three quarters of fiscal 2012 . This increase was primarily the result of four new outlets opened since the third quarter of fiscal 2012 as well as increased net revenues from existing outlets. Increased revenue from our showrooms also contributed to the increase in net revenue from our other segment. We operate our other segment to increase interest in our product in markets we have not otherwise entered with corporate-owned stores.
Gross Profit
Gross profit increased $73.0 million , or 15% , to $561.3 million for the first three quarters of fiscal 2013 from $488.3 million for the first three quarters of fiscal 2012 . Increased net revenues in our operating segments resulted in an increased gross profit. A $17.5 million inventory provision related to the pull-back of black luon pants was recorded in cost of sales during the first three quarters of fiscal 2013.
The increase in gross profit was partially offset by increases in fixed costs, such as occupancy costs and depreciation, as well as increased costs related to our production, design, distribution and merchandising departments.
Gross profit as a percentage of net revenue, or gross margin, decreased by 280  basis points, to 52.4% in the first three quarters of fiscal 2013 from 55.2% in the first three quarters of fiscal 2012 . The decrease in gross margin resulted primarily from:
a decrease in product margin of 170 basis points due to a lower sales mix of higher margin core items related to the pull-back of black luon pants, along with higher markdowns and an increase in provision for inventories charged to cost of sales; and
a non-recurring charge of 160 basis points related to the pull-back of black luon pants in the first quarter of fiscal 2013.
The decrease in gross margin was partially offset by a decrease in expenses related to our product and supply chain departments, relative to the increase in net revenue, and by leverage on fixed costs, such as depreciation and occupancy costs, which together contributed to an increase in gross margin of 50 basis points.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $59.6 million , or 23% , to $324.1 million in the first three quarters of fiscal 2013 from $264.4 million in the first three quarters of fiscal 2012 . The increase in selling, general and administrative expenses was principally comprised of:
an increase in employee costs of $21.1 million as we experienced natural growth in labor hours associated with new and existing corporate-owned stores, showrooms, outlets and other, as well as an increase in wages as we invest in our employees;
an increase in variable store costs of $6.0 million as a result of increased sales volume from new and existing corporate-owned stores, outlets and other;
an increase in head office employee costs, including stock-based compensation expense and management incentive-based compensation, of $10.5 million incurred in order to position us for long-term growth;

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an increase in other head office costs of $11.3 million as a result of the overall growth of our business and investment in strategic initiatives and projects;
an increase in administrative expenses related to our direct to consumer segment of $4.9 million associated with the growth in this channel;
an increase in variable costs such as distribution costs, credit card fees and packaging related to our direct to consumer segment of $3.7 million as a result of increased sales volume; and
an increase of $2.1 million in other costs, including occupancy costs and depreciation not included in cost of goods sold, as a result of the expansion of our business, which was partially offset by a $6.2 million foreign exchange gain in our Canadian operating entity.
As a percentage of net revenue, selling, general and administrative expenses increased 30  basis points, to 30.2% in the third quarter of fiscal 2013 from 29.9% in the third quarter of fiscal 2012 .
Income from Operations
Income from operations increased $13.3 million , or 6% , to $237.2 million in the first three quarters of fiscal 2013 from $223.9 million  in the first three quarters of fiscal 2012 . The increase was a result of increased gross profit of $73.0 million , partially offset by increased selling, general and administrative costs of $59.6 million . The increase in selling, general and administrative costs was primarily driven by the increase in our business, as seen in our net revenue increases.
 
On a segment basis, we determine income from operations without taking into account our general corporate expenses. We have reviewed our general corporate expenses and determined some costs previously classified as general corporate are direct segment expenses. Accordingly, all prior year comparable information has been reclassified to conform to the current year classification.
Income from operations before general corporate expenses for the thirty-nine week periods ended November 3, 2013 and October 28, 2012 is expressed in dollar amounts as well as percentages, presented as a percentage of net revenue of the respective operating segments below.
 
 
Thirty-Nine Week November 3, 2013 and October 28, 2012
 
 
2013
 
2012
 
2013
 
2012
 
 
(In thousands)
 
(Percentages)
Corporate-owned stores
 
$
244,915

 
$
242,045

 
29.4
 
34.0
Direct to consumer
 
68,999

 
51,644

 
41.7
 
43.4
Other
 
12,755

 
11,597

 
17.9
 
21.6
Income from operations before general corporate expense
 
326,669

 
305,286

 
 
 
 
General corporate expense
 
89,458

 
81,422

 
 
 
 
Income from operations
 
$
237,211

 
$
223,864

 
 
 
 
Corporate-Owned Stores.  Net income from our corporate-owned stores segment increased $2.9 million to $244.9 million for the first three quarters of fiscal 2013 from $242.0 million for the first three quarters of fiscal 2012 primarily due to an increase of $39.0 million in gross profit, which was offset by an increase in selling, general and administrative expenses related to employee costs as well as operating expenses associated with new stores and net revenue growth at existing stores. Income from operations as a percentage of corporate-owned stores revenue decreased by 460 basis points primarily from a decrease in gross margin due to a lower mix of higher margin core items related to the pull-back of black luon pants.
Direct to consumer.  Net income from our direct to consumer segment increase d $17.4 million , or 34% , to $69.0 million for the first three quarters of fiscal 2013 from $51.6 million for the first three quarters of fiscal 2012 . The increase was primarily the result of increase d gross profit of $26.6 million , offset by increased selling, general and administrative expenses related to our long-term strategy for developing this channel. Income from operations as a percentage of direct to consumer revenue decreased by 170 basis points primarily due to increased employee costs and other selling, general and administrative expenses as a percentage of revenue.
Other.  Net income from our other segment increase d $1.2 million , or 10% , to $12.8 million for the first three quarters of fiscal 2013 from $11.6 million for the first three quarters of fiscal 2012 . This increase was the result of increase d gross profit of $7.7 million , partially offset by increased selling, general and administrative expenses. Income from operations as a percentage of other revenue decreased by 370 basis points primarily due to increase selling, general and administrative expenses.

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General Corporate Expense.  General corporate expense increased $8.0 million , or 10% , to $89.5 million for the first three quarters of fiscal 2013 from $81.4 million for the first three quarters of fiscal 2012 . This was primarily due to increased head office employee costs, as well as other head office costs as a result of the overall growth of our business and investment in strategic initiatives and projects. The increase in general corporate expense was partially offset by a $6.2 million foreign exchange gain in our Canadian operating entity.
Other Income (Expense), Net
Other income (expense), net increased $0.7 million , or 21% , to $4.2 million in the first three quarters of fiscal 2013 from $3.5 million in the first three quarters of fiscal 2012 .
  Provision for Income Taxes
Provision for income taxes increased $6.3 million , or 10% , to $71.6 million in the first three quarters of fiscal 2013 from $65.3 million in the first three quarters of fiscal 2012 . The effective tax rate for the first three quarters of fiscal 2013 was 29.7% compared to 28.7% in the first three quarters of fiscal 2012 . The tax rate for the first three quarters of fiscal 2013 reflects the ongoing impact of the revised intercompany pricing agreements.
Net Income
Net income increased $8.7 million to $169.9 million for the first three quarters of fiscal 2013 from $161.2 million for the first three quarters of fiscal 2012 . The increase in net income was a result of an increase in gross profit of $73.0 million and an increase in other income (expense), net of $0.7 million , offset by a increase in selling, general and administrative expenses of $59.6 million and an increase in provision for income taxes of $6.3 million .
Seasonality
Historically, we have recognized a significant portion of our income from operations in the fourth fiscal quarter of each year as a result of increased sales during the holiday selling season. Despite the fact that we have experienced a significant amount of our net revenue and gross profit in the fourth quarter of each fiscal year, we believe that the true extent of the seasonality or cyclical nature of our business may have been overshadowed by our rapid growth to date.
Liquidity and Capital Resources
Our primary sources of liquidity are our current balances of cash and cash equivalents, cash flows from operations and borrowings available under our revolving credit facility. Our cash needs are primarily capital expenditures for opening new stores and remodeling existing stores, international expansion, making information technology system investments and enhancements, real estate acquisitions and funding working capital requirements. Cash and cash equivalents in excess of our needs are held in interest bearing accounts with financial institutions.
At November 3, 2013 , our working capital (excluding cash and cash equivalents) was $185.2 million and our cash and cash equivalents were $600.7  million.
The following table summarizes our net cash flows provided by and used in operating, investing and financing activities for the periods indicated:
 
 
Thirty-Nine Weeks Ended 
 November 3, 2013
 
Thirty-Nine Weeks Ended 
 October 28, 2012
 
 
(In thousands)
Total cash provided by (used in):
 
 
 
 
Operating activities
 
$
94,806

 
$
113,240

Investing activities
 
(71,945
)
 
(72,041
)
Financing activities
 
8,654

 
(11,863
)
Effect of exchange rate changes on cash
 
(20,949
)
 
650

Increase in cash and cash equivalents
 
$
10,566

 
$
29,986


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Operating Activities
Operating Activities consist primarily of net income adjusted for certain non-cash items, including provision for inventories, depreciation and amortization, stock-based compensation expense and the effect of the changes in non-cash working capital items, principally accounts payable, inventories, prepaid expenses, income taxes payable, and accrued compensation and related expenses.
Cash provided by operating activities decreased $18.4 million , to $94.8 million for the first three quarters of fiscal 2013 compared to $113.2 million for the first three quarters of fiscal 2012 . The decrease was primarily a result of increased income taxes paid during the first three quarters of fiscal 2013 compared to the first three quarters of fiscal 2012 , offset by increased net income after certain non-cash items, including provision for inventories.

Investing Activities
Investing Activities relate entirely to capital expenditures. Cash used in investing activities decreased $0.1 million to $71.9 million for the first three quarters of fiscal 2013 from $72.0 million  for the first three quarters of fiscal 2012 .
Financing Activities
Financing Activities consists of cash received on the exercise of stock options, excess tax benefits from stock-based compensation, taxes paid related to the net share settlement of equity awards, and cash paid to acquire non-controlling interest. Cash provided by financing activities increased by $20.5 million to $8.7 million for the first three quarters of fiscal 2013 from cash used in financing activities of $11.9 million for the first three quarters of fiscal 2012 . The cash used in financing activities for the first three quarters of fiscal 2012 included $26.0 million for the purchase of the non-controlling interest in lululemon australia.
We believe that our cash from operations and borrowings available to us under our revolving credit facility will be adequate to meet our liquidity needs and capital expenditure requirements for at least the next 24 months. Our cash from operations may be negatively impacted by a decrease in demand for our products as well as the other factors described in “Risk Factors” and elsewhere in this report. In addition, we may make discretionary capital improvements with respect to our stores, distribution facility, headquarters, or other systems, which we would expect to fund through the 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 from operations.
Revolving Credit Facility
In April 2007, we executed a credit facility with the Royal Bank of Canada that provided for a CDN$20.0 million uncommitted demand revolving credit facility to fund our working capital requirements. Borrowings under this uncommitted credit facility are made on a when-and-as-needed basis at our discretion.
Borrowings under the credit facility can be made either as i)  Revolving Loans — Revolving loan borrowings will bear interest at a rate equal to the bank’s CDN$ or US$ annual base rate (defined as zero% plus the lender’s annual prime rate) per annum, ii)  Offshore Loans — Offshore rate loan borrowings will bear interest at a rate equal to a base rate based upon LIBOR for the applicable interest period, plus 1.125% per annum, iii)  Bankers Acceptances — Bankers acceptance borrowings will bear interest at the bankers' acceptance rate plus 1.125% per annum, or iv)  Letters of Credit and Letters of Guarantee — Borrowings drawn down under letters of credit or guarantee issued by the banks will bear a 1.125% per annum fee.
At November 3, 2013 , aside from letters of credit and guarantees, there were no borrowings outstanding under this credit facility.
Off-Balance Sheet Arrangements
We enter into documentary letters of credit to facilitate the international purchase of merchandise. We also enter into standby letters of credit to secure certain of our obligations, including insurance programs and duties related to import purchases. As of November 3, 2013 , letters of credit and letters of guarantee totaling $1.0 million have been issued.
Other than these standby letters of credit and guarantee, we do not have any off-balance sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt. In addition, we have not entered into any derivative contracts or synthetic leases.


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Critical Accounting Policies
The preparation of financial statements in conformity with GAAP 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 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 Annual Report on Form 10-K for our 2012 fiscal year end filed with the SEC on March 21, 2013 and in Note 2 included in Item 1 of Part I of this Quarterly Report on Form 10-Q.

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Operating Locations
Our corporate-owned stores by U.S. state, Canadian province, Australian state and in New Zealand as of November 3, 2013 and February 3, 2013 , are summarized in the table below. While most of our stores are branded lululemon athletica, 11 of our corporate-owned stores are branded ivivva athletica and specialize in dance-inspired apparel for female youth.
 
 
November 3, 2013
 
February 3, 2013
United States
 
 
 
 
Alabama
 
1

 
1

Arizona
 
5

 
3

Arkansas
 
1

 

California
 
28

 
24

Colorado
 
3

 
3

Connecticut
 
3

 
3

District of Columbia
 
2

 
2

Florida
 
8

 
8

Georgia
 
3

 
3

Hawaii
 
1

 
1

Illinois
 
10

 
9

Indiana
 
1

 
1

Kansas
 
1

 
1

Louisiana
 
1

 
1

Maryland
 
4

 
3

Massachusetts
 
8

 
6

Michigan
 
3

 
2

Minnesota
 
4

 
3

Missouri
 
3

 
2

Nebraska
 
1

 
1

Nevada
 
1

 
1

New Jersey
 
7

 
6

New Mexico
 
1

 
1

New York
 
14

 
9

North Carolina
 
5

 
4

Ohio
 
5

 
5

Oklahoma
 
1

 

Oregon
 
2

 
2

Pennsylvania
 
6

 
6

Rhode Island
 
1

 

South Carolina
 
1

 
1

Tennessee
 
3

 
3

Texas
 
14

 
10

Utah
 
2

 
1

Vermont
 
1

 
1

Virginia
 
3

 
3

Washington
 
6

 
3

Wisconsin
 
2

 
2

Total United States
 
166

 
135

Canada
 
 
 
 
Alberta
 
12

 
12

British Columbia
 
11

 
12

Manitoba
 
2

 
2

Nova Scotia
 
1

 
1

Ontario
 
20

 
18

Quebec
 
5

 
4

Saskatchewan
 
2

 
2

Total Canada
 
53

 
51

Australia
 
 
 
 
Australian Capital Territory
 
1

 
1

New South Wales
 
7

 
7

Queensland
 
3

 
3

South Australia
 
1

 
1

Tasmania
 
1

 
1

Victoria
 
8

 
7

Western Australia
 
4

 
3

Total Australia
 
25

 
23

New Zealand
 
3

 
2

Total
 
247

 
211



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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign currency exchange rates. We do not hold or issue financial instruments for trading purposes.
Foreign Currency Exchange Risk.  We currently generate a significant portion of our net revenue in Canada. The reporting currency for our consolidated financial statements is the U.S. dollar. Historically, our operations were based largely in Canada. As of November 3, 2013 , we operated 53 stores in Canada. As a result, we have been impacted by changes in exchange rates and may be impacted materially for the foreseeable future. As we recognize net revenue from sales in Canada in Canadian dollars, and the U.S. dollar has strengthened during the first three quarters of fiscal 2013, it has had a negative impact on our Canadian operating results upon translation of those results into U.S. dollars for the purposes of consolidation. However, the loss in net revenue was offset by lower cost of sales and lower selling, general and administrative expenses that are generated in Canadian doll ars. A 10% depreciation in the relative value of the Canadian dollar compared to the U.S. dollar would have resulted in lost income from operations of approximately $3.8 million in the first three quarters of fiscal 2013. To the extent the ratio between our net revenue generated in Canadian dollars increases as compared to our expenses generated in Canadian dollars, we expect that our results of operations will be further impacted by changes in exchange rates. A portion of our net revenue is generated in Australia. A 10% depreciation in the relative value of the Australian dollar compared to the U.S. dollar would have resulted in additional income from operations of less than $0.1 million in the first three quarters of fiscal 2013. We do not currently hedge foreign currency fluctuations. However, in the future, in an effort to mitigate losses associated with these risks, we may at times enter into derivative finan cial instruments, although we have not historically done so. We have not, and do not intend to, engage in the practice of trading derivative securities for profit.
Interest Rate Risk.  In April 2007, we entered into an uncommitted senior secured demand revolving credit facility with Royal Bank of Canada. The revolving credit facility provides us with available borrowings in an amount up to CDN$20.0 million. Because our revolving credit facility bears 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 November 3, 2013 , we had no outstanding borrowings under our revolving facility and we do not believe we are significantly exposed to changes in interest rate risk. We currently do not engage in any interest rate hedging activity and currently have no intention to do so in the foreseeable future. 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 sales contracts, option contracts, and interest rate swaps. We have not, and do not intend to, engage in the practice of trading derivative securities for profit.
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 Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial 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 Chief Executive Officer and Chief Financial 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 November 3, 2013 . Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, at November 3, 2013 , our disclosure controls and procedures were effective.
There was no change in internal control over financial reporting during the thirteen weeks ended November 3, 2013 that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

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PART II
OTHER INFORMATION
ITEM 1.  LEGAL PROCEEDINGS
On October 25, 2013, plaintiff Laborers’ District Council Industry Pension Fund filed a books-and-records action entitled Laborers’ District Council Construction Industry Pension Fund v. lululemon athletica inc., No. 9039 (Del. Ch.) under 7 Del. C. Sec. 220 based on a demand letter it sent to the Company on or around August 8, 2013 to request certain lululemon records relating to the March 2013 sheer luon issue, the Company's announcement that its CEO intends to resign, and certain stock trades executed by the Chairman of our board of directors prior to the Company's announcement regarding its CEO. The Company moved to dismiss the complaint on November 11, 2013, and the motion remains pending. The Company believes there is no merit to this action and the Company intends to continue to defend vigorously.
On August 12, 2103 and August 23, 2013, plaintiffs Thomas Canty and Tammy Federman filed shareholder derivative actions entitled Canty v. Day , et al., No. 13-CV-5629 (S.D.N.Y.) and Federman v. Day, et al., No. 13-CV-5977 (S.D.N.Y.). Plaintiffs allege that they are acting on behalf of the Company and name as defendants current and former directors and certain officers of the Company. The complaint challenges certain public disclosures and conduct relating to the March 2013 sheer luon issue, the Company's announcement that its CEO intends to resign, and certain stock trades executed by certain defendants prior to the Company's announcement regarding its CEO. The plaintiffs have designated the Canty complaint as their operative complaint and allege violations of Section 14(a) of the Securities Exchange Act and for breach of fiduciary duty, unjust enrichment, abuse of control, and gross mismanagement. The Defendants believe there is no merit to this suit and the Defendants intend to defend vigorously.
On July 2, 2013, plaintiff Houssam Alkhoury filed a putative shareholder class action entitled Alkhoury v. lululemon athletica inc., et al., No. 13-CV-4596 (S.D.N.Y.) against lululemon, a certain director and a certain officer of the Company (collectively, “Defendants”). On September 3, 2013, plaintiff Houssam Alkhoury and putative plaintiff Louisiana Sheriffs' Pension & Relief Fund moved to be appointed as lead plaintiff in the lawsuit. On October 1, 2013, the Court appointed Louisiana Sheriffs' Pension & Relief Fund as Lead Plaintiff and on November 1, Lead Plaintiff filed a consolidated class action complaint on behalf of a proposed class of purchasers of lululemon stock between September 7, 2012 through June 11, 2013 (the “Complaint”). In its Complaint, Lead Plaintiff asserts causes of action under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 against Defendants based on certain public disclosures made by the Company relating to its product quality and the March 2013 sheer luon issue. The Company believes there is no merit to this suit and the Company intends to defend vigorously.
On May 3, 2013, plaintiff Hallandale Beach Police Officers and Firefighters Personnel Retirement Fund filed a books-and-records action entitled Hallandale Beach Police Officers and Firefighters' Personnel Retirement Fund v. lululemon athletica inc., No. 8522 (Del. Ch.)., under 7 Del. C. Sec. 220 based on a demand letter it sent to us on April 17, 2013 to request certain lululemon records relating to the March 2013 sheer luon issue and recent revisions to our executive bonus plan. We moved to dismiss the complaint on May 28, 2013. On June 14, 2013, plaintiff sent a supplemental demand letter that requested additional records from us relating to our announcement that Ms. Day intends to resign as our Chief Executive Officer, and certain stock trades executed by our Chairman prior to our announcement regarding Ms. Day. On July 1, 2013, plaintiff filed an amended complaint to incorporate allegations relating to the June 14, 2013 supplemental demand letter. We moved to dismiss the amended complaint on August 15, 2013, and, in response to this filing, plaintiffs served the Company with a new demand letter and then filed a second amended complaint on November 4, 2013. We believe there is no merit to this action and we intend to continue to defend vigorously.
We are, from time to time, involved in routine legal matters incidental to our business. Management believes 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 2012 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 athletica brand. The lululemon athletica 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

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provide a consistent, high quality 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 could be adversely affected if we fail to achieve these objectives or if our public image or reputation were to be tarnished by negative publicity. Negative publicity regarding the production methods of any of our suppliers or manufacturers could adversely affect our reputation and sales and force us to locate alternative suppliers or manufacturing sources. 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, which could have a material adverse effect on our financial condition.
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 continue to 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 continue to receive, products that either meet our technical specifications but that are nonetheless unacceptable to us, or products that are otherwise unacceptable to us or our customers. 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 are not discovered until after such products are purchased by our guests, our guests could lose confidence in the technical attributes of our products and our results of operations could suffer and our business could be harmed.
Our reliance on third-party 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 third-party 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. For example, luon fabric, which is included in many of our products, is supplied to the garment factories we use by a limited number of manufacturers, and the components used in manufacturing luon fabric may each be supplied to our manufacturers by single companies. In fiscal 2012 , approximately 60% of our products were produced by our top five manufacturing suppliers, and 45% of raw materials were produced by a single manufacturer. We have no long term contracts with our suppliers or manufacturing sources, and we compete with other companies for fabrics, raw materials, production and import quota capacity.
We have experienced, and may in the future continue to 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. 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 customer demand for our products and our results in lower net revenue and income from operations both in the short and long term.
An economic downturn or economic uncertainty in our key markets may adversely affect consumer discretionary spending and demand for our products.
Many of our products may be considered discretionary items for consumers. Factors affecting the level of consumer spending for such discretionary items include general economic conditions, particularly those in North America and other factors such as consumer confidence in future economic conditions, fears of recession, the availability of consumer credit, levels of unemployment, tax rates and the cost of consumer credit. As global economic conditions continue to be volatile or economic uncertainty remains, trends in consumer discretionary spending also remain unpredictable and subject to reductions due to credit constraints and uncertainties about the future. The current volatility in the United States economy in particular has resulted in an overall slowing in growth in the retail sector because of decreased consumer spending, which may remain depressed for the foreseeable future. These unfavorable economic conditions may lead consumers to delay or reduce purchase of our products. Consumer demand for our products may not reach our sales targets, or may decline, when there is an economic downturn or economic uncertainty in our key markets, particularly in North America. Our sensitivity to economic cycles and any related fluctuation in consumer demand may have a material adverse effect on our financial condition.

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Our sales and profitability may decline as a result of increasing product costs and decreasing selling prices.
Our business is subject to significant pressure on pricing and costs caused by many factors, including intense competition, constrained sourcing capacity and related inflationary pressure, pressure from consumers to reduce the prices we charge for our products and changes in consumer demand. These factors may cause us to experience increased costs, reduce our sales prices to consumers or experience reduced sales in response to increased prices, any of which could cause our operating margin to decline if we are unable to offset these factors with reductions in operating costs and could have a material adverse effect on our financial conditions, operating results and cash flows.
If we are unable to anticipate consumer preferences and successfully develop and introduce new, innovative and updated products, we may not be able to maintain or increase our sales and profitability.
Our success depends on our ability to identify and originate product trends as well as to anticipate and react to changing consumer demands in a timely manner. All of our products are subject to changing consumer preferences that cannot be predicted with certainty. If we are unable to introduce new products or novel technologies in a timely manner or our new products or technologies are not accepted by our customers, our competitors may introduce similar products in a more timely fashion, which could hurt our goal to be viewed as a leader in technical athletic apparel innovation. Our new products may not receive consumer acceptance as consumer preferences could shift rapidly to different types of athletic apparel or away from these types of products altogether, and our future success depends in part on our ability to anticipate and respond to these changes. Failure to anticipate and respond in a timely manner to changing consumer preferences could lead to, among other things, lower sales and excess inventory levels. Even if we are successful in anticipating consumer preferences, our ability to adequately react to and address those preferences will in part depend upon our continued ability to develop and introduce innovative, high-quality products. Our failure to effectively introduce new products that are accepted by consumers could result in a decrease in net revenue and excess inventory levels, which could have a material adverse effect on our financial condition.
Our results of operations could be materially harmed if we are unable to accurately forecast customer demand for our products.
To ensure adequate inventory supply, we must forecast inventory needs and place orders with our manufacturers based on our estimates of future demand for particular products. Our ability to accurately forecast demand for our products could be affected by many factors, including an increase or decrease in customer demand for our products or for products of our competitors, our failure to accurately forecast customer acceptance of new products, product introductions by competitors, unanticipated changes in general market conditions, and weakening of economic conditions or consumer confidence in future economic conditions. If we fail to accurately forecast customer demand we may experience excess inventory levels or a shortage of products available for sale in our stores or for delivery to customers.
Inventory levels in excess of customer demand may result in inventory write-downs or write-offs and the sale of excess inventory at discounted prices, which would cause our gross margin to suffer and could impair the strength and exclusivity of our brand. Conversely, if we underestimate customer demand for our products, our manufacturers may not be able to deliver products to meet our requirements, and this could result in damage to our reputation and customer relationships.
Any material disruption of our information systems could disrupt our business and reduce our sales.
We are increasingly dependent on information systems to operate our e-commerce websites, process transactions, respond to guest inquiries, manage inventory, purchase, sell and ship goods on a timely basis and maintain cost-efficient operations. Any material disruption or slowdown of our systems, including a disruption or slowdown caused by our failure to successfully upgrade our systems, system failures, viruses, computer “hackers” or other causes, could cause information, including data related to customer orders, to be lost or delayed which could—especially if the disruption or slowdown occurred during the holiday season—result in delays in the delivery of products to our stores and customers or lost sales, which could reduce demand for our products and cause our sales to decline. If changes in technology cause our information systems to become obsolete, or if our information systems are inadequate to handle our growth, we could lose customers.
If we continue to grow at a rapid pace, we may not be able to effectively manage our growth and the increased complexity of our business and as a result our brand image and financial performance may suffer.
We have expanded our operations rapidly since our inception in 1998 and our net revenue has increased from $40.7 million in fiscal 2004 to $1,370.4 million in fiscal 2012. If our operations continue to grow at a rapid pace, we may experience difficulties in obtaining sufficient raw materials and manufacturing capacity to produce our products, as well as delays in production and shipments, as our products are subject to risks associated with overseas sourcing and manufacturing. We could be required to continue to expand our sales and marketing, product development and distribution functions, to

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upgrade our management information systems and other processes and technology, and to obtain more space for our expanding workforce. This expansion could increase the strain on our resources, and we could experience serious operating difficulties, including difficulties in hiring, training and managing an increasing number of employees. These difficulties could result in the erosion of our brand image which could have a material adverse effect on our financial condition.
The fluctuating cost of raw materials could increase our cost of goods sold and cause our results of operations and financial condition to suffer.
The fabrics used by our suppliers and manufacturers include synthetic fabrics whose raw materials include petroleum-based products. Our products also include natural fibers, including cotton. Our costs for raw materials are affected by, among other things, weather, consumer demand, speculation on the commodities market, the relative valuations and fluctuations of the currencies of producer versus consumer countries and other factors that are generally unpredictable and beyond our control. Increases in the cost of raw materials, including petroleum or the prices we pay for our cotton yarn and cotton-based textiles, could have a material adverse effect on our cost of goods sold, results of operations, financial condition and cash flows.
Our limited operating experience and limited brand recognition in new international markets may limit our expansion strategy and cause our business and growth to suffer.
Our future growth depends in part on our international expansion efforts. We have limited experience with regulatory environments and market practices internationally, and we may not be able to penetrate or successfully operate in any new market. In connection with our expansion efforts we may encounter obstacles we did not face in North America, including cultural and linguistic differences, differences in regulatory environments, labor practices and market practices, difficulties in keeping abreast of market, business and technical developments and foreign guests’ tastes and preferences. We may also encounter difficulty expanding into new international markets because of limited brand recognition leading to delayed acceptance of our technical athletic apparel by guests in these new international markets. Our failure to develop new international markets or disappointing growth outside of existing markets will harm our business and results of operations.
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 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, such as Nike, Inc., adidas AG, which includes the adidas and Reebok brands, and The Gap, Inc, which includes the Athleta brand. Because of the fragmented nature of the industry, we also compete with other apparel sellers, including those specializing in yoga apparel. 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. In addition, our technical athletic apparel is sold at a price premium to traditional athletic apparel.
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” 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, as opposed to distribution through retail stores, wholesale or internet, and many of our competitors have substantial resources to devote toward increasing sales in such ways.
In addition, because we own no patents or 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.

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If we encounter problems with our distribution system, our ability to deliver our products to the market and to meet guest expectations could be harmed.
We rely on our distribution facilities for substantially all of our product distribution. Our distribution facilities include computer controlled and automated equipment, which means their operations are complicated and may be subject to a number of risks related to security or computer viruses, the proper operation of software and hardware, electronic or power interruptions or other system failures. In addition, because substantially all of our products are distributed from three locations, our operations could also be interrupted by labor difficulties, extreme or severe weather conditions or by floods, fires or other natural disasters near our distribution centers. For example, severe weather conditions in Sumner, Washington in 2011, including snow and freezing rain, resulted in disruption in our distribution facilities and the local transportation system. If we encounter problems with our distribution system, our ability to meet guest expectations, manage inventory, complete sales and achieve objectives for operating efficiencies could be harmed.
Our fabrics and manufacturing technology are not patented and can be imitated by our competitors.
The intellectual property rights in the technology, fabrics and processes used to manufacture our products are owned or controlled by our suppliers and are generally not unique to us. Our ability to obtain intellectual property protection for our products is therefore limited and we currently own no patents or exclusive intellectual property rights in the technology, fabrics or processes underlying our products. As a result, our current and future competitors are able to manufacture and sell products with performance characteristics, fabrics and styling similar to our products. Because many of our competitors have significantly greater financial, distribution, marketing and other resources than we do, they may be able to manufacture and sell products based on our fabrics and manufacturing technology at lower prices than we can. If our competitors do sell similar products to ours at lower prices, our net revenue and profitability could suffer.
Our failure or inability to protect our intellectual property rights could diminish the value of our brand and weaken our competitive position.
We currently rely on a combination of copyright, trademark, trade dress and unfair competition laws, as well as confidentiality procedures and licensing arrangements, to establish and protect our intellectual property rights. We cannot assure you that the steps taken by us to protect our intellectual property rights will be adequate to prevent infringement of such rights by others, including imitation of our products and misappropriation of our brand. In addition, intellectual property protection may be unavailable or limited in some foreign countries where laws or law enforcement practices may not protect our intellectual property rights as fully as in the United States or Canada, and it may be more difficult for us to successfully challenge the use of our intellectual property rights by other parties in these countries. If we fail to protect and maintain our intellectual property rights, the value of our brand could be diminished and our competitive position may suffer.

We are subject to risks associated with leasing retail space subject to long-term and non-cancelable leases.
We lease the majority of our corporate-owned stores under operating leases and our inability to secure appropriate real estate or lease terms could impact our ability to grow. Our leases generally have initial terms of between five and ten years, and generally can be extended only i