Ulta Beauty Inc (ULTA) 2016 Q3 法說會逐字稿

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

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Laura Lefebvre. Thank you Ms. Lefebvre, you may begin.

Thank you. Good afternoon and thank you for joining us for Ulta Beauty third-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 companies Safe Harbor language. The 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 from those projected in such statements, due to a number of risks and uncertainties, all of which are described in the companies filings with the SEC.

During the Q & A session, we respectfully request that you please ask one question only 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. Ulta Beauty's top line momentum accelerated in the third quarter, driving record sales and earnings performance. The team continues to execute exceptionally well against our key strategies. Highlights of the quarter include success in acquiring new brands, strength in overall newness, increases in awareness of the Ulta Beauty brand, continued excellent results from our loyalty program, improving performance of our supply chain system and robust growth in our eCommerce business.

In the third quarter we grew the top line 24.2% and delivered 16.7% comp sales on top of the 12.8% comp in the third quarter of last year. This is the best comp performance on both the one and two year basis in our history as a public Company, driven by healthy traffic and ticket growth. We achieved the strongest quarterly comps of the year in all three channels, eCommerce growth was well above plan, and the retail and salon businesses also delivered their best top line growth of the year.

In terms of categories, cosmetics, both mass and prestige, continued to lead our growth with new brands and new items from existing brands contributing to better than expected performance. Strength on the top line was broad based, as we gained market share across all major categories.

Earnings per share rose to $1.40, representing 26% growth, significantly better performance than what we anticipated going into the quarter when our initial outlook called for 13% to 17% earnings per share growth. This upside in EPS was due to better than expected top line growth and our continued success with loyalty and CRM efforts.

I'd now like to highlight some of the key drivers of our third quarter performance in the context of our strategic imperatives. Starting with our loyalty program. We grew rolling 12 month active membership by 28% to reach 21.7 million active members as our store teams continued to drive excellent conversion at check out.

Similar to the trends we've seen all year, the loyalty program metrics including retention rates, sales per member, frequency of purchase and average member ticket all continued to be very strong. We continued to prioritize more personalized CRM offers for our loyalty members, versus broad discounts and promotions. And its evolution in our marketing strategy continues to benefit margin rates and allows us to invest in other parts of the marketing mix such as television, radio and digital advertising, which continue to drive awareness and clarity about our brands.

Our Ultamate rewards credit card program continues to be well received since its launch in August. We're seeing strong guest engagement both in-store and online. Our team carried out extensive associate training and planning ahead of the launch, resulting in seamless execution of the program. Credit card sign ups are exceeding expectations. Some of the compelling promotions we're offering for new card holders are driving higher average baskets and units per transaction as guests take advantage of one-time offers.

Turning to our marketing and brand awareness activities, our third quarter marketing plan features signature promotions, like 21 Days of Beauty in September, our Gorgeous Hair event in October, and a series of activities focused on raising funds for the Breast Cancer Research Foundation. We returned as the official partner to the Ellen Degeneres show, putting BCRF and Ulta Beauty on a national stage to millions of viewers each week to raise awareness and funds. Our store teams raised nearly $3 million during this year's Gorgeous Way To Give campaign and our salon stylists were proud to perform more than 50,000 beauty services at our Cut For a Cause event in support of our BCRF fund-raising program.

From an advertising perspective, during the Fall we ran national TV and radio ads to support our 21 Days of Beauty and Gorgeous Hair promotions. The creative is new and built on the inaugural campaign from last year. We continue to also see significant growth in our social platforms, especially Instagram and Snapchat. We recently surpassed 2.6 million fans on Instagram and held our first ever Snapchat takeover with YouTube influencer Jenny Fox. We had Wende Zomnir as the Founder and Chief Creative Officer of Urban Decay take over our Snapchat and Instagram channels, yielding millions of impressions. And we also announced a partnership with E!News, with the launch of freeSTYLE, a weekly Facebook live show. The program includes fan interactions, discussions and reviews of the best and most relevant people, products and trends that matter to the 9.5 million highly engaged, E!News Facebook fans.

Now on the merchandising front, new brands and new products within existing brands drove better than expected sales growth with strength across all categories. Similar to what we've experienced all year long, makeup brands like Urban Decay, IT Cosmetics, NYX, Anastasia, Too Faced, Tarte, Clinique, Lancome, Benefit, Real Techniques and Ardell delivered the highest growth rates in the quarter.

Our own Ulta Beauty collection was also a top performer. We restaged the brand with new packaging, branding and innovation and about 600 stores now feature an enhanced wall presentation, with improved signage and elevated fixtures. And in mass skin care, Tony Moly and Boots Number 7 were stand outs and our pro hair business accelerated with newness from Devacurl and Living Proof contributing to strong comps in this category. Living Proof also partnered with our services business for a one day salon takeover event to introduce salon guests to this brand.

And we discussed many of the new brands we're adding to our assortment at our analyst day a few weeks ago, so let me recap a few of the highlights. During the third quarter we launched Estee Lauder skin care and cosmetics in 30 stores and online, we launched Shiseido, Origins and Proactiv, greatly enhancing our skin care offering. We added e.l.f. to our online assortment, we introduced the innovative Dyson hair dryer in 200 stores and online. We've also completed almost all of the 500 plus Clinique, Lancome and Benefit boutiques planned for the year. In addition, we added a best of Clinique end cap in all stores that don't have a full Clinique boutique.

Now turning to our services business. Salon sales grew 16.7% and comped 10.3%, with strength in color, hair treatments and makeup services. Our services business is increasingly using CRM campaigns to drive awareness, encourage trial of our service offerings. We rolled out our improved online booking experience to all stores during the quarter to make it even easier for our guests to make an appointment in our salons.

We continue to focus on elevating our in-house artistic team and curating design trends exclusive to Ulta Beauty. Our Fall and holiday trends include a look we call Sombre, which is a new softer in way to achieve an ombre look and a new color we call Ronze, highlights that bring together beautiful shades of copper and auburn. The artistic team participated in several designer runway shows at fashion week, driving awareness of Ulta Beauty's hair authority and inspiring the entire salon team across the chain. And our Benefit Brow boutiques continued their excellent performance with brow services now available in more than 800 stores and the successful launch of a wide range of new brow products in more shades. We're now testing online booking for brow services to make it easier for our guests to make an appointment in our Benefit Brow bars.

Turning to store growth. We opened 42 stores in the third quarter, on our way to executing our 2016 program of 100 net new stores, ending the quarter with 949 stores. Our growth and development team has completed almost all of the 500 plus prestige brand boutiques we planned for this year, including new stores and remodels, along with updates to the Ulta Beauty collection in fragrance and nail fixtures.

New store productivity remains very strong with the class of 2016 stores performing well above budget and far above sales hurdles established to meet our internal rate of return threshold. We've already approved all of the 100 stores planned for our 2017 program, including a new store on Michigan Avenue in Chicago.

As you heard at our analyst day, we completed our in depth analysis of the real estate opportunity in the US and announced a new long term target to rollout between 1400 to 1700 stores, with opportunities to further penetrate existing suburban markets, expand our penetration in small markets, and begin to develop urban markets. At the same time we updated our new store maturation ramp based on current trends and hired new store productivity, upgrading year one sales from $2.8 million to $3.1 million and revising upward our year five sales estimate to $4.5 million from $4 million. We're confident that our stores will continue to produce very attractive returns.

Turning to our eCommerce business, Ulta.com sales grew 59.1%, on top of 56.3% growth last year, contributing 240 basis points to our total Company comp. The strong revenue growth was driven entirely by increased transactions. We continue to evolve and upgrade the guest experience while improving site performance. We made enhancements to our mobile app, including a product detail page redesign to better display product options and information, integration of our recently launched content platform called The Mix, and the addition of our new salon appointment booking tool.

We launched a [try on] feature called GlamLab last month to allow guests to allow guests to virtually test products and shades within our iPhone and Android app by uploading a selfie or choosing a model with a similar completion. Our technology partner for this platform is a company known for best-in-class realism and accuracy of color matching.

Finally to update you on supply chain performance and investments, we are very pleased and proud with how smoothly our team has executed on a very complex set of initiatives and system rollouts in addition to opening two new DCs in the past year and a half. Our Greenwood DC is now serving 227 stores and fulfilling 44% of our eCommerce orders. Our newest distribution center in Dallas is ramping on schedule and currently fulfilling 130 stores and 30% of total eCommerce orders.

On the systems side, we're starting to see benefits from the core merchandise systems we recently implemented. SWIFT, our new forecasting replenishment tool, continues to ramp up and help us optimize inventory. Our store level in stocks are improving and more of our inventory is in our stores, versus in our DCs, improving the guest experience. We now have all of the tools in place to help us make better, more data based assortment and inventory decisions. So that wraps up my third quarter review.

Looking ahead to holiday, we're expecting healthy traffic and strong sales growth as a result of our integrated merchandising and marketing plans. From a product standpoint, we're excited to offer an array of newness and exclusivity in our holiday assortment across all categories and brands.

To share a few highlights, we'll feature an assortment of Clinique and Lancome products in every store for holiday, we just launched NARS, featuring three hero products, their famous blush, bronzer and a multi-purpose stick, The Multiple. These are available online and feature on a etagere in every store in time for holiday, with a more expansive assortment offered online later this month and then launched in select stores next year.

Our merchants have done a great job partnering with their brands to offer exclusive products across many brands and categories, a wide variety of holiday themed kits and stocking stuffers and mens grooming and fragrance kits. This year we upgraded our fragrance gift with purchase program, complementing the exciting newness in our holiday fragrance assortment. And we've also launched an elevated Ulta Beauty collection of our traditional blockbuster kits that have already shown strong consumer response.

And to support our compelling merchandise offerings, we rolled out our holiday advertising campaign, Joy to the Girl, which is integrated from a design and messaging perspective across all touch points, from in store signage, to new TV and radio spots running now, to print and even the packaging of our Ulta beauty collection holiday assortment. Our campaign encourages our guests to see us as a great gift giving destination as well as a place to get glammed up for holiday events with a visit to our salon. The Get Gifts and Get Glam theme is featured in our television and radio spots, through inspirational content on our social media platforms and on The Mix on our website.

Key to executing our holiday plan, our store operations, eCommerce supply chain and systems teams have all done an excellent job preparing for the busy holiday season and their efforts have already paid off with the successful Black Friday, Cyber Monday weekend, both in stores and online. All areas are staffed up and ready to delight our guests during the big weeks ahead, so now I'll hand it over to Scott to discuss our third quarter financials and our outlook for the fourth quarter.

Thanks, Mary. Good afternoon, everyone. I'll start with the income statement.

Net sales for the quarter increased 24.2% to $1.13 billion, driven by 16.7% comparable sales and continued strong performance of new stores. The total Company comp was composed of 11.1% transaction growth and 5.6% average ticket growth. The retail comp of 14.6% was comprised of 9.6% traffic and 5% ticket. Ticket growth was driven about a third by units per transaction and about two-thirds by average selling price. The salon business comped 10.3% and similar to the recent trend, was driven by ticket growth. The combined retail comp and salon comp yielded a total store comp of 14.3%.

Gross profit increased 90 basis points. The improvement was the result of product margin expansion and leverage as store rent and occupancy expenses on strong comps, offset by planned supply chain investments.

Turning to SG&A expense. We deleveraged by 80 basis points, driven by investments in growth initiatives, including store payroll to support our boutique strategy and a differentiated guest experience. And deleverage of corporate overhead costs, in part due to an impairment charge related to the closure of a store in Louisiana due to the August flooding. This was partially offset by modest leverage in marketing.

The tax rate was 37.4%, consistent with the first half of the year. Last year's Q3 tax rate of 36% reflected the benefit of some tax trueups.

Moving to the balance sheet. Inventories increased 16.5% on a per store basis, which is slightly below the comp rate. Similar to the recent trend, we continued to invest in inventory to support sales growth, gain access to new brands and expand the presence of prestige boutiques in our stores. Also, our new distribution centers in Greenwood and Dallas are ramping and performing well, but are still far from being fully optimized.

Capital expenditures were $131.6 million for the quarter, driven by new store openings, fixtures related to the continued rollout of boutiques, as well as investments in systems. We ended the quarter with $243 million in cash and short-term investments.

In terms of share buybacks, we continued to repurchase shares in the open market as part of our 10b5-1 plan. During the third quarter, we repurchased about 179,000 shares of our stock at a cost of just over $44 million. Year-to-date, including the accelerated share repurchase program, and activity under our 10b5-1 plan, we repurchased approximately 1,450,000 shares at an average price of about $205 per share. Share repurchases under our current authorization are expected to contribute about two points of EPS growth for the year. At the end of the third quarter, we had approximately $148 million remaining available under the $425 million share repurchase program announced in March 2016.

Turning now to guidance for the fourth quarter. We anticipate sales to be in a range of $1.516 to $1.541 billion versus $1.268 billion last year. We expect comparable sales to increase in the range of 12% to 14% versus 12.5% last year. ECommerce sales are expected to grow in the 40% range.

We plan to open about 25 stores in the fourth quarter, versus 14 last year, so pre-opening expense will be higher. Earnings per share are expected to be in a range of $2.08 to $2.13, versus $1.69 last year with modest leverage on both the gross profit and SG&A lines. The tax rate is expected to be 37.5% and our fully diluted share count is estimated at 63 million.

At our analyst day event in October, we raised our guidance for the full year of 2016, expecting comparable sales to grow approximately 12% to 14%, including the impact of the eCommerce business. And EPS to increase in the mid-20% range. Now, with the upside to third quarter earnings, we expect full year comparable sales to grow 13% to 15% and earnings growth to be in the high-20% range. Operating margin is expected to be up modestly for the year.

CapEx is on track to reach approximately $390 million, driven by slightly higher CapEx per new store and also includes about $80 million for boutique expansion, with 500-plus store touches for Clinique, Lancome and Benefit boutiques as well as fragrance fixtures and Ulta Beauty collection [updates]. Now, I'll turn the call over to our Conference Call host to moderate the Q&A session. Operator?

Thank you.

(Operator Instructions)

Our first question comes from Matthew Fassler of Goldman Sachs.

Thanks a lot and good afternoon. Congratulations on an obviously terrific quarter. Any way you look at it, you saw meaningful acceleration. Mary you spoke about the two-year comp if you look at the typical seasonality of the business, you really broke out. What would you say among the different drivers of the business really changed the most, you talked about the credit cards as being new and successful, would you say that that was decisive or would you say it was the convergence of brand ads would you say it was anything on the online side? What would you identify as just the primary catalyst to drive that kind of step change in sales momentum?

Thank you Matt. Honestly, I would say it's a convergence of multiple factors, some of which you just said. So we've been on a path for a while to drive increased brand awareness, that obviously starts with that. People need to know who we are. I would say the assortment of products of brands, the acceleration of new brands and the, frankly the great performance of newness, of new brands and newness within existing brands has been a key factor. And I would also say that our demand creation engine gets more fine tuned.

The team has done a great job through loyalty evolving the way that we promote, to becoming more personalized, our CRM platform working extremely well. As you mentioned, launch of the credit card has been another layer of a way for us to drive relevancy and drive share of beauty wallet with our shoppers. So it's a combination of all those things coming together, plus I would say fantastic execution. So in store, the experience we think just gets better. Our associates have done a fantastic job of converting guests into our loyalty program, and obviously our loyalty members are driving the majority of our sales. And of course our in stocks are getting better all the time and supply chain and systems and teams behind those are working to just make sure that guests have what they want. So I hate to throw the laundry list at you. But it's really a combination of all of those factors working in concert.

Can I ask a quick follow-up without breaking your rule?

Matt you just broke the rule. (laughter) Go ahead.

So to the extent that loyalty has typically generated a majority of your sales, as we look at the growth in loyalty members per store, is that a pretty good representation of your view of the growth in customers who are new to the chain on a same store basis?

Yes, I'm not sure if I can do exactly the equation that you're doing, but you know the majority of our sales -- vast majority are driven by our loyalty members and that's where the growth is coming from. And we know that we are getting new -- we really keep accelerating the growth of the number of people in the loyalty program, having 21.7 at the end of last quarter. So yes, I would say those things go together, and awareness is part of what's driving them in, but it's also the relevancy of our offers and everything else that we're doing.

Thank you.

Sure.

Our next question comes from Simeon Siegel of Nomura.

Hi this is Dan Stroller on for Simeon. Thanks for taking our question. With regard to the online booking, is there any way to quantify how much that contributed to performance? How should we think about the benefits this might provide to the brow bar? And any other ways you could leverage this tool? Thanks.

We're really are excited to have it, particularly on the brow bar. No, we are still monitoring and tracking it, it's relatively new on the brow bar, so there's no real specific data that we're ready to share about direct impact. But we think it's really important for us across all services to make it as easy as possible for our guests to make appointments and engage with us. So we'll continue to evolve the technology and we know that will improve the guest experience and we're excited about that going forward.

Awesome, thanks.

Our next question comes from Adrienne Yih of Wolfe Research.

Good afternoon, congratulations, great performance. Mary, I was out in the stores over Black Friday and Black Friday weekend and it was tremendous conversion. I was wondering could you give us the metrics on some of your Black Friday traffic stats and also what you did differently this year over last year and what the results ended up being. Thank you very much.

Sure, thank you, Adrienne. Yes, I can't get specific about the quarter that we're in. I'll just give you a little bit of color on it.

We're pleased with how the holiday is starting, very pleased and I think you saw that in action. I would say there's kind of a few things, that one is that really, it's about what we sell, what we offer. So I mentioned some of this already, but we've really got great new brands, existing brands with great newness. And then I would say we just keep raising our game as it relates to whether it's partnering with our brand partners and exclusives and great holiday kits, or really raising our own game, like on our Ulta Beauty collection blockbusters and products.

So that, I would say, is a continuation of just improving. It's not new, but it's what we do, but doing it better. Even our gift with purchase, stronger than a year ago. And then really pull together in a really fantastic 360-degree marketing plan. So more to come in the holiday and I'm pleased with how it's starting in store and online, frankly. And again, I said that our store teams and our supply chain working together to make sure that the experience is great for the guest.

And I'll just add this salon was incredibly busy during that weekend, so good job there.

Thank you.

Our next question comes from Mike Baker of Deutsche Bank.

Hi, this question is for Scott. I believe you said that SG&A would leverage in the fourth quarter; slight leverage, I think you said. And if that's right, this will be the first time in four quarters when you'll leverage SG&A. So is that a sign that we're now fully through all of the supply chain systems investments and then should we therefore think that we should be able to leverage these really strong comps going forward?

Yes, I would say as we looked at 2016, the third quarter kind of represented the high watermark, I guess I would say, as far as the deleverage is concerned. Again, a lot of factors come together at that particular point of the year whether it's boutiques, ramping up, new stores -- 42 new stores there is kind of the high bar. With the supply chain, we're just getting out of the gate did our Dallas DC there so it takes awhile for those things to scale up. So fourth quarter, as we go in with the heavier sales lift in the fourth quarter, we expect to see operating margin expansion and SG&A leverage as well.

You know, as I look to 2017 and beyond, I would just be a little careful there. Again we've given some long term financial framework there, right? When we expect operating margin to expand and I think we said generally heavier on the gross profit line, a little bit less so on the SG&A line, but they are both expected to leverage in 2017 and beyond.

Okay, understood, thanks. I'll keep it to one question.

Our next question comes from Joe Altobello from Raymond James.

Thanks, good afternoon. First question, for Scott. Obviously the upside to the gross margin in the quarter, much better than what we were looking for and I think you guys have talked about that being flattish last quarter, and Scott you mentioned product margin helped there, as well as fixed cost leverage. Could you kind of give us a little more color on what happened on the product margin side that limits that upside?

And then secondly, if I could, for Mary, as you look at the introduction of new brands going forward do you feel like there's more of an opportunity on the department store brand side or more from upstarts?

Thanks.

Yes, so as far as the product margins are concerned Joe, it's really just a continuation of all of the things we've been doing over the course of the last couple two or three years, right? So just being smart about our marketing, our merchandise mix, how we're optimizing the business for both the short and the long term. So we mentioned pulling back on broader promotional efforts and redeploying some of that into more targeted things with our loyalty and CRM tools, and that just continues to work really well.

So we're a pragmatic crew here, one of the fortunate things we have in this model is being able to toggle while we're in the quarter, and watching sales trends. So we mentioned the credit card got off to a spectacular start as we got into the quarter. We weren't expecting it to be quite so strong.

So again, Mary mentioned there's a nice offer there. 20% off your entire purchase when you sign up initially. So as we saw that take off, we were able to pull back on the postcard that we typically do later in the quarter. So again, just looking at all of the different elements and levers that we have to pull and try to optimize total results each quarter.

And Joe, I'll have Dave take your second question. Dave?

Yes, so about new brands and where we see opportunity at, I'll start with just saying we see opportunity across all parts of the store. That's one of the real secrets to our success is this is all things beauty all-in one place. So we're looking for growth in prestige brands, mass brands, hair, skin care, fragrance. And we've been -- and that's part of the reason we've been having success is we've been bringing in new brands, or expanding with existing brands, in all parts of the store. And specifically, you asked about department stores brands, or big established brands versus upstarts and frankly I think we're looking for both. We talked about expansion in some of the biggest established prestige brands.

You know we've been continuing to expand our partnership with Clinique and Lancome, we're just getting started with Estee Lauder and NARS. But then Upstarts has been a big part of our success over time and we feel really privileged to be partnering with smaller brands that are innovating in new and creative ways. Makeup Revolution in the mass cosmetic space is one example of that, but has demonstrated some nice growth. So we'll look for those opportunities, as well and both of those areas will continue to drive our growth.

Perfect, thanks guys.

Our next question comes from Rupesh Parikh of Oppenheimer.

Thanks for taking my question and congrats on a great quarter. So my one question is around your advertising efforts. So again, in the past few months you guys have again run the TV campaigns. It sounds like they are still meeting your expectations even as you lap some of the prior year efforts. I want to get a sense of what's helping to drive strong performance on some of those advertising campaigns?

Yes, so we're really - feel really good about where we are from our overall marketing campaign. We did -- this third quarter was the lap of our first national TV campaign in the Fall of 2015 and as Mary said, we repeated that again really supporting our 21 Days of Beauty effort in the middle of the quarter and the results were quite strong.

We tracked that, we measured it very closely, and we see strong and growing ROI across that probably most visible vehicle in TV. But other elements of our marketing plan, really all elements of our marketing plan are coming together to continue to drive awareness and growth. Radio is strong contributor to that, but we've been investing much more heavily in the digital space in awareness and social media, influencer, really across our entire digital footprint to connect with our guests where she wants to be connected.

Mary mentioned in her remarks, Ulta Beauty Mix is an example of that on our own website, of creating our own content as a big push, also partnering with influencers to drive that. So TV is a big part of it. We're pleased with the results, we're continuing that as we speak over the holiday period, we're back on air and we see that as a part of our mix but we'll also continue to innovate in all parts of it to make sure that we're really taking advantage of the awareness opportunity that we see ahead of us.

Great, best of luck for the holiday season.

Thank you.

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

Thanks. Good afternoon, I'll add my congrats as well. I guess my first question is ticket versus traffic. Just curious, I know you don't probably manage the business to it, but just curious as you think about -- we head into 2017 or beyond, what do you think is the makeup of that comp performance you've laid out between ticket and traffic and what might be the drivers?

And then just a second quick one is online profitability versus the store four walls, like what kind of sales volume, perhaps, does the online business need to be to reach parity? Thanks very much.

Yes, I would say on the traffic versus ticket, to me the ideal is just to be balanced. And we've been doing that pretty effectively, in the last quarter. I think we're about 2/3 traffic, 1/3 ticket. In retail, online was mostly transact traffic, which is great. But that balance is important because it's the ability to just continue to grow the business and not be reliant on just the set number of people in visit. So a balance, I think we would expect to hope -- it's never going to be exactly that every quarter, but that's the overall goal.

In terms of eCommerce profitability, I guess that's a constant area of focus. First of all, our eCommerce business has gotten more profitable in the last couple years as we've expanded the assortment. Certainly investments in the supply chain, being able to get those orders together in a more effective and efficient way.

It will probably always be somewhat lower profit margin than the bricks and mortar part of the business, just because of the shipping cost, but we're happy with it. I mean online business, as you can tell we talked at analyst day, is looking quite incremental to our guests in terms of how she uses the channel and so as we continue to close the gap of profit margin, it's a great part of the business.

Our next question comes from Ike Bourchow of Wells Fargo.

Hi, everyone. Congrats on another great quarter.

My question, I'm not sure -- Scott I think this is for you. I'm not sure if I'm looking at this right, but I think you said supply chain pressure should be the most pronounced in Q2 and Q3 and your gross margins were up really nice in Q2 and Q3, about 100 basis points each of those quarters. And looks like if you're assuming expense leverage in Q4 that the gross margin expansion should be much more moderate in Q4. My question is there is a call out there, is holiday being a more competitive quarter for you or is this just general conservatism, if I'm thinking about this right?

Yes, directionally we're on the same page. When I say it's the high watermark for supply chain deleverage, we're not expecting a lot of improvement, I guess I would say, in the fourth quarter. It's directionally about roughly the same kind of deleverage level.

But again, it takes -- these are, I would say inside joke here, we're kind of the belt and suspenders crew when we think of some of these behind the curtain complex, new systems and processes that we're implementing. So better to be prudent and careful and make sure that we can execute to make sure we keep our guests happy and the performance in both those buildings is outstanding. They are doing much better than original targets and expectations, so we're very happy with the performance.

Got it, but is there a specific reason why the gross margin gains you've been seeing, which have been pretty massive the last 12 months, why those would taper down significantly in Q4 and going forward maybe?

Yes, I would just say overall the guidance is prudent, right? Holiday is wild and wooly, and a lot of things can happen, weather, other kinds of things. So we just want to make sure that we're prudent with our outlook and make sure that we provide financial targets that we feel comfortable we can hit.

Got it, thank you.

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

Good afternoon and congrats on the continued success. I wanted to follow-up on the boutique, big investment in ramping up through the year. Can you give us a better sense of maybe how that's impacting the basket size and ticket expansion within those stores? Is it a trade up versus incremental purchase? And have you found the lift from these recent additions to be consistent with what you've experienced in the past? Perhaps difficult to view these things in a vacuum, but just interested any other learning you have from the recent rollout?

Yes, overall I'd say we continue to be really pleased with the addition of these boutiques. We haven't shared specific incrementality, although I'd say this is incremental to our business and the new boutiques are performing as well or better than, at this stage in their life, as the previous boutiques that we've launched. So we wouldn't have any reason to believe they wouldn't continue to add in the way they have been adding.

Having said that, of course there are just a portion of our new brand additions, so while they are important, a lot of other things have been driving our overall comp growth and new brand additions. So we're pleased with it and we see growth coming as we look into 2017.

Great, thanks and best of luck over holiday.

Thanks.

Our next question comes from Mark Astrachan of Stifel Nicolaus.

Thanks, good afternoon everybody. Wanted to ask about what's driving comp growth by category if you could give a bit more granularity there, makeup, skin care, etc.

And then a broader question on elaborating on one that was previously asked. I appreciate the kitchen sink answer to the question of what is rising comp growth, but what has surprised you most since March, given the original plan was 8-10%, now you're expecting 13-15%. Any granularity there would be helpful.

Yes, I'll start with that, which is that I think that it's really the performance of some of the newer brands in the newness in existing brands have been stronger than we perhaps had forecasted, credit cards stronger than we initially thought, so those are a couple things that I'd say were somewhat more accelerated. It really is -- those aren't the only things that are driving the comp growth, right, so that's why I listed the dynamic of multiple factors working together, but those are a couple examples of things that are probably stronger than we would have thought back then. And then Dave, on the other question?

Yes, on the specific categories, I guess I'd just say that we're, one, really pleased across all categories that we're seeing strong growth. I think Mary mentioned in her remarks that we're gaining share in each of our key categories and the drivers overall, we've talked about in the past, is just a highly engaged consumer in beauty and our continued ability to connect with her and gain market share and gain in her trust and loyalty and wallet share.

We think specifically, within makeup, a lot of trends driving makeup, it is the fastest growing segment of beauty right now and that's really driven by a high level engagement particularly with young women, teens and millennials, but really across all age-groups and all ethnicities. Hispanic and all women of color in particular, are happily engaged in makeup; there's more education and training and knowledge and trends around different makeup looks and styles. So it is just a really healthy category and our participation in that has extended through the brands that we're carrying, the way we're marketing it, the way we're participating in social media, so we're benefiting from that.

Skin care has been struggling for a few years, but has shown some nice signs of growth, Korean skin care has played a role in that, we're seeing strong growth in different aspects. Masks are a big part, but other Asian skin care trends are driving growth. And in overall recognition by millennials in particular that it isn't all about makeup, but you need to make sure your skin is in good shape, as well. So we're seeing nice rebound of skin care.

Other categories, fragrance that isn't growing anywhere near the level of makeup, but a lot of innovation in that space. We of course have been driving that with, one example of that is our Sarah Jessica Parker exclusive STASH. So a lot of different reasons throughout key categories and it's a big focus for Ulta to make sure that we're front and center in all of those trends.

Thank you.

Our next question comes from Chris Horvers of JPMorgan.

Thanks, good evening. So I wanted to ask about the cadence of the quarter. You pre-announced in mid October that 14-15% at the analyst day, were you anticipating a potential election disruption that didn't materialize, was there an acceleration or was it just being prudent and conservative in the outlook?

Yes, there's always a lot of things to consider during the course of the quarter, right? And this pre-announcement always presents a little bit of risk. So again, you'll want to be confident in the numbers you are offering up to investors, that you feel confident that you can hit the target. So there was some hurricane things floating around there in the middle of the quarter.

There was the election, the uncertainty again, we didn't see it reflected in our business day-to-day, but everyone else seemed to be talking about it. So again, it was just making sure we were prudent and comfortable with what we were communicating.

Understood, that's very helpful and then just as a quick follow-up, was there any incentive comp pressure that you had in this quarter because the numbers came in much better than expected. And could you quantify the impact to SG&A? Thank you.

Could you repeat that question again, Chris I don't think I quite got it.

Was there any bonus accrual?

Oh, I'm sorry I just heard the comp piece, not the incentive. Yes, so that year-over-year, there was an impact in SG&A. It's not the most significant piece of it, but there definitely was higher incentive comp accrued this year, obviously because of the performance from what we initially saw earlier in the year.

Understood, thanks very much. Have a good holiday.

Thank you.

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

Okay, good evening and congratulations on another great quarter. Just a simple question, as you think about the holiday season now, are you surprised by what your competitors are not doing differently than maybe over the last couple of years? Because it seems like based on our checks, they're doing -- sticking to the script, and we know how that story turns out.

So I don't mean to put you on the spot, but just in terms of from other retailers out there and how they are approaching the holiday season, it's a great category, obviously. But you seem to have kind of the right recipes; just surprised that some of your competitors have not adjusted their strategy.

Thank you, Jason (laughter). I don't know. I really can just focus on playing offense, which sounds cliche.

But I think we've got a really good beat on the insights, and Dave talked about this, that who we're focused on is our guest, current and prospective guests. What their needs are, how to think about a shopping experience, partnering with our brand partners to have great products and then our teams putting together great demand tools, whether it's CRM platform, credit card, all of the marketing. I really can't really comment on what people are doing or not doing.

We certainly pay a lot of attention, are out there watching it as well. I'm proud about the fact that I think we're leading through guest insights and really driving execution through a lot of collaboration and it's working.

Okay, great, thank you.

Our next question comes from Kelly Halsor of Buckingham Research Group.

Hi, guys. Thanks for taking my question, and congrats again on an excellent quarter.

I just want to follow-up on the boutiques. I think you, and correct me if I'm wrong, you called out 500 touch points related to the three brands where you have boutiques currently. And I know you guys said that you'd accelerated the growth of that this year, ahead of the holiday season. So if that is the case, what's the opportunity into next year, and are we -- are there opportunities with new brands in terms of the class of stores?

Is this a situation where as you go to the next tier down of stores, that we shouldn't expect the same sort of returns on the boutiques? Or perhaps you're not wanting to expand further, just any color on the boutiques would be helpful. And then secondly, just on the eCommerce, with the implied deceleration relative to Q3, we saw that last year as well, but I know you guys had just opened up the Greenwood DC. Now that the two DCs are running together and seem to be doing pretty well. Is there any opportunity there that you could speak about? Thanks.

Yes, so on boutiques, you're right. We talked about 500 total boutique installations across the entire chain, both new and existing stores with those three brands Clinique, Lancome and Benefit. We've said before that we intend or anticipate that about that same amount next year, both new stores as well as existing stores.

I wouldn't think of it as much going to a different tier of stores. We've really been rolling them out in our comp stores based on what's optimal from a scheduling standpoint, where it can fit, lease terms for stores. Because we do other activities within the store when we put a boutique in. We'll update our Ulta Beauty collection presentation, in some cases we put in a new fragrance presentation. So it is important part, but only a portion of the activity that we have in store when we put that in. So we'll continue to put those in next year and see that again.

I'd say -- so that's while it is important, it is one element of the new brand activity that we'll have across the whole chain next year. And as far as eCom growth in the fourth quarter, we just -- we feel confident within the guidance that we've given and we'll continue to try to focus on that business. We're happy the results we've had so far this year and it's an important season for our eCommerce business and we're confident in our efforts.

Thank you.

Our next question comes from Stephanie Wissink of Piper Jaffrey.

Thanks, good evening, everyone. Just a follow-up question on the eCommerce business, could you compare and contrast a bit your online orders versus some of the store level analytics? Is it similar from a category mix or mass versus prestige? And then as you think about overall your loyalty program, how important is that online business to driving a multi-channel shopper over time? Thank you.

Yes, so the first part of your question around mix. Generally, yes, it is very similar both online and in store, her shopping behavior is reflective of the in store experience. In particular and over the last couple of years as we've rounded out our portfolio, not so long ago we didn't have all of the brands in professional hair care or even in prestige online that we had in store.

Now we do have that, and so her behavior is very similar and we really see it as a complimentary part of our in store business. She looks to find what's most convenient for her as we book. As far as loyalty and the importance of that, your question is about loyalty importance both online and in store and how we drive that, is that right?

Yes, and I think historically you've given us some metrics around that cross channel shopper per size and importance versus the single channel.

Yes, so we shared some of those statistics back at our analyst day. It's really consistent in that 6% range of online omnichannel shopper. It's growing a little bit, but when our base store growth is so strong it takes a really high eCommerce growth to make a big difference in that number. But importantly, the absolute number of omnichannel shoppers is expanding, and that's very much part of our overall strategy.

We see that as a big part of our future growth is to get her fully engaged in all aspects of our business, eCommerce, retail business, services and salon. We feel like once we can get her engaged in all parts, then her loyalty raises, her spend has gone up, we shared those numbers before. And so we're continuing to see that in the third quarter and it will be a focus for us going forward.

Thanks guys, have a great holiday.

Thank you.

Our next question comes from Oliver Chen of Cowen and Company.

Hi, thank you. We were curious about the next few years with mobile innovation. What's on your radar for just making sure your experience is set apart?

And in that context, the reality of Amazon making strides in this category, what are just some of the factors that really continue to set you apart as you look to the future and continue to really distinguish yourself with a product assortment, with the loyalty program, with the newness factor as well versus Amazon?

And then if you could just tell us, is strobing and contouring still middle innings? Because it seems like it continues to be a hot trend. Thanks.

I love it. Oliver, I appreciate your knowledge about the categories. I'll say contouring, strobing, highlighting, all that is still popular. Interesting little fact, false eyelashes is on the move too, right?

So something that you wouldn't think is a tiny but fast growing trend too. So anyway, that's a great thing about beauty, there's so much innovation and interesting trends that cycle in and out. I would just say, I'll make a comment about mobile as stated to add more color and context here, but you're absolutely spot on. Everybody understands that mobile is the center of everybody's life, it's our appendage, our attachment. And I'm proud about the fact that I think as a Company our team has really been increasing our focus and our execution around mobile. Its becoming more important to us than ever in terms of driving sales and traffic and is fast growing.

We've been innovating in terms of our mobile platform, and I mentioned already, but an example is GlamLab, which is a nice little piece of technology that I'm not good enough to take a selfie to really execute it well, I've tried. But it's a great thing for millennials who want to have a more interactive experience.

So as our offerings and our execution in mobile improve, we just get stronger there, and it's certainly going to be the epicenter how we think about a mobile first mentality as we go forward. Is there anything else you might want to add, Dave, in terms of innovation there?

I'd just say mobile, to put it simplistically, it's really for us, it is the focus of overly all of our eCommerce efforts on this. Obviously, we'll continue to work on our desktop, but where all of the growth is and the attention is in mobile. Over two-thirds of our traffic is coming through mobile right now in a growing part of our sales.

And two core components of that, content and commerce, and we'll keep building a content experience that gives her access to the information when and where she wants it and then just make it as easy as possible for her to shop. As you well know, and it's a different shopping experience on a mobile device, and so we're continuing to innovate in that space and make it easy through finding products, paying for products and exploring new information and trends, so it's really a focus for us.

Thank you best regards.

Our last question comes from Simeon Gutman of Morgan Stanley.

Thanks, congratulations again. First, I'll put in two parts. On the top line, you said a lot of the sales or a majority are getting done on the loyalty card, as we know.

Could you tell us how -- I don't know if this was mentioned, the mix of either new sign ups, since that's where the majority of sales are coming, versus existing and how that's trended versus prior quarters? And then this is also a clarification to an earlier question. On the expense line, if I heard right, even excluding the impairment charge, did the corporate expense line delever? And if so, I'm sorry if this was said, but can you tell us why and if that should continue?

On the loyalty Simeon, so we're growing rapidly and adding new members but the majority of the sales are coming from existing members or members that have reactivated. But as we get new members into the program every day, frankly every week, obviously that gives us a great base for future sales growth.

As far as the SG&A line is concerned, the answer to the question is yes, it did delever even ex- the store impairment charge. It was primarily a mixture of things. Store payroll, and one of the primary drivers, again, part of it is connected to the boutique strategy. So there's a lot of training and payroll preparation associated with those new boutiques that are just getting off the starting line during the course of the third quarter and setting us up for success in fourth quarter and many quarters beyond that.

We were also, with people costs associated expenses in the quarter, again, the way we operate out. But we finally get all of our corporate headcount adds in place, usually in the third quarter. So again, that's max deleverage point during the course of the year and then a little bit of incentive compensation that goes along with that year-over-year comparison. Again, we leverage that as we go into fourth quarter and into the following years.

Thanks.

Ladies and gentlemen, we have reached the end of the question and answer session. I would now like to turn the call back to Ms. Mary Dillon for closing remarks.

I'd just like to thank our 30,000 associates for another fantastic quarter and all of the hard work everybody has put in and continues to put in to give our guests a great shopping experience over the holiday season. And thanks to all of you for your interest in Ulta Beauty and we wish you a happy and healthy holiday.

This concludes today's conference, thank you for your participation, you may disconnect your lines at this time.