Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 quarterly report. This discussion contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, which reflect our current views with respect to, among other things, future events and financial performance. You can identify these forward-looking statements by the use of forward-looking words such as “outlook,” “believes,” “expects,” “plans,” “estimates,” “targets,” “strategies,” or other comparable words. Any forward-looking statements contained in this Form 10-Q are based upon our historical performance and on current plans, estimates, and expectations. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future plans, estimates, targets, strategies, or expectations
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contemplated by us will be achieved. Such forward-looking statements are subject to various risks and uncertainties, which include, without limitation:
● the negative impacts the coronavirus (COVID-19) has had, and will continue to have, on our business, financial condition, profitability, cash flows, and supply chain, as well as consumer spending (including future uncertain impacts);
● epidemics, pandemics like COVID-19 or natural disasters that have and could continue to negatively impact sales;
● changes in the overall level of consumer spending and volatility in the economy, including as a result of the COVID-19 pandemic;
● a decline in operating results that has and may continue to lead to asset impairment and store closures charges;
● our ability to sustain our growth plans and successfully implement our long-range strategic and financial plan;
● our ability to gauge beauty trends and react to changing consumer preferences in a timely manner;
● the possibility that we may be unable to compete effectively in our highly competitive markets;
● our ability to execute our Efficiencies for Growth cost optimization program;
● the possibility that cybersecurity breaches and other disruptions could compromise our information or result in the unauthorized disclosure of confidential information;
● the possibility of material disruptions to our information systems;
● the possibility that the capacity of our distribution and order fulfillment infrastructure and the performance of our newly opened and to be opened distribution centers may not be adequate to support our recent growth and expected future growth plans;
● changes in the wholesale cost of our products;
● the possibility that new store openings and existing locations may be impacted by developer or co-tenant issues;
● our ability to attract and retain key executive personnel;
● our ability to successfully execute our common stock repurchase program or implement future common stock repurchase programs; and
● other risk factors detailed in our public filings with the Securities and Exchange Commission (the SEC), including risk factors contained in Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended February 1, 2020, as such were amended and supplemented in Part II, Item 1A, “Risk Factors” of our Quarterly Report on Form 10-Q for the fiscal quarter ended May 2, 2020, and which may be further amended or supplemented in our subsequently filed Quarterly Reports on Form 10-Q (including this report).
Except to the extent required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
References in the following discussion to “we,” “us,” “our,” “Ulta Beauty,” the “Company,” and similar references mean Ulta Beauty, Inc. and its consolidated subsidiaries, unless otherwise expressly stated or the context otherwise requires.
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 believe our strategy provides us with the competitive advantages that have contributed to our financial performance.
We are the largest beauty retailer in the 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
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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) deepen Ulta 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. Over the long term, we believe that the expansion of the U.S. beauty products and salon services industry, the shift in distribution channel of prestige beauty products from department stores to specialty retail stores, coupled with Ulta Beauty’s competitive strengths, positions us to capture additional market share in the industry.
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 general U.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. Long term 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 the U.S. with successful e-commerce and competitive omnichannel capabilities.
COVID-19 Response
We have been and continue to closely monitor the impact of the COVID-19 outbreak on all facets of our business. We have taken decisive actions to protect the safety of our associates and guests and to manage the business through the fluid and challenging environment resulting from the COVID-19 pandemic.
In late 2019, COVID-19 was detected in Wuhan, 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 the U.S., and in March 2020, the World Health Organization declared COVID-19 a global pandemic. Federal, state, and local governments 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, on March 19, 2020 we temporarily closed all stores across the U.S., while continuing to support our essential e-commerce operations. Effective April 19, 2020, we temporarily furloughed many of our store and salon associates and introduced curbside pickup. Throughout the second quarter, stores were reopened on a phased timeline, by taking a thoughtful, measured approach based on a variety of criteria, including state and local guidelines and the adoption of our new Shop Safe Standards related safety protocols. As of July 20, 2020, we completed our phased reopening process. By October 31, 2020, salon and brow services had resumed in almost all stores. Reflecting operational limitations related to COVID-19 and the partial resumption of services, the Company has reactivated more than half of the furloughed associates.
Our results of operations for the 13 and 39 weeks ended October 31, 2020, were significantly impacted by the effects of COVID-19. Comparable sales decreased 8.9% and 23.8% for the 13 and 39 weeks ended October 31, 2020, respectively, as a result of the COVID-19 pandemic, but the multi-year, strategic investments we have made to enhance our omnichannel and supply chain capabilities, combined with the ongoing commitment of our distribution associates, have enabled us to support increased e-commerce demand and guest engagement. In addition to decreases in net revenue, our overall profitability also decreased as compared to the prior year. These developments have further required us to recognize certain long-lived asset impairment charges and restructuring charges. Further, in connection with the Coronavirus Aid, Relief, and Economic Security (CARES) Act, we recognized payroll subsidies as a reduction of selling, general and administrative expenses in the consolidated statement of operations.
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As we navigate these unprecedented circumstances, we continue to focus on our financial flexibility, including drawing down $800.0 million under our $1.0 billion revolving credit facility on March 18, 2020, which was repaid in full on September 2, 2020. In addition, since the onset of the COVID-19 pandemic, we have taken the following steps to preserve financial liquidity:
● limited new hires and delayed merit increases for all corporate, store, and salon associates;
● reduced marketing, travel and controllable expenses;
● aligned inventory receipts with current sales trends;
● prioritized payment obligations;
● reduced new store openings, relocations and remodel projects; and
● suspended our stock repurchase program, which may be resumed in the fourth quarter of fiscal 2020.
To help support our associates through this crisis, we expanded the criteria for our Associate Relief Program to include those who need assistance due to a personal hardship as a result of COVID-19. The Ulta Beauty executive team and Board of Directors have each made personal donations to the program.
While sales are expected to be challenged as events continue to change, 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 potential temporary reclosing of certain of our stores, the potential temporary restrictions on certain store operating hours and/or in-store capacity, the duration of potential future quarantines, shelter-in-place and other travel restrictions within the U.S. and other affected countries, the severity of the virus, the duration and spread of the virus, the duration, timing and severity of the impact on consumer spending, how quickly and to what extent normal economic and operating conditions can resume, and the public’s response to resurgences of the virus and its eventual aftermath.
Industry trends
Our research indicates that Ulta Beauty has captured meaningful market share across all categories over the last several years. However, our research also suggests that the cosmetics category in the overall U.S. market experienced mid-single digit declines through fiscal 2019 and into 2020. 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. In addition, COVID-19 and its various impacts have changed consumer behavior and consumption of beauty products due to the closures of offices, retail stores and other businesses and the significant decline in social gatherings. 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 over the long term.
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; however, due to store closures during the first half of fiscal 2020, we extended our return policy to 180 days. 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 credit card and co-branded credit card programs, as well as deferred revenue related to the loyalty program and gift card breakage.
Comparable sales reflect sales for stores beginning on the first day of the 14 th 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-
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month grand opening period. Non-comparable store sales include sales from new stores that have not yet completed their 13 th month of operation and stores that were closed for part or all of the period in either year. 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 and salon services (including stores temporarily closed due to COVID-19), 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 new 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.
Impairment, restructuring and other costs include long-lived asset impairment charges, restructuring costs associated with store closings, costs associated with the suspension of our Canadian expansion, and employee related severance costs.
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Pre-opening expenses include non-capital expenditures during the period prior to store opening for new, remodeled, and relocated stores including rent from the control date through store opening date for new and relocated stores, store set-up labor, management and employee training, and grand opening advertising.
Interest expense (income), net includes both interest income and expense. 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. Interest income represents interest from cash equivalents and short-term investments with maturities of twelve months or less from the date of purchase.
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.
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Results of operations
Our quarterly periods are the 13 weeks ending on the Saturday closest to April 30, July 31, October 31, and January 31. The Company’s third quarter in fiscal 2020 and 2019 ended on October 31, 2020 and November 2, 2019, respectively. Our operating results for the 13 and 39 weeks ended October 31, 2020 may not be indicative of the results that may be expected for the fiscal year ending January 30, 2021 because of the COVID-19 pandemic. In addition, 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.
The following table presents the components of our consolidated results of operations for the periods indicated:
13 Weeks Ended
39 Weeks Ended
October 31,
November 2,
October 31,
November 2,
(Dollars in thousands)
2020
2019
2020
2019
Net sales
$
1,552,033
$
1,682,514
$
3,953,252
$
5,092,150
Cost of sales
1,006,514
1,059,081
2,775,121
3,217,971
Gross profit
545,519
623,433
1,178,131
1,874,179
Selling, general and administrative expenses
416,378
449,198
1,068,877
1,245,174
Impairment, restructuring and other costs
23,624
—
83,924
—
Pre-opening expenses
4,240
6,455
12,782
15,667
Operating income
101,277
167,780
12,548
613,338
Interest expense (income), net
1,383
(900)
5,272
(4,617)
Income before income taxes
99,894
168,680
7,276
617,955
Income tax expense
25,096
38,933
2,935
134,729
Net income
$
74,798
$
129,747
$
4,341
$
483,226
Other operating data:
Number of stores end of period
1,262
1,241
1,262
1,241
Comparable sales increase (decrease)
(8.9%)
3.2%
(23.8%)
5.4%
13 Weeks Ended
39 Weeks Ended
October 31,
November 2,
October 31,
November 2,
(Percentage of net sales)
2020
2019
2020
2019
Net sales
100.0%
100.0%
100.0%
100.0%
Cost of sales
64.9%
62.9%
70.2%
63.2%
Gross profit
35.1%
37.1%
29.8%
36.8%
Selling, general and administrative expenses
26.8%
26.7%
27.1%
24.5%
Impairment, restructuring and other costs
1.5%
0.0%
2.1%
0.0%
Pre-opening expenses
0.3%
0.4%
0.3%
0.3%
Operating income
6.5%
10.0%
0.3%
12.0%
Interest expense (income), net
0.1%
(0.1%)
0.1%
(0.1%)
Income before income taxes
6.4%
10.1%
0.2%
12.1%
Income tax expense
1.6%
2.3%
0.1%
2.6%
Net income
4.8%
7.7%
0.1%
9.5%
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Comparison of 13 weeks ended October 31, 2020 to 13 weeks ended November 2, 2019
Net sales
Net sales decreased $130.5 million or 7.8%, to $1.6 billion for the 13 weeks ended October 31, 2020, compared to $1.7 billion for the 13 weeks ended November 2, 2019. The net sales decrease was driven by the negative impacts of the COVID-19 pandemic, including social distancing, reduction of operating hours, limitations on in-store capacity and in some cases, mandated store closures and a decrease of $2.5 million in other revenue. Total comparable sales for the 13 weeks ended October 31, 2020, decreased 8.9% compared to an increase of 3.2% for the 13 weeks ended November 2, 2019. During the 13 weeks ended October 31, 2020, transactions declined 15.4% and average ticket increased 7.6%.
Gross profit
Gross profit decreased $77.9 million or 12.5%, to $545.5 million for the 13 weeks ended October 31, 2020, compared to $623.4 million for the 13 weeks ended November 2, 2019. Gross profit as a percentage of net sales decreased to 35.1% for the 13 weeks ended October 31, 2020, compared to 37.1% for the 13 weeks ended November 2, 2019. The decrease in gross profit margin was primarily due to deleverage of fixed costs due to lower sales and channel mix shifts. These pressures were partially offset by higher merchandise margins primarily due to lower promotional activity.
Selling, general and administrative expenses
Selling, general and administrative (SG&A) expenses decreased $32.8 million or 7.3%, to $416.4 million for the 13 weeks ended October 31, 2020, compared to $449.2 million for the 13 weeks ended November 2, 2019. Lower store payroll and benefits, store expenses, and marketing expenses were partially offset by higher corporate overhead expense and personal protective equipment (PPE) and COVID-related expenses. SG&A expenses as a percentage of net sales increased to 26.8% for the 13 weeks ended October 31, 2020, compared to 26.7% for the 13 weeks ended November 2, 2019, due to lower sales resulting from the impact of COVID-19.
Impairment, restructuring and other costs
Impairment, restructuring and other costs were $23.6 million for the 13 weeks ended October 31, 2020, which consisted of $15.9 million related to the suspension of our planned expansion to Canada. We expect to incur pre-tax costs in the range of $30,000 to $40,000 as a result of the suspension, the majority of which will be recognized in fiscal 2020. The remaining estimated charges primarily relate to lease termination costs. During the 13 weeks ended October 31, 2020, impairment, restructuring and other costs also included $5.7 million of severance charges and $2.0 million of lease terminations costs related to the previously announced permanent closure of 19 stores. There was no impairment, restructuring and other costs for the 13 weeks ended November 2, 2019.
Pre-opening expenses
Pre-opening expenses decreased $2.2 million to $4.2 million for the 13 weeks ended October 31, 2020, compared to $6.5 million for the 13 weeks ended November 2, 2019. During the 13 weeks ended October 31, 2020, we opened 17 new stores and relocated two stores, compared to the 13 weeks ended November 2, 2019, when we opened 31 new stores, remodeled three stores, and relocated two stores.
Interest expense (income), net
Interest expense, net was $1.4 million for the 13 weeks ended October 31, 2020 compared to $0.9 million of interest income for the 13 weeks ended November 2, 2019. Interest expense represents interest on borrowings and fees related to the credit facility. Interest income results from cash equivalents and short-term investments with maturities of twelve months or less from the date of purchase. We did not have any outstanding borrowings on our credit facility as of October 31, 2020 and November 2, 2019.
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Income tax expense
Income tax expense of $25.1 million for the 13 weeks ended October 31, 2020 represents an effective tax rate of 25.1%, compared to $38.9 million of tax expense representing an effective tax rate of 23.1% for the 13 weeks ended November 2, 2019. The higher effective tax rate is primarily due to less investment tax credits received.
Net income
Net income was $74.8 million for the 13 weeks ended October 31, 2020, compared to $129.7 million for the 13 weeks ended November 2, 2019. The decrease in net income is primarily due to the $77.9 million decrease in gross profit partially offset by a decrease in SG&A expenses of $32.8 million and $13.8 million decrease in income taxes. These decreases were partially offset by a $23.6 million increase in impairment, restructuring and other costs.
Comparison of 39 weeks ended October 31, 2020 to 39 weeks ended November 2, 2019
Net sales
Net sales decreased $1.1 billion or 22.4%, to $4.0 billion for the 39 weeks ended October 31, 2020, compared to $5.1 billion for the 39 weeks ended November 2, 2019. The net sales decrease was driven by the negative impacts of the COVID-19 pandemic, including the temporary closing of our brick-and-mortar retail stores, shelter in place orders, social distancing and quarantines, and a decrease of $4.5 million in other revenue. Total comparable sales for the 39 weeks ended October 31, 2020, decreased 23.8% compared to an increase of 5.4% for the 39 weeks ended November 2, 2019. During the 39 weeks ended October 31, 2020, transactions declined 30.1% and average ticket increased 9.0%.
Gross profit
Gross profit decreased $696.0 million or 37.1%, to $1.2 billion for the 39 weeks ended October 31, 2020, compared to $1.9 billion for the 39 weeks ended November 2, 2019. Gross profit as a percentage of net sales decreased to 29.8% for the 39 weeks ended October 31, 2020, compared to 36.8% for the 39 weeks ended November 2, 2019. The decrease in gross profit margin was primarily due to deleverage of fixed costs due to lower sales, channel mix shifts, and deleverage of salon expenses due to lower sales. These pressures were partially offset by lower promotional activity.
Selling, general and administrative expenses
SG&A expenses decreased $176.3 million or 14.2%, to $1.1 billion for the 39 weeks ended October 31, 2020, compared to $1.2 billion for the 39 weeks ended November 2, 2019. SG&A expenses as a percentage of net sales increased to 27.1% for the 39 weeks ended October 31, 2020, compared to 24.5% for the 39 weeks ended November 2, 2019. The increase was primarily due to higher expenses related to strategic growth investments made in 2019, PPE and COVID-related expenses, and the deleverage of store expenses due to lower sales resulting from the impact of COVID-19, partially offset by leverage related to the store payroll and benefits, including the employee retention credits made available under the CARES Act.
Impairment, restructuring and other costs
Impairment, restructuring and other costs were $83.9 million for the 39 weeks ended October 31, 2020, which consisted of $40.4 million due to the impairment of tangible long-lived assets and operating lease assets associated with certain retail stores, $21.9 million related to the permanent closure of 19 stores, and $5.7 million of severance charges. During the 39 weeks ended October 31, 2020, impairment, restructuring and other costs also included $15.9 million related to the suspension of our planned expansion to Canada. We expect to incur pre-tax costs in the range of $30,000 to $40,000 as a result of the suspension, the majority of which will be recognized in fiscal 2020. The remaining estimated charges primarily relate to lease termination costs. There was no impairment, restructuring and other costs for the 39 weeks ended November 2, 2019.
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Pre-opening expenses
Pre-opening expenses decreased $2.9 million to $12.8 million for the 39 weeks ended October 31, 2020, compared to $15.7 million for the 39 weeks ended November 2, 2019. During the 39 weeks ended October 31, 2020, we opened 28 new stores and relocated three stores, compared to the 39 weeks ended November 2, 2019, when we opened 73 new stores, remodeled 12 stores, and relocated six stores.
Interest expense (income), net
Interest expense, net was $5.3 million for the 39 weeks ended October 31, 2020 compared to $4.6 million of interest income, net for the 39 weeks ended November 2, 2019. Interest expense represents interest on borrowings and fees related to the credit facility. Interest income results from cash equivalents and short-term investments with maturities of twelve months or less from the date of purchase. We did not have any outstanding borrowings on our credit facility as of October 31, 2020 and November 2, 2019.
Income tax expense
Income tax expense of $2.9 million for the 39 weeks ended October 31, 2020 represents an effective tax rate of 40.3%, compared to $134.7 million of tax expense representing an effective tax rate of 21.8% for the 39 weeks ended November 2, 2019. The higher effective tax rate is primarily due to a near break-even pre-tax operating income in fiscal 2020, less investment tax credits received, and tax expense from the income tax accounting for share-based compensation compared to a tax benefit in fiscal 2019.
Net income
Net income was $4.3 million for the 39 weeks ended October 31, 2020, compared to $483.2 million for the 39 weeks ended November 2, 2019. The decrease in net income is primarily due to the $696.0 million decrease in gross profit partially offset by a $176.3 million decrease in SG&A expenses and $131.8 million decrease to income taxes. These decreases were partially offset by an $83.9 million increase in impairment, restructuring and other costs.
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. As of October 31, 2020, February 1, 2020, and November 2, 2019, we had cash and cash equivalents and short-term investments of $560.9 million, $502.3 million, and $208.8 million, respectively. As part of our response to the continued spread of COVID-19 and to improve our financial flexibility, we drew down $800.0 million under our $1.0 billion revolving credit facility on March 18, 2020. On September 2, 2020, we repaid the $800 million of borrowing that was outstanding under the facility.
The most significant components of our working capital are 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.
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The following table presents a summary of our cash flows for the periods indicated:
39 Weeks Ended
October 31,
November 2,
(In thousands)
2020
2019
Net cash provided by operating activities
$
259,045
$
557,506
Net cash used in investing activities
(13,630)
(284,893)
Net cash used in financing activities
(76,752)
(473,021)
Effect of exchange rate changes on cash and cash equivalents
(86)
—
Net increase (decrease) in cash and cash equivalents
$
168,577
$
(200,408)
Operating activities
Operating activities consist of net income adjusted for certain non-cash items, including depreciation and amortization, non-cash lease expense, long-lived asset impairment charge, deferred income taxes, stock-based compensation expense, realized gains or losses on disposal of property and equipment, and the effect of working capital changes. The decrease over the prior period is mainly due to the decrease in net income, merchandise inventories, and the timing of accounts payable. The decrease in net income was primarily due to a decrease in gross profit resulting from lower sales as a result of the COVID-19 pandemic and an increase in impairment, restructuring and other costs, partially offset by a decrease in SG&A expenses and income taxes.
Merchandise inventories, net were $1.4 billion at October 31, 2020, compared to $1.6 billion at November 2, 2019, representing a decrease of $177.8 million or 11.0%. The decrease in total inventory was primarily driven by the decline in sales due to COVID-19 and lower holiday receipts, partially offset by an increase due to 21 net new stores opened since November 2, 2019 and the opening of our Jacksonville, FL fast fulfillment center. Average inventory per store was down 12.5% compared to prior year.
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 $116.7 million during the 39 weeks ended October 31, 2020, compared to $241.1 million during the 39 weeks ended November 2, 2019. During the 39 weeks ended October 31, 2020, we contributed $5.7 million to equity method investments.
Our future investments will depend primarily on the number of new, remodeled, and relocated stores, information technology systems, and supply chain investments we undertake and the timing of these expenditures. In light of the pandemic, we reduced our capital expenditure plan for fiscal 2020, and anticipate capital expenditures will be between $150 million and $160 million.
Financing activities
Financing activities consist principally of borrowings on our revolving credit facility, 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. As of October 31, 2020, February 1, 2020, and November 2, 2019, we had no borrowings outstanding under our credit facility.
Share repurchase plan
On March 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 earlier share repurchase program. The 2018 Share Repurchase Program did not have an expiration date but provided for suspension or discontinuation at any time.
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On March 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.
On March 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 revoked the previously authorized but unused amounts of $165.3 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. On April 2, 2020, we announced that the share repurchase program had been suspended in order to strengthen our liquidity and preserve cash in the early stages of the COVID-19 pandemic. While no shares were repurchased in the third quarter, the Company may resume its stock repurchase program in the fourth quarter of fiscal 2020.
A summary of the Company’s common stock repurchase activity is presented in the following table:
39 Weeks Ended
(Dollars in millions)
October 31,
2020
November 2,
2019
Shares repurchased
326,970
1,639,438
Total cost of shares repurchased
$
73.0
$
506.9
Credit facility
On March 11, 2020, we entered into Amendment No. 1 to the Second Amended and Restated Loan Agreement (as so amended, the Loan Agreement) with Wells Fargo Bank, National Association, as Administrative Agent, Collateral Agent and a Lender thereunder; Wells Fargo Bank, National Association and JPMorgan 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 on March 11, 2025, provides maximum revolving loans equal to the lesser of $1.0 billion or a percentage of eligible owned inventory and eligible owned receivables (which borrowing base may, at the election of the Company and satisfaction of certain conditions, include a percentage of qualified cash), contains a $50.0 million subfacility for letters of credit and allows the Company to increase the revolving facility by an additional $100.0 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 bear interest, at the Company’s election, at either a base rate plus a margin of 0% to 0.125% or the London Interbank Offered Rate plus a margin of 1.125% to 1.250%, with such margins based on the Company’s borrowing availability, and the unused line fee is 0.20% per annum.
As of October 31, 2020, February 1, 2020, and November 2, 2019, we had no borrowings outstanding under the credit facility. As of October 31, 2020, the weighted average interest rate was 1.56% and we were in compliance with all terms and covenants of the 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 by Mother’s Day and Valentine’s Day. 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.
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Off-balance sheet arrangements
As of October 31, 2020, we have not entered into any “off-balance sheet” arrangements, as that term is described by the SEC. We do, however, have off-balance sheet purchase obligations incurred in the ordinary course of business.
Contractual obligations
Our contractual obligations consist of operating lease obligations, purchase obligations, and our revolving line of credit. During the 39 weeks ended October 31, 2020, we drew down and repaid $800 million of borrowing under the facility.
Critical accounting policies and estimates
Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated 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. There have been no significant changes to the critical accounting policies and estimates included in our Annual Report on Form 10-K for the fiscal year ended February 1, 2020.
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.”
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.