Ulta Beauty, Inc. - Quarter Report: 2009 August (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
| þ | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the Quarterly Period Ended August 1, 2009
or
| o | 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 SALON, COSMETICS & FRAGRANCE, INC.
(Exact name of Registrant as specified in its charter)
| Delaware | 36-3685240 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification No.) | |
| 1000 Remington Blvd., Suite 120 | 60440 | |
| Bolingbrook, Illinois | (Zip code) | |
| (Address of principal executive offices) |
Registrant’s telephone number, including area code: (630) 410-4800
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. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
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 and post such files). o Yes o No
Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). o Yes þ No
The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding as of
September 3, 2009 was 57,910,481 shares.
ULTA SALON, COSMETICS & FRAGRANCE, INC.
TABLE OF CONTENTS
TABLE OF CONTENTS
Part I — Financial Information |
||||
Item 1. Financial Statements |
||||
Balance Sheets |
3 | |||
Statements of Income |
5 | |||
Statements of Cash Flows |
6 | |||
Statement of Stockholders’ Equity |
8 | |||
Notes to Financial Statements |
9 | |||
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations |
15 | |||
Item 3. Quantitative and Qualitative Disclosures about Market Risk |
23 | |||
Item 4. Controls and Procedures |
23 | |||
Part II — Other Information |
24 | |||
Item 1. Legal Proceedings |
24 | |||
Item 1A. Risk Factors |
24 | |||
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds |
24 | |||
Item 3. Defaults Upon Senior Securities |
24 | |||
Item 4. Submission of Matters to a Vote of Security Holders |
25 | |||
Item 5. Other Information |
25 | |||
Item 6. Exhibits |
25 | |||
SIGNATURES |
26 |
2
Part I — Financial Information
Item 1. Financial Statements
| August 1, | January 31, | August 2, | ||||||||||
| (In thousands) | 2009 | 2009 | 2008 | |||||||||
| (unaudited) | (unaudited) | |||||||||||
Assets |
||||||||||||
Current assets: |
||||||||||||
Cash and cash equivalents |
$ | 3,663 | $ | 3,638 | $ | 3,255 | ||||||
Receivables, net |
13,135 | 18,268 | 19,164 | |||||||||
Merchandise inventories, net |
209,152 | 213,602 | 197,028 | |||||||||
Prepaid expenses and other current assets |
25,373 | 24,294 | 22,699 | |||||||||
Prepaid income taxes |
— | 8,628 | — | |||||||||
Deferred income taxes |
8,097 | 8,278 | 9,063 | |||||||||
Total current assets |
259,420 | 276,708 | 251,209 | |||||||||
Property and equipment, net |
288,537 | 292,224 | 278,378 | |||||||||
Deferred income taxes |
— | — | 4,080 | |||||||||
Total assets |
$ | 547,957 | $ | 568,932 | $ | 533,667 | ||||||
Liabilities and stockholders’ equity |
||||||||||||
Current liabilities: |
||||||||||||
Current portion — notes payable |
$ | 23,086 | $ | 18,000 | $ | 31,766 | ||||||
Accounts payable |
40,393 | 47,811 | 40,630 | |||||||||
Accrued liabilities |
53,350 | 51,202 | 52,865 | |||||||||
Accrued income taxes |
3,846 | — | 4,374 | |||||||||
Total current liabilities |
120,675 | 117,013 | 129,635 | |||||||||
Notes payable — less current portion |
42,365 | 88,047 | 86,390 | |||||||||
Deferred rent |
108,245 | 101,288 | 93,291 | |||||||||
Deferred income taxes |
17,616 | 17,616 | — | |||||||||
Total liabilities |
288,901 | 323,964 | 309,316 | |||||||||
Commitments and contingencies (note 3)
See accompanying notes to financial statements.
3
Ulta Salon, Cosmetics & Fragrance, Inc.
Balance Sheets (continued)
Balance Sheets (continued)
| August 1, | January 31, | August 2, | ||||||||||
| (In thousands, except per share data) | 2009 | 2009 | 2008 | |||||||||
| (unaudited) | (unaudited) | |||||||||||
Stockholders’ equity: |
||||||||||||
Common stock, $.01 par value, 400,000 shares
authorized; 58,389, 58,245 and 58,028
shares
issued; 57,884, 57,740 and 57,523 shares
outstanding; at August 1, 2009 (unaudited),
January 31, 2009 and August 2, 2008
(unaudited), respectively |
$ | 583 | $ | 582 | $ | 580 | ||||||
Treasury stock-common, at cost |
(4,179 | ) | (4,179 | ) | (4,179 | ) | ||||||
Additional paid-in capital |
296,205 | 293,052 | 289,587 | |||||||||
Accumulated deficit |
(33,186 | ) | (43,856 | ) | (61,161 | ) | ||||||
Accumulated other comprehensive loss |
(367 | ) | (631 | ) | (476 | ) | ||||||
Total stockholders’ equity |
259,056 | 244,968 | 224,351 | |||||||||
Total liabilities and stockholders’ equity |
$ | 547,957 | $ | 568,932 | $ | 533,667 | ||||||
See accompanying notes to financial statements.
4
| Three months ended | Six months ended | |||||||||||||||
| August 1, | August 2, | August 1, | August 2, | |||||||||||||
| (In thousands, except per share data) | 2009 | 2008 | 2009 | 2008 | ||||||||||||
Net sales |
$ | 273,539 | $ | 249,111 | $ | 542,364 | $ | 488,409 | ||||||||
Cost of sales |
195,028 | 175,965 | 384,510 | 341,342 | ||||||||||||
Gross profit |
78,511 | 73,146 | 157,854 | 147,067 | ||||||||||||
Selling, general and administrative expenses |
66,265 | 61,889 | 135,459 | 123,954 | ||||||||||||
Pre-opening expenses |
2,010 | 4,050 | 3,205 | 7,822 | ||||||||||||
Operating income |
10,236 | 7,207 | 19,190 | 15,291 | ||||||||||||
Interest expense |
645 | 1,016 | 1,316 | 1,931 | ||||||||||||
Income before income taxes |
9,591 | 6,191 | 17,874 | 13,360 | ||||||||||||
Income tax expense |
3,841 | 2,503 | 7,204 | 5,397 | ||||||||||||
Net income |
$ | 5,750 | $ | 3,688 | $ | 10,670 | $ | 7,963 | ||||||||
Net income per common share: |
||||||||||||||||
Basic |
$ | 0.10 | $ | 0.06 | $ | 0.18 | $ | 0.14 | ||||||||
Diluted |
$ | 0.10 | $ | 0.06 | $ | 0.18 | $ | 0.13 | ||||||||
Weighted average common shares outstanding: |
||||||||||||||||
Basic |
57,819 | 57,435 | 57,781 | 57,196 | ||||||||||||
Diluted |
59,045 | 59,012 | 58,914 | 59,000 | ||||||||||||
See accompanying notes to financial statements.
5
| Six months ended | ||||||||
| August 1, | August 2, | |||||||
| (In thousands) | 2009 | 2008 | ||||||
Operating activities |
||||||||
Net income |
$ | 10,670 | $ | 7,963 | ||||
Adjustments to reconcile net income to net cash
provided by operating activities: |
||||||||
Depreciation and amortization |
31,360 | 24,354 | ||||||
Non-cash stock compensation charges |
2,648 | 1,544 | ||||||
Excess tax benefits from stock-based compensation |
(283 | ) | (1,101 | ) | ||||
Loss on disposal of property and equipment |
184 | 252 | ||||||
Change in operating assets and liabilities: |
||||||||
Receivables |
5,133 | 1,479 | ||||||
Merchandise inventories |
4,450 | (20,919 | ) | |||||
Prepaid expenses and other assets |
(1,079 | ) | (3,515 | ) | ||||
Income taxes |
12,474 | (690 | ) | |||||
Accounts payable |
(7,418 | ) | (11,492 | ) | ||||
Accrued liabilities |
4,775 | 1,123 | ||||||
Deferred rent |
6,957 | 22,056 | ||||||
Net cash provided by operating activities |
69,871 | 21,054 | ||||||
Investing activities |
||||||||
Purchases of property and equipment |
(29,756 | ) | (68,072 | ) | ||||
Net cash used in investing activities |
(29,756 | ) | (68,072 | ) | ||||
Financing activities |
||||||||
Proceeds on long-term borrowings |
561,662 | 579,492 | ||||||
Payments on long-term borrowings |
(602,258 | ) | (536,106 | ) | ||||
Proceeds from issuance of common stock under
stock plans |
223 | 2,056 | ||||||
Excess tax benefits from stock-based compensation |
283 | 1,101 | ||||||
Initial public offering issuance costs |
— | (59 | ) | |||||
Net cash (used in) provided by financing activities |
(40,090 | ) | 46,484 | |||||
Net increase (decrease) in cash and cash equivalents |
25 | (534 | ) | |||||
Cash and cash equivalents at beginning of period |
3,638 | 3,789 | ||||||
Cash and cash equivalents at end of period |
$ | 3,663 | $ | 3,255 | ||||
See accompanying notes to financial statements.
6
Ulta Salon, Cosmetics & Fragrance, Inc.
Statements of Cash Flows (continued)
(unaudited)
Statements of Cash Flows (continued)
(unaudited)
| Six months ended | ||||||||
| August 1, | August 2, | |||||||
| (In thousands) | 2009 | 2008 | ||||||
Supplemental cash flow information |
||||||||
Cash paid for interest |
$ | 1,406 | $ | 2,175 | ||||
Cash paid (received) for income taxes |
$ | (5,553 | ) | $ | 4,987 | |||
Noncash investing and financing activities: |
||||||||
Change in property and equipment included in
accrued liabilities |
$ | (1,899 | ) | $ | (1,477 | ) | ||
Unrealized gain on interest rate swap hedge,
net of tax |
$ | 264 | $ | 243 | ||||
See accompanying notes to financial statements.
7
| Treasury - | Accumulated | |||||||||||||||||||||||||||||||
| Common Stock | Common Stock | Additional | Other | Total | ||||||||||||||||||||||||||||
| Issued | Treasury | Paid-In | Accumulated | Comprehensive | Stockholders’ | |||||||||||||||||||||||||||
| (In thousands, except per share data) | Shares | Amount | Shares | Amount | Capital | Deficit | Loss | Equity | ||||||||||||||||||||||||
Balance — January 31, 2009 |
58,245 | $ | 582 | (505 | ) | $ | (4,179 | ) | $ | 293,052 | $ | (43,856 | ) | $ | (631 | ) | $ | 244,968 | ||||||||||||||
Common stock options exercised |
144 | 1 | — | — | 222 | — | — | 223 | ||||||||||||||||||||||||
Unrealized gain on interest rate swap hedge,
net of $181 income tax |
— | — | — | — | — | — | 264 | 264 | ||||||||||||||||||||||||
Net income for the six months ended August 1, 2009 |
— | — | — | — | — | 10,670 | — | 10,670 | ||||||||||||||||||||||||
Comprehensive income |
10,934 | |||||||||||||||||||||||||||||||
Excess tax benefits from stock-based compensation |
— | — | — | — | 283 | — | — | 283 | ||||||||||||||||||||||||
Stock compensation charge |
— | — | — | — | 2,648 | — | — | 2,648 | ||||||||||||||||||||||||
Balance — August 1, 2009 |
58,389 | $ | 583 | (505 | ) | $ | (4,179 | ) | $ | 296,205 | $ | (33,186 | ) | $ | (367 | ) | $ | 259,056 | ||||||||||||||
See accompanying notes to financial statements.
8
1. Business and basis of presentation
The Company was incorporated in the state of Delaware on January 9, 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 1, 2009, the Company
operated 333 stores in 38 states, as shown in the table below:
| Number of | ||||
| State | stores | |||
Alabama |
7 | |||
Arizona |
24 | |||
Arkansas |
1 | |||
California |
30 | |||
Colorado |
11 | |||
Connecticut |
1 | |||
Delaware |
1 | |||
Florida |
24 | |||
Georgia |
17 | |||
Illinois |
32 | |||
Indiana |
6 | |||
Iowa |
3 | |||
Kansas |
1 | |||
Kentucky |
2 | |||
Louisiana |
2 | |||
Maryland |
6 | |||
Massachusetts |
4 | |||
Michigan |
9 | |||
Minnesota |
6 | |||
Mississippi |
1 | |||
Missouri |
3 | |||
Nebraska |
2 | |||
Nevada |
6 | |||
New Jersey |
10 | |||
New York |
12 | |||
North Carolina |
13 | |||
Ohio |
6 | |||
Oklahoma |
7 | |||
Oregon |
3 | |||
Pennsylvania |
14 | |||
Rhode Island |
1 | |||
South Carolina |
4 | |||
Tennessee |
3 | |||
Texas |
43 | |||
Utah |
2 | |||
Virginia |
10 | |||
Washington |
4 | |||
Wisconsin |
2 | |||
Total |
333 | |||
The accompanying unaudited 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. In the opinion of management, the accompanying financial statements reflect all
adjustments, which are of a normal 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 three months ended August 1, 2009 and August 2, 2008
are not necessarily indicative of the results to be expected for the fiscal year ending January 30,
2010, or for any other future interim period or for any future year.
These interim financial statements and the related notes should be read in conjunction with the
financial statements and notes included in the Company’s Annual Report on Form 10-K for the year
ended January 31, 2009. All amounts are stated in thousands, with the exception of per share
amounts and number of stores.
Reverse stock split
On September 17, 2007, the Company’s board of directors approved a resolution to effect a reverse
stock split of the Company’s common stock pursuant to which each share of common stock was to be
converted into 0.632 of one share of common stock. The reverse stock split became effective on
October 22, 2007. Any fractional shares resulting from the reverse stock split were rounded to
9
the
nearest whole share. Common share and per share amounts for all periods presented and the
conversion ratio of preferred to common shares have been adjusted for the 0.632 for 1 reverse stock
split.
Initial public offering
On October 30, 2007, the Company completed an initial public offering in which the Company sold
7,667 shares of common stock resulting in net proceeds of $123,549 after deducting underwriting
discounts and commissions and offering expenses. Selling stockholders sold approximately 2,154
additional shares of common stock. The Company did not receive any proceeds from the sale of shares
by the selling stockholders. The Company used the net proceeds from the offering to pay $93,012 of
accumulated dividends in arrears on the Company’s preferred stock, which satisfied all amounts due
with respect to accumulated dividends, $4,792 to redeem the Company’s Series III preferred stock,
and $25,745 to reduce the Company’s borrowings under its third amended and restated loan and
security agreement and for general corporate purposes. Also in connection with the offering, the
Company converted preferred shares into 41,524 common shares and restated the par value of its
common stock to $0.01 per share.
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 financial statements in the Company’s Annual
Report on Form 10-K for the year ended January 31, 2009. Presented below in this and the following
notes is supplemental information that should be read in conjunction with “Notes to financial
statements” in the Annual Report. The Company has evaluated subsequent events through September
10, 2009, which is the date these financial statements were issued.
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 quarters in fiscal 2009 and 2008 ended on
August 1, 2009 and August 2, 2008, respectively.
Reclassifications
Certain reclassifications have been made to the first half 2008 operating activities in the
statements of cash flows to separately present income taxes to conform to the first half 2009
presentation.
Share-based compensation
The Company accounts for share-based compensation in accordance with Statement of Financial
Accounting Standards (SFAS) No. 123(R), Share-Based Payment. Pursuant to SFAS 123(R), share-based
compensation cost is measured at grant date, based on the fair value of the award, and is
recognized as expense 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 assumptions for the periods indicated:
| Six months ended | |||||||||||
| August 1, 2009 | August 2, 2008 | ||||||||||
Volatility rate |
62.5 | % | 50.5 | % | |||||||
Average risk-free interest rate |
2.0 | % | 1.9 | % | |||||||
Average expected life (in years) |
4.6 | 4.7 | |||||||||
Dividend yield |
None | None | |||||||||
The Company granted 403 and 1,123 stock options during the six months ended August 1, 2009 and
August 2, 2008, respectively. The weighted-average grant date fair value of these options was $4.74
and $5.21, respectively.
The Company recorded stock compensation expense of $1,353 and $953 for the three months ended
August 1, 2009 and August 2, 2008, respectively. The Company recorded stock compensation expense of
$2,648 and $1,544 for the six months ended August 1, 2009 and August 2, 2008, respectively. At
August 1, 2009, there was approximately $11,549 of unrecognized compensation expense related to
unvested options.
10
Comprehensive income
Comprehensive income is comprised of net income and gains and losses from derivative instruments
designated as cash flow hedges, net of income tax. Total comprehensive income is as follows:
| Three months ended | Six months ended | |||||||||||||||
| August 1, | August 2, | August 1, | August 2, | |||||||||||||
| 2009 | 2008 | 2009 | 2008 | |||||||||||||
Net income |
$ | 5,750 | $ | 3,688 | $ | 10,670 | $ | 7,963 | ||||||||
Unrealized gain on
interest rate swap
hedge, net of
income tax |
157 | 100 | 264 | 243 | ||||||||||||
Comprehensive income |
$ | 5,907 | $ | 3,788 | $ | 10,934 | $ | 8,206 | ||||||||
Recent accounting pronouncements
In April 2009, the Financial Accounting Standards Board (FASB) issued FASB Staff Position SFAS No.
107-1 and Accounting Principles Board (APB) Opinion No. 28-1, Interim Disclosures about Fair Value
of Financial Instruments (“SFAS No. 107-1 and APB No. 28-1”), which requires quarterly disclosure
of information about fair value of financial instruments within the scope of Statement 107,
Disclosures about Fair Values of Financial Instruments. SFAS No. 107-1 and APB No. 28-1 are
effective for interim periods ending after June 15, 2009. The Company adopted the provisions of
SFAS 107-1 No. and APB No. 28-1 in the second quarter of 2009. The adoption of SFAS No. 107-1 and
APB No. 28-1 had no financial impact on the Company’s financial position or results of operations
as it is disclosure-only in nature.
In May 2009, the FASB issued SFAS No. 165, Subsequent Events. SFAS No. 165 establishes general
standards of accounting for, and requires disclosures of, events that occur after the balance sheet
date but before the financial statements are issued or are available to be issued. SFAS No.165 is
effective for interim or annual financial periods ending after June 15, 2009, and should be applied
prospectively. The Company adopted SFAS No. 165 in the second quarter of 2009. The adoption of
SFAS No. 165 had no impact on the Company’s consolidated financial position or results of
operations.
In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards CodificationTM
and the Hierarchy of Generally Accepted Accounting Principles — a replacement of SFAS No. 162. SFAS
No. 168 establishes the FASB Accounting Standards Codification as the source of authoritative
accounting principles recognized by the FASB to be applied in the preparation of financial
statements in conformity with generally accepted accounting principles. SFAS No. 168 explicitly
recognizes rules and interpretive releases of the Securities and Exchange Commission (SEC) under
federal securities laws as authoritative GAAP for SEC registrants. SFAS No. 168 is effective for
financial statements issued for fiscal years and interim periods ending after September 15, 2009.
The Company will adopt SFAS No. 168 in the third quarter of 2009, as required. The Company does not
expect SFAS No. 168 to have any impact on its consolidated financial position or results of
operations.
3. Commitments and contingencies
Leases — The Company leases stores, distribution and office facilities, and certain equipment.
Original non-cancelable lease terms range from three to ten years, and store leases generally
contain renewal options for additional years. A number of the Company’s store leases provide for
contingent rentals based upon sales. Contingent rent amounts were insignificant in the three months
ended August 1, 2009 and August 2, 2008. Total rent expense under operating leases was $17,823 and
$16,571 for the three months ended August 1, 2009 and August 2, 2008, respectively. Total rent
expense under operating leases was $35,759 and $32,030 for the six months ended August 1, 2009 and
August 2, 2008, respectively.
Securities litigation — In December 2007 and January 2008, three putative securities class action
lawsuits were filed against the Company and certain of its current and then-current executive
officers in the United States District Court for the Northern District of Illinois. Each suit
alleges that the prospectus and registration statement filed pursuant to the Company’s initial
public offering contained materially false and misleading statements and failed to disclose
material facts. Each suit claims violations of Sections 11, 12(a)(2) and/or 15 of the Securities
Act of 1933, and the two later filed suits added claims under Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934, as well as the associated Rule 10b-5. In February 2008, two of the
plaintiffs filed competing motions
to consolidate the actions and appoint lead plaintiffs and lead plaintiffs’ counsel. On March 18,
2008, after one of the plaintiffs withdrew his motion, the suits were consolidated and plaintiffs
in the Mirsky v. ULTA action were appointed lead plaintiffs. Lead plaintiffs filed their amended
complaint on May 19, 2008. The amended complaint alleges no new violations of the securities laws
not
11
asserted in the prior complaints. It adds no new defendants and drops one of the then-current
officers as a defendant. On July 21, 2008, Defendants filed a motion to dismiss the Amended
Complaint. On September 24, 2008, Lead Plaintiffs filed their opposition to the motion to dismiss,
and on October 24, 2008, Defendants filed their reply memorandum in support of their motion to
dismiss. On March 19, 2009, Defendants’ motion to dismiss was denied.
On May 29, 2009, the Company and its primary insurance carrier engaged in a mediation with counsel
representing the putative class. Although defendants continue to deny plaintiffs’ allegations, in
the interest of putting this matter behind it, the Company and its insurer have reached a tentative
settlement with plaintiffs, subject to final approval by the Court. On August 7, 2009, the Court
entered an order preliminarily approving the settlement, approving the form and manner of notice to
putative class members, and setting a final hearing to determine whether to approve the settlement
on November 16, 2009. All amounts to be paid under the tentative settlement will be paid out of
proceeds of the Company’s directors and officers liability insurance coverage.
General litigation — In July 2009, a putative employment class action lawsuit was filed against
the Company and certain unnamed defendants in State Court in California. The suit alleges that
Ulta misclassified its store General Managers and Salon Managers as exempt (from the Fair Labor
Standards Act and California Labor Code). The suit seeks to recover damages and penalties as a
result of this alleged misclassification. On August 27, 2009 the Company filed its answer to the
lawsuit and on August 31, 2009 the Company moved the action to Federal Court.
Although the Company believes that it has meritorious defenses to the claims made in the putative
class action and intends to contest the lawsuit vigorously, an adverse resolution could have a
material adverse effect on its financial position and results of operations in the period in which
the lawsuit is resolved. The Company is not presently able to reasonably estimate potential
losses, if any, related to the lawsuit.
The Company is also involved in various legal proceedings that are incidental to the conduct of its
business. In the opinion of management, the amount of any liability with respect to these
proceedings, either individually or in the aggregate, will not be material.
4. Notes payable
The Company’s credit facility is with LaSalle Bank National Association 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 $200,000 through May 31, 2011. The
facility provides maximum borrowings equal to the lesser of $200 million or a percentage of
eligible owned inventory. The advance rates on owned inventory are 80% (85% from September 1 to
January 31). The credit facility agreement contains a restrictive financial covenant requiring the
Company to maintain tangible net worth of not less than $80,000. On August 1, 2009, the Company’s
tangible net worth was approximately $259,000. 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 $100,000 and 1.25% thereafter.
The weighted-average interest rate on the outstanding borrowings as of August 1, 2009 and January
31, 2009, was 1.60% and 1.52%, respectively. At August 1, 2009, the Company had $65,451 of
outstanding borrowings under the facility. The Company has classified $42,365 as long-term as this
is the minimum amount that the Company believes will remain outstanding for an uninterrupted period
over the next year. The Company had approximately $120,798 and $86,764 of availability as of
August 1, 2009 and January 31, 2009, respectively.
The Company has an ongoing letter of credit that renews annually in October, the balance of which
was $326 as of August 1, 2009 and January 31, 2009.
5. Financial instruments
The Company is exposed to certain risks relating to its ongoing business operations. The primary
risk managed by using derivative instruments is interest rate risk. Interest rate swaps are entered
into to manage interest rate risk associated with the Company’s variable-rate borrowings. The
Company accounts for derivative financial instruments in accordance with SFAS No. 133, Accounting
for Derivative Instruments and Certain Hedging Activities, as amended.
On February 1, 2009, the Company adopted SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities — an amendment of SFAS No. 133. The adoption had no impact on amounts
recognized in the Company’s financial statements. SFAS No. 161 is intended to help investors better
understand how derivative instruments and hedging activities affect an entity’s financial position,
financial performance and cash flows through enhanced disclosure requirements. The enhanced
disclosures primarily surround disclosing the objectives and strategies for using derivative
instruments by their underlying risk as well as a tabular format of the fair values of the
derivative instruments and their gains and losses.
On January 31, 2007, the Company entered into an interest rate swap agreement with a notional
amount of $25,000 that qualified as a cash flow hedge to obtain a fixed interest rate on variable
rate debt and reduce certain exposures to interest rate fluctuations. The swap results in fixed
rate payments at an interest rate of 5.11% for a term of three years.
12
The Company does not hold or issue interest rate swap agreements for trading purposes. In the event
that a counter-party fails to meet the terms of the interest rate swap agreement, the Company’s
exposure is limited to the interest rate differential. The Company manages the credit risk of
counterparties by dealing only with institutions that the Company considers financially sound. The
Company considers the risk of non-performance to be remote.
The Company’s derivative financial instrument is designated and qualifies as a cash flow hedge.
Accordingly, the effective portion of the gain or loss on the derivative instrument is reported as
a component of accumulated other comprehensive loss and reclassified into interest expense in the
same period or periods during which the hedged transaction affects earnings. The remaining gain or
loss, the ineffective portion, on the derivative instrument, if other than inconsequential, is
recognized in interest expense during the period of change. The following table summarizes the fair
value and presentation within the balance sheets for derivatives designated as hedging instruments
under SFAS No. 133:
| Derivative Liabilities | ||||||||||||||||
| August 1, 2009 | January 31, 2009 | |||||||||||||||
| (unaudited) | ||||||||||||||||
| Balance Sheet | Balance Sheet | |||||||||||||||
| Location | Fair Value | Location | Fair Value | |||||||||||||
Interest rate swap liability |
Accrued liabilities | $ | 597 | Accrued liabilities | $ | 1,042 | ||||||||||
The following table presents the impact of derivatives in SFAS No. 133 cash flow hedging
relationships and their location within the unaudited statements of income and accumulated other
comprehensive loss (AOCL):
| Amount of Gain | Amount of Gain | Amount of Gain | ||||||||||||||||||||||
| Recognized in | Reclassfied from | Recognized in Income | ||||||||||||||||||||||
| AOCL on Derivative | AOCL into Income | on Derivative | ||||||||||||||||||||||
| (Effective Portion) | (Effective Portion) | (Ineffective Portion) | ||||||||||||||||||||||
| Three months ended | Three months ended | Three months ended | ||||||||||||||||||||||
| August 1, | August 2, | August 1, | August 2, | August 1, | August 2, | |||||||||||||||||||
| 2009 | 2008 | 2009 | 2008 | 2009 | 2008 | |||||||||||||||||||
Interest rate swap, net of tax |
$ | 157 | $ | 100 | $ | — | $ | — | $ | — | $ | — | ||||||||||||
| Amount of Gain | Amount of Gain | Amount of Gain | ||||||||||||||||||||||
| Recognized in | Reclassfied from | Recognized in Income | ||||||||||||||||||||||
| AOCL on Derivative | AOCL into Income | on Derivative | ||||||||||||||||||||||
| (Effective Portion) | (Effective Portion) | (Ineffective Portion) | ||||||||||||||||||||||
| Six months ended | Six months ended | Six months ended | ||||||||||||||||||||||
| August 1, | August 2, | August 1, | August 2, | August 1, | August 2, | |||||||||||||||||||
| 2009 | 2008 | 2009 | 2008 | 2009 | 2008 | |||||||||||||||||||
Interest rate swap, net of tax |
$ | 264 | $ | 243 | $ | — | $ | — | $ | — | $ | — | ||||||||||||
6. Fair Value Measurements
The carrying value of cash and cash equivalents, accounts receivable, and accounts payable
approximates their estimated fair values due to the short maturities of these instruments. The
estimated fair value of the Company’s variable rate debt approximates its carrying value since the
rate of interest on the variable rate debt is revised frequently based upon the current prime rate
or the Eurodollar rate.
On February 3, 2008, the Company adopted SFAS No. 157, Fair Value Measurements, for financial
assets and liabilities. The adoption had no impact on the Company’s financial statements. SFAS No.
157 established a three-tier hierarchy for fair value measurements, which prioritizes the inputs
used in measuring fair value 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. |
13
| • | 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 1, 2009, the Company held certain liabilities that are required to be measured at fair
value on a recurring basis. These included the Company’s interest rate swap agreement and certain
liabilities associated with the Company’s non-qualified deferred compensation plan. The fair value
of the Company’s interest rate swap agreement is determined based on inputs that are readily
available in public markets or can be derived from information available in publicly quoted
markets. Therefore, the Company has categorized the interest rate swap as Level 2. The fair value
of the Company’s liabilities associated with its non-qualified deferred compensation plan is based
primarily on third-party reported net asset values, which is primarily based on quoted market
prices of the underlying assets of the funds and have been categorized as Level 2. The following
table presents the Company’s financial liabilities as of August 1, 2009 measured at fair value on a
recurring basis:
| Fair value measurement using | ||||||||||||||||
| Level 1 | Level 2 | Level 3 | ||||||||||||||
Deferred compensation liabilities |
$ | — | $ | 136 | $ | — | ||||||||||
Interest rate swap liability |
$ | — | $ | 597 | $ | — | ||||||||||
7. 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:
| Three months ended | Six months ended | |||||||||||||||
| August 1, | August 2, | August 1, | August 2, | |||||||||||||
| 2009 | 2008 | 2009 | 2008 | |||||||||||||
Net income |
$ | 5,750 | $ | 3,688 | $ | 10,670 | $ | 7,963 | ||||||||
Denominator for basic net income per share —
weighted-average common shares |
57,819 | 57,435 | 57,781 | 57,196 | ||||||||||||
Dilutive effect of stock options |
1,226 | 1,577 | 1,133 | 1,804 | ||||||||||||
Denominator for diluted net income per share |
59,045 | 59,012 | 58,914 | 59,000 | ||||||||||||
Net income per common share: |
||||||||||||||||
Basic |
$ | 0.10 | $ | 0.06 | $ | 0.18 | $ | 0.14 | ||||||||
Diluted |
$ | 0.10 | $ | 0.06 | $ | 0.18 | $ | 0.13 | ||||||||
The denominators for diluted net income per common share for the three months ended August 1, 2009
and August 2, 2008 exclude 3,407 and 2,235 employee stock options, respectively, due to their
anti-dilutive effects.
The denominators for diluted net income per common share for the six months ended August 1, 2009
and August 2, 2008 exclude 3,790 and 2,235 employee stock options, respectively, due to their
anti-dilutive effects.
14
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 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 our Annual Report on Form
10-K for the year ended January 31, 2009. 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, primarily off-mall locations such as power centers and
lifestyle centers with other destination retailers. As of August 1, 2009, we operated 333 stores
across 38 states. In addition to these fundamental elements of a beauty superstore, we strive to
offer an uplifting shopping experience through what we now refer to as “The Five E’s”: Escape,
Education, Entertainment, Esthetics and Empowerment.
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 high single digit to low
double digit increases we experienced in 2006 and early 2007. We believe the sequential decline in
our quarterly comparable store sales during 2008 and the comparable store sales declines in first
and second quarter 2009 were due primarily to the difficult economic
environment. While we have experienced stabilization in our
comparable store sales in the first and second quarter of 2009, the
economy remains challenging and continues to have a negative impact
on the level of comparable store sales we can achieve.
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
15
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.
Global economic conditions
Recent global market and economic conditions have been unprecedented and challenging with tighter
credit conditions and recession in most major economies continuing in 2009. As a result of these
market conditions, the cost and availability of credit has been and may continue to be adversely
affected by illiquid credit markets and wider credit spreads. Concern about the stability of the
markets generally and the strength of counterparties specifically has led many lenders and
institutional investors to reduce, and in some cases, cease to provide credit to businesses and
consumers. These factors have led to a decrease in spending by businesses and consumers alike, and
a corresponding decrease in global infrastructure spending. Continued turbulence in the United
States and international markets and economies and prolonged declines in business and consumer
spending may adversely affect our liquidity and financial condition, and the liquidity and
financial condition of our customers, including our ability to refinance maturing liabilities and
access the capital markets to meet liquidity needs.
Basis of presentation
Net sales include store and e-commerce 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 (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 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 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; |
16
| • | 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. |
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; | ||
| • | 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.
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 quarters in fiscal 2009 and 2008 ended on August 1, 2009
and August 2, 2008, 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.
17
The following tables present the components of our results of operations for the periods indicated:
| Three months ended | Six months ended | |||||||||||||||
| August 1, | August 2, | August 1, | August 2, | |||||||||||||
| (Dollars in thousands) | 2009 | 2008 | 2009 | 2008 | ||||||||||||
Net sales |
$ | 273,539 | $ | 249,111 | $ | 542,364 | $ | 488,409 | ||||||||
Cost of sales |
195,028 | 175,965 | 384,510 | 341,342 | ||||||||||||
Gross profit |
78,511 | 73,146 | 157,854 | 147,067 | ||||||||||||
Selling, general and administrative
expenses |
66,265 | 61,889 | 135,459 | 123,954 | ||||||||||||
Pre-opening expenses |
2,010 | 4,050 | 3,205 | 7,822 | ||||||||||||
Operating income |
10,236 | 7,207 | 19,190 | 15,291 | ||||||||||||
Interest expense |
645 | 1,016 | 1,316 | 1,931 | ||||||||||||
Income before income taxes |
9,591 | 6,191 | 17,874 | 13,360 | ||||||||||||
Income tax expense |
3,841 | 2,503 | 7,204 | 5,397 | ||||||||||||
Net income |
$ | 5,750 | $ | 3,688 | $ | 10,670 | $ | 7,963 | ||||||||
Other operating data: |
||||||||||||||||
Number stores end of period |
333 | 283 | 333 | 283 | ||||||||||||
Comparable store sales (decrease) increase |
(1.7 | )% | 3.7 | % | (2.0 | )% | 3.8 | % | ||||||||
| Three months ended | Three months ended | |||||||||||||||
| August 1, | August 2, | August 1, | August 2, | |||||||||||||
| (Percentage of net sales) | 2009 | 2008 | 2009 | 2008 | ||||||||||||
Net sales |
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Cost of sales |
71.3 | % | 70.6 | % | 70.9 | % | 69.9 | % | ||||||||
Gross profit |
28.7 | % | 29.4 | % | 29.1 | % | 30.1 | % | ||||||||
Selling, general and
administrative expenses |
24.2 | % | 24.8 | % | 25.0 | % | 25.4 | % | ||||||||
Pre-opening expenses |
0.7 | % | 1.6 | % | 0.6 | % | 1.6 | % | ||||||||
Operating income |
3.7 | % | 2.9 | % | 3.5 | % | 3.1 | % | ||||||||
Interest expense |
0.2 | % | 0.4 | % | 0.2 | % | 0.4 | % | ||||||||
Income before income taxes |
3.5 | % | 2.5 | % | 3.3 | % | 2.7 | % | ||||||||
Income tax expense |
1.4 | % | 1.0 | % | 1.3 | % | 1.1 | % | ||||||||
Net income |
2.1 | % | 1.5 | % | 2.0 | % | 1.6 | % | ||||||||
During fiscal 2008, we experienced a deceleration of our comparable store sales. Our comparable
store increases for the first, second and third quarters of fiscal 2008 were 3.9%, 3.7% and 2.0%,
respectively, while our fourth quarter comparable store sales decreased 5.5% resulting in a full
year comparable store sales increase of 0.2%. We believe that the deterioration of the U.S.
economy was the primary contributing factor to our comparable store sales deceleration throughout
fiscal 2008.
18
Comparison of three months ended August 1, 2009 to three months ended August 2, 2008
Net sales
Net sales increased $24.4 million, or 9.8%, to $273.5 million for the three months ended August 1,
2009, compared to $249.1 million for the three months ended August 2, 2008. The increase is
primarily due to an additional 50 new stores operating since second quarter 2008 which contributed
$28.5 million to net sales while the sales decline in comparable stores caused a decrease of $4.1
million to net sales when compared to last year.
Our comparable store sales decreased 1.7%, which included a 2.2% increase in traffic offset by a
3.9% decrease in average ticket. We attribute the decrease in comparable store sales primarily to
the continuing difficult economic environment and its negative impact on consumer spending.
Gross profit
Gross profit increased $5.4 million, or 7.3%, to $78.5 million for the three months ended August 1,
2009, compared to $73.1 million for the three months ended August 2, 2008. Gross profit as a
percentage of net sales decreased 70 basis points to 28.7% for the three months ended August 1,
2009, compared to 29.4% for the three months ended August 2, 2008. The decrease in gross profit
margin was primarily driven by 130 basis points of deleverage in fixed store occupancy costs
resulting from the acceleration of our new store program in prior fiscal years. The fixed store
deleverage is net of 20 basis points of accelerated depreciation related to a store fixture program
and a 30 basis point benefit due to temporary rent relief in a dozen stores where co-tenant
vacancies triggered temporary rent reductions. We also experienced a 30 basis point decrease in our
merchandise margin rate due to higher customer redemption rates for our marketing coupons compared
to last year which is consistent with our experience in the first quarter fiscal 2009. The
decreases in gross profit margin were offset by the benefit of cost reductions and operating
efficiencies across our supply chain.
Selling, general and administrative expenses
Selling, general and administrative (SG&A) expenses increased $4.4 million, or 7.1%, to $66.3
million for the three months ended August 1, 2009, compared to $61.9 million for the three months
ended August 2, 2008. As a percentage of net sales, SG&A expenses decreased 60 basis points to
24.2% for the three months ended August 1, 2009, compared to 24.8% for the three months ended
August 2, 2008. The improvement in SG&A primarily represents improved leverage in store and
corporate overhead expenses as a result of our focused expense management strategies.
Pre-opening expenses
Pre-opening expenses decreased $2.1 million, or 50.4%, to $2.0 million for the three months ended
August 1, 2009, compared to $4.1 million for the three months ended August 2, 2008. During the
three months ended August 1, 2009, we opened 13 new stores, compared to 18 new store openings and 5
remodeled stores during the three months ended August 2, 2008.
Interest expense
Interest expense was $0.6 million for the three months ended August 1, 2009, compared to $1.0
million for the three months ended August 2, 2008. The decrease is the result of lower average debt
outstanding on our credit facility and a decline in our weighted-average interest rate compared to
the same period last year.
Income tax expense
Income tax expense of $3.8 million for the three months ended August 1, 2009 represents an
effective tax rate of 40.0%, compared to $2.5 million of tax expense representing an effective tax
rate of 40.4% for the three months ended August 2, 2008.
Net income
Net income increased $2.1 million, or 55.9%, to $5.8 million for the three months ended August 1,
2009, compared to $3.7 million for the three months ended August 2, 2008. The increase is primarily
related to the $5.4 million increase in gross profit and a $2.1 million decrease in pre-opening
expenses, partially offset by a $4.4 million increase in SG&A expenses.
19
Comparison of six months ended August 1, 2009 to six months ended August 2, 2008
Net sales
Net sales increased $54.0 million, or 11.0%, to $542.4 million for the six months ended August 1,
2009, compared to $488.4 million for the six months ended August 2, 2008. The increase is primarily
due to an additional 50 new stores operating since second quarter 2008 which contributed $63.2
million to net sales while the sales decline in comparable stores caused a decrease of $9.2 million
to net sales when compared to last year.
Our comparable store sales decreased 2.0%, which included a 2.1% increase in traffic offset by a
4.1% decrease in average ticket. We attribute the decrease in comparable store sales primarily to
the continuing difficult economic environment and its negative impact on consumer spending.
Gross profit
Gross profit increased $10.8 million, or 7.3%, to $157.9 million for the six months ended August 1,
2009, compared to $147.1 million for the six months ended August 2, 2008. Gross profit as a
percentage of net sales decreased 100 basis points to 29.1% for the six months ended August 1,
2009, compared to 30.1% for the six months ended August 2, 2008. The decrease in gross profit
margin was primarily driven by 130 basis points of deleverage in fixed store occupancy costs
resulting from the acceleration of our new store program in prior fiscal years. We also
experienced a 40 basis point decline in gross profit margin as the result of additional merchandise
margin investment in the first quarter to drive customer traffic in a difficult retail environment,
and the continuing negative impact due to higher redemption rates of our marketing coupons compared
to last year. These decreases in gross profit margin were offset by the benefit of cost reductions
and operating efficiencies across our supply chain.
Selling, general and administrative expenses
Selling, general and administrative (SG&A) expenses increased $11.5 million, or 9.3%, to $135.5
million for the six months ended August 1, 2009, compared to $124.0 million for the six months
ended August 2, 2008. As a percentage of net sales, SG&A expenses decreased 40 basis points to
25.0% for the six months ended August 1, 2009, compared to 25.4% for the six months ended August 2,
2008. The improvement in SG&A primarily represents improved leverage in store and corporate
overhead expenses as a result of our focused expense management strategies.
Pre-opening expenses
Pre-opening expenses decreased $4.6 million, or 59.0%, to $3.2 million for the six months ended
August 1, 2009, compared to $7.8 million for the six months ended August 2, 2008. During the six
months ended August 1, 2009, we opened 22 new stores, compared to 35 new store openings and 6
remodeled stores during the six months ended August 2, 2008.
Interest expense
Interest expense was $1.3 million for the six months ended August 1, 2009, compared to $1.9 million
for the six months ended August 2, 2008. The decrease is the result of lower average debt
outstanding on our credit facility and a decline in our weighted-average interest rate compared to
the same period last year.
Income tax expense
Income tax expense of $7.2 million for the six months ended August 1, 2009 represents an effective
tax rate of 40.3%, compared to $5.4 million of tax expense representing an effective tax rate of
40.4% for the six months ended August 2, 2008.
Net income
Net income increased $2.7 million, or 34.0%, to $10.7 million for the six months ended August 1,
2009, compared to $8.0 million for the six months ended August 2, 2008. The increase is primarily
related to the $10.8 million increase in gross profit and a $4.6 million decrease in pre-opening
expenses, partially offset by a $11.5 million increase in SG&A expenses.
20
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 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
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 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 six months ended August 1, 2009
and August 2, 2008:
| Six months ended | ||||||||
| August 1, | August 2, | |||||||
| (In thousands) | 2009 | 2008 | ||||||
Net cash provided by operating activities |
$ | 69,871 | $ | 21,054 | ||||
Net cash used in investing activities |
(29,756 | ) | (68,072 | ) | ||||
Net cash (used in) provided by financing activities |
(40,090 | ) | 46,484 | |||||
Net increase (decrease) in cash and cash equivalents |
$ | 25 | $ | (534 | ) | |||
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 losses on disposal of property and equipment, and the effect of
working capital changes.
Merchandise inventories were $209.2 million at August 1, 2009, an increase of $12.2 million
compared to August 2, 2008. The increase is primarily related to the addition of 50 net new stores
opened since August 2, 2008. Average inventory per store at August 1, 2009 decreased approximately
9.8% compared to August 2, 2008. The decrease in inventory per store is the result of specific
inventory management initiatives implemented in fiscal 2009.
Prepaid income taxes decreased $8.6 million from January 31, 2009 to August 1, 2009. The change is
primarily related to the receipt of an expected $8.0 million income tax refund in May 2009, related
to certain tax planning changes adopted in fiscal 2008.
Deferred rent liabilities were $108.2 million at August 1, 2009, an increase of $14.9 million
compared to August 2, 2008. 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 due to activity since August 2, 2008 which includes 50 net new stores.
Investing activities
We have historically used cash primarily for new and remodeled stores as well as investments in
information technology systems. Investment activities relate to capital expenditures were $29.8
million during the six months ended August 1, 2009, compared to $68.1 million during the six months
ended August 2, 2008. The decrease in capital expenditures year over year is primarily due to the
planned reduction in our new store program in fiscal 2009 due to the uncertain economy and its
effect on the real estate market place. Capital expenditures for the six months ended August 1,
2009 included 22 new stores while capital expenditures for the six months ended August 2, 2008
included 35 new stores and the addition of our second distribution center.
21
Financing activities
Financing activities consist principally of draws and payments on our credit facility and capital
stock transactions. The decrease in net cash provided by financing activities of $86.6 million in
first half 2009 compared to first half 2008 is primarily the result of increased payments on
long-term borrowings.
Credit facility
Our credit facility is with LaSalle Bank National Association 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 $200 million through May 31, 2011. The facility provides
maximum borrowings equal to the lesser of $200 million or a percentage of eligible owned inventory.
The advance rates on owned inventory are 80% (85% from September 1 to January 31).The credit
facility agreement contains a restrictive financial covenant requiring us to maintain tangible net
worth of not less than $80 million. On August 1, 2009, our tangible net worth was approximately
$259 million. Substantially all of our 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 interest rate on the outstanding balances under the facility as of August 1, 2009, January 31,
2009 and August 2, 2008 was 1.60%, 1.52% and 3.67%, respectively. At August 1, 2009, we had $65.5
million of outstanding borrowings under the facility. We have classified $42.4 million as long-term
as this is the minimum amount we believe will remain outstanding for an uninterrupted period over
the next year. We had approximately $120.8 million, $86.8 million and $31.5 million (excluding the
accordion option which was exercised on August 15, 2008) of availability as of August 1, 2009,
January 31, 2009 and August 2, 2008, respectively. We also have an ongoing letter of credit that
renews annually which had a balance of $0.3 million as of August 1, 2009, January 31, 2009 and
August 2, 2008.
Off-balance sheet arrangements
Our off-balance sheet arrangements consist of operating lease obligations and letters of credit. We
do not have any non-cancelable purchase commitments as of August 1, 2009. Our letters of credit
outstanding under our revolving credit facility were $0.3 million as of August 1, 2009.
Contractual obligations
Our contractual obligations consist of operating lease obligations and our revolving line of
credit. No material changes outside the ordinary course of business have occurred in our
contractual obligations during the three months ended August 1, 2009.
Critical accounting policies and estimates
Management’s discussion and analysis of financial condition and results of operations is based upon
our financial statements, which have been prepared in accordance with GAAP. The preparation of
these financial statements required the use of estimates and judgments that affect the reported
amounts of our assets, liabilities, revenues and expenses. Management bases estimates on historical
experience and other assumptions it believes to be reasonable under the circumstances and evaluates
these estimates on an on-going basis. Actual results may differ from these estimates. There have
been no significant changes to the critical accounting policies and estimates included in our
Annual Report on Form 10-K for the year ended January 31, 2009.
Share-based compensation
We account for share-based compensation in accordance with Statement of Financial Accounting
Standards (SFAS) No. 123(R), Share-Based Payment. Pursuant to SFAS No. 123(R), share-based
compensation cost is measured at grant date, based on the fair value of the award, and is
recognized as expense over the requisite service period for awards expected to vest.
We estimate the grant date fair value of stock options using a Black-Scholes valuation model. The
expected volatility is based on volatilities of a peer group of publicly-traded companies. The risk
free interest rate is based on the United States Treasury yield curve in effect on the date of
grant for the respective expected life of the option. The expected life represents the time the
options granted are expected to be outstanding. We have elected to use the shortcut approach in
accordance with Staff Accounting Bulletin (SAB) No. 107, Share-Based Payment, and SAB No. 110,
Simplified Method for Plain Vanilla Share Options, to develop the expected life. We recognize
compensation cost related to the stock options on a straight-line method over the requisite service
period.
22
See notes to financial statements, “Summary of significant accounting policies — Share-based
compensation,” for disclosure related to the Company’s stock compensation expense and related
valuation model assumptions.
Recent accounting pronouncements
In April 2009, the Financial Accounting Standards Board (FASB) issued FASB Staff Position SFAS No.
107-1 and Accounting Principles Board (APB) Opinion No. 28-1, Interim Disclosures about Fair Value
of Financial Instruments (“SFAS No. 107-1 and APB No. 28-1”), which requires quarterly disclosure
of information about fair value of financial instruments within the scope of Statement 107,
Disclosures about Fair Values of Financial Instruments. SFAS No. 107-1 and APB No. 28-1 are
effective for interim periods ending after June 15, 2009. We adopted the provisions of SFAS 107-1
No. and APB No. 28-1 in the second quarter of 2009. The adoption of SFAS No. 107-1 and APB No. 28-1
had no financial impact on our financial position or results of operations as it is disclosure-only
in nature.
In May 2009, the FASB issued SFAS No. 165, Subsequent Events. SFAS No. 165 establishes general
standards of accounting for, and requires disclosures of, events that occur after the balance sheet
date but before the financial statements are issued or are available to be issued. SFAS No.165 is
effective for interim or annual financial periods ending after June 15, 2009, and should be applied
prospectively. We adopted SFAS No. 165 in the second quarter of 2009. The adoption of SFAS No. 165
did not have any impact on our consolidated financial position or results of operations.
In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards CodificationTM
and the Hierarchy of Generally Accepted Accounting Principles — a replacement of SFAS No. 162. SFAS
No. 168 establishes the FASB Accounting Standards Codification as the source of authoritative
accounting principles recognized by the FASB to be applied in the preparation of financial
statements in conformity with generally accepted accounting principles. SFAS No. 168 explicitly
recognizes rules and interpretive releases of the Securities and Exchange Commission (SEC) under
federal securities laws as authoritative GAAP for SEC registrants. SFAS No. 168 is effective for
financial statements issued for fiscal years and interim periods ending after September 15, 2009.
We will adopt SFAS No. 168 in the third quarter of 2009, as required. We do not expect SFAS No. 168
to have any impact on our consolidate financial position or results of operations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk represents the risk of loss that may impact our financial position due to adverse
changes in financial market prices and rates. Our market risk exposure is primarily the result of
fluctuations in interest rates. We do not hold or issue financial instruments for trading purposes.
Interest rate sensitivity
We are exposed to interest rate risks primarily through borrowings under our credit facility.
Interest on our borrowings is based upon variable rates. We have an interest rate swap agreement in
place with a notional amount of $25.0 million which effectively converts variable rate debt to
fixed rate debt at an interest rate of 5.11%. The interest rate swap reflected in the balance
sheets as of August 1, 2009 and January 31, 2009 had a negative fair value of $0.6 million and $1.0
million, respectively, and is included in accrued liabilities. The interest rate swap is designated
as a cash flow hedge, the effective portion of which is recorded as an unrecognized gain or loss in
accumulated other comprehensive loss in stockholders’ equity. Our weighted average debt for the six
months ended August 1, 2009 was $68.0 million, adjusted for the $25.0 million hedged amount. A
hypothetical 1% increase or decrease in interest rates would have resulted in a $0.3 million change
to our interest expense for the six months ended August 1, 2009.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures over Financial Reporting
We have established disclosure controls and procedures to ensure that material information relating
to the Company is made known to the officers who certify our financial reports and to the members
of our senior management and board of directors.
Based on management’s evaluation as of August 1, 2009, our Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are effective to ensure that the
information required to be disclosed by us in our reports that we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission’s rules and forms.
23
Changes in Internal Control over Financial Reporting
There were no changes to our internal controls over financial reporting during the three months
ended August 1, 2009 that have materially affected, or are reasonably likely to materially affect,
our internal controls over financial reporting.
Part II — Other Information
Item 1. Legal Proceedings
Securities litigation — In December 2007 and January 2008, three putative securities class action
lawsuits were filed against us and certain of our current and then-current executive officers in
the United States District Court for the Northern District of Illinois. Each suit alleges that the
prospectus and registration statement filed pursuant to our initial public offering contained
materially false and misleading statements and failed to disclose material facts. Each suit claims
violations of Sections 11, 12(a)(2) and/or 15 of the Securities Act of 1933, and the two later
filed suits added claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as
well as the associated Rule 10b-5. In February 2008, two of the plaintiffs filed competing motions
to consolidate the actions and appoint lead plaintiffs and lead plaintiffs’ counsel. On March 18,
2008, after one of the plaintiffs withdrew his motion, the suits were consolidated and plaintiffs
in the Mirsky v. ULTA action were appointed lead plaintiffs. Lead plaintiffs filed their amended
complaint on May 19, 2008. The amended complaint alleges no new violations of the securities laws
not asserted in the prior complaints. It adds no new defendants and drops one of the then-current
officers as a defendant. On July 21, 2008, Defendants filed a motion to dismiss the Amended
Complaint. On September 24, 2008, Lead Plaintiffs filed their opposition to the motion to dismiss,
and on October 24, 2008, Defendants filed their reply memorandum in support of their motion to
dismiss. On March 19, 2009, Defendants’ motion to dismiss was denied.
On May 29, 2009, we and our primary insurance carrier engaged in a mediation with counsel
representing the putative class. Although we continue to deny plaintiffs’ allegations, in the
interest of putting this matter behind us, we and our insurer have reached a tentative settlement
with plaintiffs, subject to final approval by the Court. On August 7, 2009, the Court entered an
order preliminarily approving the settlement, approving the form and manner of notice to putative
class members, and setting a final hearing to determine whether to approve the settlement on
November 16, 2009. All amounts to be paid under the tentative settlement will be paid out of
proceeds of our directors and officers liability insurance coverage.
General litigation — In July 2009, a putative employment class action lawsuit was filed against us
and certain unnamed defendants in State Court in California. The suit alleges that Ulta
misclassified its store General Managers and Salon Managers as exempt (from the Fair Labor
Standards Act and California Labor Code). The suit seeks to recover damages and penalties as a
result of this alleged misclassification. On August 27, 2009 we filed our answer to the lawsuit and
on August 31, 2009 we moved the action to Federal Court. Although we believe that
we have meritorious defenses to the claims made in the putative class action and intends to contest
the lawsuit vigorously, an adverse resolution could have a material adverse effect on our financial
position and results of operations in the period in which the lawsuit is resolved. We are not
presently able to reasonably estimate potential losses, if any, related to the lawsuit.
We are also involved in various legal proceedings that are incidental to the conduct of our
business. In the opinion of management, the amount of any liability with respect to these
proceedings, either individually or in the aggregate, will not be material.
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the
factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year
ended January 31, 2009, which could materially affect our business, financial condition, financial
results or future performance. There have been no material changes from the risk factors previously
disclosed in our Annual Report on Form 10-K for the year ended January 31, 2009.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
24
Item 4. Submission of Matters to a Vote of Security Holders
At our Annual Meeting of Stockholders held on June 17, 2009, the Company’s stockholders elected
three Class II Directors to hold office until the 2012 Annual Meeting of Stockholders and ratified
the appointment of Ernst & Young LLP as our independent registered public accounting firm for our
fiscal year 2009, ending January 30, 2010.
The table below shows the results of the stockholders’ votes:
| For | Against | Abstain | Withheld | |||||||||||||
Election of Class II Directors: |
||||||||||||||||
Hervé J.F. Defforey |
51,249,733 | — | — | 602,695 | ||||||||||||
Robert F. DiRomualdo |
51,250,239 | — | — | 602,189 | ||||||||||||
Lorna E. Nagler |
51,250,111 | — | — | 602,317 | ||||||||||||
Ratification of the appointment of Ernst & Young LLP as our independent
registered public accounting firm |
51,707,566 | 141,224 | 3,638 | — | ||||||||||||
Item 5. Other Information
None
Item 6. Exhibits
| Exhibit | ||
| number | Description of document | |
3.1
|
Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 (file No. 333-144405) filed with the Securities and Exchange Commission on August 17, 2007). | |
3.2
|
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1 (file No. 333-144405) filed with the Securities and Exchange Commission on August 17, 2007). | |
4.1
|
Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-1 (file No. 333-144405) filed with the Securities and Exchange Commission on October 11, 2007). | |
4.2
|
Third Amended and Restated Registration Rights Agreement between Ulta Salon, Cosmetics & Fragrance, Inc. and the stockholders party thereto (incorporated by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1 (file No. 333-144405) filed with the Securities and Exchange Commission on August 17, 2007). | |
4.3
|
Stockholder Rights Agreement (incorporated by reference to Exhibit 4.4 to the Company’s Registration Statement on Form S-1 (file No. 333-144405) filed with the Securities and Exchange Commission on August 17, 2007). | |
31.1
|
Certification of the Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2
|
Certification of the Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1
|
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
25
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on September 10, 2009 on its behalf by the
undersigned, thereunto duly authorized.
| ULTA SALON, COSMETICS & FRAGRANCE, INC. | ||||
By:
|
/s/ Lynelle P. Kirby | |||
| President, Chief Executive Officer and Director | ||||
By:
|
/s/ Gregg R. Bodnar | |||
| Gregg R. Bodnar | ||||
| Chief Financial Officer | ||||
26