Quarterly Report (10-q)

Date : 08/29/2019 @ 8:28PM
Source : Edgar (US Regulatory)
Stock : Ulta Beauty Inc (ULTA)
Quote : 262.62  26.6 (11.27%) @ 8:49PM

Quarterly Report (10-q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended August 3, 2019

or

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from _____________ to _____________

Commission File Number: 001-33764

ULTA BEAUTY, INC.

(Exact name of Registrant as specified in its charter)


incorporation or organization)


Identification No.)

Delaware

(State or other jurisdiction of
incorporation or organization)

38-4022268

(I.R.S. Employer
Identification No.)

1000 Remington Blvd., Suite 120

Bolingbrook, Illinois

(Address of principal executive offices)

60440

(Zip code)

Registrant’s telephone number, including area code: (630) 410-4800

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol

Name of each exchange on which registered

Common Stock, par value $0.01 per share

ULTA

The NASDAQ Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer      Accelerated filer      Non-accelerated filer      Smaller reporting company       Emerging growth company 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  No

The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding as of August 26, 2019 was 58,848,950 shares.

ULTA BEAUTY, INC.

TABLE OF CONTENTS

Part I - Financial Information

Item 1.    Financial Statements

Consolidated Balance Sheets

3

Consolidated Statements of Income

4

Consolidated Statements of Cash Flows

5

Consolidated Statements of Stockholders’ Equity

6

Notes to Consolidated Financial Statements

7

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

Item 3.    Quantitative and Qualitative Disclosures about Market Risk

25

Item 4.    Controls and Procedures

26

Part II - Other Information

26

Item 1.    Legal Proceedings

26

Item 1A. Risk Factors

26

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

26

Item 3.    Defaults Upon Senior Securities

27

Item 4.    Mine Safety Disclosures

27

Item 5.    Other Information

27

Item 6.    Exhibits

28

SIGNATURES

29

2

Part I - Financial Information

Item 1.Financial Statements

Ulta Beauty, Inc.

Consolidated Balance Sheets

August 3,

February 2,

August 4,

(In thousands, except per share data)

    

2019

    

2019

    

2018

Assets

(Unaudited)

(Unaudited)

Current assets:

Cash and cash equivalents

$

177,398

$

409,251

$

237,107

Short-term investments

150,000

149,000

Receivables, net

107,263

136,168

103,666

Merchandise inventories, net

1,315,999

1,214,329

1,219,685

Prepaid expenses and other current assets

131,171

138,116

103,618

Prepaid income taxes

38,769

16,997

17,082

Total current assets

1,920,600

1,914,861

1,830,158

Property and equipment, net

1,219,948

1,226,029

1,212,978

Operating lease assets

1,499,556

Goodwill

10,870

10,870

Other intangible assets, net

3,854

4,317

Deferred compensation plan assets

24,665

20,511

19,585

Other long-term assets

30,882

14,584

10,628

Total assets

$

4,710,375

$

3,191,172

$

3,073,349

Liabilities and stockholders’ equity

Current liabilities:

Accounts payable

$

450,117

$

404,016

$

409,849

Accrued liabilities

224,202

220,666

202,999

Deferred revenue

182,354

199,054

145,907

Current operating lease liabilities

208,261

Total current liabilities

1,064,934

823,736

758,755

Non-current operating lease liabilities

1,683,743

Deferred rent

434,980

422,455

Deferred income taxes

86,598

83,864

49,700

Other long-term liabilities

35,649

28,374

29,961

Total liabilities

2,870,924

1,370,954

1,260,871

Commitments and contingencies (Note 7)

Stockholders' equity:

Common stock, $0.01 par value, 400,000 shares authorized; 58,485, 59,232, and 60,518 shares issued; 57,810, 58,584, and 59,872 share outstanding; at August 3, 2019 (unaudited), February 2, 2019, and August 4, 2018 (unaudited), respectively

585

592

605

Treasury stock-common, at cost

(34,180)

(24,908)

(24,413)

Additional paid-in capital

794,368

738,671

720,535

Retained earnings

1,078,678

1,105,863

1,115,751

Total stockholders’ equity

1,839,451

1,820,218

1,812,478

Total liabilities and stockholders’ equity

$

4,710,375

$

3,191,172

$

3,073,349

See accompanying notes to consolidated financial statements.

3

Ulta Beauty, Inc.

Consolidated Statements of Income

(Unaudited)

13 Weeks Ended

26 Weeks Ended

August 3,

August 4,

August 3,

August 4,

(In thousands, except per share data)

    

2019

2018

2019

2018

Net sales

$

1,666,607

$

1,488,221

$

3,409,636

$

3,031,888

Cost of sales

1,060,708

952,760

2,158,890

1,935,714

Gross profit

605,899

535,461

1,250,746

1,096,174

Selling, general and administrative expenses

392,843

337,142

795,976

682,766

Pre-opening expenses

5,038

4,504

9,212

9,751

Operating income

208,018

193,815

445,558

403,657

Interest income, net

(1,671)

(1,143)

(3,717)

(2,468)

Income before income taxes

209,689

194,958

449,275

406,125

Income tax expense

48,431

46,635

95,796

93,406

Net income

$

161,258

$

148,323

$

353,479

$

312,719

Net income per common share:

Basic

$

2.77

$

2.47

$

6.05

$

5.18

Diluted

$

2.76

$

2.46

$

6.02

$

5.16

Weighted average common shares outstanding:

Basic

58,171

60,070

58,401

60,340

Diluted

58,446

60,375

58,718

60,630

See accompanying notes to consolidated financial statements.

4

Ulta Beauty, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

26 Weeks Ended

August 3,

August 4,

(In thousands)

    

2019

    

2018

Operating activities

Net income

$

353,479

$

312,719

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

144,951

137,815

Non-cash lease expense

152,134

Deferred income taxes

2,734

612

Stock-based compensation expense

12,766

13,172

Loss on disposal of property and equipment

3,215

499

Change in operating assets and liabilities:

Receivables

11,437

(3,947)

Merchandise inventories

(101,670)

(123,261)

Prepaid expenses and other current assets

(18,315)

(4,952)

Income taxes

(21,772)

(29,694)

Accounts payable

46,101

84,091

Accrued liabilities

(2,629)

(6,572)

Deferred revenue

(16,700)

(6,577)

Operating lease liabilities

(138,557)

Deferred rent

14,539

Other assets and liabilities

20,162

(441)

Net cash provided by operating activities

447,336

388,003

Investing activities

Purchases of short-term investments

(245,000)

(558,163)

Proceeds from short-term investments

95,000

529,163

Purchases of property and equipment

(151,213)

(141,691)

Purchases of equity investments

(33,339)

Net cash used in investing activities

(334,552)

(170,691)

Financing activities

Repurchase of common shares

(378,300)

(260,452)

Stock options exercised

42,935

8,448

Purchase of treasury shares

(9,272)

(5,646)

Net cash used in financing activities

(344,637)

(257,650)

Net decrease in cash and cash equivalents

(231,853)

(40,338)

Cash and cash equivalents at beginning of period

409,251

277,445

Cash and cash equivalents at end of period

$

177,398

$

237,107

Supplemental cash flow information

Cash paid for income taxes (net of refunds)

    

$

97,024

$

121,914

Non-cash investing activities:

Change in property and equipment included in accrued liabilities

$

7,625

$

19,453

See accompanying notes to consolidated financial statements.

5

Ulta Beauty, Inc.

Consolidated Statements of Stockholders’ Equity

(Unaudited)

Treasury -

Common Stock

Common Stock

Additional

Total

Issued

Treasury

Paid-In

Retained

Stockholders'

(In thousands)

    

Shares

    

Amount

    

Shares

    

Amount

    

Capital

    

Earnings

    

Equity

Balance – February 3, 2018

61,441

$

614

(619)

$

(18,767)

$

698,917

$

1,093,453

$

1,774,217

Net income

164,396

164,396

Stock-based compensation

6,170

6,170

Adoption of accounting standards - ASC 606

(29,980)

(29,980)

Stock options exercised and other awards

176

2

6,510

6,512

Purchase of treasury shares

(23)

(4,831)

(4,831)

Repurchase of common shares

(619)

(6)

(133,045)

(133,051)

Balance – May 5, 2018

60,998

$

610

(642)

$

(23,598)

$

711,597

$

1,094,824

$

1,783,433

Net income

148,323

148,323

Stock-based compensation

7,002

7,002

Stock options exercised and other awards

32

1,936

1,936

Purchase of treasury shares

(4)

(815)

(815)

Repurchase of common shares

(512)

(5)

(127,396)

(127,401)

Balance – August 4, 2018

60,518

$

605

(646)

$

(24,413)

$

720,535

$

1,115,751

$

1,812,478

Treasury -

Common Stock

Common Stock

Additional

Total

Issued

Treasury

Paid-In

Retained

Stockholders'

(In thousands)

    

Shares

    

Amount

    

Shares

    

Amount

    

Capital

    

Earnings

    

Equity

Balance – February 2, 2019

59,232

$

592

(648)

$

(24,908)

$

738,671

$

1,105,863

$

1,820,218

Net income

192,221

192,221

Stock-based compensation

6,030

6,030

Adoption of accounting standards - ASC 842

(2,375)

(2,375)

Stock options exercised and other awards

348

4

42,052

42,056

Purchase of treasury shares

(27)

(9,183)

(9,183)

Repurchase of common shares

(318)

(3)

(107,396)

(107,399)

Balance – May 4, 2019

59,262

$

593

(675)

$

(34,091)

$

786,753

$

1,188,313

$

1,941,568

Net income

161,258

161,258

Stock-based compensation

6,736

6,736

Stock options exercised and other awards

15

879

879

Purchase of treasury shares

(89)

(89)

Repurchase of common shares

(792)

(8)

(270,893)

(270,901)

Balance – August 3, 2019

58,485

$

585

(675)

$

(34,180)

$

794,368

$

1,078,678

$

1,839,451

See accompanying notes to consolidated financial statements.

6

Ulta Beauty, Inc.

Notes to Consolidated Financial Statements

(In thousands, except per share and store count data) (Unaudited)

1.Business and basis of presentation

On January 29, 2017, Ulta Salon, Cosmetics & Fragrance, Inc. implemented a holding company reorganization. Pursuant to the reorganization, Ulta Beauty, Inc., which was incorporated as a Delaware corporation in December 2016, became the successor to Ulta Salon, Cosmetics & Fragrance, Inc., the former publicly-traded company and now a wholly owned subsidiary of Ulta Beauty, Inc. As used in these notes and throughout this Quarterly Report on Form 10-Q, all references to “we,” “us,” “our,” “Ulta Beauty,” or the “Company” refer to Ulta Beauty, Inc. and its consolidated subsidiaries.

The Company was originally founded in 1990 to operate specialty retail stores selling cosmetics, fragrance, haircare and skincare products, and related accessories and services. The stores also feature full-service salons. As of August 3, 2019, the Company operated 1,213 stores across 50 states, as shown in the table below.

Number of

Number of

Location

    

stores

    

Location

    

stores

Alabama

21

Montana

6

Alaska

3

Nebraska

5

Arizona

27

Nevada

15

Arkansas

10

New Hampshire

7

California

157

New Jersey

36

Colorado

26

New Mexico

6

Connecticut

16

New York

48

Delaware

3

North Carolina

32

Florida

83

North Dakota

3

Georgia

36

Ohio

42

Hawaii

4

Oklahoma

20

Idaho

9

Oregon

14

Illinois

55

Pennsylvania

43

Indiana

23

Rhode Island

3

Iowa

10

South Carolina

20

Kansas

12

South Dakota

2

Kentucky

14

Tennessee

25

Louisiana

18

Texas

110

Maine

3

Utah

14

Maryland

24

Vermont

1

Massachusetts

19

Virginia

29

Michigan

47

Washington

34

Minnesota

17

West Virginia

7

Mississippi

9

Wisconsin

20

Missouri

23

Wyoming

2

Total

1,213

The accompanying unaudited consolidated financial statements and related notes have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and the U.S. Securities and Exchange Commission’s Article 10, Regulation S-X. These financial statements were prepared on a consolidated basis to include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts, transactions, and unrealized profit were eliminated in consolidation. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments, which are of a normal

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recurring nature, necessary to fairly state the financial position and results of operations and cash flows for the interim periods presented.

The Company’s business is subject to seasonal fluctuation. Significant portions of the Company’s net sales and net income are realized during the fourth quarter of the fiscal year due to the holiday selling season. The results for the 13 and 26 weeks ended August 3, 2019 are not necessarily indicative of the results to be expected for the fiscal year ending February 1, 2020, or for any other future interim period or for any future year.

These interim consolidated financial statements and the related notes should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended February 2, 2019. All amounts are stated in thousands, with the exception of per share amounts and number of stores.

2.Summary of significant accounting policies

Information regarding the Company’s significant accounting policies is contained in Note 2, “Summary of significant accounting policies,” to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended February 2, 2019. Presented below and in the following notes is supplemental information that should be read in conjunction with “Notes to Consolidated Financial Statements” in the Annual Report.

Fiscal quarter

The Company’s quarterly periods are the 13 weeks ending on the Saturday closest to April 30, July 31, October 31, and January 31. The Company’s second quarter in fiscal 2019 and 2018 ended on August 3, 2019 and August 4, 2018, respectively.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation.

Recent accounting pronouncements not yet adopted

Intangibles – Goodwill and Other-Internal-Use Software

In August 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2018-15, Intangibles – Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customers Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract, which clarifies and aligns the accounting for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This guidance is effective for interim and annual reporting periods beginning after December 15, 2019 and should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. Early adoption is permitted. The adoption of ASU 2018-15 is not expected to have a material impact on the Company’s consolidated financial position, results of operations, or cash flows. 

Recently adopted accounting pronouncements

Leases

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The guidance in ASU 2016-02 and subsequently issued amendments requires lessees to capitalize virtually all leases with terms of more than twelve months on the balance sheet as a right-of-use asset and recognize an associated lease liability. The right-of-use asset represents the lessee’s right to use, or control the use of, a specified asset for the specified lease term. The lease liability represents the lessee’s obligation to make lease payments arising from the lease, measured on a discounted basis. Based on certain characteristics, leases are classified as financing or operating leases and their classification impacts the recognition of expense in the income statement. Entities are allowed to apply the modified retrospective approach (1) retrospectively to

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each comparative period presented or (2) retrospectively at the beginning of the period of adoption through a cumulative-effect adjustment.

The Company adopted the new standard on February 3, 2019 using the modified retrospective approach by recognizing and measuring leases without revising comparative period information or disclosures. The Company elected the transition package of three practical expedients permitted within the standard, which among other things, allows for the carryforward of historical lease classifications. In addition, the Company elected to apply the practical expedient that allows for the combination of lease and non-lease components for all asset classes. The Company made an accounting policy election to keep leases with terms of twelve months or less off the balance sheet and recognize those lease payments on a straight-line basis over the lease term.

The adoption of ASU 2016-02, resulted in the recording of operating lease assets and liabilities of $1,460,866 and $1,839,970 within the consolidated balance sheet, respectively, as of February 3, 2019. As part of the adoption, the Company recorded an adjustment to retained earnings of $2,375. The standard did not materially impact the Company’s consolidated results of operations and had no impact on cash flows. See Note 6, “Leases,” for further details.

The impact to the Company’s opening consolidated balance sheet as of February 3, 2019 was as follows:

As Reported

Effect of Adopting

Balance at

(In thousands)

    

February 2, 2019

    

ASC 842

    

February 3, 2019

Assets

(Unaudited)

Receivables, net

$

136,168

$

(17,468)

$

118,700

Prepaid expenses and other current assets

138,116

(25,260)

112,856

Property and equipment, net

1,226,029

(16,983)

1,209,046

Operating lease assets

1,460,866

1,460,866

Liabilities and stockholders’ equity

Accrued liabilities

220,666

(1,460)

219,206

Current operating lease liabilities

210,721

210,721

Deferred rent

434,980

(434,980)

Non-current operating lease liabilities

1,629,249

1,629,249

Retained earnings

1,105,863

(2,375)

1,103,488

3.Acquisitions

The Company continues to make investments to evolve the customer experience, with a strong emphasis on integrating technology across the business. To support these efforts, the Company paid $13,606 to acquire two technology companies in fiscal 2018.

On September 10, 2018, the Company acquired QM Scientific, an artificial intelligence technology company. The acquisition is not material to the Company’s consolidated financial statements.

On October 29, 2018, the Company acquired GlamST, an augmented reality technology company. The acquisition is not material to the Company’s consolidated financial statements.

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4.Revenue

The Company’s net sales include retail stores and e-commerce merchandise sales as well as salon services and other revenue. 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.

Disaggregated revenue

The following table sets forth the approximate percentage of net sales by primary category:

13 Weeks Ended  

26 Weeks Ended    

(Percentage of net sales)

August 3, 2019

August 4, 2018

August 3, 2019

August 4, 2018

Cosmetics

47%

49%

  

50%

  

51%

Skincare, Bath & Fragrance

22%

20%

21%

20%

Haircare Products & Styling Tools

21%

21%

19%

19%

Services

6%

6%

6%

6%

Other (nail products, accessories, and other)

4%

4%

4%

4%

100%

100%

100%

100%

Deferred revenue

Deferred revenue primarily represents contract liabilities for the Company’s obligation to transfer additional goods or services to a guest for which the Company has received consideration, such as unredeemed Ultamate Rewards loyalty points and unredeemed Ulta Beauty gift cards. In addition, the Company recognizes breakage on gift cards proportionately as redemption occurs.

The following table provides a summary of the changes included in deferred revenue:

13 Weeks Ended

26 Weeks Ended

August 3, 2019

August 4, 2018

August 3, 2019

August 4, 2018

Beginning balance

$

173,921

$

130,591

$

193,585

$

110,103

Adoption of ASC 606

38,773

Additions to contract liabilities (1)

64,863

89,001

135,167

174,835

Deductions to contract liabilities (2)

(66,831)

(88,976)

(156,799)

(193,095)

Ending balance

$

171,953

$

130,616

$

171,953

$

130,616

(1) Loyalty points and gift cards issued in the current period but not redeemed or expired.
(2) Revenue recognized in the current period related to the beginning liability.

5.Goodwill and other intangible assets

Goodwill, which represents the excess of cost over the fair value of net assets acquired, amounted to $10,870 at August 3, 2019 and February 2, 2019, respectively. The Company did not have any goodwill as of August 4, 2018. No additional goodwill was recognized during the 13 and 26 weeks ended August 3, 2019, respectively. The Company reviews the recoverability of goodwill annually during the fourth quarter or more frequently if an event occurs or circumstances change that would indicate that impairment may exist.

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Other intangible assets with finite useful lives are amortized over their useful lives. The Company reviews the recoverability of long-lived assets whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable.

6.Leases

The Company determines whether an arrangement is or contains a lease at contract inception. The Company leases retail stores, distribution centers, and corporate offices under non-cancellable operating leases with various expiration dates through 2032. Leases generally have an initial lease term of 10 years and include renewal options under substantially the same terms and conditions as the original leases. Leases do not contain any material residual value guarantees or material restrictive covenants.

The lease classification evaluation begins at the lease commencement date. The lease term used in the evaluation includes the non-cancellable period for which the Company has the right to use the underlying asset, together with renewal option periods when the exercise of the renewal option is reasonably certain and failure to exercise such option would result in an economic penalty. All retail store, distribution center, and corporate office leases are classified as operating leases. The Company does not have any finance leases.

Total rent payable is recorded during the lease term, including rent escalations in which the amount of future rent is fixed on the straight-line basis over the term of the lease (including the rent holiday period beginning upon control of the premises, and any fixed payments stated in the lease). For leases with an initial term greater than 12 months, a related lease liability is recorded on the balance sheet at the present value of future payments discounted at the estimated fully collateralized incremental borrowing rate (discount rate) corresponding with the lease term. In addition, a right-of-use asset is recorded as the initial amount of the lease liability, plus any lease payments made to the lessor before or at the lease commencement date and any initial direct costs incurred, less any tenant improvement allowance incentives received. Tenant incentives are amortized through the right-of-use asset as reduction of rent expense over the lease term. The difference between the minimum rents paid and the straight-line rent (deferred rent) is reflected within the associated right-of-use asset. Operating lease expense is recognized on a straight-line basis over the lease term. 

Certain leases contain provisions that require additional rent payments based upon sales volume (“variable lease cost”). Contingent rent is accrued each period as the liabilities are incurred, in addition to the straight-line rent expense. This results in some variability in lease expense as a percentage of revenues over the term of the lease in stores where contingent rent is paid.

Leases with an initial term of 12 months or less (“short-term leases”) are not recorded on the balance sheet. Short-term lease expense is recognized on a straight-line basis over the lease term.

The Company subleases certain real estate to third parties for stores with excess square footage space.

The Company does not separate lease and non-lease components (e.g., common area maintenance).

As the interest rate implicit in the lease is not readily determinable, the Company uses its incremental borrowing rate corresponding with the lease term. As there are no outstanding borrowings under the Company’s credit facility, this rate is estimated based on prevailing market conditions, comparable company and credit analysis, and judgment. The incremental borrowing rate is reassessed if there is a change to the lease term or if a modification occurs and it is not accounted for as a separate contract.

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The following table presents supplemental balance sheet information, the weighted-average remaining lease term, and discount rate for operating leases as of August 3, 2019:

(In thousands)

Classification on the Balance Sheet

    

August 3, 2019

Right-of-use assets

Operating lease assets

$

1,499,556

Current lease liabilities

Current operating lease liabilities

208,261

Non-current lease liabilities

Non-current operating lease liabilities

1,683,743

Total lease liabilities

$

1,892,004

Weighted-average remaining lease term

    

7.2 years

Weighted-average discount rate

4.1%

Lease cost

The following table presents the components of lease cost for operating leases:

13 Weeks Ended

26 Weeks Ended

(In thousands)

    

Classification on the Statement of Income

    

August 3, 2019

    

August 3, 2019

Operating lease cost

Cost of sales (1)

$

71,579

$

142,921

Variable lease cost

Cost of sales

(1,524)

(3,324)

Short-term lease cost

Selling, general and administrative expenses

73

138

Sublease income

Net sales

(149)

(290)

Total lease cost

$

69,979

$

139,445

(1) The majority of operating lease cost relates to retail stores and distribution centers and is classified within cost of sales. Operating lease cost for corporate offices is classified within selling, general and administrative expenses. Operating lease cost from the control date through store opening date is classified within pre-opening expenses.

Other information

The following table presents supplemental disclosures of cash flow information related to operating leases:

    

26 Weeks Ended

(In thousands)

    

August 3, 2019

Cash paid for operating lease liabilities (1)

$

165,882

Operating lease assets obtained in exchange for operating lease liabilities (non-cash)

190,824

(1) Excludes $36,445 related to cash received for tenant incentives.

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Maturity of lease liabilities

The following table presents maturities of operating lease liabilities as of August 3, 2019:

Fiscal year

    

(In thousands)

2019 (1)

$

113,470

2020

339,422

2021

326,124

2022

307,605

2023

271,830

2024 and thereafter

846,558

Total lease payments

$

2,205,009

Less: Imputed interest

(313,005)

Present value of operating lease liabilities

$

1,892,004

(1) Excluding the 26 weeks ended August 3, 2019.

Operating lease payments exclude $219,045 of legally binding minimum lease payments for leases signed but not yet commenced.

7.Commitments and contingencies

The Company is involved in various legal proceedings that are incidental to the conduct of the business including both class action and single plaintiff litigation. In the opinion of management, the amount of any liability with respect to these proceedings, either individually or in the aggregate, will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

8.Notes payable

On August 23, 2017, the Company entered into a Second Amended and Restated Loan Agreement (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 August 23, 2022, provides maximum revolving loans equal to the lesser of $400,000 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 $20,000 subfacility for letters of credit and allows the Company to increase the revolving facility by an additional $50,000, 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 either a base rate or the London Interbank Offered Rate plus 1.25%, and the unused line fee is 0.20% per annum.

As of August 3, 2019, February 2, 2019 and August 4, 2018, the Company had no borrowings outstanding under the credit facility and the Company was in compliance with all terms and covenants of the Loan Agreement.

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9.Fair value measurements

The carrying value of cash and cash equivalents, short-term investments, accounts receivable, and accounts payable approximates their estimated fair values due to the short maturities of these instruments.

Fair value is measured using inputs from the three levels of the fair value hierarchy, which are described as follows:

Level 1 – observable inputs such as quoted prices for identical instruments in active markets.
Level 2 – inputs other than quoted prices in active markets that are observable either directly or indirectly through corroboration with observable market data.
Level 3 – unobservable inputs in which there is little or no market data, which would require the Company to develop its own assumptions.

As of August 3, 2019, February 2, 2019 and August 4, 2018, the Company held financial liabilities included in other long-term liabilities on the consolidated balance sheets of $26,848, $19,615, and $20,419, respectively, related to its non-qualified deferred compensation plan. The liabilities have been categorized as Level 2 as they are based on third-party reported values, which are based primarily on quoted market prices of underlying assets of the funds within the plan.

10.Investments

The Company’s short-term investments as of August 3, 2019 and August 4, 2018 consist of $150,000 and $149,000, respectively, in certificates of deposit. The Company did not have any short-term investments as of February 2, 2019. Short-term investments are carried at cost, which approximates fair value and are recorded in the consolidated balance sheets in short-term investments.

The Company’s investments in renewable energy projects are accounted for under the equity method of accounting.  The balance of these investments is included in other long-term assets in the consolidated balance sheet. The Company contributed capital of $33,339 and received distributions including $17,370 of investment tax credits during the 26 weeks ended August 3, 2019.

11.Stock-based compensation

The Company measures stock-based compensation expense on the grant date, based on the fair value of the award, and recognizes the expense on a straight-line basis over the requisite service period for awards expected to vest. The Company estimated the grant date fair value of stock options using a Black-Scholes valuation model using the following weighted-average assumptions for the periods indicated:

    

26 Weeks Ended

August 3,

August 4,

    

2019

    

2018

Volatility rate

 

31.0%

29.0%

Average risk-free interest rate

 

2.3%

2.4%

Average expected life (in years)

 

3.5

 

3.4

Dividend yield

 

None

 

None

The Company granted 97 and 163 stock options during the 26 weeks ended August 3, 2019 and August 4, 2018, respectively. The stock-based compensation expense charged against operating income for stock options was $2,199 and $2,215 for the 13 weeks ended August 3, 2019 and August 4, 2018, respectively. The stock-based compensation expense charged against operating income for stock options was $4,319 and $4,423 for the 26 weeks ended August 3, 2019 and August 4, 2018, respectively. The weighted-average grant date fair value of these stock options was $89.91 and $50.10 for the 26 weeks ended August 3, 2019 and August 4, 2018, respectively. At August 3, 2019, there was approximately $20,473 of unrecognized stock-based compensation expense related to unvested stock options.

The Company issued 47 and 92 restricted stock units during the 26 weeks ended August 3, 2019 and August 4, 2018, respectively. The stock-based compensation expense charged against operating income for restricted stock units was

14

$3,422 and $3,290 for the 13 weeks ended August 3, 2019 and August 4, 2018, respectively. The stock-based compensation expense charged against operating income for restricted stock units was $6,243 and $5,795 for the 26 weeks ended August 3, 2019 and August 4, 2018, respectively. At August 3, 2019, there was approximately $27,170 of unrecognized stock-based compensation expense related to restricted stock units.

The Company issued 21 and 33 performance-based restricted stock units during the 26 weeks ended August 3, 2019 and August 4, 2018, respectively. The stock-based compensation expense charged against operating income for performance-based restricted stock units was $1,390 and $1,722 for the 13 weeks ended August 3, 2019 and August 4, 2018, respectively. The stock-based compensation expense charged against operating income for performance-based restricted stock units was $3,101 and $3,179 for the 26 weeks ended August 3, 2019 and August 4, 2018, respectively. At August 3, 2019, there was approximately $12,745 of unrecognized stock-based compensation expense related to performance-based restricted stock units.

12.Income taxes

Income tax expense reflects the federal statutory tax rate and the weighted average state statutory tax rate for the states in which the Company operates stores. Income tax expense of $48,431 for the 13 weeks ended August 3, 2019 represents an effective tax rate of 23.1%, compared to $46,635 of tax expense representing an effective tax rate of 23.9% for the 13 weeks ended August 4, 2018. The lower effective tax rate is primarily due to an increase in federal income tax credits.

Income tax expense of $95,796 for the 26 weeks ended August 3, 2019 represents an effective tax rate of 21.3%, compared to $93,406 of tax expense representing an effective tax rate of 23.0% for the 26 weeks ended August 4, 2018. The lower effective tax rate is primarily due to income tax accounting for share-based compensation.

13.Net income per common share

The following is a reconciliation of net income and the number of shares of common stock used in the computation of net income per basic and diluted share:

13 Weeks Ended

26 Weeks Ended

August 3,

August 4,

August 3,

August 4,

(In thousands, except per share data)

    

2019

    

2018

    

2019

    

2018

Numerator for diluted net income per share – net income

    

$

161,258

$

148,323

$

353,479

$

312,719

Denominator for basic net income per share – weighted-average common shares

58,171

60,070

58,401

60,340

Dilutive effect of stock options and non-vested stock

275

305

317

290

Denominator for diluted net income per share

58,446

60,375

58,718

60,630

Net income per common share:

Basic

$

2.77

$

2.47

$

6.05

$

5.18

Diluted

$

2.76

$

2.46

$

6.02

$

5.16

The denominator for diluted net income per common share for the 13 weeks ended August 3, 2019 and August 4, 2018 excludes 101 and 285 employee stock options and restricted stock units, respectively, due to their anti-dilutive effects. The denominator for diluted net income per common share for the 26 weeks ended August 3, 2019 and August 4, 2018 excludes 164 and 378 employee stock options and restricted stock units, respectively, due to their anti-dilutive effects. Outstanding performance-based restricted stock units are included in the computation of dilutive shares only to the extent that the underlying performance conditions are satisfied prior to the end of the reporting period or would be considered satisfied if the end of the reporting period were the end of the related contingency period and the results would be dilutive under the treasury stock method.

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14.Share repurchase program

On March 9, 2017, the Company 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 $425,000 of the Company’s common stock. The 2017 Share Repurchase Program authorization revoked the previously authorized but unused amount of $79,863 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.

On March 15, 2018, the Company 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 $625,000 of the Company’s common stock. The 2018 Share Repurchase Program authorization revoked the previously authorized but unused amount of $41,317 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.

On March 14, 2019, the Company announced that the Board of Directors authorized a new share repurchase program (the 2019 Share Repurchase Program) pursuant to which the Company may repurchase up to $875,000 of the Company’s common stock. The 2019 Share Repurchase Program authorization revoked the previously authorized but unused amount of $25,435 from the 2018 Share Repurchase Program. The 2019 Share Repurchase Program does not have an expiration date and may be suspended or discontinued at any time.

During the 26 weeks ended August 3, 2019, the Company purchased 1,110 shares of common stock for $378,301. During the 26 weeks ended August 4, 2018, the Company purchased 1,131 shares of common stock for $260,452.

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 contemplated by us will be achieved. Such forward-looking statements are subject to various risks and uncertainties, which include, without limitation:

changes in the overall level of consumer spending and volatility in the economy;
the possibility that we may be unable to compete effectively in our highly competitive markets;
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;
our ability to sustain our growth plans and successfully implement our long-range strategic and financial plan;
the 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;
our ability to gauge beauty trends and react to changing consumer preferences in a timely manner;
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;
natural disasters that could negatively impact sales;
our ability to successfully execute our common stock repurchase program or implement future common stock repurchase programs; and

16

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 2, 2019, as such may be 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 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. We believe that the expanding 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, position 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. 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.

Current business trends

Our research indicates that Ulta 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 has experienced mid-single digit declines through the first six months of 2019. Beauty cycles are impacted by demographics and innovation.  While demographic

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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.

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 as a result, any fees received from guests are included in the transaction price allocated to the performance obligation of providing goods with a corresponding amount accrued within cost of sales for amounts paid to applicable carriers. 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 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 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.

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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.

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.

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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 second quarter in fiscal 2019 and 2018 ended on August 3, 2019 and August 4, 2018, respectively. 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: