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ULTA > SEC Filings for ULTA > Form 10-Q on 29-Nov-2012All Recent SEC Filings

Show all filings for ULTA SALON, COSMETICS & FRAGRANCE, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for ULTA SALON, COSMETICS & FRAGRANCE, INC.


29-Nov-2012

Quarterly Report


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," 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 and existing locations 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 Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended January 28, 2012. 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. After extensive research, we recognized an opportunity to better satisfy how a woman wanted to shop for beauty


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products. This led to what we believe to be a unique retail approach that focuses on all aspects of how women prefer to shop for beauty products by combining one-stop shopping, a compelling value proposition and convenient locations, together with an uplifting specialty retail experience. 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 focus on providing affordable indulgence to our customers by combining one-stop shopping in convenient locations 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 20,000 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 predominately located in convenient, high-traffic locations such as power centers. As of October 27, 2012, we operated 537 stores across 45 states.

The continued growth of our business and any future increases in net sales, net income and cash flows are dependent on our ability to execute our growth strategy, including growing our store base, expanding our product, brand and service offerings, enhancing our loyalty program, broadening our marketing reach, expanding our digital business and improving our profitability by expanding operating margin. 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. Our comparable store sales have fluctuated in the past and we expect them to continue to fluctuate in the future. A variety of factors affect our comparable store 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 store sales and by opening new stores. Gross profit as a percentage of net sales is expected to increase as a result of our ability to expand merchandise margin and leverage our supply chain infrastructure and fixed store costs with comparable store sales increases and operating efficiencies. 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.

General economic conditions

Economic conditions in the U.S. continue to be uneven. Fiscal stress in Europe and economic uncertainty in the U.S. related to deficit issues, potential tax increases and federal spending cuts has resulted in significant fluctuations in the U.S. stock markets. While the U.S. credit markets have stabilized and credit availability has improved compared to the recent recessionary period, economic growth is expected to continue to be weak. Consumer spending habits are affected by levels of unemployment, unsettled financial markets, weakness in housing and real estate, higher interest rates, fuel and energy costs, and consumer perception of economic conditions, among others. Sudden negative changes in one or more of the factors that influence consumer spending could adversely affect consumer spending levels which could lead to reduced consumer demand for our merchandise and adversely affect our sales levels and financial performance.

Current business trends

We recorded a 8.4% comparable store sale increase during the 13 week third quarter period and a 9.3% comparable store sales increase during the first 39 weeks of fiscal 2012. We do not expect the high single digit to low double digit comparable store sales increases of recent quarters to continue into the future. Our long-term annual net income growth target of 25% to 30% is based on comparable store sales increases of 3% to 5%.

Basis of presentation

The Company has determined its operating segments on the same basis that it uses to internally evaluate performance. We have combined our three operating segments: retail stores, salon services and e-commerce, into one reportable segment because they have a similar class of consumer, economic characteristics and nature of products.

Net sales include store and e-commerce merchandise sales as well as salon service revenue. We recognize merchandise revenue at the point of sale in our retail stores and the time of shipment in the case of e-commerce 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.


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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. E-commerce merchandise sales are excluded from comparable store sales. There may be variations in the way in which some of our competitors and other retailers calculate comparable or same store sales.

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 general national, regional and local economic conditions and corresponding impact on consumer 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 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;

customer loyalty program expense; and

shrink and inventory valuation reserves.

Our cost of sales may be negatively impacted as we open an increasing number of stores. Changes in our merchandise mix may also have an impact on cost of sales. This presentation of items included in cost of sales may not be comparable to the way in which our competitors or other retailers compute their cost of sales.

Selling, general and administrative expenses include:

payroll, bonus and benefit costs for retail and corporate employees;

advertising and marketing costs;

occupancy costs related to our corporate office facilities;


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stock-based compensation expense;

depreciation and amortization for all assets except those related to our retail and warehouse 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 expense represents unused facility fees associated with our credit facility, which is structured as an asset based lending instrument. Our credit facility may be used to fund seasonal inventory needs and new and remodel store capital requirements in excess of our cash on hand and 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 third quarters in fiscal 2012 and 2011 ended on October 27, 2012 and October 29, 2011, 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:

                                                 13 Weeks Ended                           39 Weeks Ended
                                        October 27,          October 29,         October 27,         October 29,
(Dollars in thousands)                     2012                 2011                 2012                2011
Net sales                              $     505,640        $     413,067        $  1,461,421        $  1,193,640
Cost of sales                                320,147              263,884             937,391             775,265

Gross profit                                 185,493              149,183             524,030             418,375

Selling, general and
administrative expenses                      117,934              100,997             334,917             286,423
Pre-opening expenses                           6,252                3,958              12,901               9,004

Operating income                              61,307               44,228             176,212             122,948
Interest expense                                  39                  176                 164                 496

Income before income taxes                    61,268               44,052             176,048             122,452
Income tax expense                            23,117               17,284              68,031              48,483

Net income                             $      38,151        $      26,768        $    108,017        $     73,969

Other operating data:
Number of stores end of period                   537                  442                 537                 442
Comparable store sales increase                  8.4 %                9.6 %               9.3 %              10.7 %

                                                 13 Weeks Ended                           39 Weeks Ended
                                        October 27,          October 29,         October 27,         October 29,
(Percentage of net sales)                  2012                 2011                 2012                2011
Net sales                                      100.0 %              100.0 %             100.0 %             100.0 %
Cost of sales                                   63.3 %               63.9 %              64.1 %              64.9 %

Gross profit                                    36.7 %               36.1 %              35.9 %              35.1 %

Selling, general and
administrative expenses                         23.3 %               24.5 %              22.9 %              24.0 %
Pre-opening expenses                             1.2 %                1.0 %               0.9 %               0.8 %

Operating income                                12.1 %               10.7 %              12.1 %              10.3 %
Interest expense                                 0.0 %                0.0 %               0.0 %               0.0 %

Income before income taxes                      12.1 %               10.7 %              12.0 %              10.3 %
Income tax expense                               4.6 %                4.2 %               4.7 %               4.1 %

Net income                                       7.5 %                6.5 %               7.4 %               6.2 %


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Comparison of 13 weeks ended October 27, 2012 to 13 weeks ended October 29, 2011

Net sales

Net sales increased $92.5 million, or 22.4%, to $505.6 million for the 13 weeks ended October 27, 2012, compared to $413.1 million for the 13 weeks ended October 29, 2011. Salon service sales increased $4.3 million, or 17.2%, to $29.3 million compared to$25.0 million in third quarter 2011. The net sales increases are due to comparable stores increases of $33.0 million and non-comparable stores increases of $59.5 million compared to the third quarter 2011.

Our 8.4% comparable store sales increase included a 7.9% increase in traffic and a 0.5% increase in average ticket. We attribute the increase in comparable store sales to our successful marketing and merchandising strategies.

Gross profit

Gross profit increased $36.3 million, or 24.3%, to $185.5 million for the 13 weeks ended October 27, 2012, compared to $149.2 million for the 13 weeks ended October 29, 2011. Gross profit as a percentage of net sales increased 60 basis points to 36.7% for the 13 weeks ended October 27, 2012, compared to 36.1% for the 13 weeks ended October 29, 2011. The increases in gross profit margin were primarily driven by:

40 basis points improvement in merchandise margins driven by our marketing and merchandising strategies; and

40 basis points of leverage in fixed store costs attributed to the impact of higher sales volume.

Selling, general and administrative expenses

Selling, general and administrative (SG&A) expenses increased $16.9 million, or 16.8%, to $117.9 million for the 13 weeks ended October 27, 2012, compared to $101.0 million for the 13 weeks ended October 29, 2011. As a percentage of net sales, SG&A expenses decreased 120 basis points to 23.3% for the 13 weeks ended October 27, 2012, compared to 24.5% for the 13 weeks ended October 29, 2011. The leverage in SG&A expenses was primarily driven by 110 basis points in corporate overhead leverage attributed to higher sales volume.

Pre-opening expenses

Pre-opening expenses increased $2.3 million to $6.3 million for the 13 weeks ended October 27, 2012, compared to $4.0 million for the 13 weeks ended October 29, 2011. During the 13 weeks ended October 27, 2012, we opened 49 new stores , relocated 1 store and remodeled 11, compared to 28 new store openings and 1 relocated store during the 13 weeks ended October 29, 2011.

Interest expense

Interest expense was insignificant for the 13 weeks ended October 27, 2012 and October 29, 2011. We did not access our credit facility during the third quarter fiscal 2012 or 2011. Interest expense for both periods represents various unused fees related to the credit facility.

Income tax expense

Income tax expense of $23.1 million for the 13 weeks ended October 27, 2012 represents an effective tax rate of 37.7%, compared to $17.3 million of tax expense representing an effective tax rate of 39.2% for the 13 weeks ended October 29, 2011. The lower tax rate is primarily due to stock option exercises.

Net income

Net income increased $11.4 million, or 42.5%, to $38.2 million for the 13 weeks ended October 27, 2012, compared to $26.8 million for the 13 weeks ended October 29, 2011. The increase is primarily related to the $36.3 million increase in gross profit, offset by a $16.9 million increase in SG&A expenses and a $5.8 million increase in income tax expense.


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Comparison of 39 weeks ended October 27, 2012 to 39 weeks ended October 29, 2011

Net sales

Net sales increased $267.8 million, or 22.4%, to $1,461.4 million for the 39 weeks ended October 27, 2012, compared to $1,193.6 million for the 39 weeks ended October 29, 2011. Salon service sales increased $14.0 million, or 19.3%, to $86.5 million compared to $72.5 million in the first 39 weeks of fiscal 2011. The net sales increases are due to comparable stores increases of $106.4 million and non-comparable stores increases of $161.4 million compared to the first 39 weeks of fiscal 2011.

Our 9.3% comparable store sales increase included a 6.4% increase in traffic and a 2.9% increase in average ticket. We attribute the increase in comparable store sales to our successful marketing and merchandising strategies.

Gross profit

Gross profit increased $105.6 million, or 25.3%, to $524.0 million for the 39 weeks ended October 27, 2012, compared to $418.4 million for the 39 weeks ended October 29, 2011. Gross profit as a percentage of net sales increased 80 basis points to 35.9% for the 39 weeks ended October 27, 2012, compared to 35.1% for the 39 weeks ended October 29, 2011. The increases in gross profit margin were primarily driven by:

50 basis points improvement in merchandise margins driven by our marketing and merchandising strategies; and

50 basis points of leverage in fixed store costs attributed to the impact of higher sales volume.

Selling, general and administrative expenses

Selling, general and administrative (SG&A) expenses increased $48.5 million, or 16.9%, to $334.9 million for the 39 weeks ended October 27, 2012, compared to $286.4 million for the 39 weeks ended October 29, 2011. As a percentage of net sales, SG&A expenses decreased 110 basis points to 22.9% for the 39 weeks ended October 27, 2012, compared to 24.0% for the 39 weeks ended October 29, 2011. The leverage in SG&A expenses was primarily driven by:

40 basis points improvement in variable store and marketing expense leverage attributed to cost efficiencies and higher sales volume; and

70 basis points in corporate overhead leverage attributed to higher sales volume.

Pre-opening expenses

Pre-opening expenses increased $3.9 million to $12.9 million for the 39 weeks ended October 27, 2012, compared to $9.0 million for the 39 weeks ended October 29, 2011. During the 39 weeks ended October 27, 2012, we opened 89 new stores, relocated 3 stores and remodeled 20 stores, compared to 54 new store openings, 2 relocated stores and 17 remodeled stores during the 39 weeks ended October 29, 2011.

Interest expense

Interest expense was insignificant for the 39 weeks ended October 27, 2012 and October 29, 2011. We did not utilize our credit facility during the first nine months of fiscal 2012 or 2011. Interest expense for both periods represents various unused fees related to the credit facility.

Income tax expense

Income tax expense of $68.0 million for the 39 weeks ended October 27, 2012 represents an effective tax rate of 38.6%, compared to $48.5 million of tax expense representing an effective tax rate of 39.6% for the 39 weeks ended October 29, 2011. The lower tax rate is primarily due to stock option exercises and less non-deductible executive compensation.


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Net income

Net income increased $34.0 million, or 46.0%, to $108.0 million for the 39 weeks ended October 27, 2012, compared to $74.0 million for the 39 weeks ended October 29, 2011. The increase is primarily related to the $105.6 million increase in gross profit, offset by a $48.5 million increase in SG&A expenses and a $19.5 million increase in income tax 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, and for continued improvement in our information technology systems.

Our primary sources of liquidity are cash on hand and cash flows from operations, including changes in working capital and borrowings under our credit facility. The most significant component of our working capital is merchandise inventories 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 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 on hand, cash generated from operations and borrowings under our credit facility will satisfy the Company's working capital needs, capital expenditure needs, commitments, and other liquidity requirements through at least the next 12 months.

The following table presents a summary of our cash flows for the periods indicated:

                                                                    39 Weeks Ended
                                                           October 27,           October 29,
(In thousands)                                                2012                  2011
Net cash provided by operating activities                 $      77,458         $      77,460
Net cash used in investing activities                          (144,030 )             (97,695 )
Net cash provided by financing activities                         4,558                39,707

Net (decrease) increase in cash and cash equivalents      $     (62,014 )       $      19,472

Operating activities

Operating activities consist of net income adjusted for certain non-cash items, including depreciation and amortization, non-cash stock-based compensation, realized gains or losses on disposal of property and equipment, and the effect of working capital changes.

Merchandise inventories were $462.8 million at October 27, 2012, compared to $354.9 million at October 29, 2011, representing an increase of $107.9 million. The increase is primarily due to the addition of 95 net new stores opened since October 29, 2011 and the opening of the Chambersburg, Pennsylvania distribution center. The increase in average inventory per store reflects the Company's normal holiday inventory build, incremental inventory related to the recently added prestige brand boutiques as well as strategic inventory investments to help ensure strong holiday in-stock levels.

Deferred rent liabilities were $202.3 million at October 27, 2012, an increase of $41.3 million compared to October 29, 2011. Deferred rent includes deferred construction allowances, future rental increases and rent holidays which are all recognized on a straight-line basis over their respective lease term. The increase is primarily due to the addition of 95 net new stores opened since October 29, 2011 and the opening of the Chambersburg, Pennsylvania distribution center.

The $23.9 million cash flow benefit from income taxes is attributed to Federal income tax deductions due to accelerated bonus depreciation on fixed assets and tax deductible stock option exercises and share sales deemed to be disqualifying dispositions.

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