Ulta Beauty Inc (ULTA) 2016 Q2 法說會逐字稿

Greetings and welcome to the Ulta Beauty 2016 second-quarter earnings results conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Ms. Laurel Lefebvre, Vice President of Investor Relations. Thank you, you may begin.

Thank you, good afternoon and thank you for joining us for Ulta Beauty's second-quarter 2016 conference call. Hosting our call are Mary Dillon, Chief Executive Officer, and Scott Settersten, Chief Financial Officer. Also joining us is Dave Kimbell, Chief Merchandising and Marketing Officer.

Before we begin, I'd like to remind you of the Company's Safe Harbor language. Statements contained in this conference call which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially had from those projected in such statements, due to a number of risks and uncertainties, all of which are described in the Company's filings with the SEC.

During the Q&A session, we respectfully request that you please ask just one question to allow us to have time to respond to as many of you as possible during the hour scheduled for this call. I'll now turn it over to Mary.

Thank you, Laurel. Good afternoon. Our team achieved another quarter of excellent top and bottom line performance, while making significant progress in many elements of our growth strategy.

Highlights of the quarter include the continued impact of a strong pipeline of newness and innovation in merchandising, progress in growing our brand awareness, reaching major milestones related to our loyalty program, continued rapid growth in our e-commerce business, and successful execution of our supply chain investment. To summarize our second-quarter financial performance, total Company sales grew 21.9%, and comp sales rose 14.4%, on top of 10.1% comps in the second quarter of 2015, driven by healthy gains in both transaction count and average ticket.

Strength in cosmetics, both mass and prestige, continues to be the biggest driver of our growth, but our other major categories are contributing, as well. E-commerce performance was very strong, and the salon business achieved solid top line growth. We delivered earnings per share growth of 24.3%, despite significant investments in the business, including the opening of our new distribution center in Dallas, implementing core merchandising systems, and rolling out a large number of prestige brand boutiques and related store remodels.

Let me cover some of the highlights driving our performance in the second quarter, starting with our efforts to acquire new customers. Our loyalty program surpassed the 20 million member mark, and now boasts 20.6 million active members, growing more than 27% year-over-year on a rolling 12-month basis. We believe our evolving marketing strategy, with a growing focus on multimedia advertising and digital marketing is working to raise our profile and consumer awareness, and to better define our brands.

Once people discover Ulta Beauty, our store associates continue to do a fantastic job signing them up for our ULTAmate Rewards loyalty program. Retention rate, sales per member, frequency of purchase, and average member ticket remain very strong.

We were also very excited to launch our new ULTAmate Rewards credit card program chain-wide just a few weeks ago. We now offer members an Ulta Beauty private label credit card, which can be used in any of our stores, and at Ulta.com, and we offer a co-branded credit card, which can be used wherever MasterCard is accepted.

Our team has been working diligently on this project for more than a year, designing a program we know our members will love, upgrading our POS systems, preparing our store associates, and developing a robust marketing program. It's a great example of enterprise-wide collaboration across multiple areas of the business.

The credit card is designed to enhance our ULTAmate Rewards program by offering greater benefits to our members, which we believe will drive increased engagement and loyalty. While we don't expect this new program to have a material impact on our results in the short-term, early indications are quite positive, and we believe this will create tremendous value for our guests and our Company over the long term.

Our marketing mix continues to evolve, with increased use of television, radio, digital and social media, and less reliance on traditional print vehicles. During the second quarter, we executed a successful Gorgeous Hair event, supported by national radio and digital campaigns. Reflecting our 2016 focus on the lip category, we continued our Lip Happily campaign, and launched the #ThisIsHowILip digital campaign with native content integration, influencers, dedicated e-mails, video and banners with mass reach beauty sites like Vivala, Refinery29 and POPSUGAR.

Now turning to merchandising. Newness and innovation continues to drive the business.

We're seeing ongoing strength in both mass and prestige cosmetics, with impressive growth in Urban Decay, It Cosmetics, Nyx, Anastasia, Too Faced, Tarte, Clinique, Lancome, Benefit, Maybelline, Real Techniques and the Ulta Beauty collection. The professional hair care category was also strong, anchored by great execution of the signature Ulta Beauty promotion, our liter event, featuring compelling prices on jumbo sizes of salon hair care brands.

New items contributed significantly to the overall comp. Noteworthy additions included Urban Decay's new assortment of 100 Shades of Vice lipstick. The introduction of Anastasia color cosmetics, the launch of Soap & Glory cosmetics, hundreds of new SKUs from Nyx, and innovation in the nail category with Essie's Gel Couture nail polish featuring up to 14 day durability.

We added several new limited distribution brands, including Shiseido, e.l.f, Julep, Drybar, Maui Moisture and Vita Liberata. We also expanded clearance skincare to additional stores, and rolled out BECCA cosmetics to almost the entire chain.

The Ulta Beauty collection continued its rapid growth, with new products and an upgraded presentation, which includes a new wall layout, and improved graphics, while also improving the shopping experience with our chain-wide tester program for the Ulta Beauty collection, as well as Nyx within the mass cosmetics assortment. We're very pleased with the strong execution of the large number of Clinique and Lancome boutique installations that are planned this year, and the stores are excited to introduce these prestige brands to our guests.

We'll continue to enhance the overall assortment with a strong pipeline of brands for the rest of the year, and many more brands in the wings for 2017. Also, we recently launched the iconic Estee Lauder brand on our website, and we'll roll it out to 30 stores in September, with a broader expansion planned for next Spring.

To update you on our services business, our salon sales rose 14.3%, and comped 8%, with strength in hair color, hair treatments, and makeup services. We saw strong response to our CRM campaign to drive services, and continued to develop additional strategies to drive new customer acquisition over the long term. One example, we're testing enhancements to our online booking software, and expect to roll-out the new platform this Fall.

The new booking tool will make it much easier for our guests to select her service and schedule her appointment online, where and when it's convenient for her. Also our salon stylists were excited to experience our Fall/Winter training programs, developed by our elite artistic team, featuring a glamping theme, which is designed to integrate on-trend hair and makeup looks, like Ronze hair color, a blend of coppery red and bronze and Natural Darling makeup, which is a fresh take on no makeup makeup. We also introduced Bro Layage, the first time we featured a men's hair care color service.

Our Benefit Brow Bar business continued its strong performance with brow services in 785 stores at the end of the quarter, with more than 500 of these offering brow tinting, as well. We also enhanced Benefit's product offerings during the quarter, with the addition of 36 new innovative brow products, which are merchandised in the boutiques, as well as on custom fixtures in our stores.

Turning to new store growth, we opened up 24 stores and closed three stores in the second quarter. One closure was the Chicago State Street location, and the other two were relocations. We're on track to complete our 2016 program of 100 net new stores, and ended the quarter with 907 stores.

New store productivity continues to be excellent, with new stores performing well above their budgets and their IRR targets. In addition to the new store program, our growth and development team is very focused on ensuring high quality execution of our prestige boutique rollout, and we completed a large number of the more than 500 Clinique, Lancome, and Benefit boutiques planned for this year.

We're taking advantage of this boutique expansion activity to further refresh our store fleet, with improvements in fragrance, nail and Ulta Beauty collection fixtures. And looking ahead we have already approved 100 stores for next year's real estate program.

Now moving on to Ulta.com, our e-commerce growth was very strong, up 54.9%, and contributing 180 basis points to our total Company comp. Site traffic accounted for almost all of the growth, as we continued to invest in digital marketing. E-commerce margins improved in part due to more efficient fulfillment costs from orders delivered from our new Greenwood distribution center.

Similar to our performance in stores, the fastest growing categories were prestige and mass cosmetics. Professional hair care was also a stand out, as this category ramps up online, following the addition of many brands previously sold in store only last year. Our signature liter event, featuring jumbo sizes of hair care products at compelling prices, was very successful online during the quarter.

To highlight our authority in hair care, we also conducted our first-ever live beauty chat with expert salon stylists. These members of our elite Ulta Beauty artistic team answered guest questions on hair products, tools and tips.

Turning to assortment newness, we launched Shiseido skincare products on the website, ahead of our limited in-store launch. Continuing on our efforts to increase our portfolio of online brands, we introduced e.l.f., a popular value-priced cosmetics brand at the end of the quarter. This new brand features many new products exclusive to Ulta Beauty in the assortment, and got off to a very strong start in the website.

We continue to improve the guest experience at Ulta.com, with more content for the beauty enthusiast, and recently, we launched a new feature called Ulta Beauty Mix with tips, articles and how-tos. The content is shoppable, and we view this as our first significant step towards merging content and commerce.

In addition, we have made several technical enhancements to the website, including a search engine optimization URL rewrite. We also released updates for our iPhone, Android and iPad Apps, including support for Ulta Reward credit card applications and account management, and improved loyalty program sign up process, a new gift card purchase capability, and Apple Pay expedited check out.

Turning to supply chain and systems, I'm very pleased to report that our new Dallas DC opened up on time in early July, and is currently fulfilling more than 90 stores, and about 30% of our e-commerce volume. The Dallas DC is expected to ramp up a bit faster than Greenwood, with plans to service more than 130 stores and 25,000 e-commerce orders per day by the end of the holiday period. Similar to the benefits we're seeing from the Greenwood DC, the advantages of the Dallas operating model includes fewer, fuller and more stable retail cartons, increased categorization, and improved labeling, and enhancements for e-commerce orders.

The Greenwood, Indiana DC, now just over a year old, is serving about 220 stores, and fulfilling almost 40% of our e-commerce orders. We still plan to end the year delivering to approximately 240 stores from Greenwood.

On the systems side, SWIFT, our new forecasting and replenishment tool has now been rolled out to all product categories. The space and floor planning and assortment optimization tool went live a few weeks ago, and our teams are starting to use the new system to plan for holiday and next year's store planogram. The space planning system will be fully integrated with SWIFT, and these processes will be integrated with our new master data system, which will automate the work, and thus reduce the time needed to create floor plans and our increasingly complex spas. So needless to say, I am extremely proud of how our teams have executed across these initiatives, while supporting strong growth.

Before I turn it over to Scott, I'd like to preview our upcoming investor conference in Chicago on October 13. I'm very excited to update you on our long-term growth strategies, and looking forward to giving you a deeper understanding of the drivers of our business, the future growth opportunities we're prioritizing, and also to give you insight into the talents and capabilities across our leadership team.

You'll hear about our view of category and consumer trends that support our confidence and growth in the beauty category. We'll show how we plan to continue to elevate awareness and clarity about Ulta Beauty as a retail brand. We'll provide an update on our loyalty program, and how we are using data in new ways to drive greater share of wallet of our ULTAmate Rewards members. We'll discuss the pipeline of new brands we plan to add to our assortment, and provide new insight about our products and services offerings.

We'll describe how our supply chain and systems investments position us to drive cost efficiencies and higher service levels. We'll discuss the multi-faceted real estate analysis we've just completed, that gives us confidence in many more years of store growth ahead, confirming square footage growth as a key part of our strategy to double our market share in the next several years.

We'll detail the margin drivers that give us great confidence in achieving our mid-teens operating margin target by 2019, and show you why we're confident in achieving a long-term earnings growth targets we set as part of the strategic plan that we shared back in 2014, even on a much bigger base of business than we forecasted in the initial plan. So now, I'll turn it over to Scott to give us more details about our second-quarter results, and our outlook for the third quarter and the year.

Thanks, Mary. Good afternoon, everyone. I'll start with the income statement. Net sales for the second quarter increased 21.9% to $1.07 billion, and once again, our top line was driven by a very healthy 14.4% comp and strong new store productivity.

The total Company comp was composed of 9.7% transaction growth, and 4.7% average ticket growth. The retail comp of 12.9% was made up of 8.9% traffic, and 4% ticket. The salon business comped 8%. We followed the increase driven by ticket growth, similar to trends earlier in the year.

E-commerce growth of 54.9% was driven almost entirely by increased traffic, with ticket growth up low single digits. Gross profit increased 110 basis points. The improvement was driven by leverage of store, rent and occupancy expenses, as well as by healthy product margin expansion, partially offset by planned supply chain investments in our new distribution centers. E-commerce margins also improved, with strength in the high margin professional hair care segment.

Moving on to SG&A expense. We deleveraged by 110 basis points, driven by additional headcount to support our growth initiatives, as well as an unexpected charge related to a store closure. We recently closed our multi-level State Street store in Chicago. The store was temporarily closed back in May, due to disruption from a construction in an adjacent building.

The extensive damages to the store and the extraordinary amount of time and expense required to reopen the store resulted in our decision to permanently close the location, necessitating a significant impairment charge. This charge represented about a third of the SG&A deleverage in the quarter. We reassigned our impacted associates to nearby alternate stores, and have assisted guests to minimize any disruption in their shopping experience. We are currently evaluating nearby relocation opportunities, and expect to get a replacement store up and running soon.

Turning to the balance sheet and cash flow, inventories were up 18.7% on a per store basis, a bit higher than expected, reflecting the opening of our new distribution center in Dallas. Excluding the impact of the inventory for the new DC, inventories were up 14.5% on a per-store basis, in line with our comp. We continued to invest in inventory, given the better than expected top line growth, new brand additions, and the step up expansion of prestige boutiques.

Going forward, we're expecting to see total inventory per door growth more in line with comp growth by the end of the year, and anticipate that the efficiencies from our supply chain investments, including new DCs and merchandise planning tools, will become more evident in our financial results, starting in 2017.

Capital Expenditures were $95.3 million in the quarter, driven by new store openings, fixtures for the rollout of prestige brand boutiques, and supply chain investments. We ended the quarter with $304.1 million in cash and short-term investments.

In terms of share buybacks, year-to-date, including our ASR, which settled in the second quarter, and activity under our 10b5-1 plans, we have repurchased 1.27 million shares at an average price of approximately $199 per share. At the end of the quarter, approximately [$193] million remained under the [$425] million share repurchase authorization.

Turning now to guidance for the third quarter, we anticipate sales to be in the range of 1.072 billion to 1.090 billion, compared to 911 million last year. We expect comparable sales to increase in the range of 11% to 13% versus 12.8% last year. Online sales growth is expected to be in the 40% range. We plan to open about 40 stores in Q3, compared to 45 stores during the same period last year, and pre-opening expense for the quarter is expected to be about $7.6 million.

Earnings per share are expected to be in the range of $1.25 to $1.30, versus $1.11 for Q3 of 2015. We anticipate a tax rate of 37.6%, and a fully diluted share count of approximately 63 million.

Our supply chain investments, particularly the ramp-up of our new Dallas DC, on top of the Greenwood building, still only fulfilling about half its planned capacity, will continue to weigh on margins the rest of the year. We expect to see the largest impact in the third quarter, with deleveraging of P&L reflecting the high watermark of our supply chain investments. We anticipate stronger earnings growth in the fourth quarter on higher sales volume.

In light of the strength in the business in the first half of the year, we are raising our guidance for the full year 2016. We now expect comparable sales to be in the range of 11% to 13% for the full year versus prior guidance of 10% to 12%. We now expect to grow earnings per share in the low to mid 20s percentage range, versus our prior guidance of low 20s percentage growth. We continue to expect that share repurchase activity under our $425 million authorization will contribute about two percentage points of earnings per share growth this year.

The other elements of our full year guidance are unchanged. We're on track to open approximately 100 net new stores, all planned to be our 10,000 square foot prototype. We expect to open about 40 stores in Q3, and 25 stores in Q4. We are also executing 12 major remodels and two relocations. We plan to grow e-commerce approximately 40%.

CapEx is on target to be about $390 million, driven by slightly higher capital per new store, and the rollout of boutiques. As a reminder, we've planned about $80 million for the boutique expansion and update, with the rollout of over 500 Clinique, Lancome and Benefit boutiques underway, as well as updates to our fragrance fixtures and the Ulta Beauty collection.

I'll now turn the call over to our conference call host for the Q&A session. Operator?

(Operator Instructions)

Our first question comes from the Simeon Gutman from Morgan Stanley.

It's Joshua Siber on for Simeon. I'm curious, where are you in the investment cycle, relative to where you thought you'd be when you laid out your five-year guidance two years ago?

I'd say we're right on track with that. We described that this year, last year, and this year would be kind of the key years of investment relative to the new distribution centers in Greenwood and Dallas all on track, investing in new systems and capabilities all on track, so we're pretty much right on track with what we described.

Okay, and with respect to your consumer, how are you seeing average age trend, are you skewing younger with more social media mix of advertising?

Josh this is Dave Kimbell. Yes, we see strength really across all ages and demographics. We don't look specifically, we certainly look at, but we -- demographics, but we're actually more focused around psychographic around this beauty enthusiast, and we see that growth in all ages. Having said that, we're excited about strength with Millennials and teenagers, a lot of growth there, and strong performance of our brand, awareness growing there, and we see continued growth in that space. So really growth across all ages and demographics right now.

Okay, thanks a lot.

Our next question is from Oliver Chen from Cowen and Company.

Congrats on solid results. We just had a general question regarding Amazon and your competitive advantages online, in terms of what you're offering versus Amazon. And also, as brands go direct-to-consumer, it would be great to get briefed there. And what, on the long term for online, what are your thoughts on margins in the context of just the changing customer expectations, as online continues to evolve? Thank you.

Thank you, Oliver. I'll start and I'll ask if Scott and Dave want to jump in, so please do. I guess I would just step back and say, we compete as you know, with a lot of players, both bricks and mortar as well as online, but really nobody brings together everything that we do in one place. So I don't think so much about head-to-head competition in any one place, even though we certainly look very closely at the competitive environment.

So our online offerings now represent everything we have in the store and more, pretty much everything we have in the store, plus more, we're starting to expand that. Our guests enjoy the online experience, we are improving the shipping time frame every day, and certainly, as she participates in buying products online at Ulta Beauty, she gets points, and that is the whole loyalty program she loves. So the more she buys from us, the more that she gets points that then she can redeem anywhere in the store.

So certainly we compete with Amazon in some ways in beauty. I would say we offer a great selection that our guests love, but of course as you know, we also have an exceptional bricks and mortar physical experience, that our guests love, and really the beauty enthusiast that Dave described love to go in person and buy beauty, and experience beauty, and of course get our services. So I look at them as part of the mosaic of competition, and I think our proposition for our guest is really superior in total.

In terms of margin on e-commerce that's getting stronger. A big reason behind the investments that we've done in our distribution centers is to really improve the efficiency and effectiveness of that part of our business, and that's happening. I'd say the guest is happier with the speed of delivery, and certainly the margins are improving.

Thanks for the details on Investor Day, looking forward to it.

Our next question comes from Steph Wissink from Piper Jaffray.

Just a follow-up question, Mary, on your comments around the prestige brand boutique. I'm wondering if you can give us a sense of once you rollout those boutiques in store, what the mix between prestige and mass will look like? And then Dave just as a follow-up to that, how you're thinking about marketing the localization of some of those boutique rollouts and drawing on your customer traffic in those local markets. Thank you.

Thank you, Steph. You know what? We don't really break out the exact mix, but in total, the part of the really compelling access of our proposition to our guests will always be the case of this assortment of categories and price points. And so while the shift to prestige has been happening over several years, and we're thrilled with the array of prestige brands that we have that we're rolling out, I don't anticipate that mix to change dramatically, relative to mass, in the future.

What's happening is we just have a great assortment of prestige brands to choose from, and that's great, and we love those brand partners. But again for our guest, it's very important she always feels that she can come in and have that combination of categories and price points that she loves about Ulta Beauty.

As far as targeting localization, I'd say a couple things. First of all, with boutique brands in particular, Clinique and Lancome, Benefit, Bare, those -- we're building boutiques at a fast pace, but we're also expanding those brands, Clinique and Lancome into every store. There's a presence of some SKUs in every store, and that allows us to market the brand at a total Company level, national level, because every store will have some SKUs, both of those -- really all of those boutique brands but we also tailor and target and localize our communication through our CRM activity. E-mail is a big part of that, our magazines will also customize based on location, and those are close to a specific store with a boutique. We will customize that communication. At the same time our national advertising marketing is really talking about the total Ulta Beauty, all things beauty, all in one place messaging.

Thank you, best of luck.

Our next question is from Kelly Halsor from Buckingham Research.

Congrats on a great quarter. Just was wondering if we could dig in a little bit more into the back half guidance. Should we look at the magnitude of the gross margin deleverage related to supply chain investments to be similar to what you saw in Q3 last year, when you opened up the Greenwood facility, or are you implying maybe it's a little bit more, considering you have Greenwood and Dallas both open now? And then just secondly on the SG&A cadence, how should we think about SG&A in the back half of the year now, that you will start to be lapping the advertising investments that you made in the back half of last year? Thank you.

So the deleverage from the supply chain is significant, again I don't want to be reconciling basis points quarter to quarter, but it's in the general zip code, I would say, to what you saw in third quarter last year. Net-net I think for the third quarter, gross profit is flattish year-over-year when you add up all of the puts and takes, because we are still going to get a sizeable fixed store cost leverage benefit in the quarter, we're going to continue to expand merchandise margins like we have earlier in the year, and so that will cover up some of the hurt, I guess I would say from the deleverage from supply chain

What I don't think most of the models include now is the SG&A deleverage in the third quarter. It's much more significant than what most people are thinking. It's really a combination of the boutiques, the high water mark on the boutiques and the remodel programs, and all of the other things we have in process to drive growth for the business. So again, it's just a matter of sequencing the quarters. A lot of it ends up in the third quarter this year.

We've got some consulting timing that we moved from earlier in the year to back half to help us plan for the future, as well to help us frame out growth drivers that will help us next year and beyond. And then there's another store impairment charge coming in the third quarter. That was just a fairly recent development as part of the heavy flooding down in Louisiana, so that's another roughly $0.02 charge that was unexpected, that we have to record in the third quarter, so that's really the combination of things.

When I think about the rest of the year then moving on to the fourth quarter again supply chain we start to get some benefits there, so we expect to get leverage overall on some of those supply chain investments. SG&A then, we get back into a normal cadence. The heavier sales volume in the fourth quarter, the upfront costs from some of those boutiques are behind us now, and we get leverage SG&A in the fourth quarter. So that's how we end up full year then, with slight leverage coming from gross profit and slight deleverage on the SG&A line that gives us an all-in slight leverage for the year on operating margin.

Okay, great, if I could squeeze in one more. Very excited to see that you're introducing Estee, it's considered a pretty premier brand, cosmetics brand. Any opportunity there in terms of boutique opportunities, similar to what you're doing now with Clinique and Lancome?

Yes, we're excited to be launching introducing Estee Lauder that launched online within the last week or so, and then we'll be rolling that out into 30 stores next month. So at that point, you'll be able to see the presentation will be different than the way we've done some other brands that we're really excited about. And we're particularly excited about, it's really focused on the strongest most iconic elements of that line, parts like Advanced Night Repair, Double Wear makeup, complementing it with things, the Perfectionist Serum, Extreme Lash, and we have had a strong fragrance, Estee Lauder fragrance business for a while, so this will complement that very well. So we're going to watch it closely, it's one of the largest prestige brands in the world, and so we're happy to have it in the store, and we'll learn and look to continue to expand that over time.

Great, thank you very much.

The next question comes from David Schick from Consumer Edge Research.

With the continued success you've seen in this country, how does it factor into thinking about the way you might attack other markets?

Well, first, I always start with the fact that we've got a lot of great opportunity here in the US. We're going to continue to be able to drive growth, we think, for many years. And as we start to think about international, we're starting to frame and look at possibilities. There's nothing to announce, but certainly we're looking at where might it make sense from a consumer environment, and competitive environment, overall business environment. And we'll make some decisions, if we move forward, we would do that in a way that would be let's learn about it first, and then decide if we would go further. So in the analysis phase, I guess, is the best way to think about it right now.

Okay, thanks.

Our next question comes from Dana Telsey from Telsey Advisory Group.

Congratulations on the results. As you think about the new brands that you're adding to the mix, what's being taken out of the mix? And as you look towards next year, what categories are you thinking about that you'd like to add to the mix? And given the salon business, and obviously now some men's opportunity there, how do you see the growth of the salon business and the margin implications? Thank you.

I'm going to tag team this with Dave. Maybe I'll just start with the salon piece, I'm glad you noticed that, yes, Brolayage is -- I want people to line up that appointment on this call, but just with the creativity of our artistic team that really invented that idea, balayage for guys. But anyway, I'm really -- our salon and overall services business are a really critical part of our strategic imperatives, going forward.

So we have hair services, skin services, and brow services. And still in many ways quite small but performing really well. An industry in hair that's flattish, we're gaining market share, we're growing. So we see that as an area that we're working on, just how do you think about continuing to drive that as a growth lever, attractive driver, bringing in new guests.

I'm sure you know that when a guest becomes a salon guest, you know she or he becomes one of our best guests, because they come frequently and they spend 2.5 times the amount of non-salon users. So more to come on that, and we think it's going to provide not only growth but also the ability to really position us as a beauty authority for many years to come. Categories?

Yes as far as assortment and managing that and looking at new brands, certainly as we add many of the great new brands that we've talked about and that Mary mentioned, that does mean in many cases that we have to make room for that. And it's really a focused approach on looking at sales and gross margin per square foot, inventory turn, a bunch of metrics that really look for the most profitable usage of our space, but also focused on elements that are really delivering against our core proposition of all things beauty, all in one place. And so when we look at adding new brands, makeup is the fastest-growing part of the beauty business, and certainly it is within our portfolio, so you'll continue to see makeup brands for sure.

But we want to make sure we're really focused on understanding how her needs are evolving, and we're bringing innovation across all elements, both mass and prestige. We have had a lot of innovation, great exciting innovation in fragrance, we have got Sarah Jessica Parker's fragrance coming out on Sunday that I think is going to be great, so a lot of innovation continued in fragrance.

Skincare is an area that has had its ups and downs, where we see growth and potential within that, and then certainly hair care and connected to our salon, it's a big, very important part of our business. The styling part, liquids, shampoos, conditioners, tools, our professional tools areas, personal tools areas. So we'll continue to innovate across all parts of the store, and optimize our assortment as we go forward.

Thank you.

Our next question comes from Mark Altschwager from Robert W. Baird.

Great quarter. Can you talk a little bit more about your partnership with Alliance Data in the private label credit program? Just first how should we be thinking about any revenue sharing or P&L implications over time? And you've already had a lot of success with your loyalty program obviously and the CRM initiatives, but how do you see that evolving as you start to leverage the ADS capabilities on that front? Thanks.

Great, thank you. Thanks for asking about that. I just want to give a little plug. I'm really proud about our team, having really worked this for over a year, and it's a very cross functional effort, as you can imagine, to prepare an organization to launch something like this, and we're off to a strong start.

And the good news is, we based it first and foremost on guest insight which is our guests are very interested in this program because it gives them an opportunity to just get more points at Ulta Beauty, but also for us obviously, it's creating more loyalty, more increasing her share of wallet going to us. So that's all great.

And we are not going to get into parsing apart all the details of the deal. ADS is a great partner. I will say they manage the program for us and take the credit risk, so that's great, and more to come. So our CRM team is really the folks who really own this project, and you can imagine, they've got a lot of ideas about how to leverage this going forward to drive growth. So more to come on that, and we feel good about where we are.

Great, thanks again.

Our next question comes from Ike Boruchow from Wells Fargo.

Just a quick one. Mary, you've talked about your replenishment business being fairly small today. I'm curious, how big is it, if you can say? And how do you view that part of the business, longer term? Is it a key focus for you, or is it just -- are you focused on other parts of the business, in terms of incremental growth from here?

Thank you, Ike. Well the good news is that everything we sell, almost everything we sell is highly replenishable. But the great news is that our guest, the beauty enthusiast, is really not interested in just the same product every time. There's categories she will need to replenish when she's out, there might be a couple items that she's quite attached to.

But I'll tell you for the most part our guests are really coming in and loving to try new products. She loves trends, she loves newness, she loves great new products that are launched by our brand partners. So what we're finding is that very little of the business is one-for-one replenishment. And if that becomes bigger, perhaps, in the future, we're always looking at that, to see if there's a way we can make it even easier for her. But what she seems to be responding to is the breadth of innovation newness.

And if you look, for example, at our e-commerce guest, the guest who shops online and in store, again, some of our best guests, they spend significantly more than somebody who is not buying online, and what she's tending to buy is in response to things that we're bringing to her attention via e-mail. So it's usually new products or exclusives, or new trends. So again, I don't have anything against replenishment, I love the fact that we're replenishing our products a lot, but the one-for-one piece is something that's not a big part of the business.

Great, thanks a lot.

Our next question comes from Jason Gere from KeyBanc Capital Markets.

Two questions. First one, did you say what your loyalty card membership growth was in the quarter? And I was just wondering as this continues to rise, like how do you think about what the potential penetration can be? And on that point, what was the transaction size for loyalty card members versus non-loyalty card in the quarter?

Yes, so our loyalty program did exceed that 20 million member mark to 20.6 million active members, that's a 27% growth rate, so we're really pleased with that. That's very strong. We've had very strong growth with that, and that will, we think, continue. And we're really happy with our new members, it's actually been a strong lot of new members coming in, getting engaged with our program, understanding the benefits of the program. We'll also be able to then talk to them about new elements like the credit card, so clearly a big driver for us going forward. The second part of your question was around?

The basket for the loyalty guests. It basically represents what we quoted in our prepared remarks, Jason. So again, the loyalty program is more of an 80% of our total sales, and so when we're looking at those metrics, that's basically what it represents.

Fair enough. And then I guess the other question was, just given where the stock price is right now, how do you internally think about maybe splitting your stock at this point? The only reason I say that is a big part of your story is reaching out to that retail customer, and if a stock was let's say under $100, maybe you'll get more of your retail customers actually becoming shareholders as well?

Yes, that's something that we've kicked around from time to time with our Board of Directors, again thinking about all options, on being as shareholder friendly as we can be, whether it's capital allocations or things like stock split. So surprisingly, I've only gotten this question maybe two times in the three-plus years I've been here, and it's been at the annual shareholder meeting, right? So it's usually a local retail holder that would ask that kind of question, so generally speaking, most of our shares are held by big, large investment funds and houses, and most of those folks aren't that interested, based on our Q&A with them about entertaining a stock split. So it's nothing that's on the front burner, but of course, it's something we'll always be ready to consider.

Thanks.

Our next question comes from Mark Astrachan from Stifel.

Wanted to ask about thoughts on the sustainability of cosmetics growth, given the contribution to comp, and how do you weigh newer smallish brands versus those from larger companies like Estee that you talked about and L'Oreal, who are likely increasingly eager to work with you, considering trends in other channels like department stores?

Yes, well let me start by saying, as a category beauty has been growing for multiple years. It's a strong, it's up last quarter, was up 5%, prestige was up higher than that, but all growing, as you said makeup growing, the lead in terms of growth. Skincare, every category we saw growth last quarter.

So the good news is, we're in a category that's growing. As we look at consumer trends going forward and Dave touched on this, but younger women, Millennials, Hispanic women, fastest-growing segment of our population, there is a propensity we think for the beauty category for all those to continue to play a very important role for overall spend of her money, and how she spends her time, so that's all good.

And the great thing is that innovation comes from companies large and small. It's probably the most exciting consumer category, I think, that exists, because innovation comes from many different sources. And we positioned ourselves to hopefully be a great partner for brands to do business with, and we offer this variety of product categories and price points. So I think that also helps to sort of insulate us as the subcategories go up and down, and Dave talked a little bit about those categories, we're trying to look out multiple years, thinking where do we place our bets, but knowing that really innovation is coming from many sources and we think the foundation of growth is there for us.

Got it, great and just one follow-up. In the next quarter from a guidance standpoint, it looks like the two-year CAGR and even for the balance of the year back half gets a little stronger relative to Q2 trends. Is there anything in the timing, Scott, that may influence the rate of growth in comps in second quarter versus third quarter, fourth quarter?

I know, it gets a little -- you look at quarters and you try to stack them together. We look at the single, the double, the triple stack, every which way you can look at the comp. There's nothing extraordinary that sticks out in any one. Each quarter is a unique set of opportunities and challenges.

I would say generally speaking, the back half of the year, we feel really great about the boutiques, right? The tail wind we're going to get from that finally all being installed. There's a great pipeline of newness coming, and we believe we've got a great set ready to go for holiday, both on the assortment and the way we have our stores set up, and our gift card program. So we're very bullish on the back half of the year.

Thank you.

Our next question is from Brian Tunick from Royal Bank of Canada.

Congrats to everyone. I guess on the boutiques first, just thinking about the free cash flow going forward, I think you're earmarking $80 million this year for the boutiques, on the CapEx side. Should we be viewing that as a one-time number, or maybe that's a peak number? And then the second question is, on your stated store targets, and I know you'll update us at the analyst day, but if there's more department store closings coming, or you guys think your e-com penetration can get to a certain level, how does that inform ultimately what you think the right size of the North America store base can be?

Okay, well I'll start with the store piece first and certainly this will be something we'll talk more about in October. I think the dynamics have been happening have been happening for some periods of time, in terms of how people shop for beauty. So that's not new to us. It's encouraging to us.

As we look at the how our stores are performing today, the store classes getting stronger, even after this many years of being in business, that's really encouraging. And we think that everything that surrounds how we're doing business, driving awareness, giving the great products and services are all enhancing that. So I feel good about that. We had, we think that our 10,000 square foot store has plenty of growth ahead. We're also looking at smaller markets, urban or suburban downtown type formats.

So all those things we feel, given frankly the fact that we only have a 5% share of this really enthusiastic beauty shopper, provides us plenty of runway for growth. So we'll talk more about this, but we certainly have done a lot of work and analysis, and feel confident we can drive market share growth frankly, both through comp store growth as well as new stores.

As far as the CapEx related to boutiques, again, I just want to remind folks that the boutiques were always in the plan back in 2014, when we rolled out the five-year financial targets. There was an assumption in there for boutiques, over those five years. We just accelerated that, so we pulled it forward.

2016, a big step up, roughly $80 million as you mentioned. That will repeat next year into 2017, so we're viewing it as a two year cycle. And at that point we'll have again those two great brands in the majority of our comp stores, and it will be just about new store build up from that point.

Thanks very much.

Our next question is from Joseph Altobello from Raymond James.

This is Christina on for Joe. I was wondering if you could talk about the rollout of Honest Beauty this past quarter?

Sure, we're really pleased with it. It's great brand, of course, from Jessica Alba's Company, and it's off to a great start. It's part of a -- the Honest Company has been a leader in a broader trend around natural, and it's great to bring that to the beauty segment. There's other brands that have been in that space for a while with us, and we're seeing a lot of growth across the area. But really pleased with that, and think it will be -- continue to drive nice growth for us going forward.

Great. Thank you so much.

Our next question is from Chris Horvers from JPMorgan.

Mary, you gave us a little taste of what you plan on talking about at the Analyst day, and so I wanted to follow-up on one of your comments. You mentioned getting to the mid-teens operating margin by 2019, and of course we would like to parse words, and that by stands out to us. So does this imply that your original mid-teens forecast could be reached prior to 2019, because clearly the comps have exceeded expectations? Or does perhaps that long term operating margin target see some upside?

Yes, you know, talk about parsing. I like that. We're not going to get into details on that today, except to say we feel confident about reaching the target that we set out, back a couple years ago, and frankly at a much bigger scale of business today, right? With a lot more complexity, so I'd stand by that description.

Okay we're Lip Happy here, so we like to --.

Okay. #ThatsHowILip. I like it, thank you.

So then, since I didn't get that one, can you talk about your in-stock rates, how they're improving at the store level, how they're improving online, and contributing to the comp growth? You mentioned the two new DCs are about 70% of the volume. Is the rest from the vendor, and does that percentage go up over time?

So with the e-commerce just to be clear, so we service e-commerce out of four buildings today. So Chambersburg out East, Romeoville here locally in Chicago, and the two new, Greenwood and Dallas. And so again, nothing's coming direct from the vendor, so we're doing all of that.

The new buildings are just much more efficient. They are designed to actually do e-commerce, pick and fill and ship processes, unlike the older buildings, which were retrofitted and not quite as efficient. So we're happy to see that and we're showing the benefits show up in the P&L as currently, and as we think about the future, so we're very excited about that.

As far as in-stock rates overall, that's something that we -- that's priority number one, when we think about the guest experience in our stores. And that's part and parcel of all of the investments that we've been talking about for the last couple years, whether it's distribution centers to help the throughput there, capacity and capability overall, but also we are doing a lot of work behind the scenes with merchandise planning tools, SWIFT we talked about. Master data, managing that better. Floor planning and space planning tools are going online, as well, to help with in-stocks overall. And then our team internally here is a lot of individual projects, and look sees going around how we can do a better job. Just making sure we go extra heavy on A and B SKUs so we don't disappoint folks, and how can we be more effective with some of the C, D, E and F SKUs, in stores, and how we better align ourselves on that. So all oars are in the water when it comes to in-stocks and inventory productivity across the enterprise.

Thank you.

Our next question comes from Rupesh Parikh from Oppenheimer.

It's actually Erica Eiler on for Rupesh. Thanks for taking our question. So clearly, another strong quarter from your team, and your results continue to stand out. But we are seeing a mixed consumer backdrop out there. Is there anything that you're seeing from a consumer or even a geographical perspective that concerns you at all?

Well, we aren't complacent about our results, so I'll say that. But I will tell you that as we look at it, our results have been pretty consistent, I would say across regions, period to period, pretty consistent. So then you just saw the kind of comps we've delivered. So we're seeing that a strong consumer sentiment, right?

And I think that it's because we continue to benefit from the fact that we're in a category that's important to our guest, and I mentioned this earlier, it's replenishable, it's affordable indulgence, and beauty is popular right now, in many ways, in terms of culture and social media. So you combine that with being in a range of categories and price points, even if somebody is a little bit more pinched, you can get great product at a lower price from us, and in partnership with our brand partners, we are continuing to excite her with newness. So I feel like our results would say there's certain pockets of consumer spending that are quite strong, and we see that macro for the category of beauty as well. But we'll just continue to watch it closely.

Great, thanks for all of the color.

Our next question comes from Omar Saad from Evercore ISI.

Nice quarter. I wanted to follow-up on one of your earlier questions about the potential for category expansions in the future, and ask more specifically about bath and home, and those types of related products, scents and soaps, if those are categories that you'd look to going into, I think would have a very nice overlap with the customer base, and with all things beauty, as well.

I'd start by saying we're always looking across every element of the beauty space to find growth, and we are listening to our guests and finding opportunities. Our focus is on continuing to drive a lot of innovation in those most important biggest categories that we have, makeup, hair, skincare, fragrance, nail is important. But we are seeing some nice growth in additional categories one of which you mentioned, the bath and body space is one that is a nice category, obviously not anywhere near as big for us as something like makeup, but we do see growth potential.

We've added some new brands into that space, Fizz & Bubble, Soap & Glory among others. And we've got great business, the exclusive distribution of The Body Shop outside of their own shops as an example, so it's not huge for -- that total bath and body space isn't enormous for us, but it's an example of what you're talking about, we do see potential growth to continue to add to that, and make sure that we're delivering against what our guest is looking for. So we'll look across all different avenues, in addition to the big ones we're driving growth on today.

While we're on the topic of the product offering, I've heard you mention a couple times now in the last few quarter prestige and mass. The areas of strength, almost a bit of a bar bell. High low. Are you evolving? Do you see yourself evolving the offering, and the density of the price points around the high low strategy, or could this be a little bit more of a transitory effect?

Well, make sure I understand your question. But the mass and prestige has been part of our business, and is part of the original insight the Company was founded on, and certainly is a critical key part of our strategy today. We've grown our prestige business pretty quickly over the last several years, as we've added a number of brands, but we've also been focused on growing mass. So a key part of what our guests really responds to us is this idea of mass and prestige, because that's -- while she shops, that's how when you look at the products that she has at home, most women don't have either prestige or either mass only. They have both.

So providing both to her is a key part of our strategy. We will never shift away from that. We want to see growth on both sides, because that's what our guest wants. So we're investing heavily in the experience, as well as bringing in new brands and innovation across both sides, at the range of price points that we think is what our customers really want.

I understand, thank you.

Our next question comes from Simeon Siegel from Nomura.

Congrats. Any way to quantify what portion of the transaction growth came from new customers versus greater frequency of visits? And just sorry if I should already know this, but when you open up new prestige boutiques, do you general rules or [preferences] regarding geographically clustering those brands, or spreading them out, and if they are clustered, any color on how the existing boutiques have done after the new openings? Thanks.

On the customers, I don't think we have broken out that level of detail. What I would say is there's a few key elements that are driving our total customer growth. Retention is strong and healthy, and as we look across, as we understand, just loyalty programs, not necessarily just in beauty, but loyalty programs, we think we have a very healthy -- probably at the leading level of retention, so that's key and strong, and will continue to be.

Reactivation, we've talked about in the past, and that also was strong in the second quarter, which is essentially those that had not shopped, that had been members of our program, but had not shopped with us in the last year, through some elements, our expanded marketing, advertising, new store openings, perhaps we'll get them in and driving that. But new totally new guest is absolutely still a big growth driver, getting that guest, attracting new guests across the country, both obviously new stores, but existing stores, bringing her in as a key part to our growth. So those three things are what's driving that growth. And then boutiques was, I don't know if I fully understood the question about it.

The location.

Where we're located, it's really across the country, we're looking at really stores as we continue to add these 500 boutiques, we're seeing success in big markets, small markets, all different regions of the country and we'll continue to expand. As Scott said, by the end of next year, we'll be in a large percentage of our total chain, so thereby being in most stores across the country.

Thanks, best of luck for the rest of the year.

Thank you. I'd now like to turn the floor over to Ms. Dillon for any closing comments.

Thank you. I just want to thank everybody for your interest in Ulta Beauty, and we look forward to seeing you in a few weeks at our Analyst day. Importantly, I'd also like to thank all of the Ulta Beauty associates for delivering yet another terrific quarter. Take care.

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.