ULTA BEAUTY, INC. 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
Overview
We were founded in 1990 as a beauty retailer at a time when prestige, mass, and salon products were sold through distinct channels - department stores for prestige products; drug stores and mass merchandisers for mass products; and salons and authorized retail outlets for professional hair care products. We developed a unique specialty retail concept that offers a broad range of brands and price points, a compelling value proposition, and a convenient and welcoming shopping environment. We define our target consumer as a beauty enthusiast, a consumer who is passionate about the beauty category and has high expectations for the shopping experience. We estimate the beauty enthusiasts represents approximately 57% of shoppers and 77% of spend in theU.S. beauty category. We believe our strategy provides us with the competitive advantages that have contributed to our financial performance. We are the largest beauty retailer inthe United States and the premier beauty destination for cosmetics, fragrance, skin care products, hair care products, and salon services. We provide unmatched product breadth, value, and convenience in a distinctive specialty retail environment. Key aspects of our business include: our ability to offer our guests a unique combination of more than 25,000 beauty products from across the categories of prestige and mass cosmetics, fragrance, haircare, skincare, bath and body products, and salon styling tools, as well as a full-service salon in every store featuring hair, skin, and brow services; our focus on delivering a compelling value proposition to our guests across all of our product categories; and convenience, as our stores are predominantly located in convenient, high-traffic locations such as power centers. The continued growth of our business and any future increases in net sales, net income, and cash flows is dependent on our ability to execute our strategic imperatives: 1) drive growth across beauty enthusiast consumer groups, 2) deepenUlta Beauty love and loyalty, 3) deliver a one of a kind, world class beauty assortment, 4) lead the in-store and beauty services experience transformation, 5) reinvent beauty digital engagement, 6) deliver operational excellence and drive efficiencies, and 7) invest in talent that drives a winning culture. We believe that the expandingU.S. beauty products and salon services industry, the shift in distribution channel of prestige beauty products from department stores to specialty retail stores, coupled withUlta Beauty's competitive strengths, positions us to capture additional market share in the industry. 29
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Comparable sales is a key metric that is monitored closely within the retail industry. Our comparable sales have fluctuated in the past, and we expect them to continue to fluctuate in the future. A variety of factors affect our comparable sales, including generalU.S. economic conditions, changes in merchandise strategy or mix, and timing and effectiveness of our marketing activities, among others. Over the long term, our growth strategy is to increase total net sales through increases in our comparable sales, opening new stores, and increasing omnichannel capabilities. Operating profit is expected to increase as a result of our ability to expand merchandise margin and leverage our fixed store costs with comparable sales increases and operating efficiencies offset by incremental investments in people, systems, and supply chain required to support a 1,500 to 1,700 store chain in theU.S. with successful e-commerce and competitive omnichannel capabilities. Current business trends Our research indicates thatUlta Beauty continues to drive meaningful market share across all categories. However, our research also suggests that the cosmetics category in the overall U.S. market experienced mid-single digit declines through fiscal 2019. Beauty cycles are impacted by demographics and innovation. While demographic trends continue to be favorable, we believe a lack of incremental innovation has resulted in a challenging cycle for the cosmetics category, as innovation brought to the market has not resulted in incremental product purchases. Despite the overall market decline in the cosmetics category, we remain confident that our differentiated and diverse business model, our commitment to strategic investments, and our highly engaged associates will continue to drive market share gains.
COVID-19
In late 2019, COVID-19 was detected inWuhan, China and other jurisdictions, prompting the Chinese government to quarantine certain affected regions and impose both internal and external travel restrictions within the country. The virus has since spread to almost every other part of the world, including theU.S. , and inMarch 2020 , theWorld Health Organization declared COVID-19 a global pandemic. Federal, state, and local governments have since implemented various restrictions, including travel restrictions, border closings, restrictions on public gatherings, quarantining of people who may have been exposed to the virus, shelter-in-place restrictions and limitations on business operations. In response to government recommendations and for the health and safety of our associates and guests, we announced onMarch 17, 2020 our decision to temporarily close all stores across theU.S. While too early to quantify, our sales and results of operations will be negatively impacted by this decision. Even after our stores are re-opened, the virus could also negatively impact our results of operations by continuing to weaken demand for our products and services and/or by disrupting our supply chain. As events are rapidly changing, we are unable to accurately predict the impact that COVID-19 will have on our results of operations due to uncertainties including, but not limited to, the duration of the closing of our stores, the duration of quarantines, shelter-in-place and other travel restrictions within theU.S. and other affected countries, the severity of the virus, the duration of the outbreak, and the public's response to the outbreak and its eventual aftermath.
Basis of presentation
The Company has one reportable segment, which includes retail stores, salon services, and e-commerce.
We recognize merchandise revenue at the point of sale in our retail stores.
E-commerce merchandise sales are recognized based upon shipment of merchandise
to the guest based on meeting the transfer of control criteria. Retail store and
e-commerce sales are recorded net of estimated returns. Shipping and handling
are treated as costs to fulfill the contract and not a separate performance
obligation. Accordingly, we recognize revenue for our single performance
obligation related to online sales at the time control of the merchandise passes
to the customer, which is at the time of shipment. We provide refunds for
merchandise returns within 60 days from the original purchase date. State sales
taxes are presented on a net basis as we consider our self a pass-through
conduit for collecting and remitting state sales tax. Salon service revenue is
recognized at the time the service is provided to the guest. Gift card sales
revenue is deferred until the guest redeems the gift card. Company coupons and
other incentives are recorded as a reduction of net sales. Other revenue sources
include the private label and co-branded credit card programs, as well as
deferred revenue related to the loyalty program and gift card breakage.
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Comparable sales reflect sales for stores beginning on the first day of the 14th month of operation. Therefore, a store is included in our comparable store base on the first day of the period after one year of operations plus the initial one-month grand opening period. Non-comparable store sales include sales from new stores that have not yet completed their 13th month of operation and stores that were closed for part or all of the period in either year as a result of remodel activity. Remodeled stores are included in comparable sales unless the store was closed for a portion of the current or prior period. Comparable sales include retail sales, salon services, and e-commerce. There may be variations in the way in which some of our competitors and other retailers calculate comparable or same store sales. Measuring comparable sales allows us to evaluate the performance of our store base as well as several other aspects of our overall strategy. Several factors could positively or negatively impact our comparable sales results:
? the general national, regional, and local economic conditions and corresponding
impact on customer spending levels;
? the introduction of new products or brands;
? the location of new stores in existing store markets;
? competition;
? our ability to respond on a timely basis to changes in consumer preferences;
? the effectiveness of our various merchandising and marketing activities; and
? the number of new stores opened and the impact on the average age of all of our
comparable stores. Cost of sales includes:
? the cost of merchandise sold, including substantially all vendor allowances,
which are treated as a reduction of merchandise costs;
? distribution costs including labor and related benefits, freight, rent,
depreciation and amortization, real estate taxes, utilities, and insurance;
? shipping and handling costs;
retail stores occupancy costs including rent, depreciation and amortization,
? real estate taxes, utilities, repairs and maintenance, insurance, licenses, and
cleaning expenses;
? salon services payroll and benefits; and
? shrink and inventory valuation reserves.
Our cost of sales may be negatively impacted as we open an increasing number of stores. Changes in our merchandise mix may also have an impact on cost of sales. This presentation of items included in cost of sales may not be comparable to the way in which our competitors or other retailers compute their cost of sales.
Selling, general and administrative expenses include:
? payroll, bonus, and benefit costs for retail stores and corporate employees;
? advertising and marketing costs;
? occupancy costs related to our corporate office facilities;
? stock-based compensation expense;
depreciation and amortization for all assets, except those related to our
? retail stores and distribution operations, which are included in cost of
sales; and
? legal, finance, information systems, and other corporate overhead costs.
This presentation of items in selling, general and administrative expenses may
not be comparable to the way in which our competitors or other retailers compute
their selling, general and administrative expenses.
Pre-opening expenses include non-capital expenditures during the period prior to
store opening for new, remodeled, and relocated stores including rent during the
construction period for new and relocated stores, store set-up labor, management
and employee training, and grand opening advertising.
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Interest income, net includes both interest income and expense. Interest income represents interest from cash equivalents and short-term investments with maturities of twelve months or less from the date of purchase. Interest expense includes interest costs and facility fees associated with our credit facility, which is structured as an asset-based lending instrument. Our credit facility interest is based on a variable interest rate structure which can result in increased cost in periods of rising interest rates.
Income tax expense reflects the federal statutory tax rate and the weighted average state statutory tax rate for the states in which we operate stores.
Results of operations
Our fiscal years are the 52- or 53-week periods ending on the Saturday closest toJanuary 31 . The Company's fiscal years endedFebruary 1, 2020 (fiscal 2019),February 2, 2019 (fiscal 2018), andFebruary 3, 2018 (fiscal 2017) were 52, 52, and 53-week years, respectively. As ofFebruary 1, 2020 , we operated 1,254 stores across 50 states. The following tables present the components of our consolidated results of operations for
the
periods indicated:
Fiscal year ended
February 1, February 2, February 3,
(Dollars in thousands) 2020 2019 2018
Net sales $ 7,398,068 $ 6,716,615 $ 5,884,506
Cost of sales 4,717,004 4,307,304 3,787,697
Gross profit 2,681,064 2,409,311 2,096,809
Selling, general and administrative
expenses 1,760,716 1,535,464 1,287,232
Pre-opening expenses 19,254 19,767 24,286
Operating income 901,094 854,080 785,291
Interest income, net (5,056) (5,061) (1,568)
Income before income taxes 906,150 859,141 786,859
Income tax expense 200,205 200,582 231,625
Net income $ 705,945 $ 658,559 $ 555,234
Other operating data:Number of stores end of period 1,254 1,174
1074
Comparable sales increase 5.0% 8.1% 11.0%
Fiscal year ended
February 1, February 2, February 3,
(Percentage of net sales) 2020 2019 2018
Net sales 100.0% 100.0% 100.0%
Cost of sales 63.8% 64.1% 64.4%
Gross profit 36.2% 35.9% 35.6%
Selling, general and administrative
expenses 23.8% 22.9% 21.9%
Pre-opening expenses 0.3% 0.3% 0.4%
Operating income 12.1% 12.7% 13.3%
Interest income, net 0.1% 0.1% 0.0%
Income before income taxes 12.2% 12.8% 13.3%
Income tax expense 2.7% 3.0% 3.9%
Net income 9.5% 9.8% 9.4%
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Fiscal year 2019 versus fiscal year 2018
Net sales
Net sales increased$681.5 million , or 10.1%, to$7,398.1 million in fiscal 2019 compared to$6,716.6 million in fiscal 2018. The net sales increases are due to the opening of 80 net new stores in 2019, a 5.0% increase in comparable sales, and an increase of$23.4 million in other revenue. The 5.0% comparable sales increase included a 3.3% increase in transactions and a 1.7% increase in average ticket. We attribute the increase in comparable sales to our successful marketing and merchandising strategies.
Gross profit
Gross profit increased$271.8 million , or 11.3%, to$2,681.1 million in fiscal 2019, compared to$2,409.3 million in fiscal 2018. Gross profit as a percentage of net sales increased 30 basis points to 36.2% in fiscal 2019 compared to 35.9% in fiscal 2018. The increase in gross profit margin was primarily due to:
50 basis points improvement in merchandise margins driven by our marketing and
? merchandising strategies and benefits from our Efficiencies for Growth (EFG)
initiatives;
? 20 basis points of leverage in fixed store costs attributed to the impact of
higher sales volume, partially offset by;
? 40 basis points of deleverage due to investments in our salon services and
supply chain operation.
Selling, general and administrative expenses
Selling, general and administrative (SG&A) expenses increased$225.3 million , or 14.7%, to$1,760.7 million in fiscal 2019 compared to$1,535.5 million in fiscal 2018. As a percentage of net sales, SG&A expenses increased 90 basis points to 23.8% in fiscal 2019 compared to 22.9% in fiscal 2018. The deleverage in SG&A expenses was primarily due to:
? 80 basis points of deleverage primarily due to strategic investments in future
growth opportunities and infrastructure to support our EFG initiatives;
? 50 basis points of deleverage related to higher payroll and benefit-related
expenses, partially offset by;
? 30 basis points of leverage in lower variable compensation expense; and
? 10 basis points of leverage in marketing expense attributed to strong sales
growth. Pre-opening expenses Pre-opening expenses decreased$0.5 million , or 2.6%, to$19.3 million in fiscal 2019 compared to$19.8 million in fiscal 2018. During fiscal 2019, we opened 86 new stores, remodeled 12 stores, and relocated eight stores. During fiscal 2018, we opened 107 new stores, remodeled 13 stores, and relocated two stores.
Interest income, net
Interest income, net was$5.1 million in fiscal 2019 and fiscal 2018. Interest income results from cash equivalents and short-term investments with maturities of twelve months or less from the date of purchase. Interest expense represents interest on borrowings and fees related to the credit facility. We did not have any outstanding borrowings on our credit facility as ofFebruary 1, 2020 andFebruary 2, 2019 . Income tax expense
Income tax expense of$200.2 million in fiscal 2019 represents an effective tax rate of 22.1%, compared to fiscal 2018 income tax expense of$200.6 million and an effective tax rate of 23.3%. The lower tax rate is primarily due to income tax accounting for share-based compensation and federal income tax credits.
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Net income
Net income increased $47.4 million , or 7.2%, to $705.9 million in fiscal 2019
compared to $658.6 million in fiscal 2018. The increase in net income was
primarily due to a $271.8 million increase in gross profit partially offset by a
$225.3 million increase in SG&A expenses.
Fiscal year 2018 versus fiscal year 2017
Net sales
Net sales increased$832.1 million , or 14.1%, to$6,716.6 million in fiscal 2018 compared to$5,884.5 million in fiscal 2017. The net sales increases are due to the opening of 100 net new stores in fiscal 2018, an 8.1% increase in comparable sales, and other revenue increased$48.9 million . The sales for the 53rd week of fiscal 2017 were approximately$108.8 million . The 8.1% comparable sales increase included a 5.3% increase in transactions and a 2.8% increase in average ticket. We attribute the increase in comparable sales to our successful marketing and merchandising strategies.
Gross profit
Gross profit increased$312.5 million , or 14.9%, to$2,409.3 million in fiscal 2018, compared to$2,096.8 million in fiscal 2017. Gross profit as a percentage of net sales increased 30 basis points to 35.9% in fiscal 2018 compared to 35.6% in fiscal 2017. The impact of new revenue recognition accounting drove 55 basis points of leverage. The remaining 25 basis points of deleverage in gross profit margin was primarily due to:
55 basis points deleverage attributed to category and channel mix shifts and
? investments in our salon services and supply chain operation, partially offset
by;
? 30 basis points leverage in fixed store costs attributed to the impact of
higher sales volume.
Selling, general and administrative expenses
SG&A expenses increased$248.2 million , or 19.3%, to$1,535.5 million in fiscal 2018 compared to$1,287.2 million in fiscal 2017. As a percentage of net sales, SG&A expenses increased 100 basis points to 22.9% in fiscal 2018 compared to 21.9% in fiscal 2017. The impact of new revenue recognition accounting drove 80 basis points of deleverage. The remaining 20 basis points of deleverage in SG&A expenses was primarily due to:
? 30 basis points deleverage due to investments in store labor to support growth
initiatives, partially offset by;
? 10 basis points leverage in corporate overhead due to the impact of higher
sales volume. Pre-opening expenses Pre-opening expenses decreased$4.5 million , or 18.6%, to$19.8 million in fiscal 2018 compared to$24.3 million in fiscal 2017. During fiscal 2018, we opened 107 new stores, remodeled 13 stores, and relocated two stores. During fiscal 2017, we opened 102 new stores, remodeled 11 stores, and relocated seven stores. Interest income, net Interest income, net was$5.1 million in fiscal 2018 compared to$1.6 million in fiscal 2017. Interest income results from cash equivalents and short-term investments with maturities of twelve months or less from the date of purchase. Interest expense represents interest on borrowings and fees related to the credit facility. We did not have any outstanding borrowings on our credit facility as ofFebruary 2, 2019 andFebruary 3, 2018 . 34 Table of Contents Income tax expense
Income tax expense of$200.6 million in fiscal 2018 represents an effective tax rate of 23.3%, compared to fiscal 2017 income tax expense of$231.6 million and an effective tax rate of 29.4%. The lower tax rate is primarily due tax reform. Net income
Net income increased$103.3 million , or 18.6%, to$658.6 million in fiscal 2018 compared to$555.2 million in fiscal 2017. The increase in net income was primarily due to a$312.5 million increase in gross profit and a$31.0 million decrease in income tax expense, which was partially offset by a$248.2 million increase in SG&A expenses.
Liquidity and capital resources
Our primary cash needs are for rent, capital expenditures for new, remodeled,
relocated, and refreshed stores (prestige boutiques and related in-store
merchandising upgrades), increased merchandise inventories related to store
expansion and new brand additions, in-store boutiques (sets of custom-designed
fixtures configured to prominently display certain prestige brands within our
stores), supply chain improvements, share repurchases, and continued improvement
in our information technology systems.
Our primary sources of liquidity are cash and cash equivalents, short-term
investments, cash flows from operations, including changes in working capital,
and borrowings under our credit facility. The most significant component of our
working capital is merchandise inventories and cash and cash equivalents reduced
by related accounts payable and accrued expenses.
Our working capital needs are greatest from August through November each year as
a result of our inventory build-up during this period for the approaching
holiday season. This is also the time of year when we are at maximum investment
levels in our new store class and may not have collected all of the landlord
allowances due to us as part of our lease agreements. Based on past performance
and current expectations, we believe that cash and cash equivalents, short-term
investments, cash generated from operations, and borrowings under the credit
facility will satisfy the Company's working capital needs, capital expenditure
needs, commitments, and other liquidity requirements through at least the next
twelve months.
The following table presents a summary of our cash flows for fiscal years 2019,
2018, and 2017:
Fiscal year ended
February 1, February 2, February 3,(In thousands) 2020 2019 2018 Net cash provided by operating activities$ 1,101,293 $ 956,127 $ 779,366 Net cash used in investing activities (471,480) (215,107) (530,714) Net cash used in financing activities (646,739) (609,214) (356,217) Net increase (decrease) in cash and cash equivalents$ (16,926) $
131,806$ (107,565) Operating activities Operating activities consist of net income adjusted for certain non-cash items, including depreciation and amortization, non-cash lease expense, deferred income taxes, stock-based compensation, realized gains or losses on disposal of property and equipment, and the effect of working capital changes. The fiscal 2019 increase over fiscal 2018 is mainly due to the increase in net income, merchandise inventories, other assets and liabilities, and the timing of prepaid expenses and other assets, partially offset by the timing of accounts payable. The increase in net income was due to an increase in gross profit due to sales increases and improvements in merchandise margins, partially offset by increased SG&A expenses due to investments in future growth. Changes in other assets and liabilities was primarily due to increased participation in our deferred compensation plan. Merchandise inventories, net were$1,293.7 million atFebruary 1, 2020 , compared to$1,214.3 million atFebruary 2, 2019 , representing an increase of$79.4 million or 6.5%. 35
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Average inventory per store (defined as merchandise inventory divided by number of stores open) was flat compared to prior year. The increase in inventory is primarily due to the addition on 80 net new stores opened sinceFebruary 2, 2019 .
Investing activities
We have historically used cash primarily for new, remodeled, relocated, and refreshed stores, supply chain investments, short-term investments, and investments in information technology systems. Investment activities for capital expenditures were$298.5 million in fiscal 2019 compared to$319.4 million and$440.7 million in fiscal 2018 and 2017, respectively. Capital expenditures decreased in fiscal 2019 compared to fiscal 2018 primarily from lower merchandising fixtures due to less spend on store refreshes and a decrease in the number of store openings, offset by increases in store maintenance and other due to corporate office renovations. Purchases of short-term investments were$110.0 million during fiscal 2019 and consist of certificates of deposit with maturities of three to twelve months from the date of purchase. The following table presents a summary of our store activities in fiscal years 2019, 2018, and 2017: Fiscal Fiscal Fiscal 2019 2018 2017 Stores opened 86 107 102 Stores remodeled 12 13 11 Stores relocated 8 2 7 Stores refreshed 240 109 190 During fiscal 2019, the average investment required to open a new Ulta Beauty store was approximately$1.3 million , which includes capital investment net of landlord contributions, pre-opening expenses, and initial inventory net of payables. The average investment required to remodel an Ulta Beauty store was approximately$0.9 million in fiscal 2019. The average investment required to refresh an Ulta Beauty store was approximately$0.1 million in fiscal 2019. Capital expenditures for fiscal 2019, 2018, and 2017 by major category are as follows: Fiscal Fiscal Fiscal (In millions) 2019 2018 2017
New, Remodeled, and Relocated Stores
29 63 87
Information Technology Systems 54 51 74
Supply Chain 17 22 42
Store Maintenance and Other 58 29 48
Total $ 299 $ 319 $ 441
Our future investments will depend primarily on the number of new, remodeled,
and relocated stores, information technology systems, and supply chain
investments that we undertake and the timing of these expenditures. Based on
past performance and current expectations, we believe our sources of liquidity
will be sufficient to fund future capital expenditures.
Financing activities
Financing activities in fiscal 2019, 2018, and 2017 consist principally of share
repurchases and capital stock transactions. Purchases of treasury shares
represent the fair value of common shares repurchased from plan participants in
connection with shares withheld to satisfy minimum statutory tax obligations
upon the vesting of restricted stock.
We had no borrowings outstanding under our credit facility at the end of fiscal
2019, 2018, and 2017. The zero outstanding borrowings position is due to a
combination of factors including strong sales growth, overall performance of
management initiatives including expense control as well as inventory and other
working capital reductions. We may
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require borrowings under the facility from time to time in future periods for unexpected business disruptions, to support our new store program, share repurchases, and seasonal inventory needs. As a precautionary measure and to enhance financial flexibility in light of the uncertainty arising from the spread of COVID-19, onMarch 23, 2020 , the Company announced that it drew down$800 million under the amended Loan Agreement.
Share repurchase plan
OnMarch 9, 2017 , we announced that the Board of Directors authorized a share repurchase program (the 2017 Share Repurchase Program) pursuant to which the Company could repurchase up to$425.0 million of the Company's common stock. The 2017 Share Repurchase Program authorization revoked the previously authorized but unused amount of$79.9 million from the earlier share repurchase program. The 2017 Share Repurchase Program did not have an expiration date but provided for suspension or discontinuation at any time. OnMarch 15, 2018 , we announced that the Board of Directors authorized a share repurchase program (the 2018 Share Repurchase Program) pursuant to which the Company could repurchase up to$625.0 million of the Company's common stock. The 2018 Share Repurchase Program authorization revoked the previously authorized but unused amount of$41.3 million from the 2017 Share Repurchase Program. The 2018 Share Repurchase Program did not have an expiration date but provided for suspension or discontinuation at any time. OnMarch 14, 2019 , we announced that the Board of Directors authorized a new share repurchase program (the 2019 Share Repurchase Program) pursuant to which the Company could repurchase up to$875.0 million of the Company's common stock. The 2019 Share Repurchase Program authorization revoked the previously authorized but unused amount of$25.4 million from the 2018 Share Repurchase Program. The 2019 Share Repurchase Program did not have an expiration date but provided for suspension or discontinuation at any time. A summary of the Company's common stock repurchase activity is presented in the following table: Fiscal Fiscal Fiscal (Dollars in millions) 2019 2018 2017 Shares repurchased 2,320,896 2,463,555 1,503,545
Total cost of shares repurchased
OnMarch 12, 2020 , we announced that the Board of Directors authorized a new share repurchase program (the 2020 Share Repurchase Program) pursuant to which the Company may repurchase up to$1.6 billion of the Company's common stock. The 2020 Share Repurchase Program authorization revokes the previously authorized but unused amounts of$214.6 million from the 2019 Share Repurchase Program. The 2020 Share Repurchase Program does not have an expiration date and may be suspended or discontinued at any time.
Credit facility
OnAugust 23, 2017 , we entered into a Second Amended and Restated Loan Agreement (the Loan Agreement) withWells Fargo Bank, National Association , as Administrative Agent, Collateral Agent and a Lender thereunder;Wells Fargo Bank, National Association andJPMorgan Chase Bank, N.A ., as Lead Arrangers and Bookrunners;JPMorgan Chase Bank, N.A ., as Syndication Agent and a Lender;PNC Bank, National Association , as Documentation Agent and a Lender; and the other lenders party thereto. The Loan Agreement matures onAugust 23, 2022 , provides maximum revolving loans equal to the lesser of$400.0 million or a percentage of eligible owned inventory (which borrowing base may, at the election of the Company and satisfaction of certain conditions, include a percentage of eligible owned receivables and qualified cash), contains a$20.0 million subfacility for letters of credit and allows the Company to increase the revolving facility by an additional$50.0 million , subject to the consent by each lender and other conditions. The Loan Agreement contains a requirement to maintain a fixed charge coverage ratio of not less than 1.0 to 1.0 during such periods when availability under the Loan Agreement falls below a specified threshold. Substantially all of the Company's assets are pledged as collateral for outstanding borrowings under the Loan Agreement. Outstanding borrowings will bear interest at either a base rate or the LIBOR plus 1.25%, and the unused line fee is 0.20% per annum. 37
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As ofFebruary 1, 2020 andFebruary 2, 2019 , we had no borrowings outstanding under the credit facility and the Company was in compliance with all terms and covenants of the Loan Agreement. OnMarch 11, 2020 , the Company entered into Amendment No. 1 to the Loan Agreement, which amended the existing agreement. The amendment extends the maturity of the facility toMarch 11, 2025 , provides maximum revolving loans equal to the lesser of$1.0 billion or a percentage of eligible owned inventory and receivables, contains a$50 million sub-facility for letters of credit and allows the Company to increase the revolving facility by an additional$100 million . As a precautionary measure and to enhance financial flexibility in light of the uncertainty arising from the spread of COVID-19, onMarch 23, 2020 , the Company announced that it drew down$800 million under the amended Loan Agreement.
Seasonality
Our business is subject to seasonal fluctuation. Significant portions of our net sales and profits are realized during the fourth quarter of the fiscal year due to the holiday selling season. To a lesser extent, our business is also affected byMother's Day andValentine's Day season. Any decrease in sales during these higher sales volume periods could have an adverse effect on our business, financial condition, or operating results for the entire fiscal year. Our quarterly results of operations have varied in the past and are likely to do so again in the future. As such, we believe that period-to-period comparisons of our results of operations should not be relied upon as an indication of our future performance.
Impact of inflation and changing prices
Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and SG&A expenses as a percentage of net sales if the selling prices of our products do not increase with these increased costs. In addition, inflation could materially increase the interest rates on any future debt.
Off-balance sheet arrangements
As of
Contractual obligations
The following table summarizes our contractual arrangements and the timing and
effect that such commitments are expected to have on our liquidity and cash
flows in future periods. The table below includes obligations for executed
agreements for which we do not yet have the right to control the use of the
property as of
Less Than 1 to 3 3 to 5 More than 5
(In thousands) Total 1 Year Years Years YearsOperating lease obligations (1)$ 2,250,191 $ 310,663 $ 672,880 $ 550,132 $ 716,516 Purchase obligations 35,006 32,316 2,690
- -
Total (2) $ 2,285,197 $ 342,979 $ 675,570 $ 550,132 $ 716,516 These amounts are for our undiscounted lease obligations recorded in our (1) consolidated balance sheets, as operating lease liabilities. For additional
information about our leases, see Note 8 to our consolidated financial
statements, "Leases."
The unrecognized tax benefit of
related future cash flows, if any.
Purchase obligations reflect legally binding agreements entered into by the Company to purchase goods or services. Excluded from our purchase obligations are normal purchases and contracts entered into in the ordinary course of
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business. The amount of purchase obligations relates to commitments made to a
third party for products and services for the new fast fulfillment center
expected to open in fiscal 2021, advertising, and other goods and service
contracts entered into as of
Critical accounting policies and estimates
Management's discussion and analysis of financial condition and results of operations is based upon our financial statements, which have been prepared in accordance withU.S. generally accepted accounting principles (GAAP). The preparation of these financial statements required the use of estimates and judgments that affect the reported amounts of our assets, liabilities, revenues, and expenses. Management bases estimates on historical experience and other assumptions it believes to be reasonable under the circumstances and evaluates these estimates on an on-going basis. Actual results may differ from these estimates. A discussion of our more significant estimates follows. Management has discussed the development, selection, and disclosure of these estimates and assumptions with the Audit Committee of the Board of Directors.
Inventory valuation
Merchandise inventories are carried at the lower of cost or market (net realizable value). Cost is determined using the moving average cost method and includes costs incurred to purchase and distribute goods as well as related vendor allowances including co-op advertising, markdowns, and volume discounts. We record valuation adjustments to our inventories if the cost of a specific product on hand exceeds the amount we expect to realize from the ultimate sale or disposal of the inventory. These estimates are based on management's judgment regarding future demand, age of inventory, and analysis of historical experience. If actual demand or market conditions are different than those projected by management, future merchandise margin rates may be unfavorably or favorably affected by adjustments to these estimates. Inventories are adjusted for the results of periodic physical inventory counts at each of our locations. We record a shrink reserve representing management's estimate of inventory losses by location that have occurred since the date of the last physical count. This estimate is based on management's analysis of historical results and operating trends. We do not believe that there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our inventory reserves. Adjustments to earnings resulting from revisions to management's estimates of the inventory reserves have been insignificant during fiscal 2019, 2018, and 2017. An increase or decrease in the lower of cost or market (net realizable value) reserve of 10% would not have a material impact on our pre-tax income for fiscal 2019. An increase or decrease in the shrink rate included in the shrink reserve calculation of 10% would not have a material impact on our pre-tax income for fiscal 2019.
Vendor allowances
The majority of cash consideration received from a vendor is considered to be a reduction of the cost of the related products and is reflected in cost of sales in our consolidated statements of income as the related products are sold unless it is in exchange for an asset or service or a reimbursement of a specific, incremental, identifiable cost incurred by the Company in selling the vendors' products. We estimate the amount recorded as a reduction of inventory at the end of each period based on a detailed analysis of inventory turns and management's analysis of the facts and circumstances of the various contractual agreements with vendors. We record cash consideration expected to be received from vendors in receivables. We do not believe there is a reasonable likelihood there will be a material change in the future estimates or assumptions we use to calculate our reduction of inventory. An increase or decrease in inventory turns of five basis points would not have a material impact on our pre-tax income for fiscal 2019.
Impairment of long-lived tangible assets
We review long-lived tangible assets whenever events or circumstances indicate
these assets might not be recoverable. Assets are primarily reviewed at the
store level, which is the lowest level for which cash flows can be identified.
Significant estimates are used in determining future operating results of each
store over its remaining lease term. An
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impairment loss would be recorded if the carrying amount of the long-lived asset exceeds its fair value. We do not believe that there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our impairment charges. No significant impairment charges were recognized in fiscal 2019, fiscal 2018, or fiscal 2017.
Loyalty program
We maintain a customer loyalty program, Ultamate Rewards, which allows members to earn points based on purchases of merchandise or services. Points earned are valid for at least one year. The loyalty program represents a material right to the customer and points may be redeemed on future products and services. Revenue from the loyalty program is recognized when the members redeem points or points expire. We defer revenue related to points earned that have not yet been redeemed. The amount of deferred revenue includes estimates for the standalone selling price of points earned by members and the percentage of points expected to be redeemed. The expected redemption percentage is based on historical redemption patterns and considers current information or trends. The estimated redemption rate is evaluated each reporting period. We do not believe that there is a reasonable likelihood there will be a material change in the future estimates or assumptions used to calculate the estimated redemption rate. Adjustments to earnings resulting from revisions to management's estimates of the redemption rates have been insignificant during fiscal 2019, 2018, and 2017. An increase or decrease in the estimated redemption rate of 5% would not have a material impact on our pre-tax income in fiscal 2019.
Income taxes
We are subject to income taxes inthe United States . Judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We recognize deferred income taxes for the estimated future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are anticipated to be recovered or settled. The effect on deferred taxes of a change in income tax rates is recognized in the consolidated statements of income in the period of enactment. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets to the amount expected to be realized unless it is more-likely-than-not that such assets will be realized in full. The estimated tax benefit of an uncertain tax position is recorded in our consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax position will withstand challenge, if any, from applicable taxing authorities. Judgment is required in assessing the future tax consequences of events that have been recognized on our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements.
Recent accounting pronouncements not yet adopted
See Note 2 to our consolidated financial statements, "Summary of significant accounting policies - Recent accounting pronouncements not yet adopted."
Recently adopted accounting pronouncements
See Note 2 to our consolidated financial statements, "Summary of significant accounting policies - Recently adopted accounting pronouncements."
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