Summary of ULTA SALON, COSMETICS & FRAGRANCE, INC.

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 consolidated 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 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," 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 or expectations contemplated by us will be achieved. Such forward-looking statements are subject to various risks and uncertainties, which include, without limitation: the impact of weakness in the economy; changes in the overall level of consumer spending; changes in the wholesale cost of our products; the possibility that we may be unable to compete effectively in our highly competitive markets; the possibility that our continued opening of new stores could strain our resources and have a material adverse effect on our business and financial performance; the possibility that new store openings may be impacted by developer or co-tenant issues; the possibility that the capacity of our distribution and order fulfillment infrastructure may not be adequate to support our recent growth and expected future growth plans; the possibility of material disruptions to our information systems; weather conditions that could negatively impact sales and other risk factors detailed in our public filings with the Securities and Exchange Commission (the "SEC"), including risk factors contained in our Annual Report on Form 10-K for the year ended February 2, 2008. We assume no obligation to update any forward-looking statements as a result of new information, future events or developments. References in the following discussion to "we", "us", "our", "the Company", "Ulta" and similar references mean Ulta Salon, Cosmetics & Fragrance, Inc. unless otherwise expressly stated or the context otherwise requires. Overview
We were founded in 1990 as a discount beauty retailer at a time when prestige, mass and salon products were sold through separate distribution channels. In 1999, we embarked on a multi-year strategy to understand and embrace what women want in a beauty retailer and transform Ulta into the shopping experience that it is today. We pioneered what we believe to be our unique combination of beauty superstore and specialty store attributes. We believe our strategy provides us with the competitive advantages that have contributed to our strong financial performance.
We are currently the largest beauty retailer that provides one-stop shopping for prestige, mass and salon products and salon services in the United States. We combine the unique elements of a beauty superstore with the distinctive environment and experience of a specialty retailer. Key aspects of our beauty superstore strategy include our ability to offer our customers a broad selection of over 21,000 beauty products across the categories of cosmetics, fragrance, haircare, skincare, bath and body products and salon styling tools, as well as salon haircare products. We focus on delivering a compelling value proposition to our customers across all of our product categories. Our stores are conveniently located in high-traffic, off-mall locations such as power centers and lifestyle centers with other destination retailers. As of May 3, 2008, we operated 265 stores across 32 states. In addition to these fundamental elements of a beauty superstore, we strive to offer an uplifting shopping experience through what we refer to as "The Four E's": Escape, Education, Entertainment and Esthetics.
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 growth strategy, including growing our store base, expanding our prestige brand offerings, driving incremental salon traffic, expanding our online business, and continuing to enhance our brand awareness. We believe that the steadily expanding U.S. beauty products and services industry, the shift in distribution of prestige beauty products from department stores to specialty retail stores, coupled with Ulta's competitive strengths, positions us to capture additional market share in the industry through successful execution of our growth strategy.
Comparable store sales is a key metric that is monitored closely within the retail industry. We do not expect our future comparable store sales increases to reflect the levels experienced in prior periods. This is due in part to the difficulty in improving on such significant increases in subsequent periods. The Company adopted a structured stock option compensation program in July 2007. The award of stock options under this program will result in increased stock-based compensation expense in future periods as compared to the expense reflected in our historical financial statements.
Over the long-term, our growth strategy is to increase total net sales through increases in our comparable store sales and by opening new stores. Gross profit as a percentage of net sales is expected to be relatively consistent with historical rates given our planned

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distribution infrastructure investments and the impact of the rate of new store growth. We plan to continue to improve our operating results by leveraging our fixed costs and decreasing our selling, general and administrative expenses, as a percentage of our net sales.
On October 30, 2007, we completed an initial public offering in which we sold 7,666,667 shares of common stock resulting in net proceeds of $123.5 million after deducting underwriting discounts and commissions and offering expenses. Selling stockholders sold approximately 2,153,928 additional shares of common stock. We did not receive any proceeds from the sale of shares by the selling stockholders. We used the net proceeds from the offering to pay $93.0 million of accumulated dividends in arrears on the Company's preferred stock, which satisfied all amounts due with respect to accumulated dividends, $4.8 million to redeem the Company's Series III preferred stock, and $25.7 million to reduce our borrowings under our third amended and restated loan and security agreement and for general corporate purposes. Also in connection with the offering, the Company converted 41,524,002 preferred shares into common shares and restated the par value of its common stock to $0.01 per share. Basis of presentation
Net sales include store and Internet merchandise sales as well as salon service revenue. Salon service revenue represents less than 10% of our combined product sales and services revenues and therefore, these revenues are combined with product sales. We recognize merchandise revenue at the point of sale, or POS, in our retail stores and the time of shipment in the case of Internet sales. Merchandise sales are recorded net of estimated returns. Salon service revenue is recognized at the time the service is provided. Gift card sales revenue is deferred until the customer redeems the gift card. Company coupons and other incentives are recorded as a reduction of net sales.

Comparable store 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 store sales unless the store was closed for a portion of the current or prior period. There may be variations in the way in which some of our competitors and other retailers calculate comparable or same store sales. As a result, data herein regarding our comparable store sales may not be comparable to similar data made available by our competitors or other retailers.

Comparable store sales is a critical measure that 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 store sales results:
• 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 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 all vendor allowances, which are treated as a reduction of merchandise costs;

• warehousing and distribution costs including labor and related benefits, freight, rent, depreciation and amortization, real estate taxes, utilities, and insurance;

• store occupancy costs including rent, depreciation and amortization, real estate taxes, utilities, repairs and maintenance, insurance, licenses, and cleaning expenses;

• salon payroll and benefits; and

• shrink and inventory valuation reserves.

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Our cost of sales may be impacted as we open an increasing number of stores. We also expect that cost of sales as a percentage of net sales will be negatively impacted in the next several years as a result of accelerated depreciation related to our store remodel program. The program was adopted in third quarter fiscal 2006. We have accelerated depreciation expense on assets to be disposed of during the remodel process such that those assets will be fully depreciated at the time of the planned remodel. 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 and corporate employees;

• advertising and marketing costs;

• occupancy costs related to our corporate office facilities;

• public company expense including Sarbanes-Oxley compliance expenses;

• stock-based compensation expense related to option grants which will result in increases in expense as we implemented a structured stock option compensation program in 2007;

• depreciation and amortization for all assets except those related to our retail and warehouse operations which is 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 expense includes non-capital expenditures during the period prior to store opening for new and remodeled stores including store set-up labor, management and employee training, and grand opening advertising. Pre-opening expenses also includes rent during the construction period related to new stores.
Interest expense includes interest costs associated with our credit facility which is structured as an asset based lending instrument. Our interest expense will fluctuate based on the seasonal borrowing requirements associated with acquiring inventory in advance of key holiday selling periods and fluctuation in the variable interest rates we are charged on outstanding balances. Our credit facility is used to fund seasonal inventory needs and new and remodel store capital requirements in excess of our cash flow from operations. 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 first quarters in fiscal 2008 and 2007 ended on May 3, 2008 and May 5, 2007, 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 tables present the components of our results of operations for the periods indicated:

                                                          Three months ended                      Three months ended
                                                      May 3,              May 5,               May 3,              May 5,
                                                       2008                2007                 2008                2007
                                                        (Dollars in thousands)                (Percentage of net sales)
Net sales                                          $   239,298          $ 194,113                 100.0 %           100.0 %
Cost of sales                                          165,377            134,600                  69.1 %            69.3 %

Gross profit                                            73,921             59,513                  30.9 %            30.7 %

Selling, general and administrative expenses            62,065             47,982                  25.9 %            24.7 %
Pre-opening expenses                                     3,772              1,656                   1.6 %             0.9 %

Operating income                                         8,084              9,875                   3.4 %             5.1 %
Interest expense                                           915                996                   0.4 %             0.5 %

Income before income taxes                               7,169              8,879                   3.0 %             4.6 %
Income tax expense                                       2,894              3,560                   1.2 %             1.8 %

Net income                                         $     4,275          $   5,319                   1.8 %             2.7 %


Other operating data:
Number stores end of period                                265                203
Comparable store sales increase                            3.9 %              9.2 %

Comparison of three months ended May 3, 2008 to three months ended May 5, 2007 Net sales
Net sales increased $45.2 million, or 23.3%, to $239.3 million for the three months ended May 3, 2008, compared to $194.1 million for the three months ended May 5, 2007. The increase is due to an additional 62 net new stores operating since first quarter 2007 and a 3.9% increase in comparable store sales. Non-comparable stores contributed $38.1 million of the net sales increase while comparable stores contributed $7.1 million of the total net sales increase. Our comparable store sales growth in 2008 was driven by a combination of higher average ticket and positive customer traffic. The increase in average ticket was driven by continued expansion of our prestige brand assortment. Gross profit
Gross profit increased $14.4 million, or 24.2%, to $73.9 million for the three months ended May 3, 2008, compared to $59.5 million for the three months ended May 5, 2007. Gross profit as a percentage of net sales increased 20 basis points to 30.9% for the three months ended May 3, 2008, compared to 30.7% for the three months ended May 5, 2007.
The increase in gross profit is due to a 40 basis point increase in advertising allowances, net of a de-leverage of fixed store occupancy costs due to increased new store openings. The increase in advertising allowances is related to the additional marketing event in the first quarter 2008 as discussed below in selling, general and administrative expenses. Advertising allowances are recognized in gross profit when the related vendor product is sold.

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Selling, general and administrative expenses Selling, general and administrative expenses increased $14.1 million, or 29.4%, to $62.1 million for the three months ended May 3, 2008, compared to $48.0 million for the three months ended May 5, 2007. As a percentage of net sales, selling, general and administrative expenses increased 120 basis points to 25.9% for the three months ended May 3, 2008, compared to 24.7% for the three months ended May 5, 2007. The increase includes a $1.1 million, or 50 basis point, increase in advertising expense related to one incremental advertising vehicle during the first quarter 2008. In addition, the first quarter 2008 includes $0.3 million, or 15 basis points, of incremental share-based compensation expense and a $0.7 million, or 30 basis point, severance charge related to the previously announced management change. Pre-opening expenses
Pre-opening expenses increased $2.1 million, or 127.8%, to $3.8 million for the three months ended May 3, 2008, compared to $1.7 million for the three months ended May 5, 2007. During the three months ended May 3, 2008, we opened 17 new stores and remodeled 1 store, compared to 7 new store openings and 3 remodels during the three months ended May 5, 2007. Interest expense
Interest expense was $0.9 million for the three months ended May 3, 2008, compared to $1.0 million for the three months ended May 5, 2007. The increase in our average debt outstanding on our credit facility was offset by a decline in our weighted-average interest rate compared to the same period last year. Income tax expense
Income tax expense of $2.9 million for the three months ended May 3, 2008 represents an effective tax rate of 40.4%, compared to $3.6 million of tax expense representing an effective tax rate of 40.1% for the three months ended May 5, 2007.
Net income
Net income decreased $1.0 million, or 19.6%, to $4.3 million for the three months ended May 3, 2008, compared to $5.3 million for the three months ended May 5, 2007. The decrease is primarily related to the increase in the store opening program resulting in an incremental $2.1 million in pre-opening expenses and a $0.7 million severance expense.
Liquidity and capital resources
Our primary cash needs are for capital expenditures for new, relocated, and remodeled stores, increased merchandise inventories related to store expansion, planned expansion of our headquarters, a new second distribution facility, and for continued improvement in our information technology systems. Our primary sources of liquidity are cash flows from operations, changes in working capital, and borrowings under our credit facility. The most significant component of our working capital is merchandise inventories reduced by related accounts payable and accrued expenses. Our working capital position benefits from the fact that we generally collect cash from sales to customers the same day, or within several days of the related sale, while we typically have up to 30 days to pay our vendors.
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 have not yet collected the landlord allowances due us as part of our lease agreements. Based on past performance and current expectations, we believe that cash generated from operations and borrowings under the credit facility, with the accordion option exercised, will satisfy the company's working capital needs, capital expenditure needs, commitments, and other liquidity requirements through at least the next 12 months. Merchandise inventories were $212.6 million at May 3, 2008, an increase of $59.7 million from May 5, 2007. Approximately $44.7 million of the increase is due to the addition of 62 net new stores opened since May 5, 2007; approximately $9.0 million represents incremental inventory related to our newly opened distribution center; and $6.0 million relates to inventory for 12 of the 18 stores we plan to open in the second quarter of 2008. Average inventory per store was flat to the prior year quarter, excluding the additional $9.0 million of inventory related to the new distribution center.

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On October 30, 2007, we completed an initial public offering in which we sold 7,666,667 shares of common stock to the public at a price of $18.00 per share resulting in aggregate gross proceeds from the sale of shares of common stock of $138.0 million. Selling stockholders sold approximately 2,153,928 additional shares of common stock. We did not receive any proceeds from the sale of shares by the selling stockholders. The aggregate net proceeds to us were $123.5 million after deducting $9.7 million in underwriting discounts and commissions and $4.8 million in offering expenses. We used the net proceeds from the offering to pay $93.0 million of accumulated dividends in arrears on the Company's preferred stock, which satisfied all amounts due with respect to accumulated dividends, $4.8 million to redeem the Company's Series III preferred stock, and $25.7 million to reduce our borrowings under our third amended and restated loan and security agreement and for general corporate purposes. Also in connection with the offering, the Company converted 41,524,002 preferred shares into common shares and restated the par value of its common stock to $0.01 per share.
Credit facility
Our credit facility is with LaSalle Bank National Association and its successors as the administrative agent, Wachovia Capital Finance Corporation as collateral agent, and JP Morgan Chase Bank as documentation agent. This facility provides maximum credit of $150 million and a $50 million accordion option through May 31, 2011. The credit facility agreement contains a restrictive financial covenant on tangible net worth. Substantially all of the Company's assets are pledged as collateral for outstanding borrowings under the facility. Outstanding borrowings bear interest at the prime rate or the Eurodollar rate plus 1.00% up to $100 million and 1.25% thereafter. The advance rates on owned inventory are 80% (85% from September 1 to January 31). We plan to exercise the $50 million accordion option of our credit facility during fiscal 2008.
The weighted-average interest rate on the outstanding balances under the facility as of May 3, 2008 and February 2, 2008 was 3.951% and 4.812%, respectively. We had approximately $45.1 million and $73.1 million of availability as of May 3, 2008 and February 2, 2008, respectively, excluding the accordion option. We also have an ongoing letter of credit that renews annually. The balance was $0.3 million as of May 3, 2008 and February 2, 2008. As of May 3, 2008, we had classified $86.4 million of outstanding borrowings under the facility as long-term, as this is the minimum amount we believe will remain outstanding for an uninterrupted period over the next year. Operating activities
Operating activities consist of net income adjusted for certain non-cash items, including depreciation and amortization, non-cash stock-based compensation, excess tax benefits from stock-based compensation, realized gains and losses on disposal of property and equipment, and the effect of changes in working capital items.

                                                            Three months ended
                                                           May 3,        May 5,
     (Dollars in thousands)                                 2008          2007

     Net income                                          $   4,275     $   5,319
     Items not affecting cash:
     Depreciation and amoritzation                          12,018         9,840
     Deferred income taxes                                       -          (822 )
     Non-cash stock compensation charges                       591           289
     Excess tax benefits from stock-based compensation      (1,083 )           -
     Loss on disposal of property and equipment                127           135
     Changes in working capital items                      (17,345 )     (28,932 )

     Net cash used in operating activities               $  (1,417 )   $ (14,171 )

Net cash used in operating activities was $1.4 million and $14.2 million for the three months ended May 3, 2008 and May 5, 2007, respectively. The decrease in net cash used in operating activities of $12.8 million is primarily attributed to an increase of $11.6 million in net working capital changes related to an additional 62 net new stores operating since first quarter 2007.

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Investing activities
Investing activities consist primarily of capital expenditures for new and remodeled stores as well as investments in information technology systems.

                                                        Three months ended
                                                       May 3,        May 5,
         (Dollars in thousands)                         2008          2007

         Purchases of property and equipment, net    $ (30,545 )   $ (17,757 )
         Receipt of related party notes receivable           -           373

         Net cash used in investing activities       $ (30,545 )   $ (17,384 )

Net cash used in investing activities was $30.5 million and $17.4 million for the three months ended May 3, 2008 and May 5, 2007, respectively, primarily representing new store investments.
Financing activities
Financing activities consist principally of draws and payments on our credit facility and capital stock transactions.

                                                                Three months ended
                                                               May 3,         May 5,
 (Dollars in thousands)                                         2008           2007

 Proceeds on long-term borrowings                           $  289,238     $  239,123
 Payments on long-term borrowings                             (259,474 )     (206,769 )
 Initial public offering issuance costs                            (59 )            -
 Purchase of treasury stock                                          -         (1,830 )
 Excess tax benefits from stock-based compensation               1,083              -
 Proceeds from issuance of common stock under stock plans        1,360            547

 Net cash provided by financing activities                  $   32,148     $   31,071

Net cash provided by financing activities was $32.1 million and $31.1 million . . .