WILLIAMS SONOMA INC (WSM) FY 2024 MD&A

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition, results of operations, and liquidity and capital resources for the 52 weeks ended January 28, 2024 (“fiscal 2023”), and the 52 weeks ended January 29, 2023 (“fiscal 2022”) should be read in conjunction with our Consolidated Financial Statements and notes thereto. All explanations of changes in operational results are discussed in order of magnitude.

A discussion and analysis of our financial condition, results of operations, and liquidity and capital resources for the 52 weeks ended January 29, 2023 (“fiscal 2022”), compared to the 52 weeks ended January 30, 2022 (“fiscal 2021”), can be found under Item 7 in our Annual Report on Form 10-K for fiscal 2022, filed with the SEC on March 24, 2023, which is available on the SEC’s website at www.sec.gov and under the Financial Reports section of our Investor Relations website.

OVERVIEW

Williams-Sonoma, Inc. is an omni-channel specialty retailer of high-quality, sustainable products for the home. Our products in our portfolio of nine brands — Williams Sonoma, Pottery Barn, Pottery Barn Kids, Pottery Barn Teen, West Elm, Williams Sonoma Home, Rejuvenation, Mark and Graham, and GreenRow — are marketed through e-commerce websites, direct-mail catalogs and our retail stores. These brands are also part of The Key Rewards, our loyalty and credit card program that offers members exclusive benefits across the Williams-Sonoma family of brands. We operate in the U.S., Puerto Rico, Canada, Australia and the United Kingdom, offer international shipping to customers worldwide, and have unaffiliated franchisees that operate stores in the Middle East, the Philippines, Mexico, South Korea and India, as well as e-commerce websites in certain locations. We are also proud to be a leader in our industry with our values-based culture and commitment to achieving our sustainability goals.

Beginning in fiscal 2021 and continuing through fiscal 2022, global supply chain disruptions caused delays in inventory receipts and backorder delays, increased raw material costs, and higher shipping-related charges. These disruptions improved in the fourth quarter of fiscal 2022. However, the costs from these supply chain challenges impacted our Consolidated Statement of Earnings in the first half of fiscal 2023.

Fiscal 2023 Financial Results

Net revenues in fiscal 2023 decreased $923.8 million, or 10.6%, with company comparable brand revenue ("company comp") decline of 9.9%. Our full year revenues reflect a challenging environment for home furnishings. This decrease was driven by continuing customer hesitancy towards furniture purchases and our strategy to reduce promotional activity, partially offset by strength in certain non-furniture categories. Company comp decreased 3.4% on a two-year basis and increased 35.6% on a four-year basis.

Comparable brand revenue ("brand comp") for Pottery Barn, our largest brand, decreased 9.7%, increased 5.2% on a two-year basis and increased 44.3% on a four-year basis. The fiscal 2023 decline was driven by reduced furniture demand and our strategy to reduce promotional activity, partially offset by relative strength from our seasonal decorating, entertaining and home textiles categories. Brand comp for the Pottery Barn Kids and Teen businesses decreased 5.5%, decreased 5.1% on a two-year basis and increased 23.1% on a four-year basis. The fiscal 2023 decline resulted from pressure in certain of our children's furniture categories, but saw relative strength from our baby and seasonal offerings and new product collaborations.

Brand comp for West Elm decreased 18.8%, decreased 16.3% on a two-year basis and increased 32.0% on a four-year basis. The fiscal 2023 decline was driven by West Elm continuing to be the brand most affected by the customer pull back in furniture as a result of the brand's high percentage of its assortment in the furniture category and our strategy to reduce promotional activity, partially offset by relative strength from new designs across all categories including furniture, textiles and decorative accessories.

Brand comp for the Williams Sonoma brand decreased 0.7%, decreased 2.4% brand on a two-year basis and increased 31.9% on a four-year basis. The fiscal 2023 decline resulted from our home business, partially offset by strength in the kitchen business driven by electrics, seasonal, cookware and bakeware categories as well as new product collaborations.

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Finally, our emerging brands, Rejuvenation and Mark and Graham, combined, delivered low single-digit brand comp growth.

We ended the year with a cash balance of $1.3 billion and generated positive operating cash flow of $1.7 billion. In addition to our cash balance, we also ended the year with no outstanding borrowings under our revolving line of credit. This strong liquidity position allowed us to provide stockholder returns of $545.5 million through stock repurchases and dividends, and to fund the operations of the business by investing $188.5 million in capital expenditures.

In fiscal 2023, diluted earnings per share was $14.55 (which included (i) a $0.20 impact related to exit costs associated with the closure of our West Coast manufacturing facility and the exiting of Aperture, a division of our Outward subsidiary, and (ii) a $0.09 impact related to reduction-in-force initiatives, primarily in our corporate functions) versus $16.32 in fiscal 2022 (which included a $0.21 impact from the impairment of Aperture).

Our three key differentiators - our in-house design, our digital-first channel strategy, and our values - continue to distinguish us as the world’s largest digital-first, design-led and sustainable home retailer. Our in-house design capabilities and vertically integrated sourcing organization allow us to deliver high-quality, sustainable products at competitive prices.

As a digital-first company, we are in continuous pursuit of incremental improvement to our customers’ shopping journey online. Our ongoing investment in our proprietary e-commerce technology continues to improve our online experience. We are focused on offering customers inspiring content and dynamic tools to assist with design projects. Our internal teams, including creative and customer service, are already benefiting from the speed and cost efficiencies this technology provides. Through our e-commerce platform, our in-house customer relationship management and data analytic teams optimize our digital spend and customer connections.

We remain passionate about our best-in-class retail business. Our stores are beautifully designed and curated with inspirational assortments. Our continued retail optimization efforts have transformed our store fleet to be positioned in the most profitable, inspiring, and strategic locations.

On the sustainability front, we take great pride in the progress we are making within our impact initiatives and sustainability leadership across the home furnishings industry. These commitments are reflected in the high quality, durable, sustainable products that we offer our customers, and continues to distinguish our company and our brands.

Looking Ahead to 2024

Looking ahead to 2024, we are focused on three key priorities, which include (i) returning to growth, (ii) elevating our world-class customer service and (iii) driving earnings.

Returning to Growth

Our growth will be driven by our business strategies in each of our core businesses, our emerging brands, our business-to-business program and our global business. Our largest cross-brand growth driver is business-to-business, which positions us to furnish our customers everywhere - from restaurants to hotels, from football stadiums to office spaces.

Our emerging brands, including Rejuvenation and Mark and Graham, are expected to also provide incremental growth. These two brands service the white space needs of customers and demonstrate our ability to develop new businesses and expand our portfolio. And, launched in fiscal 2023, our newest emerging brand GreenRow, which utilizes sustainable materials and manufacturing practices to create colorful, heirloom-quality products, continues to gain momentum.

Another successful growth initiative is our continued expansion into global markets. In India, we continue to see growth from strong marketing and brand awareness campaigns across the brands with a high penetration of design crew business. In Mexico, the market continues to show strength, driven by improved in-stocks and a strong holiday season. In Canada, our digital initiatives continue to gain new customers and drive results for our brands, and we are pleased with the recent launches of Rejuvenation, Mark and Graham and Williams Sonoma Home.

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Elevating our World-Class Customer Service

We are continuing to improve our world-class customer service by driving supply chain improvements from reduced out-of-market and multiple shipments, fewer customer accommodations, lower returns and damages, and reduced replacements. Additionally, we are focused on continued optimization and automation in our distribution centers and logistics networks to improve our service times.

Driving Earnings

The supply chain improvements contributing to elevating our world-class customer service are expected to continue to contribute meaningfully to our profitability. Additionally, our pricing power, high e-commerce sales mix, retail optimization and investment in highly efficient advertising are expected to drive earnings as we continue to control costs from our overall financial discipline. In fiscal 2024, we expect to maintain our employment cost savings that we achieved in fiscal 2023, following our comprehensive review of our organization structure.

As we look forward to the year ahead, we believe these key priorities will set us apart from our competition and allow us to drive long-term growth and profitability. We have a powerful portfolio of brands, serving a range of categories, aesthetics, and life stages and we have built a strong omni-channel platform and infrastructure, which positions us well for the next stage of growth. However, the current uncertain macroeconomic environment with the weak housing market, elevated interest rates, layoffs, inflationary pressure, political uncertainty and global geopolitical tension may continue to impact our results. For information on risks, please see “Risk Factors” in Part I, Item 1A.

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Results of Operations

NET REVENUES

Net revenues consist of sales of merchandise to our customers through our e-commerce websites, retail stores and direct-mail catalogs, and include shipping fees received from customers for delivery of merchandise to their homes. Our revenues also include sales to our business-to-business customers and franchisees, incentives received from credit card issuers in connection with our private label and co-branded credit cards, and breakage income related to our stored-value cards.

Net revenues in fiscal 2023 decreased $923.8 million or 10.6%, with company comp decline of 9.9%. Our full year revenues reflect a challenging environment for home furnishings. This decrease was driven by continuing customer hesitancy towards furniture purchases and our strategy to reduce promotional activity, partially offset by strength in certain non-furniture categories. Company comp decreased 3.4% on a two-year basis and increased 35.6% on a four-year basis.

The following table summarizes our net revenues by brand for fiscal 2023 and fiscal 2022:

1Includes business-to-business net revenues within each brand.

2Primarily consists of net revenues from Rejuvenation, our international franchise operations, Mark and Graham, and GreenRow.

Comparable Brand Revenue

Comparable brand revenue includes comparable e-commerce sales, including through our direct-mail catalog, and store sales, as well as shipping fees, sales returns and other discounts associated with current period sales. Comparable stores are defined as permanent stores where gross square footage did not change by more than 20% in the previous 12 months, and which have been open for at least 12 consecutive months without closure for more than seven days within the same fiscal month. Comparable stores that were temporarily closed during fiscal 2021 due to the pandemic were not excluded from the comparable brand revenue calculation. Outlet comparable store revenues are included in their respective brands. Business-to-business revenues are included in comparable brand revenue for each of our brands. Sales to our international franchisees are excluded from comparable brand revenue as their stores and e-commerce websites are not operated by us. Sales from certain operations are also excluded until such time that we believe those sales are meaningful to evaluating their performance. Additionally, comparable brand revenue for newer concepts is not separately disclosed until such time that we believe those sales are meaningful to evaluating the performance of the brand.

1Comparable brand revenue includes business-to-business revenues within each brand.

2Total comparable brand revenue growth includes the results of Rejuvenation and Mark and Graham.

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RETAIL STORE DATA

GROSS PROFIT

1Includes occupancy expenses of $814.3 million, $785.4 million and $728.0 million in fiscal 2023, fiscal 2022 and fiscal 2021, respectively.

Gross profit is equal to our net revenues less costs of goods sold. Cost of goods sold includes (i) cost of goods, which consists of cost of merchandise, inbound freight expenses, freight-to-store expenses and other inventory related costs such as replacements, damages, obsolescence and shrinkage; (ii) occupancy expenses, which consists of rent, other occupancy costs (including property taxes, common area maintenance and utilities) and depreciation; and (iii) shipping costs, which consists of third-party delivery services and shipping materials. Selling margin is our gross profit before occupancy costs.

Our classification of expenses in gross profit may not be comparable to other public companies, as we do not include non-occupancy-related costs associated with our distribution network in cost of goods sold. These costs, which include distribution network employment, third-party warehouse management and other distribution-related administrative expenses, are recorded in selling, general and administrative expenses ("SG&A").

Fiscal 2023 vs. Fiscal 2022

Gross profit decreased $374.1 million, or 10.2%, compared to fiscal 2022. Gross margin increased to 42.6% from 42.4% in fiscal 2022. The 20 basis point expansion in gross margin was driven by (i) improvement in selling margin due to higher merchandise margins from lower input costs resulting from decreased ocean freight, detention and demurrage costs in the second half of fiscal 2023 and reduced promotional activity, partially offset by (ii) higher occupancy costs resulting from our new distribution centers on the West Coast to support our long-term growth.

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Fiscal 2022 vs. Fiscal 2021

Gross profit increased $45.8 million, or 1.3%, compared to fiscal 2021. Gross margin decreased to 42.4% from 44.0% in fiscal 2021. The 160 basis point decline in gross margin was driven by deterioration in selling margin due to (i) lower merchandise margins from higher input costs as we absorbed higher product costs, ocean freight, detention and demurrage due to the impact of supply chain disruption and global inflation pressures, (ii) higher outbound customer shipping costs due to out-of-market shipping and shipping multiple times for multi-unit orders, and (iii) higher occupancy costs resulting from incremental costs from our new distribution centers on the East and West Coasts to support our long-term growth, which was partially offset by (iv) our retail store optimization initiatives.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

SG&A consists of non-occupancy-related costs associated with our retail stores and e-commerce websites, distribution and manufacturing facilities, customer care centers, supply chain operations (buying, receiving and inspection) and corporate administrative functions. These costs include employment, advertising, third-party credit card processing, impairment and other general expenses.

Fiscal 2023 vs. Fiscal 2022

SG&A decreased $119.9 million or 5.5%, compared to fiscal 2022. SG&A as a percentage of net revenues increased to 26.6% from 25.1% for fiscal 2022. This increase in rate was primarily driven by (i) the deleverage of employment costs from higher performance-based incentive compensation in fiscal 2023 compared to fiscal 2022 commensurate with business performance, partially offset by (ii) managed variable employment costs in line with top-line trends, (iii) the cost savings from reduction-in-force actions taken in the first half of fiscal 2023 and (iv) the leverage of advertising expenses.

INCOME TAXES

The effective income tax rate was 25.4% for fiscal 2023 and 24.8% for fiscal 2022. Compared to fiscal 2022, the increase in the tax rate is primarily due to less excess tax benefit from stock-based compensation and the tax effect of the earnings mix change between the two fiscal years, partially offset by the expiration of the statutes of limitation related to uncertain tax positions in fiscal 2023.

The Inflation Reduction Act, enacted on August 16, 2022, includes a new 15% minimum tax on “adjusted financial statement income” effective for tax years beginning after December 31, 2022. The Company was not subject to the minimum tax for fiscal 2023.

In addition to U.S. tax law changes, a number of countries have begun to enact legislation to implement the Organization for Economic Cooperation and Development (“OECD”) international tax framework, including the Pillar Two minimum tax regime. The OECD continues to release additional guidance on these rules and the Framework calls for law enactment by OECD and G20 members to take effect in 2024 or 2025. Pillar Two minimum tax will be treated as a period cost in future years and did not impact our results of operations for fiscal 2023. We are continuing to evaluate the potential impact on future periods of the Pillar Two Framework, and monitoring legislative developments by other countries, especially in the regions that we operate.

LIQUIDITY AND CAPITAL RESOURCES

Material Cash Requirements

We are party to contractual obligations involving commitments to make payments to third parties in the future. Certain contractual obligations are reflected on our Consolidated Balance Sheet as of January 28, 2024, while others are considered future obligations. Our material cash requirements as of January 28, 2024 include the following contractual obligations and commitments arising in the normal course of business:

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•Our operating leases had fixed lease payment obligations, including imputed interest, of $1.6 billion, with $320.1 million payable within 12 months. See Note E to our Consolidated Financial Statements for amount outstanding as of January 28, 2024 related to operating leases.

•Our purchase obligations consist primarily of open purchase orders to purchase inventory as well as commitments for products and services used in the normal course of business. As of January 28, 2024, our purchase obligations were approximately $911.9 million, with $854.5 million expected to be settled within 12 months.

In addition, we had $31.6 million of unrecognized tax benefits recorded in our accompanying Consolidated Balance Sheet as of January 28, 2024, for which we cannot make a reasonably reliable estimate of the amount and period of payment. See Note D to our Consolidated Financial Statements for information related to income taxes.

We are party to a variety of contractual agreements under which we may be obligated to indemnify the other party for certain matters. These contracts primarily relate to commercial matters, operating leases, trademarks, intellectual property and financial matters. Under these contracts, we may provide certain routine indemnifications relating to representations and warranties or personal injury matters. The terms of these indemnifications range in duration and may not be explicitly defined. Historically, we have not made significant payments for these indemnifications. We believe that if we were to incur a loss in any of these matters, the loss would not have a material effect on our financial condition or results of operations.

See Note I to our Consolidated Financial Statements for further information related to our commitments and contingencies.

Dividends

In fiscal 2023 and fiscal 2022, total cash dividends declared were approximately $236.8 million, or $3.60 per common share, and $216.3 million, or $3.12 per common share, respectively. In March 2024, our Board of Directors authorized a 26% increase in our quarterly cash dividend, from $0.90 to $1.13 per common share, subject to capital availability. Our quarterly cash dividend may be limited or terminated at any time.

Stock Repurchase Program

See section titled “Stock Repurchase Program” within Part II, Item 5 of this Annual Report on Form 10-K for further information.

Liquidity Outlook

We believe our cash on hand, cash flows from operations, and our available credit facilities will provide adequate liquidity for our business operations as well as dividends, capital expenditures, stock repurchases, and other liquidity requirements associated with our business operations over the next 12 months. We are currently not aware of any other trends or demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, our liquidity increasing or decreasing in any material way that will impact our capital needs during or beyond the next 12 months.

Sources of Liquidity

As of January 28, 2024, we held $1.3 billion in cash and cash equivalents, the majority of which was held in interest-bearing demand deposit accounts and money market funds, and of which $86.0 million was held by our international subsidiaries. As is consistent within our industry, our cash balances are seasonal in nature, with the fourth quarter historically representing a significantly higher level of cash than other periods.

Throughout the fiscal year, we utilize our cash resources to build our inventory levels in preparation for our fourth quarter holiday sales. Our largest source of operating cash flows is cash collections from the sale of our merchandise throughout the year. In fiscal 2024, we plan to use our cash resources to fund our inventory and inventory-related purchases, employment related-costs, advertising and marketing initiatives, rental payments on our leases, stock repurchases and dividend payments, the payment of income taxes and property and equipment purchases.

In addition to our cash balances on hand, we have a credit facility (the "Credit Facility") which provides for a $500 million unsecured revolving line of credit (the “Revolver”). Our Revolver may be used to borrow revolving loans or to request the issuance of letters of credit. We may, upon notice to the administrative agent, request existing

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or new lenders, at such lenders’ option, to increase the Revolver by up to $250 million to provide for a total of $750 million of unsecured revolving credit.

During fiscal 2023, we had no borrowings under our Revolver. Additionally, as of January 28, 2024, issued but undrawn standby letters of credit of $11.2 million were outstanding under our Revolver. The standby letters of credit were primarily issued to secure the liabilities associated with workers’ compensation and other insurance programs.

Our Credit Facility contains certain restrictive loan covenants, including, among others, a financial covenant requiring a maximum leverage ratio (funded debt adjusted for operating lease liabilities to earnings before interest, income tax, depreciation, amortization and rent expense), and covenants limiting our ability to incur indebtedness, grant liens, make acquisitions, merge or consolidate, and dispose of assets. As of January 28, 2024, we were in compliance with our financial covenants under our credit facility and, based on our current projections, we expect to remain in compliance throughout the next 12 months.

Letter of Credit Facilities

We have three unsecured letter of credit facilities for a total of $35 million. Our letter of credit facilities contain covenants that are consistent with our Credit Facility. Interest on unreimbursed amounts under our letter of credit facilities accrues at a base rate as defined in the credit facility, plus an applicable margin based on our leverage ratio. As of January 28, 2024, the aggregate amount outstanding under our letter of credit facilities was $0.1 million, which represents only a future commitment to fund inventory purchases to which we had not taken legal title. On August 18, 2023, we renewed two of our letter of credit facilities on substantially similar terms. Two of the letter of credit facilities totaling $30 million mature on August 18, 2024, and the latest expiration date possible for future letters of credit issued under these facilities is January 15, 2025. One of the letter of credit facilities totaling $5 million matures on September 30, 2026, which is also the latest expiration date possible for future letters of credit issued under the facility.

Cash Flows from Operating Activities

For fiscal 2023, net cash provided by operating activities was $1.7 billion compared to $1.1 billion in fiscal 2022. For fiscal 2023, net cash provided by operating activities was primarily attributable to (i) net earnings adjusted for non-cash items, (ii) merchandise inventories as a result of decreasing customer demand, and (iii) accounts payable and gift card and other deferred revenue as a result of ongoing working capital enhancements. Net cash provided by operating activities compared to fiscal 2022 increased primarily due to (i) lower spending on merchandise inventories, (ii) an increase in accounts payable, (iii) an increase in accrued expenses and other liabilities due to higher performance-based incentive compensation and (iv) an increase in gift card and other deferred revenue, partially offset by (v) a decrease in net earnings adjusted for non-cash items.

Cash Flows from Investing Activities

For fiscal 2023, net cash used in investing activities was $188.3 million compared to $354.0 million in fiscal 2022 and was primarily attributable to purchases of property and equipment related to technology and supply chain enhancements.

Cash Flows from Financing Activities

For fiscal 2023, net cash used in financing activities was $0.6 billion compared to $1.2 billion in fiscal 2022 and was primarily attributable to the repurchases of common stock and payment of dividends. Net cash used in financing activities for fiscal 2023 decreased compared to fiscal 2022, primarily due to a decrease in repurchases of common stock.

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IMPACT OF INFLATION

While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we have experienced varying levels of inflation, resulting in part from various supply chain disruptions, increased shipping and transportation costs, increased product costs, increased labor costs in the supply chain and other disruptions caused by the pandemic and the uncertain economic environment. Global trends, including inflationary pressures, are weakening consumer sentiment, negatively impacting consumer spending behavior and slowing down consumer demand for our products. However, our unique operating model and pricing power helped mitigate these increased costs during fiscal 2023. We cannot be assured that our results of operations and financial condition will not be materially impacted by inflation in the future. For information on risks, please see “Risk Factors” in Part I, Item 1A.

CRITICAL ACCOUNTING ESTIMATES

Our Consolidated Financial Statements requires us to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. These estimates are evaluated on an ongoing basis and are based on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ from these estimates.

Merchandise Inventories

The significant estimates used in our inventory valuation are obsolescence (including excess and slow-moving inventory and lower of cost or net realizable value reserves) and estimates of inventory shrinkage. We reserve for obsolescence based on historical trends of inventory sold below cost and specific identification.

The reserves for shrinkage are recorded throughout the year based on historical shrinkage results, cycle count results within our distribution centers, expectations of future shrinkage and current inventory levels, and are therefore subject to uncertainty. Actual shrinkage is recorded at year-end based on the results of our cycle counts and year-end physical inventory counts, and can vary from our estimates recorded throughout the year due to such factors as changes in operations, the mix of our inventory (which ranges from large furniture to small tabletop items) and execution against loss prevention initiatives in our stores, distribution facilities and off-site storage locations, and with our third-party warehouse and transportation providers. Accordingly, there is no material shrinkage reserve at year-end. Historically, actual shrinkage has not differed materially from our estimates.

Our obsolescence and shrinkage reserve calculations contain estimates that require management to make assumptions and to apply judgment regarding a number of factors, including market conditions, the selling environment, historical results and current inventory trends. We have made no material changes to our assumptions included in the calculations of the obsolescence and shrinkage reserves throughout the year. In addition, we do not believe a 10% change in our inventory reserves would have a material effect on our net earnings. As of January 28, 2024 and January 29, 2023, our inventory obsolescence reserves were $23.6 million and $24.7 million, respectively.

Long-lived Assets

Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets.

We review the carrying value of all long-lived assets for impairment, primarily at an individual store level, whenever events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable. Our impairment analyses determine whether projected cash flows from operations are sufficient to recover the carrying value of these assets. The asset group is comprised of both property and equipment and operating lease right-of-use assets. Impairment may result when the carrying value of the asset or asset group exceeds the estimated undiscounted future cash flows over its remaining useful life. Our estimate of undiscounted future cash flows over the lease term is based upon our experience, the historical operations and estimates of future profitability and economic conditions. The estimates of future profitability and economic conditions require estimating such factors as sales growth, gross margin, employment costs, lease escalations, inflation and the overall economics of the retail industry, and are therefore subject to variability and difficult to predict. For right-of-use assets, we determine the fair value of the assets by using estimated market rental rates. These estimates can be affected by factors such as future results, real estate supply and demand, closure plans, and economic conditions that can be difficult to predict. Actual future results may differ from those estimates. If a long-lived asset is found to be

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impaired, the amount recognized for impairment is equal to the excess of the asset or asset group’s net carrying value over its estimated fair value.

During fiscal 2023, we recognized impairment charges of $14.5 million, which consisted of (i) the write-down of leasehold improvements of eleven underperforming stores of $6.4 million, (ii) the write-down of operating lease right-of-use-assets of $4.4 million, and (iii) the write-off of property and equipment of $3.7 million resulting from the exit of Aperture, a division of our Outward subsidiary, all of which is recognized within SG&A. During fiscal 2022, we recognized impairment charges of $15.6 million, which consisted of: (i) $3.3 million related to the impairment of property and equipment and $2.6 million related to the impairment of operating lease right-of-use assets resulting from underperforming stores in Australia and (ii) $9.7 million related to the impairment of property and equipment associated with Aperture due to these assets not being recoverable in light of projected future cash flows, all of which is recognized within SG&A. During fiscal 2021, no impairment charges were recognized.

Leases

The significant estimates used in accounting for our leases relate to the incremental borrowing rate used in the present value of lease obligations calculation. As our leases generally do not provide information about the rate implicit in the lease, we utilize an estimated incremental borrowing rate to calculate the present value of our future lease obligations. The incremental borrowing rate represents the rate of interest we would have to pay on a collateralized borrowing, for an amount equal to the lease payments, over a similar term and in a similar economic environment. We use judgment in determining our incremental borrowing rate, which is applied to each lease based on the lease term. A 50 basis point increase or decrease in the incremental borrowing rate would not have a material impact on the value of our new or remeasured right-of-use assets and lease liabilities. As of fiscal 2023 and fiscal 2022, our weighted-average incremental borrowing rates were 3.8% and 3.4%, respectively. Many of our leases contain renewal and early termination options. The option periods are generally not included in the lease term used to measure our lease liabilities and right-of-use assets upon commencement, as we do not believe the exercise of these options to be reasonably certain. We remeasure the lease liability and right-of-use asset when we are reasonably certain to exercise a renewal or an early termination option. We use judgment in determining lease classification, including our determination of the economic life and the fair market value of the identified asset. The fair market value of the identified asset is generally estimated based on comparable market data provided by third-party sources.

Income Taxes

We record reserves for our estimates of the additional income tax liability that is more likely than not to result from the ultimate resolution of foreign and domestic tax examinations. The results of these examinations and negotiations with taxing authorities may affect the ultimate settlement of these issues. We review and update the estimates used in the accrual for uncertain tax positions as more definitive information becomes available from taxing authorities, upon completion of tax examinations, upon expiration of statutes of limitation, or upon occurrence of other events. As of January 28, 2024, we had $31.6 million of gross unrecognized tax benefits, of which $25.8 million would, if recognized, affect the effective tax rate. Additionally, we accrue interest and penalties related to these unrecognized tax benefits in the provision for income taxes. As of January 28, 2024 and January 29, 2023, our accruals for the payment of interest and penalties totaled $5.3 million and $6.1 million, respectively. Due to the potential resolution of tax issues, it is reasonably possible that the balance of our gross unrecognized tax benefits could decrease within the next twelve months by a range of $0 to $5.8 million.

In order to compute income tax on an interim basis, we estimate what our effective tax rate will be for the full fiscal year and adjust these estimates throughout the year as necessary. Adjustments to our income tax provision due to changes in our estimated effective tax rate are recorded in the interim period in which the change occurs. The tax expense (or benefit) related to items other than ordinary income is individually computed and recognized when the items occur. Our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of our earnings in various taxing jurisdictions or changes in tax law. Our effective tax rates for fiscal 2023 and fiscal 2022 were 25.4% and 24.8%, respectively.

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