Ulta Beauty Inc (ULTA) 2014 Q1 法說會逐字稿

Greetings and welcome to the Ulta Beauty first-quarter 2014 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, Laurel Lefebvre, Vice President, Investor Relations. Thank you. You may begin.

Thank you. Good afternoon and thank you for joining us for Ulta Beauty's first-quarter 2014 conference call. Hosting our call are Mary Dillon, Chief Executive Officer and Scott Settersten, Chief Financial Officer. Also joining us are Janet Taake, Chief Merchandising Officer and Dave Kimbell, Chief 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.

We 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. Good afternoon, everyone. I'm pleased to report a strong start to the year, with better-than-expected sales and earnings growth in the first quarter. The team's accomplishments included driving continued momentum in our online business, successfully rolling out new brands, completing a smooth conversion of our loyalty program onto one platform and closely managing inventory. In addition, transactions at comp retail stores turned positive, reversing the slight decline in the second half of 2013.

We're also making excellent progress with our strategic planning work and we're on track to deliver long-term vision in five-year financial targets, which we plan to announce on our second-quarter earnings call in September and follow up with an Analyst Day in October. As I said last quarter, the strategy work is designed to refresh our vision and chart a course for an evolution of our business model and to create a play-book for sustainable profitable growth.

To recap the numbers for the first quarter, we grew sales 22.5% and delivered an 8.7% total Company comp on top of the 6.7% comp in the first quarter of 2013, both including the impact of online sales growth. Our e-commerce business performed very well, driving 72.3% comparable sales growth. Similar to the past several quarters, prestige cosmetics and skincare were the strongest categories. We were pleased to see transactions turn positive at retail, with a healthier balance between transactions and average ticket driving the strong comp in the quarter. Earnings per share were up 18.5% to $0.77 versus $0.65 last year, driven primarily by better-than-expected sales and some planned expenses shipments maintenance later in the year.

Scott will cover the detailed financial results for the first quarter and our guidance for the second quarter and FY14 in a moment, but before that I'd like to provide an update on our five growth strategies -- new store growth, new product services and brands, our loyalty program, marketing and Ulta.com. Starting with real estate, we opened 21 stores during the quarter, ending the first quarter with 696 stores. We're on track to deliver our planned 100-store program this year for an increase in square footage of approximately 15%. New stores continue to open up strong and the class of 2014 stores is exceeding its sales budget. Rent remains stable and we continue to fill our real estate pipeline with high-quality sites. For the remainder of the year, we expect to open 20 stores in the second quarter, 50 in the third, and 9 in the fourth.

We also expect to complete 12 remodels this year and are planning to complete a smaller scale remodel of our mass cosmetics plan-o-gram in about 60 stores over the summer. We haven't seen anything in the market or in our stores performance to change our long-term view on the potential for 1,200 of our full-size 10,000 square foot stores in the U S. Today we view the potential for a smaller store as largely incremental to the 1,200 store target, but of course we expect to learn a lot about the potential for a smaller box once we open up two 5,000 square foot test stores later this year in smaller markets.

Turning now to merchandising, our merchant team delivered a strong first quarter with the strongest comp gain in prestige color and skincare. It Cosmetics and Mally, launched last year in selected stores, are now fully rolled out for the entire chain. Ulta is the only retail chain offering these popular brands and our guests are delighted to find their products in our stores and online. We also expanded space for Urban Decay in all of our stores, showcasing the Naked franchise. Our nearly 500 Benefit boutiques continue to perform very well, with new product launches and the rollout of brow tinting services to additional stores. Newness is always a significant driver of our comps, with contributions from recent brand additions such as Japonesque, Meaningful Beauty and ShaeMoisture. The fragrance category was energized by two big launches, Dolce and Gabon's Dolce and Ralph Lorenz Midnight Romance.

Now turning to services, our salon team drove solid results in the first quarter, maintaining good topline momentum and contributing to the total Company comp. The salon business's strong comps were driven by increases in average tickets and positive guest count. Retention of salon managers and stylists continue to improve, bolstering our strong performance as tenure is highly correlated with sales in the salon business. We executed several successful promotions focused on hair color and skin treatments to drive awareness and trial and develop a strong integrated services message for salon services and benefit brow services in our direct mail and e-mail communications.

Moving onto an update on our loyalty program and customer relationship platform, we now have 13.4 million active loyalty members who shopped with us in the past 12 months and we've completed the conversion of all members to the Ultimate Rewards program as of the end of February. We've seen a great deal of excitement about the program from our newly converted guests regarding the benefits and the flexibility of the program, as well as the new benefit of a loyalty program, offering a free Ck One mascara on each guest's birthday.

So far we've seen strong performance in comp store sales and margin dollar growth from the recently converted regions, driven by both transaction growth and higher average ticket. Our loyalty program provides a valuable database of customer and purchase information that we can use to deliver increasingly personalized offers. Having all of our guests on the points-based program enables more efficient use of our CRM platform and will continue to improve the effectiveness of our targeted campaign.

Now turning to marketing, continued partnership between our merchant and marketing teams is enhancing the effectiveness of our communication, including direct mail, website and promotions, which we believe is helping to drive comps. During the first quarter, we executed successful programs like our signature 21 Days of Beauty, featuring beauty deals and in-store events with an increased focus on social media. Our trends of spring report positioned Ulta as a beauty authority and we enhanced our Mother's Day promotion with a stronger gift-with-purchase program and several new fragrance launches.

Our marketing collateral continues to evolve as we build a more compelling and emotional connection with our guests. Our marketing team is also making good progress on refining our brand positioning, carrying out a marketing mix analysis and executing the test-and-learn initiative we talked about last March, all with the goal of driving Ulta's continued profitable growth through new guest acquisition and less reliance on discounts.

Wrapping up our fifth growth strategy are e-commerce business. Ulta.com continued to see strong sales momentum in the first quarter with topline comp growth of 72.3%, contributing nearly two points of comp to our same-store sales. We continued to enhance the online shopping experience through new releases of the platform. The latest improvement include a product Q&A platform called Ask Ulta on the site and the addition of brand stores to highlight collections and breadth of assortment as well as promote services, like the benefit brow bar.

We continue to invest in omni-channel capabilities like the newly launched feature called Find In-Store which enables guests to check the availability of many popular SKUs in their local stores. We also continue to increase fulfillment capacity to support the rapid growth in our e-commerce business. This completes the update on our growth strategy so I'll now hand it over to Scott.

Thanks, Mary. Good afternoon, everyone. First quarter sales were $713.8 million compared to $582.7 million last year, an increase of 22.5%. Comparable sales increased 8.7%. The retail comp, which includes salon, was 6.8% and e-commerce growth of 72.3% added 190 basis points to the comp. The transaction and ticket contributions to the total Company comp were more balanced, with transactions up 2.5% and ticket up 6.2%. The ticket increase was driven by roughly 20% units and 80% average selling price, as our business continues to mix up to more prestige categories, which are generally at higher price points. We were very pleased to see that retail-only comparable transactions increased 120 basis points, almost a two-point sequential improvement from Q4.

Gross profit dollars increased 20.6% to $246 million. As we expected, gross profit margin declined 50 basis points to 34.5% from 35% in Q1 of last year. While retail product margins were strong, the overall product margin rate was down about 40 basis points, driven by a number of factors including a higher mix of Ulta.com sales, some product mix shifts within prestige and the impact from converting the remaining 50% of the country to the Ultimate Rewards program, which delivers more gross margin dollars but at a slightly lower rate. For the full year, we anticipate product margins will be slightly higher than last year, based on some of the newness and the category mix we're planning for the rest of the year.

As a reminder, the Ulta.com impact to our margin rate is primarily due to sales mix. As most of you know, we do not currently sell the full assortment of our professional hair care products online, so having a lower mix of that higher-margin product online does dilute our e-commerce rate somewhat compared to bricks and mortar. However, from a margin dollar perspective, we believe that a significant portion of our e-commerce sales are incremental as we have seen that our guests who engage with us across both channels also spend more in-store. While it is natural to focus on the margin rate as a stand-alone measure, we are focused on the big picture, which is that we are capturing more beauty dollars overall, and that is good news for both Ulta and shareholders.

We're delighted with the tremendous growth in market share gains we're seeing in prestige cosmetics and skincare. While high margin, they are not as high margin as some of the other prestige categories we sell. In the first quarter, those mix shifts had a slight impact on overall margin rate. We expect to see these mix impacts mitigate as we go through the year. I would also remind you that having all our guests on the Ultimate Rewards program had a modest impact on gross margin rates. We know our guests are much more engaged with this more flexible, attractive program, so they use it more. We expect the program to deliver higher sales and gross margin dollars, but the margin rate is a bit lower than our previous certificate-based program.

The remaining 10 basis points of deleverage relates to fixed store costs, which we expect to continue for the full year as we add 100 new stores this year on top of 125 last year and 100 in 2012. Taking a long-term view, the modest deleverage we expect to see in 2014 is minor in comparison to the increased market share we are capturing with these stores and the long-term gross profit and cash flow these investments will generate in the coming years. We are very happy with new store productivity. Our 2012 and 2013 classes of new stores continue to exceed our internal sales and investment return targets, and store openings in the first quarter this year exceeded their grand opening sales targets. Our store model has proven to work well in all geographies and we continue to review and approve high-quality sites consistent with our historical practices.

Back to the P&L, SG&A expenses rose 22.1% to $162.4 million, flat as a percentage of sales at 22.8% due to planned investments in marketing, supply chain, e-commerce and store labor, with better than expected driven by strong expense controls and some planned expenses that were delayed and pushed later in the year. Pre-opening expense was $2.6 million, compared to $3.2 million in Q1 of 2013, driven by 21 store openings during the quarter compared to 28 new stores opened during Q1 of 2013. Operating margin decreased 30 basis points to 11.3% versus 11.6% in Q1 of last year. Net income increased 19.4% to $50 million, or $0.77 per diluted share, versus $41.8 million, or $0.65 per diluted share, last year. EPS grew 18.5%.

Turning to the balance sheet, inventories were $531.4 million at the end of the quarter, compared to $442.1 million at the end of Q1 2013, driven by 120 net new stores open since May last year. Inventories were down 50 basis points on a per-store basis as our supply chain and store teams have done a nice job keeping inventory very clean through a large number of product transitions. Capital expenditures were $39.1 million for the quarter, driven primarily by our new store opening program as well as supply chain and IT investments, and depreciation and amortization for the quarter was $30.4 million. We generated about $34.6 million of free cash flow for the quarter and ended the first quarter with $457 million in cash on the balance sheet.

While we delivered a first quarter above expectations, and have a solid start to our second quarter, we believe it is prudent to maintain our view of full-year guidance until we get a bit more of the year under our belt. If the environment remains stable, we'd expect to do better. We expect to open about 100 new stores this year, along with 12 remodels. We anticipate comparable sales to increase in the 4% to 6% range and total sales to increase in the mid-teens range for the year. As a reminder, P&L investments for the year include supply chain expenses to support the planned 2015 opening of a fourth DC, marketing to convert 50% of the country to the Ultimate Rewards loyalty program and investments to increase training for both store and salon associates to improve the guest experience, as well as some test-and-learn initiatives around brand awareness and new guests acquisition, most of which are occurring in the back half of the year.

We expect that earnings per share will grow in the mid-teens percentage range this year, excluding any potential accretion from share repurchases. Our existing authorization has about $113 million remaining. We expect to invest about $265 million in capital in 2014, with approximately $117 million earmarked for new stores, remodels and relocations; $28 million for merchandise fixtures; $50 million for IT systems, including e -commerce; $45 million for supply chain projects; and about $25 million for maintenance CapEx.

Turning more specifically to the second quarter of 2014, we expect sales to increase in the range of $706 million to $717 million versus $601 million last year. We expect comparable sales to increase in the range of 5% to 7%. Pre-opening expense is expected to come in around $3.4 million, with 20 stores planned to open in the second quarter. We expect to achieve earnings-per-share in the range of $0.78 to $0.83, compared to $0.70 in Q2 of last year. Our tax rate is expected to be approximately 38.4%, and our fully diluted share count will be approximately $64.8 million, excluding any potential share repurchase activity.

Before we move on to the Q&A, I'd like to give you an update on our supply-chain investments. In April, we signed a lease for our new distribution center near Indianapolis, which we expect to open mid-2015. This facility will be about double the size of our existing buildings and will have all new warehouse management and control systems. The new facility will also have more sophisticated material-handling technology and ultimately a more efficient operating model compared to our current facilities. This model will take inventory lead time out of our supply-chain by allowing more frequent shipments, which will improve store in-stocks and inventory turns. It will also create labor efficiencies in the distribution center and allow us to deliver more shelf-ready product to our stores.

Having the product delivered more frequently and shelf ready will allow our store associates to get the product on the shelf faster and more efficiently, and improve in-stocks and product presentation. The new DCN systems are the first phase of a multi-year network optimization project as we continue to evaluate our supply-chain capability and capacity to support future growth. We expect this project to generate a good return on investment over the longer-term, on benefits including speeding up the supply chain, improved labor efficiencies, and providing more inventory flexibility to drive improved inventory turns. This is clearly an important investment and we are all highly focused on execution to ensure that it delivers the expected operating and financial benefits.

With that, I'll turn the call over to our conference call host to begin the Q&A. Operator?

Thank you.

(Operator Instructions)

Neely Tamminga, Piper Jaffray.

This is Kayla Berg on for Neely Tamminga. Just wondering, digging deeper into your e-commerce sales, can you guys tell based on your loyalty data how your customers choosing e-commerce versus a store visit? Said another way, within your loyalty base, how much is she using the site to buy products versus going into the store? And with that example, what is her purchasing behavior online look like burst in-store, as again looking at your loyalty customer base, maybe looking at average transaction size and dollars or units and how does that look differently online versus in-store? Thanks.

This is Dave Kimbell. We absolutely see a lot of cross purchase activity within our membership database between the website and our stores. I don't think we're prepared to share specific details around some of the specific questions that you have, but it is as our e-commerce capability has grown over the last 18 months and become a bigger part of our business, one of the things that we're particularly excited about is our ability to reach her where and when she wants to shop with us. Importantly, our members are finding that to be a very convenient way for them to shop, so they're visiting both stores and e-commerce and that's certainly something that we are encouraging as we continue to leverage e-commerce as a way to drive customers back into our stores.

Great. Thanks.

Aram Rubinson, Wolfe Research.

Great job on the results. Two things. First of all, on the new store productivity, I know historically you've talked about 70% or in that range. Our calculation for this quarter was around 74% and to get to your guidance for second quarter, I think I needed at least at 75%. So the question is, what are you doing differently there, and is it a function of also opening fewer stores that maybe we can cherry pick just the best and if that's a sustainable? And then I have a follow-up.

No, Aram, I wouldn't say there's anything specific that we're doing any differently to drive new store productivity. I think we're just seeing the natural maturation of the stores we put in place over the last two years. Notably, we observed that first quarter this year the stores coming out of the gate, the 21 new stores in the first quarter were just exceptionally strong. So nothing special that we're doing other than our normal great day-to-day activities to support new store openings.

Okay. Because sometimes when you choose fewer stores you get a better hit rate, I guess is what I was trying to get at. That's not what you're seeing just yet, you're saying?

No. We're not seeing any of that.

And then my second question is, in the 10-Q it says -- our long-term strategies to drive operating profit is expected to increase as a result of our ability to expand merchandise margin and leverage our fixed costs with comparable store sales increases and operating efficiencies offset by incremental investments in people, et cetera. Wondering if that word offset is to be read fully offset or partially offset?

I would -- my response to that would be partially offset, and I think we've shared that with many, many investors that we've talked to over the course of last year. We still believe that a mid-teens operating margin target is a reasonable one for Ulta and one we feel capable of achieving over the longer term. Again, we've got some investments that we're making in the near term, notably supply-chain, e-commerce, cycling our hyper-growth new store program here over the course of the last couple of years. We feel like once we get through that, we're going to see benefits coming from those investments and we're also going to see continued mix up in the prestige part of our business, which we think will drive improved operating margins over the long term.

And comps of 8.7 don't hurt either. Thanks for taking my question.

Gary Balter, Credit Suisse.

I don't think I read the press release as closely as Aram, so it may not be (laughter) detailed. Two questions. One is, you mentioned that obviously traffic went up. How much of that do you tie in with the rollout of the loyalty program, the Ultimate Rewards, to all the customers and what does that imply for future quarters?

Gary, it's Mary. Thank you. I'd say there were several factors that we believe drove the transactions and we're encouraged to see that improvement over the long term. We're going to want to continue to have that balance, but it's really a combination of things. It's probably hard to parse out just one thing, but certainly rolling out the loyalty program is part of it. But we also have had some great newness in brands that we talked about, like It and Mally, space expansion, more compelling marketing and merchandising I see overall in our materials in-store and online. So really a combination of those things all together we believe is what drove that to happen.

Thank you. Mary, just following up, you mentioned when you're talking about the really strong results in e-commerce that you had a new release of the platform or some upgrades. Where are you in the e-commerce rollout of your platform and what do we expect in the future? Thank you.

I'll ask Dave to take that.

Absolutely. We're continuing to expand our capabilities. As you're probably aware, last year, late last year, we launched our new site that has been performing very well and is one of the drivers of our success and we continue to add new capabilities. I think a couple of things that Mary referred to earlier, brand stores, with the new capability in partnership with some of the key brands, we have a new feature around Ask Ulta, where customers can engage with us and ask specific questions around products or beauty tips.

And then we continue to expand our capabilities. We've got, as Mary mentioned, our inventory availability online, both on our site and then within Google, which is, we found, to be a great convenience for our customers in Q1. We've had about 0.25 million views of inventory on our site. And that's important not only to connect with our customers today, but to set ourselves up for future omni-channel capabilities. We've built in some live chat capabilities. We've redesigned our loyalty and guest services. So there's a variety of things as we continue to build our web and digital experience that we think will be critical to continue the strong growth that we've had in that space.

Thank you.

Oliver Chen, Citi.

Congratulations on a great quarter. Regarding your comments on the evolution of gross margin, what is going to drive the category mix positive impact there? And also the breakout, getting the 20% unit growth, was impressive. Is that a trend that will continue and could you give us color on what's working on the unit growth side?

Hi, Oliver. Thank you. First of all on the gross profit margin, let me start at a high level. As Scott described, there's a few different items that drove some margin deleverage in the quarter, and some of those headwinds will continue for the year but we do expect to see modest improvements for the full year. And really it's a couple of things. One is a newness that we have in the pipeline and also as we continue to evolve our promotional strategy, and pull back on some discounts carefully, we think that those two things alone will help us.

Thank you. And on the unit front, do you expect the momentum and breakout to continue at this rate between AUR versus units?

Yes. We're trying to drive a healthy balance of all that over time, so some of the test-and-learn programs that were doing this year are trying to see how we can lever that sales equation even further. We're looking at it across the board. Part of this is obviously, first and foremost, getting new guests to Ulta and then having our current guests come more often, shop more often, so whether she's buying more units per transaction or higher-priced items in her basket, all of those are frankly good levers for us to explore that we think are all going to be part of our future growth.

Thanks. And Mary, on the customer acquisition front, what would you prioritize as the top catalyst for the continued momentum in terms of realizing opportunity there? And we're looking forward to Investor Day. If you could give us a few thoughts on the nature of what we may expect to hear about, that would be great. Thank you.

Well, I can't preview Investor Day, but what I can tell you is that consistently we've said that, and we know that from a data perspective, that awareness of Ulta just as a retailer is lower than really it can be. So it starts with just getting more guests that are in our sweet spot of our target to become aware of Ulta and then to become aware of what we're about. So really the long-term work that we're doing is really about how do we, we should almost call it relaunch the brand, to people who maybe have not been in Ulta for a long time where have never been in an Ulta or don't really know what we're at like right now, versus what we were perhaps a long time ago.

We think there's a lot of opportunity there and it starts with awareness, clarity of what we stand for and then it's about continuing to do what we do really well, which is offer her a differentiated experience in the store, most importantly with an array of great products and services that she can only get at Ulta. It's really all those things together. I can't prioritize only one because they're all, I think, exciting opportunities for us.

Thank you. Best regards.

Brian Tunick, JPMorgan.

This is [Deena Boyna] filling in for Brian. Thanks for taking our question. We wanted to ask about your product introductions for the rest of the year. Are there any product launches or emerging trends you're really excited about for the rest of the year and do you have any updates to your Clinique and Lancome shop and shop rollout events?

Thank you for asking a question. As far as future -- any new products or rollouts we would not share at this point in time. Of course we always are focused on newness, whether it be products, exclusives, or new brands, but I would not be specific. And back to Clinique and Lancome, we opened a significant amount of doors last year, I think I mentioned on our last call, and we're very pleased with that business and we continue to monitor, but it's like a new store. It ramps over time, so we're partnering with our vendors to make sure that we maximize the business together. I really don't have any other updates other than that, that we're very pleased with both businesses.

And as far as trends, some of the trends continue. Lip has been very strong. We see that continuing this year and as we move forward into fall. Also, anti-aging continues to be strong for us. We're also seeing complexion, or face, being very strong as Q1 ended and I think it will continue.

Great. Thanks. And can you update us on the store maturity (inaudible)? I know you mentioned new stores exceed expectations, but I wanted to see if there's a change in your comp assumptions by store age, particularly given the product mix is somewhat changing and e-commerce is now a growing part of the business?

Yes. There hasn't been any change in the core model and what we see the performance of those new stores compared to what we share in our standard investor deck. So no, new stores still very productive in line with our expectations and the stores that are beyond five years old, again in a healthy comp environment there, additive to the comp. They are all comping at a very healthy low to mid-single digit range.

Great. Thanks. Best of luck.

Matthew Fassler, Goldman Sachs.

I have two questions. The first relates to gross margin. You made some comments about the mix within prestige, and the notion that the prestige products that you sold more of in Q1 might be a little lower margin than some of the prestige products perhaps that you've sold in the past and that you expect to sell going forward. Any color as to the drivers of that trend and what changes you expect to see that will make prestige more of a pure positive to gross margin rate?

Hi Matt. What I would say is that within -- prestige is a pretty the category, right, so there's a lot of different brands that we have that are in the place that we call prestige and some of them have, they have different margins. All of them are good strong margin and good high price points, right, but within that there's certain brands that have somewhat higher or lower so it's really just about that. It's a little bit of a shift within that. As we look at our pipeline for the rest of the year and what we expect in terms of newness, we believe that will moderate and shift up positive.

So you have visibility to launches in such that make you feel that way?

Yes.

Great. And then my second question, I believe at the outset of the year you spoke about $0.10 of investment, most of it in SG&A, and the initiatives that you've spoken about in the past and again today. Scott, if you haven't done so, I may have missed it, could you quantify how much of that $0.10 you booked in Q1? And to the extent that you said some investments were deferred to later in the year, how much of what you originally expected to spend in Q1 did you push out to later in 2014?

It was virtually zero in Q1, to answer the question directly, and it's all back-half loaded to 2014. I would say directionally it's the heaviest in Q3. That's where we're really going to be able to get some actions in place and it will continue on into the fourth quarter.

Great. Thank you so much.

Daniel Hofkin, William Blair.

Congratulations on a great result. Just a couple follow-up questions. One, if I could ask the Clinique/Lancome question slightly differently, would you -- at this point do you feel like over time there's still a meaningful opportunity to add one or both of those brands or others of that stature to the meaningful part of the chain that don't already have them?

This is Janet. Thank you for the question. We're pleased with the business, as I said. There's opportunity and we're hopeful that we'll continue to expand both brands and there's opportunity for others. At this point, as I mentioned, I have no further update.

Okay. And then just a follow-up on the thoughts around the promotional cadence, it sounds -- you didn't call it out in the first quarter, so is it fair to say it was not a meaningful difference year over year in the first quarter?

Well, part of -- we actually slightly pulled back on our promotions versus year ago. I wouldn't say it's so significant that it's super meaningful yet, but it's a trend that we are encouraged by because strategically, we think it's important and one of the things I believe in is just walk before you run on something like this, right? Value is important to our guests and we need to make sure that we offer value, but we have done some things to start to modify our mix and our offer strategy. Dave talked about our CRM platform. We're leveraging that to deliver more relevant offers.

We're expanding our digital reach to drive awareness and I would say that we're balancing value equation with offers that are more relevant, more personalized, perhaps even a more emotional connection, you might say, to our guests. We are making some changes there that are having improvements in terms of our promotion level. That's going to be difficult for analysts, I think, to track that going forward because as we get more segmented and more personalized, it won't be as obvious to everybody what we're doing, because we won't be doing the same office to everybody. But we're encouraged by that and again, that's an important part of how we think about the long term for the business.

Okay. So basically, you're also clearly aiming at more effective and higher payback on the promotions that you run, so that seems to be part of it too.

Yes.

And then, just thinking about as the year progresses, the reason I asked the question is obviously second half of last year and there were some unique external dynamics at work that all retailers were grappling with, but what -- at this stage is, there something about the second half, this coming second half that you'd expect to allow you to be maybe less promotional than you were in the second half of last year, or at least similar year over year, based on maybe the new fully rolled out Ultimate Rewards program or other more targeted promotion that helps that?

Right. Well, I feel good about where we are and I feel good that I really believe that every day we're raising our game as it relates to our ability to be more fine tuned with our promotions and, as you said, use that to drive more incremental profitable sales. That's the ultimate game here. Really, as I look at our full-year, it's still early in the year and we feel it's prudent to hold where we are as we get -- until we get deeper into the year. To your point, we don't really know what holiday holds, but I do think that I feel good about where we are and I believe we were going to continue to raise our game. If our sales momentum continues and if our upcoming newness performs better than expected, we could see some upside.

Great. Well, best of luck in the second quarter and look forward to the update in the fall.

Ike Boruchow, Sterne Agee.

Congrats, everyone. Quick clarification. Scott, did I hear correctly that even ex e-com business that your traffic levels were positive for Q1? I think 1%, you said?

Yes. That's correct. 1.2%, actually. So it's a 200 basis points improvement from what we saw in the fourth quarter.

Right. Okay. So I guess my question is, I think most retailers saw a sequential deceleration, or a lot retailers saw a sequential deceleration in their traffic trends. Is there anything you can point to in terms of what you guys did to improve your own traffic levels from Q4?

I wouldn't say there's any one particular thing, as Mary mentioned. The way we've seen it and measured it, it looks like it's a combination of things, right? So it's some of the great new products we introduced in the first quarter, whether it's expanding Urban Decay or cosmetics and adding to what we offer in the box, continuing to improve our marketing and merchandising inside the stores. We expect that the back half of the year will have some easier compares, so we would expect the transaction trend being positive to continue through the rest of the year.

Okay. Great. Just one more on the gross margin line. Looks like the comps came in a couple points above your guidance but the gross margin looked a little weaker to us. I think you clarified this, but I just want to double check. It sounds like your like-for-like retail margins were just like you planned them, and this was just a function of sales came from different channels and different products and because of that, the profitability was a little less. Is that a fair assessment of the gross margin for Q1?

That's fair. Again, the retail product margins as we define, which is 90% of the business, we are very healthy. Mary mentioned slight pullback on some of the promotional level there so it helped us be able to maintain margin rate on that. But it's just some of the other mix items that we saw occur during the first quarter. Again, we see a number of those things being able to either mitigate or moderate as we get further into the year.

To that point, can you give us some color on Q2? I know you give us the comp and the sales and EPS, but in terms of how you expect gross margin to play out for second quarter?

Yes. Sorry, Ike. We're not getting to that level of detail on guidance any longer. We stopped doing that when we kicked off 2014.

But you'd expect those headwinds to dissipate, is what you're saying on the gross margin line?

Directionally, the loyalty headwind is going to be with us for the rest of the year. E-commerce, we would expect that to moderate because we're going to continue to expand our assortment there and the business continues to scale, so we would expect some moderation there. And then on a product mix, again directionally, we expect that to improve as we get deeper into the year, because we do have some nice newness in the queue, which is going to be rate accretive to us in the back half.

Got it. Congratulations, guys.

Thank you.

Evren Kopelman, Wells Fargo.

Congratulations from me as well. First question is, can you compare/contrast the environment that you saw in the first quarter compared to the fourth quarter? If you needed to be more or less promotional, if others around you, either in the beauty category or other product categories you compete with? If you could share some thoughts on that, that would be great.

Well, certainly the fourth quarter of last year was really promotional, as we saw across all retail, right? So in gift-giving categories that we might compete with, we compete with everybody at that time of the year, so even with outside of beauty, we also had very promotional quarter. This year I would say that within beauty, I would say it's not necessarily less promotional. This is a very competitive environment, as you know, and everybody's fighting for share. We've gotten, I think, better every day as it relates to how we do our promotions and how we target them and use them to get our guests to come in and buy more often and buy with less discounts. So I think certainly I would say the broader promotional environment, less intense, but within beauty, pretty competitive.

Okay. Another question is, have you seen any changes in your the pace of new customer additions compared to prior years? And how do you anticipate that to change going forward?

Let me say one thing, which is the big part of this test-and-learn that we've referenced and we'll be running some of these awareness and new guests acquisitions tests as we get further into the year. The whole goal of that is to drive new guests acquisition but do it in different ways. So right now we've got a great 13 million-plus people in our loyalty program, and that's a strong program that's driving the majority of our sales, which is great. We think there's opportunity to have a lot more people as loyalty members to Ulta in the future, right? To do that, you have to actually make sure that you're communicating in the effective and efficient ways to get people's attention and to get them aware of Ulta, right? That's why we're doing those tests is to see is there an opportunity for us, which we believe there is, to drive new guests acquisition through a range of tactics, from traditional media to social media and search optimization. So there's plenty of ways for us to do that, and we think that's going to be the big learning for us this summer and into the fall that we can then leverage as we look forward.

Great. And if I could ask one last one is, on the mature stores, older stores, how is the -- maybe you could share some color on how those stores performed relative to the rest of chain? Thank you.

Again, our new store model's intact. New stores are performing as expected. And again, it's a healthy comp increase year over year. And as we would expect, those older stores are contributing to the comp increases. So we're seeing healthy low-digit into the mid-digit kind of comp year over year in some of those more mature stores. Very happy with the productivity of those stores right now.

David Wu, Telsey Advisory Group.

Congrats on the great quarter. Can you elaborate more on the two 5,000 square-foot stores are planning to test in the smaller markets? And any color around the expected four-wall profitability and merchandising differences versus the full-size stores?

Right. David, well, first of all have to keep this at a pretty high level, because we are still in the planning phases and we haven't really publicly communicated a lot about this yet, but I'll say we're all very excited about the opportunity. It's really an opportunity to go into, right now, I'd say just consider them smaller markets, similar in some ways to where we operate today but just smaller markets with less dense populations. The stores will be 5,000 square-foot stores.

We think about it as really bring the Ulta experience into a market where, frankly, we think our women targets are going to be very excited -- our women future guests are going to be very excited about having an Ulta experience. It will be curated down, certainly. Less space, but we'll have a salon in every in every store. We'll have a mix of products similar to what we have today in every store. It gives us an opportunity to experiment a little bit with fixtures and lighting and things like that. But most importantly will be for us to learn about the economics. We feel like we're very confident the economics will be strong and good but we need to learn that. We also need to learn about labor model and service model. More to come on that.

And are those locations also based in power centers?

I don't know if I want to disclose where they are exactly at. But yes, similar real estate strategy to today.

And obviously maybe too early to tell, but what do think the smaller format store potential could be over time?

Too early to tell would be a good way -- it's really something -- we've modeled it, certainly, it's not -- we see that it looks like and will be quite accretive, I guess I'd say. We see it as an incremental opportunity to our real estate strategy and overall business strategy. Part of what we're defining in our five-year plan is through these tests, is what is that potential?

Excellent. Thank you very much.

Joe Altobello, Oppenheimer.

Just want to go back to something you mentioned earlier, Scott, about the directional cadence of gross margin this year, maybe even next year. If I understand you correctly, it sounds like this year that you're looking for a little bit of gross margin expansion but most of that's going to be offset by investments you're making on the SG&A side. As we look ahead to 2015, I would imagine the headwinds that dissipate later this year eventually go away, effectively, so you're going to get better gross margin expansion next year. And then the $0.10 of mostly SG&A investment that happens this year probably dissipates as well. So would you guys expect to see even greater gross margin expansion next year, given what you're investing this year?

Joe, I don't think I'm prepared to go all the way out there with you on that line of questioning, but I would clarify on the gross profit line, we did mention product margins. Retail product margins we expect to be slightly up year over year for full 2014. But that's going to be offset somewhat by some of the investment headwinds that will roll through that line, most notably fixed-store cost deleverage for the full year. So gross profit may be slightly up for the year but in the flat to slightly up kind of area, I would say. And that $0.10 worth of SG&A, you're right. That's where it goes. That's where the test-and-learn is. It's hard to say right now how that's going to play out. We want to see what the results are and then take actions from there on what we want to invest in, in the future or what path we'd like to follow.

Okay. I thought I'd give it a shot, that's all. In terms of the evolution of the promotional strategy, obviously it sounds like you're easing up there a little bit and I know one quarter is a very small sample size, because a lot of how that plays out will have to do with what your competition's doing, et cetera. So are you guys worried all that your core customer base has become accustomed to promotion, and as you ease up on that lever, that they may look to go elsewhere, or is that not a concern at this point? Thank you.

That's exactly why we're, I would say, walk before you run on this kind of thing. So far, I think it looks very encouraging. Again, value is part of the equation the guests have come to expect from Ulta. It's really across a lot of different dimensions -- gift with purchases, free samples, beauty steals, and then of course our loyalty program. And then there's been discounts like coupons and postcards. So as we're pulling those apart, and we're doing some analytic work to pull it apart as well as just experimentation, I really very much believe that the early data would suggest that we are not -- we don't have guests that are overly reliant. There may be a segment that is like that. That's probably true for every business. But for the most part we are confident that as we understand her better and we personalize offers to her more and we bring in the things that she is excited about trying and buying, that there's a lot of runway there.

Okay. Great. Thank you.

John Kernan, Cowen & Company.

Congrats on a very nice quarter. Scott, I think in your prepared remarks you talked about if the environment remains stable you'd expect to put -- do a little bit better than your outlook for the year. Does that imply you need to keep doing 9% comps, or is there some type of line item you think you have good visibility into that could drive some upside to the current outlook?

No. We're just looking -- the glass is half-full, right? We're looking at business -- well, we're just coming out of a great first quarter where our guidance, especially in the comp line, was a little ahead of our full-year guidance targets. And again, we're doing the same with the second quarter because sales are strong. We're seeing good strength in some of the newness that we're introducing to our guest, so we just want people to realize that if things continue on, the plane that we're on today, we would expect to see some upside as we go through the year.

Okay. That's helpful. And then, can you -- I think it's obviously been a big driver of the comp. Can you remind us what inning you think you're in terms of that continuing to be a comp driver as the prestige becomes a bigger part of the mix? Thanks.

We would expect -- again, big picture, we are focused on trying to have a nice healthy balance between ticket and traffic driving our business. We see ticket recently over the last three or four quarters has been a heavier contributor to the comp. We're starting to see now transactions, more traffic trying to get back in balance here. We would expect that phenomenon to occur as we get through the rest of 2014. We think we're on track to have more normalized and a better balance between the two comprising our total.

The only thing I would add it's not only about shifting more of the mix to prestige. It's also about more units per transaction for our guests. We have a lot of items in the store, plenty of opportunities for her to pick up more in her basket every time she shops, so we think we can drive that balance over time.

Okay. Very helpful. Thank you.

Jason Gere, KeyBanc.

Just noticing the balance sheet and all the cash that you're sitting on $7 a share, so can you maybe you update us just on the thinking in terms of the uses of cash at this point? Is this something -- maybe you'll talk more at the Analyst Day, but clearly with no debt and you have a very attractive (inaudible) EBITDA, I was wondering, first off, if you could give a little color on how you can put that cash to work?

Jason, we discuss uses of cash and capital allocation with our Board on a regular basis. Right now, our current, our best thinking is, the best investment is to continue to drive organic growth in the business, so we're investing in new stores. We're expanding our supply chain capabilities and driving our e-commerce growth as best we can. We're assessing capital allocation as part of a long-term strategy work that we're doing as a group and we will be able to give you more color on our plans for the future and long-term when we meet with you in the fall.

Okay. That's good. And then just a second question. As e-commerce gets a little bit better, and forgive me if you did talk about this earlier. Can you talk about what the average purchase size was online versus in the store? The reason why I'm asking is just when I think about the customer coming into the store, usually they know what they're looking for but there's always those impulse items too. When you're online, sometimes you don't have the time for the impulse items. I'm just wondering, as you see the shift move, how do you get that customer who's shopping online to buy more than what they're just looking for?

Yes. Absolutely it's a big opportunity for us. I'd say you're right in general that the e-com has -- there's opportunity for us to continue to grow that. I think we're pleased with really all measures within our e-commerce business right now -- traffic, conversion and average order, but as we get smarter with our cadence of promotion and communication on the web, we think we'll have opportunity to continue to drive that. And so much of that will be driven by our deeper understanding of our customers and targeting message and communication through some of the new capabilities I talked about within our website.

So yes, we do have opportunity to continue to grow average order in our e-commerce. We've made progress on that over the last several quarters as we've launched our new site and continue to see opportunity there.

Can you quantify the difference between average order online versus average order of a loyalty card member versus a non-loyalty card number? Is this something that you can provide just to give a little color so we can see what the potential opportunity may be?

It's not on the loyalty side of things. Generally speaking, a bricks and mortar transaction is round numbers. Call it $35 a ring, normally, and e-commerce is north of $50. A lot of that is the free shipping offers and things like that, which generally tend to drive up average order value.

Okay. Great. Thank you for the questions.

Jill Nelson, Johnson Rice.

Sorry to add another gross margin question, but trying to understand first quarter decline on the merchandise margin line, given last quarter -- I'm sorry last year in the first quarter you were hit by a one-time event with a gift-with-purchase issue. Just trying to compare that to how you performed this first quarter and then in contrast of the improvement you're expecting for the remainder of the year.

Yes. A new quarter, a new set of challenges, right? And opportunities to manage. So I was hoping I would never have to talk about one quarter last year, the GWP, but thanks for reminding me, Jill. (Laughter)

I would just reiterate what I said previously, which is the core retail product margins that we see in the business, which again is 90%-plus of our business, is in really good shape, and part of it is our ability to slightly back off on promotional level as well as continued to improve the mix of the overall box with adding additional prestige kinds of brands and items to our mix overall. That's a great thing for the business. I did mention that loyalty, we -- there's a bit of a rate hit that we take on that and I would expect that continue for the rest of the year. Again, that's a long-term good for Ulta. Loyalty is one of our best, biggest, most important assets that we have.

E-commerce, we've talked about that for the last year or so. That's the nature of that business. We continue to build the assortment out there. We'll continue to do that throughout 2014 and we expect the rate to improve there in the long term, with better assortment and more scale to that business to help cover some of the investments money we had to do.

And then lastly, the product mix, the shifts we saw in prestige, we expect that to moderate as we get deeper into the year and again just say again, we've got some nice things in the queue. I'm looking at Janet, my merchant partner. We got some great things in the queue for the back half of the year that we expect to help margin rates.

All right. Appreciate it. And last question, inventory per store was down this quarter. How are you looking at that metric for the remainder of the year?

That's another thing we've grappled with for the last year or so. We've made some important investments in inventory, both to help general in-stock levels in the stores, and then with the boutiques we've made some significant inventory investments as well. Those have been good for the business. Good long-term investments for us. We've cycled all that now and so we feel like we're in a really good position and we expect per-door inventory increases to be well below the comp increases for the year.

Appreciate it. Thank you.

Mark Altschwager, Robert W. Baird.

Congratulations. You touched on the mix shift going on within prestige, but could you update us on the performance of mass versus prestige, and whether you're seeing any evidence of broadening of strengths across price points?

We haven't seen any shift really in the total box shop, so to speak. We still -- customers, she's coming into shop prestige. That's what drawing her into the store. We also know, when she checks out, there's still mass items in her basket. She's cross shopping the store and that's really one of the secrets to Ulta's success, is we can capture both parts of her shopping trip.

Great. Thanks. Could you talk a little bit about the store experience? You've been investing a lot in training, but what metrics are you looking at to gauge whether these investments are translating into a better, more differentiated experience?

Right. Well, we're early on in the test-and-learn of those, so we're doing a couple things. One is increasing moderately our overall base level of training for our associates. But really, if we look at the test-and-learn, it's really about learning about if we were to ramp that up even further, and frankly have more guest facing time, even more knowledge to our associates, maybe through technology, and the key measures, of course, will be does that drive incremental profitable growth? We have to measure that over some period of time, but we're pretty confident that while our guest does not want to be -- she sometimes doesn't want some help and other times she does, we believe we know the right way to do that.

But we believe that for many of our guests with more knowledge, more recommendations from our associates, she may increase the units per transaction and we'll measure that closely and make sure that, that kind of investment would work over time. Having said that, a lot of our supply-chain investments will also, we hope, over time allow our associates to have more customer-facing time. So with that incremental investments, we believe that's also going to be one of the ways that we can drive growth.

Thank you.

We have no further questions at this time. I would like to turn the floor back over to Mary Dillon for closing remarks.

In closing I'd like to thank all of our Ulta Beauty associates who delivered a great quarter while working to refine our strategy to drive sustainable long-term growth. Thanks to all of you for your interest in Ulta Beauty. I look forward to speaking with you soon.

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