Ulta Beauty Inc (ULTA) 2013 Q3 法說會逐字稿

Greetings and welcome to the Ulta Beauty third-quarter 2013 earnings results conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Laurel Lefebvre, Vice President of Investor Relations. Thank you. You may begin.

Thank you. Good afternoon and thank you for joining us for Ulta Beauty's third-quarter 2013 conference call. Hosting our call are Mary Dillon, Chief Executive Officer, and Scott Settersten, Chief Financial Officer. Also joining us are Janet Taake, Senior Vice President of Merchandising and Jeff Severts, Senior Vice President of Marketing.

Before we begin, I would 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.

We may make references during this call to the metric free cash flow, a non-GAAP financial measure defined as cash provided by operating activities minus purchases of property and equipment. I'll now turn the call over to Mary.

Thank you, Laurel, and good afternoon, everyone. I'm pleased to report solid top-line performance in the third quarter and a particular rapid growth in our e-commerce business despite a tougher-than-expected sales environment. After seeing good momentum in the second quarter and early in the third quarter, our sales trends in retail customer transactions softened somewhat in late September and October. We adjusted our promotional strategy to drive transactions and deliver healthy top-line growth but gave up a bit of margin in the process. We nonetheless delivered solid earnings growth, in line with sales growth excluding severance charges, and made good progress in each of our key strategies.

To recap the headlines, we grew sales 22.4% and delivered a 6.8% total Company comp following an 8.9% comp in the third quarter of 2012, both including the impact of online sales growth. E-commerce built on its strong momentum, with 74% growth contributing 170 basis points to the comp. Prestige cosmetics and skin care continued to be the strongest categories, while we experienced some softness in the nail and fragrance categories, consistent with industry-wide trends. Our comp was driven entirely by ticket, evenly split between units per transaction and average selling price, while transactions were slightly negative. Part of this transaction decline was driven by this year's strategy of reducing and better targeting our coupons and price promotions, intended to reduce reliance on such discounts over time. We also believe we experienced the wider weakness in traffic that many retailers felt in the third quarter. In light of this change in trend, we elected late in the quarter to increase our promotions in order to protect our market share gains in an incrementally tougher retail landscape.

GAAP earnings per share were $0.70, up 18%. Earnings per share, excluding severance charges and retention costs, were $0.72, up 22%. Charges for severance and retention costs resulted from changes at the Senior Management level to strengthen needed capabilities in supply chain and human resources. We achieved slightly less gross margin expansion than we planned as a result of our increased level of promotion to drive sales late in the quarter. Investments in supply chain, e-commerce, and labor came in as expected.

The current trend in the Business and the overall heightened promotional environment for the holiday season are making us more cautious on earnings expectations for the fourth quarter and heading into next year. As you've seen in the press release, we've lowered our earning growth rate expectations for the fourth quarter and the full year of 2013. In addition, while we are still in the midst of the budgeting process and haven't finalized our plan for 2014, based on what we know today about our square footage plans likely in the 15% range, and several investments we need to prioritize to drive sustainable long-term growth, we expect that our earnings growth next year will likely be in the similar range to the current year.

Looking even further ahead, I'm sure you're all anxious to understand how this more muted view of the end of the current year and next year fits into our long-term sales and earnings algorithm. Right now, our first priority is to focus on delivering a strong holiday for Ulta and to continue to deliver market share gains. We are also focused on the long-term view and are currently conducting an in-depth and future-focused strategic planning process to align and prioritize our growth strategies, as well as the additional investments we will need to make to remain a high-performance and high-growth Company.

Since I joined Ulta Beauty in July, I've continued to be impressed by the strength of our business model and the passion of our associates. I'm confident in our ability to offer a differentiated total experience for our guests now and into the future, whether in our store, our salon, or online. Over the next several years, it is clear that our square footage growth will necessarily moderate off a larger base and we will need to find new ways to grow. I believe there are significant opportunities ahead for Ulta in areas such as driving higher brand awareness, developing smaller and urban store formats, increasing our digital presence both online and in-store, and growing our capabilities to enable initiatives like localization of assortment.

I've also seen we need to update our capabilities in certain areas, which will require additional investment over a multi-year horizon in order to achieve our growth aspirations. Some of the areas we plan to invest in include customer-facing training in our stores and salons; systems investments to improve the customer experience; digital marketing to drive brand awareness; and a multi-year supply chain project, including a new warehouse in 2015. As we complete our in-depth strategic planning process over the next several months, we plan to be in a position to update our long-term growth targets. We expect to remain a high-performance, high-growth Company, while building an even stronger foundation for the future.

Scott will provide more details on our financial results for the third quarter and our guidance in a moment, but first I'd like to update you on recent progress on the five components of our strategy to build an even stronger Business for the long-term: store growth; new products, services, and brands; our loyalty program; marketing; and Ulta.com.

Starting with real estate, we opened up 55 stores during the quarter, the most new stores we've ever opened in one quarter. With additional 10 stores already opened in the early fourth quarter and 1 planned for January, we are close to completion of our 2013 real estate program of 125 stores and remain very pleased with the team's execution of store openings and the productivity of our new stores. We are still finalizing our plans for our 2014 real estate program and expect to grow square footage approximately 15%. We also plan to remodel several more stores than we did this year and are still finalizing the scope of the remodel program. We also anticipate a large number of smaller in-store projects, such as additional prestige boutiques and reflowing the mass cosmetics planogram in some of the older stores to make the shopping experience in that category more consistent across the chain. We believe this balanced approach will lead to continued excellent store performance, but will obviously have an impact on the top line, following two years of 22% to 23% square footage growth.

Turning now to merchandising, we continue to expand our portfolio with new brands, products, and services. In fact, it is been my pleasure over the past several months to meet many of our key vendor partners to learn about their businesses and brands and collaborate on how we will continue to partner together. Recent launches of IT Cosmetics and Mally have been very strong out of the gate, and we're seeing excellent performance from brands like Urban Decay and many of the exclusive kits we develop with them and several other prestige brands. In the personal care appliances category, the innovative Curl Secret from Conair has been a hit with our customers and we expect it to be a big seller through the holidays.

To update you on the roll-out of Lancome and Clinique boutiques, as of the end of Q3, we've completed the build-out of these prestige boutiques that we planned for this year. We now have 100 stores with Clinique boutiques and 105 stores with Lancome boutiques. Customers are responding very well to our offering in both brands, which add to our positioning as a beauty destination. We continue to see rapid growth also in the Benefit brand. We now have Benefits Brow Bars in 500 stores, and 225 of these stores are offering the new service of brow tinting which is off to a great start. A strong services offering combined with a steady stream of launches of successful products are making Benefit one of the fastest growing brands in our portfolio.

Looking ahead, we see a strong pipeline of new brands and innovation in the beauty industry. While we don't generally launch many new brands in the fourth quarter as we are focusing on holiday, we are excited to announce, exclusively at Ulta, the Japonesque Color collection, a beautifully packaged line of prestige cosmetics from the brand famous for high-quality brushes. We also introduced the Pedi Sonic from Clarisonic, adding to this brand's high-growth portfolio of skin care tools. The highly-anticipated Urban Decay Naked 3 palette will be launching next week, with a significant marketing plan to take advantage of that franchise's cult following.

Turning to salon, the salon team continues have a great year with strong top-line performance, which again this quarter contributed to the total Company comp. With solid execution of promotions, expansion of services like lash extensions, and programs that are improving the tenure of our stylists, the salon team is gaining share. We continue to see significant opportunity to drive awareness and trial of our services offering and differentiate Ulta as the perfect beauty destination.

Moving on to an update on our loyalty programs and customer relationship management platform. We currently have 12.5 million active loyalty members who've shopped within the last 12 months, up 18% compared to last year, in part driven by a loyalty sweepstakes program during the quarter, which drove strong new customer acquisition. We continue to see increases in retention in our loyalty customer base and average sales per existing customer are growing. We are on track to convert all of our customers to the ULTAmate Rewards program in the first quarter of 2014. Having all of our customers on the points based program will enable more efficient use of our CRM platform.

Now turning to marketing. During the quarter we executed our signature 21 Days of Beauty event, featuring special deals and events focused on prestige brands. We continue our support of the Breast Cancer Research Foundation in October through the sale of products in our stores, events like our salon Cut-A-Thon and other events and programs designed to raise awareness of the cause. In November, we ran a two-week event in 100 stores called Brows Across America to highlight Benefit Brow services. This program exceeded expectations, driving incremental sales, as well as awareness and excitement in our stores.

We also continue to evolve our tactics to reduce reliance on price promotions, such as tailoring our offers on better segmentation of our customer base and increased brand equity events like the ones just mentioned. While this change did have a somewhat dampening effect on the transactions versus a year ago, we do feel this is a better way to build our Business over the long-term. We will continue to refine the strategy and we will be nimble with our production cadence so we can respond to changes in the environment the way we did late in the quarter. We are confident we are building better tools and better insights to pursue a stronger promotion strategy in the long run.

Looking ahead to the fourth quarter and important holiday season, we are focused on continuing to grow market share through a strong set of offerings, including a strength in gift with purchase program and marketing campaign designed around some of our hottest new fragrances. Next week, we're launching a marketing campaign designed to generate excitement about the launch of the Urban Decay Naked 3 palette, offering fans a chance to buy the latest palette in advance of the official launch.

And wrapping up with our fifth growth strategy, our e-commerce business. Q3 was an excellent quarter for Ulta.com, demonstrating continued momentum on the top-line despite tough prior-year comparisons and a major site relaunch. Our limited-time Beauty Breaks, our sample Beauty Bags, and CRM program all contributed to better-than-expected sales growth. Ulta.com delivered continued margin improvement through growing scale, better supply chain capabilities, and a favorable product mix. The biggest news for Ulta.com is the launch of our new website, a significant step forward for us. The platform was rolled out over a period of several weeks to make sure the new site was operating the way we planned. The new site enhances visibility to our product assortment, highlighting bestsellers and featuring products across all categories. Search capabilities were vastly improved and brands were recognized for better visibility.

Ulta is one of the first retailers to feature responsive web design, a new technology that enables a consistent browsing experience regardless of the device the customer is using, be it a laptop, mobile phone, or tablet. The new site is receiving positive consumer feedback on the usability improvements and browsing experience and we're seeing an increase in conversion rates on the new site. I'd like to congratulate our entire team for their great execution and focus in delivering a top-notch website and supporting a successful Black Friday and Cyber Monday.

On the supply chain side, we continue to ramp up the volume of e-commerce orders fulfilled out of our Northeast DC. Chambersburg is well-staffed the holidays and operating very effectively. Our associates supporting our e-commerce business in both Romeoville and Chambersburg are working very hard to support customer demand throughout this holiday season.

This completes my updates of the progress on our five growth priorities, and with that, now I will hand it over to Scott.

Thanks, Mary. Good afternoon, everyone.

We recorded total sales of $618.8 million compared to $505.6 million last year, an increase of 22.4%, with a comp store sales increase of 6.8%. The retail comp was 5.1%, and e-commerce growth of 74% added 170 basis points to the comp. Gross profit dollars increased 24.9% to $231.7 million, and gross profit margin rose 70 basis points to 37.4% from 36.7% in Q3 of last year, driven by strength in our prestige categories and better-than-expected leverage of fixed costs. While strong, this margin expansion was a bit less than our guidance due to an uptick in promotional activity later in the quarter to drive sales on the weaker-than-expected consumer traffic.

SG&A expenses, excluding the impact of the severance charges Mary mentioned, rose 26.7% to $149.5 million, up 90 basis points as a percentage of sales to 24.2%. This was driven by the planned investments in our new website, supply chain project, store labor, and brand awareness that we've discussed previously, in line with our expectations. Pre-opening expense increased to $7.5 million compared to $6.3 million last year, driven by 55 store openings during the quarter compared to 49 new stores opened during Q3 of last year. Operating margin, including the severance charges, decreased 30 basis points to 11.8% versus 12.1% last year. Net income increased 19.1% to $45.4 million, or $0.70 per diluted share, versus $38.2 million, or $0.59 per diluted share, last year. Excluding the severance charges, EPS was $0.72, or 22% growth.

Turning to the balance sheet, inventories were $582.3 million at the end of the quarter, compared to $462.8 million at the end of Q3 2012, up 1.7% on a per-store basis. This is consistent with our plan for the year, where after making permanent investment in inventory at the end of last year to improve in-stock levels, and continuing to invest in prestige boutiques, we expect to see inventory-per-door growth below comp growth by the end of the year. Capital expenditures were $78.9 million for the quarter, driven primarily by our new store opening program. Depreciation and amortization for the quarter were $27 million.

Turning now to guidance for the fourth quarter, based on current sales trends, less certainty about consumer sentiment, and what appears to be shaping up to be a highly promotional holiday season, we believe it is prudent to take a more cautious view of the fourth quarter from a margin perspective, since we are focused, as we have always been, on maintaining strong market share gains. We expect sales to increase in the range of $853 million to $867 million versus $758.8 million last year, which included an extra week. We expect comparable store sales to increase in the range of 7% to 9%. Our same-store sales comparison for the quarter is based on weeks 40 to 52. We have two elements at work in Q4 that drive the comp metric but do not translate to earnings.

First, we benefit from the comparison to the disruption we experienced due to the Superstorm Sandy disaster, which negatively impacted last year's Q4 comp by roughly 100 basis points. Second, we have an easier comparison as a result of not lapping the 53rd week of 2012, which was a strong sales week. Absent these one-time impacts, our comp guidance would be 5% to 7%. We will open 11 new stores in the fourth quarter to complete our 2013 plan, versus 13 in last year's fourth quarter. So pre-opening expense is expected to be in line with last year.

We expect to achieve earnings per share in the range of $1.07 to $1.10 compared to last year, which it was $1, which included about $0.05 of benefit from the extra week. Gross profit margin is now expected to be flat, as we prepare to participate in a highly promotional holiday season. SG&A rate is expected to increase 50 basis points versus last year's 20.3% rate due to planned investments in the Business. Operating margin, [though], is expected to decrease approximately 50 basis points. Our tax rate is expected to be approximately 38.2%, and our fully diluted share count will be approximately 65 million.

Turning now to the full year 2013. In light of the weaker-than-expected back half of the year, and conservative earnings view on Q4, we now expect 2013 to come in at an earnings growth rate in the 20% range, adjusted for the 53rd week last year, compared to our previous expectations of mid-20%s EPS growth. We expect the full-year comp to be in the range of 7% to 8% and CapEx will be approximately $225 million. As you know, we give specific guidance about the coming year on our Q4 conference call in March. We are not changing that practice. At this point in the year, we are deep in our planning process for 2014. While we are not yet prepared to give specific guidance for next year, we wanted to share some of our preliminary views.

First, we expect square footage growth to moderate off a larger base to about 15% versus 22% this year. Second, while the beauty category overall continues to grow, industry growth in both prestige and mass have been less robust in recent years and the deceleration has continued during 2013. We have also seen weaker trends in several categories, including nail and fragrance, consistent with the industry. Third, we expect to continue to invest for the future in areas that will improve the guest experience and give us stronger multi-channel capabilities, primarily in the areas of supply chain and in-store technology improvements.

We are still in the process of making decisions for 2014 to deliver the best possible results while investing for the future. However, assuming industry growth dynamics remain unchanged, and a less certain consumer macro-environment continues into next year, we believe it is prudent to plan for earnings growth similar to 2013, as we may have to maintain a more promotional posture to maintain market share gains.

As Mary mentioned, we have some work to do on our long-range plan before providing a definitive update on our longer-term growth expectations. So stay tuned for more details on the multi-year view beyond 2014. On a final note, I would like to remind you all that on our June conference call, we announced that we were discontinuing our practice of announcing holiday sales in early January. With that, I'll turn the call over to our conference call host to begin the Q&A session. Operator?

(Operator Instructions)

Oliver Chen, Citigroup.

Hi everyone, this is Nancy Hilliker filling in for Oliver Chen. My first question is related really to the promotional strategy. Have you guys seen a difference in promotions, different ideas that you have been testing over the past quarter and the past month?

And then is there any approach to maybe competitors offering prestige beauty online? Are you seeing any approach -- a different approach to strategy in terms of that, as well? Thank you.

Let me take a start at this, which is in term of promotions, I would say that over the course of the year we have been smartly experimenting with different ways to drive consumer retention and value with less discounting. So through the use of our CRM capabilities and some tweaks to some of our other tactics, we've been learning and experimenting with what our parameters are around how we can drive long-term growth with a little bit less reliance on promotion.

As we said, as we saw the environment start to change towards the end of the third quarter, the great thing is that we were able to nimbly, I would say, adjust and adapt to that because we have tools that we can turn very quickly. So we are going to continue to look for ways that for the long haul we can reduce some reliance on promotion and price discounts, but also, as we have said in the call, we want to play to win and we are going to continue to be aggressive in the fourth quarter as we expect it to be very promotional.

Okay, thank you and then just as a follow-up, any thoughts as to the online competitors? Are there any other promotional strategies maybe that you can use to continue to gain market share?

First of all, there is a lot of activity in this category, that's for sure, and we are certainly aggressive. Our e-commerce performance in the quarter, we are very proud about that, and particularly the change for our new website, which is performing extremely well, with even stronger conversion, so we are constantly watching the competitive environment certainly. I don't think there's anything that we've seen that's surprised us but we know we should be at a stance to continue to be aggressive and again with our tools being more nimble and facile and more consumer friendly on our website, it gives us the opportunity to continue to play very strong.

Brian Tunick, JPMorgan.

Just looking ahead for a second, first. Scott, does it make sense, broadly speaking, that if you are guiding us for 15% square footage growth and for earnings growth next year to be similar to this year, that, that would embed a 50 basis point, 60 basis point operating margin expansion? And just wondering if that is true, what buckets or what areas would be gross or SG&A that you would expect operating margin expansion? And then, does your view that the earnings or your guidance is under review going forward, does that take away the mid-teen operating margin that the previous Management team had offered to The Street before, given how you guys are now looking at the business model with slowing category growth? Thanks very much.

Thanks, Brian. The first thing I would say is we are not giving any specific guidance for 2014 at this point in time. But being mindful of your question, directionally, we would think 2014 would shape up much in the way that 2013 did, with the emphasis in the strategy being on trying to lever back on the promotional environment overall and continuing to develop the guest experience in the store to drive the business, long-term profitable growth of the guest experience in our stores. So, big picture, I would say its more in the merchandise margin and gross profit line, directionally speaking for 2014. Again, much like it was in 2013.

With respect to the mid-teens operating margin target, again I would say that -- we are suspending that initially by what we're saying here for the near-term on 2014 and what we think the guidance targets are for 2014.

Aram Rubinson, Wolfe Research.

You guys do a very high dollars per square foot level at around $415 and it seems like you are trying to figure out the balance between how much of that is sticky customers and how much of that might be cherry pickers because you are struggling maybe to balance the promotional cadence. If you were to look at your customer base and say, that $415, if we had the right customers in the store for the brand, what do you think that sales per square foot number would actually be? I'm just trying to figure out how much of there might be at risk?

And then if you can also just tell us how you are fiddling with the promotional cadence just to make sure that, that drop-off, if there is one, doesn't happen too quick?

Yes, let me just start in a couple ways. One is that we -- as we described in terms of the full-year expectations -- we are still performing at a strong level in terms of top-line growth and really one of the top in the industry. So, we are not troubled by what we're seeing in terms of our customer trends. What we are doing is reacting to an environment that looks to be more promotional and also being mindful of future investments that we believe need to be made to continue to support our growing Business.

So, our base of customers right now is strong. We've got a really strong loyalty membership group of customers who are very responsive and we are learning as we are tweaking some of our tactics about how to really personalize and customize offers to them in a way that we believe we'll drive as it is more units per transaction. And that is a good thing. So the way that we are thinking about our promotional tactics right now, I would say, is really not dramatic. These are small changes around the edges to learn about the sensitivity and we're doing them at a time that the marketplace is maybe a little bit volatile and consumer sentiment is a little bit unpredictable.

The good news is that we can ratchet back, which is what we've done, to our more traditional cadence. But I believe we've got the best tools that we've ever had to continue to test and learn. We know that there is a lot of guests who -- there is a lot for them to discover at Ulta and a lot of products that when we bring it to their attention via some of our e-mails and Beauty Breaks and whatnot, we are seeing great response, so we will continue to play with that and drive our growth.

And just to follow-up and recap, this quarter, as far as I can tell, you did hit your earnings target and you did hit your sales target and you did have gross margins up with merchandise margins from the 10-Q saying that, that was up 60 basis points, and your inventories weren't too out of whack. So I'm just wondering as well if you are doing any bar setting as the new CEO coming in, or -- because the numbers look good overall, at least relative to what you had issued in terms of guidance?

Yes, that is an accurate reflection of our performance relative to guidance. And really what we're doing today is just, what we think is our best view of what to expect in the fourth quarter given the environment, as well as is our preliminary view of 2014. Ulta is and will still continue to be a high-growth Company and the 2014 look that we are giving, which isn't guidance, but the early view is still a very high-growth Company. But it is different than what was stated before.

I would say this isn't about bar setting but it is about -- as Scott said and I said in my comments -- this is also a great time for us to take a step back and really create a 10-year view of Ulta. This has been a very successful Company for many years, but like any business, the environment changes, whether it is the consumer environment, the categories we compete in, the competitive environment, so we really want to take a very thoughtful and deep view of our strategic planning. There's going to be plenty of choices we believe we have for future growth. We want to prioritize those and then come back with guidance based on that work.

Gary Balter, Credit Suisse.

Mary, the tone that we're hearing is different than on your last quarter. So, is it -- could you walk us through, in the last three months or maybe it's longer than that, what are the elements within the Company that you felt are not executing that require the investments that you are talking about, to say, let's slow the growth, let's reinvest, let's pull out with a better Company. Where is the focus right now for where you need to make those investments?

Yes, I would say a couple of things. One is, we are also in an environment that is changing and fluid in the marketplace. As we said in the third quarter, we did see a change in our trend towards the end of the quarter and we are reacting to that. I feel very optimistic and upbeat about our prospects, and again, we are going to come out of this year with a very top performance in terms of top and bottom line. But it is somewhat different than what we would have guided even really just coming out of the -- in the middle of the second quarter. So that is different and that would give us a reason to say let's look at our preliminary view of 2014 and provide the best transparency to that, that we can.

Beyond that, I feel very optimistic about our future growth prospects. I'd say the only thing is different is as I learned about our Business, I continue to be very optimistic, but I think we're going to have to be choiceful in terms of how we pick our spots for future growth. There's investments that will continue to be required as we look at a competitive environment that is increasingly omni-channel. Consumer views are changing, categories are evolving. It is really not anything more than -- regardless of how this quarter performed, we would have been doing the strategic planning, frankly, and really want to come out in the future with our best view of what that future growth looks like. We very much expect Ulta to continue to be a high-growth, high-performance Company. That stance has not changed.

Okay and just following up and then I'll get off, you mentioned a few times including this answer, the competitive environment is changing, it got tougher. Could you be a little more specific on what's changed from expectations because everybody expected a difficult Christmas period?

I was talking about that more in a long-term view, which is that, as we know that there is more people competing in beauty and really the need to be able to really operate in a very omni-channel environment, which is part of what our investment in our supply chain and ITs are going to allow us to do. In terms of the short-term, I would just say, as we saw some impacts on our transactions towards the end of the second quarter relative to our promotional changes, we felt that is probably a little bit more promotionally sensitive than we might have thought going into the fourth quarter, but not dramatically so.

Evren Kopelman, Wells Fargo.

I wanted to ask in terms of the slowdown you saw at the end of the quarter, is it primarily a nail and fragrance category issue that you mentioned or do you see a slowdown in the growth rates of even outperforming categories like the prestige, skin care, fragrance, and salon?

Yes, hello, Evren. A couple of data points, again, for people who follow the industry fairly closely. If you look back over the last couple of years, 8 to 10 quarters, you would notice that both prestige and mass color cosmetic categories were really at the high watermark at the end of fiscal 2011, so both of those categories were just into the double-digit year-over-year growth rates at that point in time and they've both been on a slow deceleration over the course of the last two years. So that we ended Q3, mass color year-over-year was flat and prestige color was low to mid-single-digits. So we are bucking those headwinds overall in our box, besides the category -- the nail and the fragrance deceleration that has been talked about in the open marketplace here for the last couple of quarters. So there's a number of headwinds that we have category-wise, that to this point in time, we have been able to mitigate fairly well, even with the pull back on some of the promotional things that we are doing for the Business.

People are curious as to the timing of things. Coming out of Q2, we felt really good about where we were. Our plans were working; we felt comfortable with where we were through the guidance phase of last quarter's call; and really this transaction trend went south on us late September and really heavily into October. So we are taking a really close look at that, both from an internal view on what did we do that could have changed the guest perception or shopping patterns or was it a more macro kinds of things that have stacked on top of each other here over time. Again, we are deep into the investigation process on all those things and you can rest assured we are working hard to try to find the answer.

Great, that make sense. The other question is, your younger stores typically comp stronger than your older ones, as the younger ones mature. Have you seen any changes to that historical trend or can we expect that to continue?

No, the comp stack for the third quarter is pretty similar to what we had back in the first quarter. You can remember back we did a 6.7% all-in comp in the first quarter; we're doing a 6.8% here. So by and large the stores look the same. The stores from zero to five years, that comp ramp looks exactly the same as what is reflected in our model. When you get beyond year 5, year 6 through 15 is roughly in the -- it's in the solid low single-digit range. Then when you get beyond the 15-year range, it is more or less a net 0%. So consistent with what we would expect at this comp level. So again, we feel we are pleased with the 2013 slate of new stores and no change in the ramps.

Ike Boruchow, Sterne Agee.

My question is, the last time we heard from you, you were guiding a 5% to 7% comp for both Q3 and the year, which essentially implied a 5% to 7% comp for Q4, so to guide it now a 7% to 9% comp for Q4 with sales that are so far below The Street is just a little confusing. Can you just help us understand the Q4 top-line outlook and how does that compare to your view of what the Q4 sales number was going to be three months ago?

Yes, we tried to give you a realistic view of the Business. Again, I mentioned in my prepared comments that there is 200 basis points in that 7% to 9%, Ike, that is really just a basic measurement, the arithmetic measuring versus last year, so, it is not really reflective of the core of the Business. The core business is still operating at a 5% to 7%.

But what we think about the outlook for Q4 coming down, is that a function -- you said more promotional environment, so obviously margins are lower than you had planned, but are the total sales dollars, are those also where you're putting them now, are they lower than what you thought three months ago or is that someone unchanged?

They are somewhat lower. We did see a drop-off in retail sales late in the third quarter, which we mentioned here, driven by transaction deceleration, so we have taken down our internal view of what we expect retail sales to be in the fourth quarter. Yes, that has been taken down somewhat.

Daniel Hofkin, William Blair & Company.

Just a follow-up on that question -- it's still not completely clear if you have -- I totally get that last year's comparison was affected by Sandy, that ought to benefit your comp growth and your total sales growth, it would seem, this year. So, we are just trying to understand what appears to be, and again maybe it is just the calendar shift that you described, but what appears to be a mismatch between the comp that you are projecting and the total sales growth, which has a much smaller spread relative to the comp than we're used to seeing? That is the first question.

Dan, I don't think I really have anything more to share on that one, other than the -- we are calling it 200 basis points roughly of the year-over-year comparison. And we have taken down our retail comp estimates for the fourth quarter that are -- really it is the competitive environment. And the conservative view that we are taking on the fourth quarter and what the margin rate investment is going to need to be to maintain those sales levels, so --

So are you implying that you are expecting a moderation in new store performance or let's say non-comp store performance in the balance of the year that is maybe more significant?

No, I don't think so. Our stores are continuing to perform at the levels that we expect them to. We may not see an over-performance environment, like maybe that you have seen in the past or have been reflected in models just through the delivering of actual results. Historically, stores -- our new store program has way over-delivered what our initial expectations were. Naturally, in an environment where comps are a bit more challenged, there is going to be some headwinds on those new stores. They are not immune to what is going on with the macro consumer environment so that might be (technical difficulty) if you're looking at it from a modeling perspective.

Matthew Fassler, Goldman Sachs.

The first question I would ask, you talked about severance and some changes that you're making in supply chain and HR. Could you give us any more details on the changes that you made there?

Yes, sure, that was related to two changes at the executive team level in terms of the HR and the supply chain functions and just my judgment about capabilities that we needed there for the future. So we've got a great, strong team here. We made a couple of changes and we are moving forward.

Mary, did you replace the senior executives in those roles with internal people at this stage?

One was internal and one was external.

Okay, my second question relates to the real estate plans. This year, obviously, you're going to end up in the low to mid-20s. You were pretty close to that last year and in 2011 and prior to that, you had peaked at 15% but that was coming out of a downturn. So as I combine the move to 15% next year with your discussion of developing urban and smaller store prototypes, what is your sense of the blue sky footprint potential for the existing format as you have it? And would you say that has changed all from perhaps what you guys have talked about prior to the time you came to the Company?

No, Matt, our view is on the 1,200 store potential for our 10,000 square-foot box. Nothing has changed with respect to any of that. Again, what we are faced with here in the near term is just, whatever, a pendulum swing that will come and it will go and consumer and category itself will bounce back here. Again, over the long term, we feel really good about our model and about the category overall.

As we look at next year, it is really a balance. We said before that 125 stores this year was on the outer reaches of what we felt like we could do comfortably, both supporting it with operating disciplines and training and all the other things we have to do with our new store associates. As we look to next year, we want to do a few more remodels -- again, so those are more or less like a new store, so that adds in, gets you to your total build-out. And then there is a few more things internally that we want to do -- in-store projects with planogram changes in the mass area and a few other things we want to do. So, all in all, we feel really comfortable with where we are and it is more of a balanced approach next year.

Got it and one last quick one. If you think about the promotional environment, last year in the fourth quarter, the gross margin had a bit of a setback, and it almost seems like there are either seasonal entrants into the business, or some of your competitors choose to turn up the juice at this time of year. It seems to be a recurring pattern. Is it the year-round players who you find aggravating the competitive backdrop or are there more seasonal players, be it general merchants or others, who tend to refocus on this around holiday, who seem to be gumming up the works a bit from a margin perspective?

One thing I do want to point out is that, in the fourth quarter, even though we are guiding gross profit flat year-over-year, we are expecting merchandise margin to expand by roughly 50 basis points. So our plan of trying to balance the promotional environment here whilst continuing to drive a great value orientation for our customer is still in place. What we've seen here develop recently -- again, everybody sees this in the news, right? Our mailboxes are full every night, our e-mail accounts are full. We see the fashion and soft good guys out there with 50% off the whole store on the first week of the holiday. Nobody really expected that. We knew it was going to be competitive, but we didn't know it was going to be to this extent.

Looking at it, again, objectively in a balanced way, we said we need to compete here to maintain our gains, but when I think back, and this is one of the benefits for being around for a while -- thinking back, analogizing back to really the last time we saw discussions about inventory levels with these soft good players and the need to get through this stuff before the end of the holiday season was back in 2008, and that was a tough environment for everyone. And we will take the same view this year as we did then -- a balanced view between investing margin and chasing the comp number, so we will be very mindful of that.

I just want to add one thing, which is that up until a recent shift in trend, the tweaks to our promotional strategy were encouraging to us. So in no way, shape, or form do we step back from that as a longer-term way for us to continue to drive top line and bottom line, because we know we are getting smarter, we can test and learn. And yes, the environment change, we can respond to it, but we are going to continue to drive that over the long-haul.

Understood. Thank you so much.

David Wu, Telsey Advisory Group.

First, in terms of next year's square footage guidance of 15% growth, it is obviously that is at the low-end of your long-term target range of 15% to 20% and I understand that you're planning to do more remodels next year, but can you talk about whether or why you're not opening up more stores next year and if you're perhaps seeing any real estate limitations out there, and if you are still sticking to your long-term 15% to 20% square footage growth target range?

Let me just start by saying that 125 stores this year, as we've said, is probably about the peak in terms of really just executing with excellence. Every time we open up new stores, we do a great job identifying real estate and constructing those stores, but we also have to hire folks and staff them and train them and have them ready for our guests. So we feel good about that number and really we're -- believe that coming down off of that is really just a way for next year to make sure that we are striking that right balance. We are not concerned about our ability to find the right real estate and to build those stores and we are not concerned about the productivity of our store model. We just think this is a better pace for us right now.

Great and can you talk more about your strategy for the brand boutiques, including your initial plans for next year and what the longer-term opportunity could be?

Well, as you know, we are very thrilled with the fact that our assortment continues to evolve. Our team here has done a great job partnering with really great vendors and iconic brands and that has been part of the magic of Ulta, frankly, and it is great. So as I said my prepared comments, we have gotten to 100 Clinique store boutiques and 105 Lancome boutiques this year, which is great. Benefit boutique doing exceptionally well and we are going to continue to build out that strategy. So I can't tell you specifics today, but you can imagine that, that is high on our hit list of things to continue to build on.

Great and in terms of the higher promotions, are you expecting this to impact your non-prestige business or are you becoming more promotional also on the prestige side?

No, by and large, again, when we talk about promotion and discounting, that is non-prestige business. Prestige product, that category, by and large, there is no discounting allowed. It's MSRP out the door.

Got it. So in terms of then the slower traffic and sales that you saw towards the tail end of September and into October, did that mainly impact then the non-prestige side or did you also see a little bit of a pull back on prestige as well?

No, the promotions itself, it is generally non-prestige related. Again, from time-to-time, prestige becomes part of the mix, with some of the offers that we give our guests, but by and large, in the third quarter was non-prestige related categories.

Where you saw the pullback?

Yes.

Got it, thank you.

Mark Altschwager, Robert W. Baird.

I wanted to touch a little bit more on the supply chain side. Mary, I was hoping you could talk about your long-term vision there. You made some changes so what is your assessment of the supply chain today and where does it need to go in order to support the type of growth that Ulta is capable of?

Sure. I will just answer that really at a macro level. Our supply chain today is performing very well for us, yet we know that we need to do more. Especially because, number one, we are a growing Business, so we need more infrastructure to support our multi-year growth plans. We also know that we need to continually increase our ability to compete in an omni-channel way. So we are thrilled with our e-commerce performance, but we want to make sure that we have the capability at a minimum to be able to have our guests, for example, understand if they can order online and pick up in our stores. Whether or not we ship from stores is a different question, but we are really looking at the range of capabilities. As I am sure you imagine, that's not -- you need to have the right systems in place to allow that kind of capability.

We also know that we have opportunities just in end-to-end efficiency in our supply chain. So we have taken some time to really build a robust view of that. We are -- the first stage of that is really building a new distribution center in 2015, which we are planning, but beyond that there is also plans to invest in the right systems and in people and capability and capacity to support our long-term growth ambitions. We plan to get to 1,200 stores and continue to be a very high-growth retailer so we need a supply chain that supports that.

Okay, thank you. And then on the services side, where do you see the biggest opportunities and how do you think about allocating the space in the store? And then as the environment gets more competitive, how do services fit with the long-term vision of building brand awareness and customer engagement?

Right, it is a perfect example of, as we step back and think about our 10-year view of Ulta and how we really want to differentiate Ulta, that is exactly the kind of question we are asking ourselves. Ultimately, we really have a differentiated proposition today because of the one-stop-shop ability, the exciting assortment that we offer, but also the fact that you can get services in our stores, which I don't think anybody can get online, yet, and hopefully never.

But anyway, we've got a really differentiated concept that we believe is going to really be the place that allows us to win for the long term. So we are going to examine what we think about trends, consumer trends, anti-aging. An example might be skin health -- there's ways that we can think about, is there more we can do there? But that is just one example. But we'll put all those under the examination lens here as we think about places that we will continue to invest to grow, but for sure services will continue to be part of our long-term proposition.

Thank you.

Kayla Berg, Piper Jaffray.

First, if you would, could you share your thoughts about approaching holiday from a digital marketing perspective versus last year, and also how do you guys feel positioned for holiday in fragrance this year across the price points and newness?

Okay, can I ask you guys to take those for us, Janet and Jeff? You want to take the marketing? We have our team.

Sure, Kayla, I would say that our digital marketing efforts will be pretty consistent with what you have seen from us for the balance of the year. So as we've talked through the first couple of quarters of the year, we are a lot more focused on the digital space than we have been traditionally and you are just going to see that continue. Not going to give you much more detail than that because I'm sure the competition would love to hear it.

And as fragrance, this is Janet, basically, we have our exclusive gift with purchase that we started in November and continue through holiday and that is exclusive to Ulta and something we've done for many, many years and we're very excited. We have improved the quality of both of those. One has already been in the stores and the second one hits this week, actually. But we are also encouraged by some of the newness that we have seen at the end of third quarter. Just to comment on one direction -- [out of the box] was very strong, along with Honey from Marc Jacobs and a few other things. Gift sets are strong and also we feel very good about some of the opening price points in purse sprays or roller balls, if you will. So from a fragrance perspective, we are ready for holiday.

Okay, and one last quick follow-up. Where do you guys expect to end the year in terms of inventory levels?

We expect to in the year in line, similar to where we ended third quarter. So it will be well below what the comp increase is for the year. We feel very, very comfortable with our inventory position. Again, as many of you know, there is very little in the way of fashion risk in our inventory, so very little obsolescence risk, so again very comfortable. We are on plan and expect to hit our targets at the end of the year.

Great, thank you.

[Christina Metcalf], Oppenheimer.

Hi, most of my questions have already been asked but I was just wondering if salon comps were still above [prior to] comps this quarter?

They were indeed. They added roughly 10 basis points to the comp for the quarter. So, still performing very strong.

Great and then I'm not sure if you answered this already but I believe last quarter you said that you were expecting e-commerce sales to go down just because of the new website rollout and obviously this quarter they were pretty similar. So what are your expectations for 4Q?

Well, yes, we were very happy with that transition and we were being cautious about that, so that is better than we expected. The first three quarters, still I would say, were benefiting from some pretty high-ticket products that we were selling that were hot products and [the] supplements and some tools. We are excited about our continued growth but the comps do to get tougher going forward. So we are going to continue to grow. I'm not sure if we're citing a specific number, but we are going to continue to have tough comps, but we also feel more optimistic with the transition going better than it did.

And I would add, we picked up steam at the end of 2012 with our e-commerce site and had a really good fourth quarter, so I wouldn't expect a 70% growth for the fourth quarter year-over-year.

Okay, thank you.

Jill Nelson, Johnson Rice.

A quick one on fourth-quarter gross margin. You did mention that merchandise margins are planned up. Could you talk about maybe the pressures in that line item you're expecting?

On the gross profit line?

Yes, because you had said for overall it would be flat?

Right, we are happily expecting to see merchandise margin expansion with product mix and the prestige mix being richer as part of the overall Business. We do have headwinds with fixed-store cost. That is really the primary offset there, Jill. It is really the accelerated new store program, especially with 125 new stores now entering into the chain here late in the third quarter. That is the headwind that is offsetting the merchandise margin gains.

Okay, and then big picture question into 2014. Clearly, you need to put in more investments into the Business. Could you maybe just talk about some of the big buckets? You've mentioned supply chain, but maybe if you could put them in order or just some type of magnitude of where you feel like the Company has under-invested and what needs to help grow the Business for -- into next year? Thank you.

I wouldn't use the term under-invested, Jill. We've talked to many of you -- at least I have over the last year. As a growing Company, there's always things we would like to investing, but you need to have the proper team in place and the proper third parties to help coach you along on some of these more complicated things. So I would just remind everyone, the biggest investment we are making is in the new store program. Big acceleration in 2012 and in 2013, and even next year at 15%, 100 stores, do the arithmetic, that is no small feat for us. That is still the best investment, produces the best shareholder returns, that we currently have. In the current term, though, that creates some headwinds for us on fixed store cost. Again, we don't get the leverage with all those stores going in place, that we have in recent years. So that hurts is a bit.

Some of the investments are more certain things. Mary talked about supply chain -- we are going to get a lot of new capabilities there which are going to be very helpful going down the road. There's things in IT. Again, they are primarily customer-facing kinds of investments, so in-store POS systems that will allow us to do more mobile and all that flashy iPad stuff which everyone does now and we need to invest in as well. That is what the guest expects. There's other investments, like brand awareness, marketing investments, training for store associates to make sure we give the right guest experience, in places like the skin category, which is high-touch and high-impact. So those are one of the things that we are talking about as part of the strategic planning process, and how far do we need to go and to what extent do we need to do those kinds of things.

And then there's other things, I can compliance costs -- not investments -- but will be a drag on earnings next year around healthcare. So some of that stuff is starting to kick in now and I can tell you, generally speaking, it is more expensive than anybody really thought initially. So that is the short bucket list for what we are looking at for 2014.

Thank you.

Thank you. That is all the time we have for questions. I would like to turn the floor back over to Ms. Dillon for any closing remarks.

In closing, I would like to thank all of our Ulta Beauty Associates who've worked very hard to deliver solid results in a tough environment in the third quarter. I'm very proud of the team for driving strong store sales while delivering on elements of our longer-term initiatives to position the Company for success over the long-haul. While we are acknowledging some of the challenges we're facing in the near term, I know the long-term opportunities for Ulta still make it one of the most exciting growth stories in all of retail. Thank you for your interest in Ulta Beauty and I look forward to speaking with you soon.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.