Ulta Beauty Inc (ULTA) 2017 Q1 法說會逐字稿

Greetings, and welcome to the Ulta Beauty First Quarter 2018 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. Laurel Lefebvre.

Thank you.

You may begin.

Thank you.

Good afternoon, and thanks for joining us.

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.

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 company's filings with the SEC.

(Operator Instructions)

I'll now turn it over to Mary.

Thank you, Laurel.

Good afternoon.

The Ulta Beauty team kicked off 2017 with excellent first quarter results.

Strong sales growth, driven by product newness and solid execution of our merchandise and marketing programs, translated into better-than-expected earnings growth, even excluding the significant tax rate benefit.

Comp sales grew 14.3% on top of 15.2% in the first quarter of last year, maintaining the more than 29% 2-year comp trend we achieved in the previous couple of quarters.

Comp sales were driven by balanced traffic and ticket growth in our stores and remarkable strength in e-commerce.

We're particularly proud of these results in light of the challenging environment many retailers are experiencing.

Our differentiated and increasingly compelling assortment, the experiential nature of our stores, the strength of our loyalty program and CRM capabilities that help us drive traffic and manage promotional activity with greater precision, the supply chain investments we've made to support the acceleration of our e-commerce channel, all of these assets are contributing to our exceptional growth.

Now let me provide some more detail on the components of our strategy that drove our first quarter performance, starting with our strategic imperative to acquire new guests and deepen loyalty of existing guests.

During the first quarter, we acquired 1.1 million net new loyalty members, bringing the Ultamate Rewards program to 24.5 million active members.

This represents growth of 26% year-over-year, driven by continued strong execution by our store teams who are passionate about converting new members and healthy traffic in our stores, supported by our merchandising and marketing efforts.

As we anticipated, the growth rate is beginning to moderate slightly as we cycle the big impact from initiatives that lifted conversion rate over the past several quarters.

But we still expect to see rapid growth in loyalty membership well above square footage growth.

All of the metrics we track, including retention rate, sales per member, frequency of purchase and average member ticket, remain very strong.

We continue to find ways to enhance the benefits of the program, particularly adding perks for our most engaged Platinum level customers who spend more than $450 a year.

Our brands are increasingly interested in partnering with us on loyalty and CRM efforts.

An example of this is our most recent pre-birthday gift for loyalty members.

It was a deluxe sample of Lancome's new Monsieur Big mascara, offered to our members before the full-size product launch in store.

Our Credit Card program continues to exceed expectations and we're excited to be launching the gift card program with Blackhawk in grocery stores this quarter.

To update you on progress in increasing brand awareness, in April, we reached 86% aided awareness versus 84% a year ago, and our unaided awareness was up 6 points at 45% this year versus 39% last year.

Awareness of Ulta Beauty brand is at an all-time high as our marketing and PR activities, including TV and radio advertising for 21 Days Of Beauty; partnerships such as those with POPSUGAR and Refinery29, which included an activation at the Coachella festival; and a stronger focus on social media all are contributing to make Ulta Beauty top of mind.

Key promotional periods during the quarter included our spring trend report, where we highlight new styles of products through the integration of hair and makeup trends in our print and social media channels; 21 Days Of Beauty, our signature prestige beauty event that just keeps getting bigger and better; and Mother's Day, when we highlight the fragrance category.

For the Spring 21 Days Of Beauty event, we enhanced the daily beauty steals program with additional hot buys and elevated our ULTA Beauty Collection offering, resulting in our strongest 21 Days Of Beauty event ever.

One of our daily beauty steals, Anastasia Beverly Hills' iconic Brow Wiz pencil, broke the record for the best beauty steal in the history of the event.

For Mother's Day, we upgraded our "gift with fragrance purchase" offer and elevated both our Pamper Her with Pretty and our Mother's Day Gift Guide.

This year's social media activation invited our guests to share their mom's beauty wisdom, which was about best tips and makeup advice.

And this garnered high engagement on social media.

Now turning to our efforts in merchandising.

We continue to gain share across every major category, with particular strength in prestige cosmetics as well as in skin care in both the mass and prestige categories.

IT Cosmetics, Tarte, Too Faced, Mario Badescu, BECCA, Anastasia, Clinique, Lancome, Benefit, TONYMOLY, Yes to and the ULTA Beauty Collection were among the best-performing brands for the quarter.

Positive product launches included IT Cosmetics' Confidence in a Compact serum foundation, Too Faced's Peanut Butter & Honey palette, Smashbox's Be Legendary liquid metal lip color, BECCA's Sunchaser bronzing palette, Stila's Magnificent Metals eye shadow and a new line of 30 Estee Lauder lipsticks exclusive to Ulta Beauty that are now featured in 650 stores.

The new brand pipeline remains robust as well.

Recent additions to the prestige cosmetics portfolio include several brands much loved by beauty enthusiasts, including Nudestix and COVER FX.

In prestige skin care, we launched Nyakio; and a new brand targeted to millennials, NIA, which stands for Not Into Aging.

We also added a handpicked assortment of K-beauty favorites to our prestige skincare offering.

Our Pro Hair assortment received a significant assortment reflow with the addition of Klorane; Aquage; Flawless by Gabrielle Union, which is exclusive to Ulta Beauty; and Madison Reed salon quality hair color.

In mass cosmetics, we launched several new brands in select stores: L.A. Girl, Catrice and Models Own.

The mass skincare portfolio added Skinfood and Derma-E essentials.

In addition, many existing brands expanded into additional doors, including NARS, Origins, Drybar and Estee Lauder.

Now to update you on our M.A.C introduction, we launched about 600 M.A.C SKUs online a couple of weeks ago, and the brand is off to a very strong start on the website.

To generate buzz for the e-commerce launch, we ran a 1-day flash sale for a lip palette on Instagram a week before the launch.

The excitement is building for a M.A.C launch in stores for this quarter.

We're on track to open more than 100 M.A.C doors before the end of the year with a similar breadth of assortment.

The first M.A.C boutique will open on June 10 in Davenport, Iowa.

Moving on to services.

The Salon business grew 16.7% and comped 9.9%, with strength in color services, blowouts and makeup services.

We're investing in people and processes in our services business to continually improve the guest experience and drive sustainable market share gains.

So for example, we're investing in training and brand building for The Salon through the recently announced formation of the Ulta Beauty Pro Team.

This is a group of 5 artists and educators from some of the industry's top professional hair care brands: Redken, Matrix, L'ANZA and Wella.

With over 100 years of combined experience, these professionals will elevate the profile of The Salon and Ulta Beauty, and help to educate and inspire our stylists across the country by working to enhance our salon education programming, building trend collections and providing training.

Their efforts will be complemented by the Ulta Beauty design team, who will bring these collections to life with the company's 80 educators, who, in turn, will train ULTA Beauty's 6,500 stylists.

In addition, we've created a dedicated team at corporate to build out our analytical capabilities, and we'll be testing a variety of changes to our model, including pricing, staffing and technology enhancements.

As a result of all these investments, we're very optimistic about the opportunity to continue to enhance our market position in salon services.

Now turning to store expansion.

We opened 18 stores in the first quarter to launch our 2017 program of 100 new stores.

We closed 2 stores, relocated 2 and ended the quarter with 990 stores.

New store productivity continues to be very strong, reflecting excellent site selection, growing brand awareness and an increasingly appealing assortment of brands.

We're on track to open a handful of high-profile stores this year, including a store on Michigan Avenue in Chicago opening in a couple of weeks, our first store in Manhattan planned for October and a store in the Mall of America expected to open in the fall as well.

As a result of these higher-rent locations as well as the higher percentage of stores on the West and East Coast with generally higher rents than in the center of the country, we expect some modest pressure on rent per square foot for the chain.

We're confident we can offset this in part by continuing to optimize lease terms.

We're very active with renegotiations of rents as part of the lease renewal process after the initial 10-year term to ensure we're paying the most competitive rents.

To update you on the e-commerce business.

The ulta.com team delivered growth of 70.9% in the first quarter.

This was the highest quarterly growth rate for our e-com business since the first quarter of 2014, back when the base was only $17 million.

This sales growth contributed 340 basis points to our total company comp, driven almost entirely by transaction growth.

As we study our guest purchase behavior, our e-commerce business is proving to be largely incremental.

The Ultamate Rewards member who shops online are also increasing their purchases in bricks and mortar versus shifting their purchases online.

We continue to improve our site experience and fulfillment capabilities.

ulta.com drove very strong growth during 21 Days Of Beauty and other events, including the limited time offers we call Beauty Bags and Beauty Breaks!, and special offers for Platinum loyalty members.

These events are often a catalyst for retail guests to become omnichannel shoppers, which brings many benefits.

The number of omnichannel loyalty members continues to increase and now represent 8.6% of our members, up 140 basis points year-over-year.

We continue to add online-only brands and expand the assortment of brands we carry in stores.

During the quarter, total traffic growth was up 77% and mobile traffic rose 107%, driven by growth in paid search, affiliate, display and social, including Facebook, Twitter and YouTube.

And now turning to progress in our supply chain and systems.

Supply chain operations really performed well across all metrics in the first quarter, maintaining a high in-stock position throughout the quarter while managing multiple resets, introducing new brands and working with some of our brand partners to get back in stock after strong holiday demand.

Our supply chain supported ulta.com's strong performance as we continue to ramp order volumes shipping out of our new, more efficient distribution centers.

Our DCs processed significantly more e-com shipments than forecasted during the quarter, while improving productivity, decreasing cost per shipment and keeping labor costs in line with forecasts.

From an inventory management perspective, we maintained high inventory in stock to support our best-ever 21 Days Of Beauty event.

Our top SKUs continue to be fully supported as we identify opportunities to make our inventory more productive.

Finally, to update you on our new distribution center in Fresno, California.

Construction is underway and we're on track for a summer 2018 opening.

As a reminder, this DC is similar to our Dallas DC, a 670,000-square-foot facility that can service up to 400 stores and 45,000 e-commerce orders per day.

This DC will enable new distribution technologies that would increase our productivity and significantly reduce transit time to our West Coast customers.

In summary, 2017 is off to a great start, and I'd like to hand it over to Scott to discuss the drivers of our first quarter financials and our outlook for the second quarter and 2017.

Thanks, Mary.

Good afternoon, everyone.

Starting with the income statement.

Sales for the quarter rose 22.5% to $1.3 billion, driven by 14.3% comparable sales growth and continued very strong new store productivity.

The total comp of 14.3% was made up of 8.7% transaction growth and 5.6% average ticket growth.

The retail comp was 10.9%, composed of 6.2% traffic growth and 4.7% average ticket, with ticket roughly split equally in between units per transaction and average selling price.

The Salon business comped 9.9%, driven primarily by ticket growth, although traffic growth was the strongest we've seen in several quarters.

The retail and salon comp combined for a total store comp of 10.9%.

Operating margin increased 60 basis points, driven by SG&A leverage.

The drivers of our P&L were fairly similar to what we saw in the fourth quarter, with gross profit decreasing by 20 basis points and SG&A improving by 80 basis points.

On the gross profit line, we leveraged rent and occupancy costs, and product margins at retail were about flat.

This reflects similar levels of promotion year-over-year, with one exception.

As you know, we introduced the Ultamate Rewards credit card in August last year as an important tool to enhance loyalty and drive higher share of wallet of our guests.

We're very happy with the program and the positive overall impact to the P&L.

However, it impacts some of the geography of expenses and benefits.

When guests sign up for the card, they receive a onetime 20% off offer, and begin to earn extra loyalty points.

Both pressure gross margin rate, but we see offsetting these factors with credit card income, including sign-up royalties, labor support and lower transaction processing fees, which are included in SG&A.

On the mix side, we benefited from strong growth in the ULTA Beauty Collection and some of the higher-margin brands, but offsets included headwinds from higher mix of boutique brand sales.

As a reminder, some of the prestige brands we've added are contributing significant margin dollars, but are dilutive to margin rate.

With the hundreds of prestige brand boutiques we rolled out last year and are now accelerating this year, we are seeing a higher percentage of sales from these brands and anticipate that this margin rate headwind will continue.

We also felt some pressure from a higher mix of e-commerce sales, investments in The Salon business, as well as higher distribution costs as our recent DCs and newly implemented systems continue to scale up.

Turning to SG&A.

Improvement here was primarily driven by advertising expense leverage on strong sales, corporate overhead savings as we anniversary-ed G&A investments made last year to support our supply chain and systems initiatives, and benefits from the Ultamate Rewards credit card.

We also had some savings due to the timing of certain expenses, with some planned activities in areas like marketing and consulting that didn't occur as expected in the first quarter.

But these dollars are expected to be deployed later in the year.

These timing impacts represented about half of the earnings upside in the quarter, excluding the tax rate benefit.

Investments in store labor to enhance the guest experience and to ensure strong execution of planogram changes partially offset these improvements.

Just to touch on the tax rate for a moment.

You saw that we called out a $0.14 earnings per share benefit in the quarter, primarily related to the new accounting standard that changes how companies record the tax effects of employees' stock option exercises and vestings of equity awards.

The tax benefit moves from the balance sheet to the P&L.

Going forward, we may see fluctuations in our tax rate quarter-to-quarter, which will be difficult to forecast.

Broadly speaking, we expect the full year rate to be about 1 point lower than last year or approximately 36.5%.

Our guidance will assume a 37.5% tax rate for the remainder of the year.

Moving on to the balance sheet.

Inventories increased 11.2% on a per-store basis, well below the comp rate, driven by solid inventory management, especially in light of the inventory additions for new brands and boutiques as well as ramping up the Dallas distribution center.

Capital expenditures were $77 million for the quarter, driven by new store openings, systems and fixtures for prestige brand boutiques.

Depreciation and amortization was $62 million for the quarter.

We ended the quarter with $472 million in cash and short-term investments.

In terms of share buybacks, we continue to repurchase shares through our 10b5-1 plan.

During the first quarter, we repurchased approximately 185,000 shares of our stock at a cost of $51.6 million or an average share price of $279.

As of April 29, 2017, approximately $395 million remained available under the $425 million share repurchase program announced in March 2017.

Turning now to guidance for the second quarter and fiscal 2017.

For the second quarter, we expect sales to be in the range of $1.257 billion to $1.278 billion versus $1.069 billion last year.

We expect comparable sales to increase in the range of 10% to 12% versus 14.4% last year.

E-commerce sales are expected to grow in the 50% range.

We plan to open approximately 25 new stores in the second quarter versus 24 last year, so preopening is expected to be slightly higher.

Diluted earnings per share are expected to be in the range of $1.72 to $1.77 versus $1.43 last year, with leverage on the gross profit line and modest deleverage on the SG&A line, with overall operating margin rate flattish.

The tax rate, excluding any impact of the new accounting standard for share-based payments, is expected to be 37.5% and our fully diluted share count is estimated at 62.4 million.

Now turning to full year guidance.

We plan to open approximately 100 new stores, all of which will be our prototypical format.

We plan to complete about 11 major remodels and 6 relocations during the year.

We expect to grow our e-commerce business approximately 50%.

Total company comps are expected to be in the 9% to 11% range.

CapEx is expected to be $460 million, including new stores, remodels, relocations, approximately 700 prestige brand expansions and investments in systems to improve inventory visibility, which will enable future omnichannel capabilities.

We are increasing our annual earnings-per-share guidance to flow through the tax rate benefit reported in Q1, and about half of the operating upside to account for the timing of planned expenses shifting from the first quarter till later in the year.

We anticipate earnings-per-share growth in the mid-20s percentage range compared to our earlier outlook of low 20s EPS growth.

This includes the impact of the 53rd week, assumes approximately $300 million share buybacks and assumes a full year tax rate of 36.5%, and a tax rate of 37.5% for quarters 2 through 4. To be clear, our EPS outlook excludes any impact from the new accounting standard for share-based payments for the remainder of the year.

Operating margin is expected to increase in the 20 to 30 basis point range.

And with that, I'll turn it over to our conference call host to moderate the Q&A session.

(Operator Instructions) Our first question comes from Mark Altschwager from Robert W. Baird.

I did want to ask about the loyalty program.

You've had a lot of success in the past year reactivating some of the lapsed loyalty members.

Just curious how much opportunity remains on that front.

And then for some of your more mature stores, just how are you thinking about the balance between adding new members versus capturing that incremental share of wallet to drive the comp moving forward?

Thank you, Mark.

Let's -- I'll break this into 2. I'll [take] the second part of the question first.

I'd say, in total, wherever our stores exist, whether they're more mature or newer stores, we see plenty of opportunity to continue to drive market share growth and loyalty member growth.

And so, over time, certainly it's about more share of wallet of current members.

But we believe there's opportunity out there as we look at the marketplace for both of those kinds of growth going forward.

In terms of lapsed users, do you want to...

Yes, absolutely.

Mark, this is Dave.

Yes, the -- we have had a lot of success, as you mentioned, continuing to reengage lapsed guests.

And that has continued and continued in the first quarter of this year, and we see more opportunity in that.

We've got a larger database beyond the number of members, active members, and we continue to reach out and attract them, both through our broader marketing that we know reaches them and encourages them to come back, and then some direct marketing efforts that we started to experiment with.

So we see continued opportunity on that side as well.

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

So the question we had is a broader question on that topic regarding Amazon.

What are your thoughts on how you preserve the specialness of your brand?

And how you will continue to do a really superior excellent job with the growth and loyalty you're seeing in the face of Amazon, which, as you know, has so many -- such a big user base?

And then if you could just brief us on your thoughts around your smaller format, pros and cons, in terms of what you're thinking about flexible formats as you continue to grow and be relevant across different types of opportunities, given that there's opportunities in different formats, I'm sure.

Okay.

The two-pronged question.

Got it.

In terms of -- I would just step back and just say that I think that we feel, as we've discussed kind of at length about -- as we look at the category we operate in, the consumers that we're focused on, the beauty enthusiasts, our loyalty program is quite large, 24.5 million people and growing, right?

The uniqueness of our business model is that we're in a category that's not only growing, but as we look at demographic trends and we look at millennials and Gen X and Latinos, all fast-growing sectors of our economy, these are all folks who really are engaged in beauty and, frankly, love the way that we offer how to shop for beauty.

This notion of All Things Beauty, All in One Place clearly is resonating.

And it's very much about an in-person experience as well as we're seeing a very incremental online experience.

And so the notion of continuing to have a wonderful shopping experience with a great assortment of products and categories and brands, plus services, plus the ability to have a great online experience, we see plenty of runway for us to continue to be a very relevant both bricks and mortar and online player.

We know that the beauty enthusiasts love to shop in person and our associates love that interaction with the guests as well.

So that, we think -- I believe strongly that, that platform, we'll continue to do what we do, but just getting better at it all the time is what we're focused on and why we feel confident about our ability to continue on the growth path.

In terms of formats, we just have a couple of those smaller-format stores and we learned a lot about operating them.

We like what we saw, but we also feel, as we've said, very confident that our base of, overall, 10,000-square-foot format is our most productive, best for our guests.

We see plenty of real estate opportunities to do more of that.

And we see opportunities both to go deeper into markets that we're in, to go open up stores in more one-store kind of markets as well as urban opportunities.

And most of those cases, we'd say, the 10,000-square-foot could be a little bit less, it could be a little bit more.

But bringing Ulta Beauty in kind of the full-throttle way that we do it is really, we think, the best way to continue to proceed.

Our next question comes from Mark Astrachan of Stifel.

Curious how you think about the ultimate number of boutiques in stores relative to current levels if you start to think about it on a longer-term basis?

And how do you think about the existing brands for those versus newer brands?

And related to that, how do you think about picking up more brands from some of the larger beauty companies, like the L'Oreals and Estees, compared to indie brands that may not have broader distribution?

I'd say think about this as a continuation of some of all of those, all of the above, how's that?

Then our guests, they are really interested in brands that they know and love.

They want to be able to access those in a more convenient format, like Ulta Beauty, as well as discovering new brands that maybe we're the first to bring to market.

So that mosaic of interesting brands in -- we'll continue to play that out in the future.

In terms of boutiques, Dave, you want to add to that?

Yes.

Yes.

As we said before, we're adding about 700 boutiques across the chain this year, with those key boutique brands, Clinique, Lancome, Benefit and M.A.C.

And we see more expansion, certainly as we build new stores.

Many of them will get all of those or most of those boutiques.

And then we'll continue to penetrate our existing stores where it makes sense, and we have the opportunity to go back in and do that.

So that will be a continued source of growth, but it's, by no means, the only growth.

And as we're -- building on what Mary said, continued mix of both big established brands, like a M.A.C or an Estee Lauder, but also uncovering new, emerging and independent brands and bringing that balance to our guests, which is what she wants.

That's helpful.

If I could squeeze in one more sort of related question.

Just curious how you're thinking about, with now a few weeks of M.A.C online, how you're seeing that doing relative to, I don't know, expectations?

It might not be the best way to think about it.

But just in terms of how sales have been, whether you think it's cannibalizing these stores outside of Ulta, and sort of thoughts about how that would fit into the e-commerce expectations, which would seem like it could be even better than that given that M.A.C just started.

Yes.

So not to talk too specifically about any individual brand performance, other than to say we're very pleased.

We're just a couple of weeks in, as Mary mentioned in her comments, that we're happy with the results.

And then we've included that -- our anticipation of continued success there in our forward-looking view of business.

So we're excited about it, and we'll continue to drive that business going forward.

Our next question comes from Christopher Horvers of JP Morgan Chase.

So I wonder, first of all, on the M.A.C question.

I know you're pleased with the results so far, but I guess could you share any thoughts on the demographics that you're picking up on the M.A.C side?

And how maybe that -- how your core customer is also responding to that M.A.C offering?

And then, in terms of the how the quarter played out for you, obviously you got it a lot lower to start the quarter.

Was February hurt by tax refunds, and then does it sound like you basically just recaptured that into the balance of the quarter?

Yes, I'll start with that, I guess, which is -- yes, I mean, I think -- we saw some -- a little choppiness.

Overall, it kind of averaged out.

But we saw a little bit of volatility, I'd say, late January, early February, probably due to the same factors that others saw with the tax refund.

April was our strongest of the period, that has also benefited from a change in Easter timing.

So in total, I'd say, it kind of all worked itself out and it wasn't -- we felt good about -- I mean, we had -- we did better than we had guided, better than we thought, and I think the e-commerce business in particular was stronger than we had planned, so that was kind of how it netted out.

In terms of M.A.C, I would just say way too early.

We just launched it online, but I appreciate the question.

And I would say, I would expect that this will be very much -- our core guests will love it, and it's already showing in the online response that she is.

I wouldn't expect it to be different, right, than who would be interested in many of the other brands that we offer, but she's excited to be able to get that Ulta Beauty, that's for sure.

Understood.

And I think the biggest question out there right now is what you're seeing in the promotional environment from the department store channel.

I mean, there was some news out there that you added a couple of incremental promotions.

It sounded like it went to your best customers to optimize the value to them.

But what are you seeing in the department store channel?

And is there a wholesale change going on in terms of the complexion of the industry?

Well, that's a deep question.

I'd say this: beauty, it really always has been a competitive category.

I would just step back by saying that I think our results in terms of traffic and market share underscore that what we're doing is working, right, it's competitive.

Also, I would say, yes, in the quarter, we -- over the past several quarters and several years, we've actually been modifying our approach to marketing tactics with a meaningful reduction in the broad-based discounts to more kind of balanced and targeted mix.

We do use postcards.

We do it on a more limited and targeted basis, really, than we ever have.

So in the quarter, we did two.

We did one that was -- they were both digital.

One was very targeted to our Platinum-only guests in February.

So we've got a lot of different levers that we can use and flex as we need to in terms of demand creation.

So I feel that we will always be offering a great value proposition to our guests.

And we've got the right tools to allow that to happen.

So will some competitors get more aggressive with price promotions?

Sure.

That sometimes happens in a competitive market, but we've got the levers that we can use to respond in a dynamic environment.

I'd also add that we always -- we work with our brand partners to make sure that we have really great exciting offers for our guests all the time.

And again, I would say that our results are showing that that's working.

Our next question comes from Rupesh Parikh of Oppenheimer.

So I was hoping to get a little more clarity in terms of how you guys are thinking about gross margins for the balance of the year.

It sounds like the greater e-commerce sales this quarter and greater prestige sales weighed on your margins in Q1.

So just want to get a sense if you expect similar pressures or potential decline to continue for the remainder of the year.

Yes, I mean, the one thing I would just remind folks of is that we're lapping some pretty significant promotional kind of pullbacks here over the course of the last, whatever, call it 6 to 8 quarters, right?

So we're lapping some pretty tough compares, I would say, on the margin line recently.

So in the big scheme of things, we look at each quarter individually and try to optimize as best we can to deliver the best overall result for the business.

There's nothing, as we sit here today, that would indicate that there would be any significant change in the trend that we've seen here recently, and we'll just do our best, right, to try to course correct as we think necessary as we navigate through that.

Our next question comes from Simeon Siegel of Nomura.

Are you -- Mary or Dave, are you seeing any change in your incremental customer as your brand awareness grows?

And are you reaching any new demographics with marketing?

And then how is the awareness in city centers, just particularly ahead of the high-profile store openings?

Yes.

We've had a -- definitely an effort to continue to expand our appeal across all consumers in all markets and geographies, and I think we're seeing success with that.

Our awareness, in total, continues to grow and, certainly, it's much higher than it was 2 or 3 years ago.

Our aided awareness is 86%.

Our unaided awareness remains at about an all-time high, around 45%.

So we're feeling very good about that.

We have a big focus this year, we've talked about it in the past, in expanding our efforts to reach Latina guests.

We've had more dedicated marketing partnerships with key media sites, like Vivala and POPSUGAR Latina and others to kind of reach out directly through influencers.

We're testing some Spanish-language advertising later this year that will give us the opportunity to reach them more directly.

So there's -- we see strength there and lots of opportunity to continue to build that.

As far as urban centers, we do measure and look at awareness across major centers.

And it's actually quite strong.

I mean, Los Angeles is an example.

We've opened quite a few stores there over the last few years and get the strong awareness that really mimics our national.

Chicago, New York, we're building and it's quite strong.

So yes, there isn't big pockets of undeveloped in urban areas, but we see more growth potential across the board and specifically with key groups like Latinas.

And then just the point of the leveraging marketing.

What's the right way to think about marketing dollar growth or as a percent of sales?

And then, Scott, I don't know if I missed it, but did you say what the right way to think about total SG&A dollar growth for Q2 and the full year would be?

Yes.

We don't really talk about SG&A in terms of dollars like some of the big box guys do.

I mean, when we're thinking about the full year, I guess, this gets back to the pressures question as well.

I mean, I think we said operating margin flattish in the second quarter, up a little bit on the gross profit line, down a little bit on the SG&A line.

I think as we navigate through the rest of the year, the third quarter, I would say, gross profit, we're going to have a little bit more pressure on that because some of the rent, the heavier rents we're going to pay for some of those higher-profile kind of stores that are common in Manhattan and Mall of America and a few others in the boroughs of the New York Metro area.

So that might be a little tougher on the gross profit line.

We'll get a little offset there in SG&A to offset it there again.

I'd say maybe slight deleverage in the third quarter overall, and then we make it back up in the fourth quarter when we've got -- we're lapping the Dallas DC there and we're scaling up on e-commerce and retail overall.

So we're seeing more leverage in the fourth quarter.

Our next question comes from Mike Baker of Deutsche Bank.

More of a longer-term bigger-picture question.

Typically, I think you saw it this quarter, as companies grow their e-commerce, it does pressure margins because I think contrary to what a lot people thought years ago, e-commerce can actually be a lower-margin business.

The question though is how does that leverage as your e-commerce business grows?

As e-commerce business gets bigger, do the margins on the e-commerce itself get better and then, therefore, becomes less of a drag?

Or if that doesn't occur, as e-commerce grows, does the drag actually get bigger?

Well, first of all, I'd step back and say, just to reiterate something that was great about our e-commerce business growth, which is that as we measure and look at it closely, it looks to be a very incremental business to us.

So I'll come back to margin, but in total, this is incremental dollars.

And it's kind of supported by the consumer behavior that we understand.

Our guest, especially our most engaged guest, she loves to buy a lot of offers from us.

And so when somebody becomes an omnichannel shopper, they end up basically being our best guest because they're spending 2.5x the amount of money than somebody who's just shopping in store.

21 Days Of Beauty is a great example of an event that can drive that kind of incremental additive behavior.

It's 21 days, a lot of days, every day there's a deal, a special offer.

So a guest might come in a couple of times and then see a couple of things online that she also wants to get.

So it's an incremental shopping occasion.

So it plays out that, whether it's an event or a palette that she can only get online at first before we put it in stores or other special things she's looking for, it's sort of feeding into this behavior and creating a nice, incremental business for us.

That said, we also -- the margin, yes, it's somewhat lower on our e-commerce business.

And we don't really break this out in a lot of detail.

But basically, they're pretty -- it's getting closer.

The gap is not that large and it's actually closing.

So it's incremental dollars at a somewhat less but narrowing gap of margin.

And it's just the kind of decision that we think is right for our business as we continue to grow the business in total.

And our supply chain investments have certainly helped us to make this part of our business more efficient over time.

Our next question comes from Ike Boruchow, Wells Fargo.

Scott, so I always thought the prestige brand business was higher margin for you.

But I think you said in your prepared remarks, the new prestige boutique sales are a little dilutive.

Can you maybe just walk us through some of the economics on how the boutique business differs from the other prestige business that you guys have?

Sure, Ike.

It's an interesting mix, and that's why we've been trying to walk people back a little bit from counting the number of boutiques we're putting in and what store locations and so on that they're going into because it is kind of an interesting mix and dynamic that we have in the store.

And it's the overall offering and the variety of brands and the different price points, I mean, collectively, with services, that's driving the results, right?

So back directly more to your question, so the prestige boutique brands are -- well, take a step back, prestige generally, overall, is higher-margin business than mass is, all right?

So that's one general statement.

But there's a lot of exceptions to the general rule unfortunately, or fortunately for us.

So on the prestige side, those boutique brands are lower than a lot of our other prestige brands, right?

So adding into the mix, while it's driving incremental sales and margin dollars, on a rate basis, creates a headwind for us.

So again, fantastic comps, very healthy growth there, excellent overall result for us.

On the mass side, well, again, it's generally lower-margin business.

The exceptions there: ULTA Beauty Collection, right, very high private-label margins there; NYX would be another one that provides better-than-average mass margin rate.

So the secret sauce then, also, is having all those different levers and ability to promote and drive conversion on those brands to help deliver the best overall result.

Our next question comes from Shannon Coyne of BMO Capital Markets.

Just wondering if you could talk directionally about the growth rates in the prestige brands versus the mass brands.

Do you find that the growth rates are widening or converging over time?

And then maybe, if so, kind of what's driving those different -- any changes that you might be seeing?

Yes.

So I'd say, if you just look across the industry as a whole, over the last several quarters, year or so, prestige in general has had a higher growth rate than mass.

Both have been growing.

And that's been true, largely true at Ulta, that the prestige brands have been growing -- or prestige portfolio has been growing a little bit faster than mass.

Having said that, mass is quite strong.

Prestige has the benefit of -- we're still building our penetration and adding probably more brands into prestige than in the mass over the last year or so.

But our focus is to drive growth, and we're pleased with the growth that we're seeing on both sides of the business.

Again, that's one of the key differentiators for us is the mass to prestige, the ability to offer All Things Beauty, All in One Place.

So we're really happy with the growth.

And a nice benefit of having a diverse portfolio is we can take advantage of wherever there's growth in the industry and then drive our own business that way.

Our next question comes from David Schick of Consumer Edge Research.

Just wanted an update on -- as you've added the prestige brands, is it bringing in a different customer at a different clip?

I think we've talked about this before over the last year, but any update to whether it's a different customer, your existing customer trying those brands, what's driving the ticket?

Well, we've been adding a -- as we've talked about over the last several quarters, we're really pleased and, I guess, proud of the new member growth that we've been having.

I'll tell you, that growth comes as some are coming in for new prestige brands.

Many are coming in for the first time and buying mass brands, they buy hair brands.

So there's still a mix of the new brands.

But I'd say yes, adding brands anywhere in the house can help us attract new customer -- new customers, if it's a known brand or a new brand that we're launching with social -- some social buzz, exclusivity.

So certainly, that helps to add new prestige brands in driving new members in.

But by no means is it the only source of new member growth in our business.

Ulta Beauty does a great job of introducing customers to their prestige brands with many -- often our guests that come in and buy mass discover brands in the prestige portfolio for the first time at Ulta Beauty.

So that's a big growth driver for us and an important growth driver for our brand partners.

Yes.

I would just add one thing to what Dave said, which is kind of the core premise that we operate off of, [they give us a really good] deep understanding of the consumer segments in the beauty market.

And the beauty enthusiast is a phrase that we use, but it really defines a core segment.

It's really a large segment, it's 57% of shoppers.

By definition, they are -- they buy products and brands all across the spectrum in terms of price points and categories.

So I wouldn't expect that by adding certain types of brands, like prestige brands, that's going to fundamentally change who's attracted to Ulta Beauty.

I think as Dave said, well, it kind of adds to the mosaic, but she consistently -- she might change that -- shift that mix a bit over time, but she loves the fact that she can get an array, that's what we call it, All Things Beauty, All in One Place.

So this we expect to continue, and we expect the beauty enthusiast segment to grow as well.

Our next question comes from Joe Altobello of Raymond James.

So I was hoping to get a little more insight into the spending patterns for your typical Ultamate Rewards member and how that plays out over time?

How long do you see that ramp up before there's a plateau?

And how does spending patterns of your newer members differ from spending patterns of your more tenured members?

Well, our newer members -- our members spend more over time as she gets more engaged at Ulta Beauty, and certainly as she becomes a multiple -- an omnichannel shopper.

But Joe, if you step back, we still really only have 1/3 on average of our shopper's beauty wallet.

Certainly higher for some, lower for others.

We also know that most of our members -- our members are only shopping about 1/4 of the categories that we operate in.

So it's hard to kind of pinpoint the exact feeling.

I think there's plenty of opportunity for us to continue to drive growth through share of both new members coming into the program as well as the beauty wallet of our existing members, plenty of opportunities for that to continue to expand.

Okay, got you.

And then, if I could just sneak one more in for Scott.

The ROIC of the nontraditional doors versus your typical 10,000-square-foot variety?

I think we said on our fourth quarter call, right, probably not at exactly the same kind of returns.

At least in the early years, we're not expecting that.

I mean, these are significantly higher cost kind of real estate deals, but they are subject to the same exact disciplines that we use for every other store in the chain.

These are not the term "flagship" in any way shape or form.

They're expected to be very productive stores over the long time.

We're just allowing ourselves a little cushion to see them -- give ourselves a little bit more ramp-up time in those stores.

They're going to -- we expect them to produce very solid financial results for our investors.

Our next question comes from Adrienne Yih of Wolfe Research.

Mary, I guess my question is going to go back to e-commerce and the tremendous strength and growth you saw there, up 70%.

Were you surprised by that, first of all?

And then secondarily, were you doing something to kind of move the customer to that particular channel?

And Scott, I guess in that vein, when we're looking at the gross margin from -- or the margin, both gross margin and operating margin, on the gross margin side, is it pressuring because it's inclusive of free shipping, there are smaller, lower-margin items there?

And then, is it operating margin-accretive?

So to the extent that we see this growth -- this channel growing, it should be accretive to earnings?

Okay.

Thanks, Adrienne.

I'll take the first part on e-commerce.

Yes, it was a stronger result than we had planned.

We're very, very excited about this asset.

Because of our supply chain investments, we're able to fulfill what the guest wanted in a way that was really exceptional.

So that was terrific.

And I would say, we're probably benefiting for some newer digital marketing tools that we implemented last year.

So paid search, display advertising, paid social, those are all building momentum to really drive traffic, so that certainly benefited our e-commerce business.

We also just have great offers, I think they're really smartly targeted, site improvements and, again, the supply chain investments that have made the overall experience for the guest even better.

So those things in total, I think, created that kind of momentum on e-commerce.

And that's a good question, Adrienne.

I think people get -- it gets a little fuzzy, right, when you're talking about margin and the contribution on e-commerce versus retail, I know myself.

So we've been spending a lot of time here.

Actually, we just refreshed our board here recently on just new ways of thinking about that.

So yes, the difference that the gross margin versus operating margin -- I'd say at operating margin level, we're almost to the point now where we're kind of agnostic on what channel she buys in.

And so when you think about the dynamics there, it really almost, not quite, but it's close to being a wash, with the trade-off being on the shipping.

We've made a lot of progress, right, on the efficiencies in our DCs here over the last couple of years.

We have the full assortment online now.

Remember, it wasn't that long ago that we didn't have Pro Hair online, which was one of our higher-margin categories.

So we've gotten to a good place overall with our e-commerce business, where at the operating margin line, it's almost kind of a net 0. You're trading off shipping costs for store labor and boutique investments and all those things that you're doing in the stores, right, labor investments that go along with that.

So that's the good news.

Working our way back up to the gross profit line.

Really, what's going on there is it's more of, I'd call it, a category, a product mix kind of issue, right?

So the margin there is lower online than it is in our typical store, at least today it is.

And it's generally because it's -- we overindex on things like PCA, right?

So think $200 hairdryers, where it's easier, you're going to price compare that maybe a little bit more closely than you would if you were walking around a store.

You got easier access to a coupon, right?

It's easier to go find is there some kind of deal I can get on this appliance when I'm spending this kind of money.

So that's kind of what's putting pressure on the gross profit line, I would say, right now.

But again, we kind of make up for a lot of that as you move your way down the P&L.

So the good news there as well is it's something that we're aware of and we're working on and thinking about ways that we can try to improve that for our business as we look to the future.

And then to your gross margin, up a little bit in the second quarter, what dynamics changed there?

Or what's the underlying e-commerce growth in Q2?

It's a roughly 50% comp, we said, for the second quarter.

Our next question comes from Omar Saad of Evercore ISI.

Great quarter.

It's interesting to us that it seems like your -- your traffic numbers are phenomenal.

But almost as they slow down just a little bit, you're seeing the e-commerce side accelerate.

And I'm wondering, through the great data that you guys collected through the loyalty program, if you can see patterns or trends.

Is it the same consumers shopping less in stores and more online?

Is it total incremental trips that are coming online in addition to what they've been doing in the stores?

Or is it new people who are shopping online only?

Would love to kind of get a perspective on that, those changing dynamics between your online and physical stores.

Yes, I'll start.

Dave, if there's anything else you want to add.

But it is -- we really have very few people that shop online only at all.

It's really the bulk of our business is people shopping obviously in store, and then around 8.5% of our guests are now doing omnichannel shopping.

And really, as I said earlier, as we study it, it looks to be quite incremental.

So I mean, in any given quarter, there's going to be variations, I guess, on traffic patterns and whatnot.

But the incremental, what's happening with the e-commerce business, really, for those guests, as we kind of separate them out and look at them, they're growing in terms of retail sales the same as similar-looking guests are adding e-commerce trips, I guess you'd call it, and purchases on top of that.

So I think it's a very healthy place to be and it plays into the consumer insights that we have about how she likes to shop.

The most engaged shopper likes to try a lot of things that we offer and [we ship those up] well online.

So I think it's a continuation of that, which is great for our business longer term because these omnichannel shoppers are our best guests, not unlike our salon guests, most engaged today.

Yes, the only thing I guess I'd...

Definitely.

Sorry, go ahead.

I was just going to say, that only thing I'd add, it goes back to Mary's wallet share opportunity, and I think that's really the big driver of this is we're -- we believe it's very incremental.

And because of that, it's capturing just a greater share of her wallet.

So we see a lot of runway there without cannibalizing stores.

So our goal is to have them work together.

We want the new guests that we acquire online to get into stores as quickly as possible, and then we're working hard to convert our in-store customers to online.

So there doesn't appear to be a big trade-off at this point, and we see a lot of runway ahead of us.

Yes, that's definitely pretty interesting that you're not seeing the in-store trips and spend drop off that much as they add online trips to their menu.

Thank you.

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

I just wanted to follow up on a previous question since there's been a lot of chatter around the beauty category lately.

So how did the total beauty category grow, your prestige beauty in particular and prestige cosmetics?

And just remind us of how it grew in FY '16?

And then, as you go deeper with some of these premier prestige brands, have you thought about how that opens you up or possibly makes you more exposed to competitors who may not be as disciplined with their promotional cadence?

And is that a conversation you've had with some of these key vendors?

Historically, they've been very disciplined with their pricing and promotions.

And then, just secondly, I know Pro Hair care is a pretty important category in the second quarter.

How's that category been growing?

Has there been any changes in growth or anything we should be thinking about?

Let me just start with the first part.

I'll see if Dave can come back in on the category type work.

So I guess I would just say, as I said before, that it's certainly a competitive category.

There's a lot of moving dynamics.

All we can do is play our offense, and I think our offense has proven to be a pretty good offense, right?

So we offer our guests a whole array of ways to get great deals.

And being a great total value proposition is important for every consumer category that exists.

And so we can flex up and down.

I would say that our ability would be very targeted, to be very varied in our marketing mix and our demand creation tools, and the ability to leverage our loyalty program to get insights and drive -- work with our brand partners to offer really targeted, smart promotions is pretty unparalleled.

And so I think that for us, as we work with our brand partners, we are making sure that we have -- always working to make sure we got great guest offers that are compelling and differentiated.

And I'm confident that that's going to continue to be a way for us to be -- continue to win and drive share growth in a dynamic marketplace.

And frankly, our guests love the fact that when she buys more from us, she gets more points that she can then redeem in the store.

So the loyalty program really is the foundation of helping us I think be protective in our competitive position.

[The second] category?

Yes, on the total category, I don't know if we got full insight on the combined category.

What I will -- although we feel confident in beauty as we have for a while and see a lot of growth, all the demographic trends that we talked about are every bit as true today as when we talked about it in the past, continue to see high engagement in beauty with young women, with Latinas, African Americans, there's plenty of growth ahead of us.

We will -- I will say, we see strong growth in categories that hadn't been growing as strong like skin care.

We've seen strong in performance in fragrance.

Bath is doing well.

You asked specifically about hair.

Hair has been strong for us and you're right that we've got -- hair is always important for us and we've got some big kind of activities on hair.

We've launched several new brands and there's strong newness across key brands, like Paul Mitchell and Dyson, and Mary mentioned the Flawless line that we just launched.

So there's Madison Reed.

So lots of newness, lots of strength, good marketing and promotional strategy in hair, so we're confident about that.

So we feel really good about the total category and are seeing some strength in key pockets that we're excited about.

Ladies and gentlemen, we have reached the end of the question-and-answer session.

I would like to turn the call over to Ms. Mary Dillon for closing remarks.

I'd just like to say thank you to our 34,000 associates who delivered a terrific start to 2017 and have set the stage for another year of strong top and bottom line growth.

And thank you all for your interest in Ulta Beauty, and look forward to speaking with you soon.

Thank you.

This concludes today's conference.

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