Ulta Beauty Inc (ULTA) 2014 Q3 法說會逐字稿

Greetings ladies and gentlemen, and welcome to the Ulta Beauty third 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, Ms. Laurel Lefebvre.

Thank you.

You may begin.

Thank you.

Good afternoon, and thank you for joining us for Ulta Beauty's third 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 would like to remind you of the Company's Safe Harbor language.

The statements contained in this conference call which are not historical fact 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 will now turn the call over to Mary.

Thank you, Laurel.

Good afternoon everyone.

I'm pleased to announce the Ulta team delivered excellent sales and earnings growth in the third quarter.

To recap the numbers, sales grew 20.5%, and we delivered a 9.5% total company comp, on top of a 6.8% comp in the third quarter of 2013, both including the impact of e-commerce growth.

Our 9.5% comp was nicely balance between transactions and tickets.

The key drivers of our performance were continued strength in prestige and mass color cosmetics, the successful introduction of new products and brands, a more effective and well executed marketing strategy, double-digit comps in our salon business, and rapid growth in e-commerce.

Ulta.com performed very well, driving 46.7% comp sales growth.

Gross margin was healthy, as we continue our efforts to deliver more targeted offers and moderate our reliance on broad-based price discounts.

Earnings per share were up 30% to $0.91, versus $0.70 of GAAP EPS last year.

Scott will cover the detailed financial results for the third quarter and our guidance for the fourth quarter in a moment, but before that, I'd like to provide an update on our six strategic imperatives.

As you know, we recently updated our strategic plan and five-year financial targets, and provided additional insight into the components of our long-range plan at our analyst day in October.

We believe this plan represents a strong set of strategic imperatives and specific initiatives that will allow Ulta to continue its market share gains and deliver strong, sustainable sales and earnings growth.

Now I'll spend a few minutes updating you on activities underlining each of the six strategic imperatives.

The first imperative is to acquire new guests and deepen loyalty with existing guests.

As we discussed, we believe that one source of future growth is through the acquisition of new guests.

In order to do that, we know there's an opportunity to first drive awareness of Ulta, as well as clarity about the overall Ulta experience.

In the past several months, we've sharpened our brand's positioning, developed an advertising campaign, and began an in-market test to measure the impact of TV, print, radio and digital advertising in six representative markets around the country.

We recently completed the test, and are now analyzing the trend-out data.

Preliminary indications are positive, and we expect this test to influence our marketing strategy for 2015.

Another key aspect of this brand building strategy is to leverage PR to increase awareness and establish Ulta as a leading beauty authority.

We continue to drive millions of earned media impressions in the third quarter through broadcast and print PR opportunities, in support of grand openings and product launches.

In addition, throughout the month of October, we partnered with the Ellen DeGeneres show to highlight our longstanding support of the Breast Cancer Research Foundation.

The total number of media impressions Ulta received from the Ellen partnership approached 500 million.

In addition, due to increased awareness of our Cut-A-Thon, our salon teams provided 26% more free haircuts with a donation to the BCRF than last year.

We raised millions of dollars this year for BCRF, a cause important to our guests and our associates, and we have taken an important step towards increasing awareness of Ulta.

Another critical initiative in support of the first strategic imperative is growing and further leveraging our loyalty program and CRM capabilities to increase loyalty and grow share of wallet with our members.

At the end of the third quarter, our ULTAmate Rewards program had grown 16.1% year over year, reaching 14.5 million active members.

Our strong comp growth across retail, salon and e-commerce was driven by loyalty member sales growth.

Average sales per member increased compared to last year, equally influenced by greater shopping frequency and higher spend per transaction.

We continue to increase the effectiveness of our targeted CRM campaigns, in order to drive incremental sales, improve retention and engage members in our service offerings.

Now on to the second strategic imperative, which is to differentiate by delivering a distinctive and personalized guest experience across all channels.

A key initiative is assessing higher staffing levels to determine the impact on sales and the guest experience.

During the third quarter, we tested different labor models with increased customer-facing hours in 60 stores across the country.

Similar to the advertising test, we are currently measuring several financial and customer satisfaction retention metrics to assess how to incorporate a more effective labor model as we go forward.

On the digital side, we've also been busy improving the guest experience.

We've introduced live interactive chats with key vendors on a regular basis.

We have launched a new iPad app, and added content to the site to inspire, educate and share.

We've also implemented a new technology on Ulta.com to enable video commerce, or shop-able videos, where guests can click to buy merchandise shown in videos that are created by passionate Ulta bloggers.

Our third strategic imperative is to offer relevant, innovative and often exclusive products that excite our guests.

Newness continues to be a significant driver of our business, and our merchandising team is doing an excellent job expanding and curating our portfolio.

During the third quarter, we rolled out, across the chain, a specialized fixture to house an exclusive collection of makeup brushes, in partnership with IT Cosmetics.

With 66 SKUs across multiple price points, these brushes have been an instant hit with our guests.

We also launched a premium skin care, Algenist, hair care brand Keranique, as well as new fragrances from Michael Kors.

We rolled our popular color cosmetics brand BECCA to 282 stores, as well.

With its broad range of shades, this brand is a great addition to our portfolio, and very relevant to women of color.

Looking ahead to the holiday season, we're excited about the many exclusive holiday items we've introduced in partnership with our prestige brands, and a strong gift with purchase program to support our fragrance offering.

We recently introduced a bath collection for the Ulta brand, with new fragrances and packaging.

We've also significantly upgraded our gift card program and merchandising in time for the holiday season.

So we believe our merchandise assortment, combined with a robust marketing plan, anchored on the Gift Gorgeously theme that includes radio, advertising, PR, social, digital and in-store marketing will resonate with our guests.

Now moving on to the fourth strategic imperative, delivering exceptional services in three core areas: hair, skin health and brows.

The salon business grew 20.5%, and comped 10% for the quarter, adding 10 basis points to the retail comp.

This performance was driven primarily by increases in average ticket, but guest count was also positive and strengthened during the quarter.

Our strongest comping categories were hair color, blowouts, skin services and makeup services.

Skin services had their best comp all year, due in large part to the launch of new peel service that builds repeat business.

We were pleased to see an acceleration in new guest acquisition throughout the quarter, supported by our new online booking capability.

During the quarter, 36,000 appointments were booked online, and more than 80% of those were new salon guests.

Beginning in October, we launched a CRM campaign designed to acquire new salon guests from our existing loyalty customer base, with targeted offers for hair, brow and skin services.

As we noted at our investor conference in October, salon customers spend 2.5 times more than non-salon guests, and shop twice as frequently.

But they represent less than 7% of our loyalty program members.

So converting more of our ULTAmate rewards program members to become salon customers is a good opportunity for us.

Turning to brow services, we now have about 600 Benefit brow bars, and are performing brow tinting services in almost 400 of these.

Benefit boutiques continue to perform very well, with strength in both products and services.

The fifth strategic imperative is to grow stores and e-commerce to reach and serve more guests.

We opened 50 stores during the quarter, ending the third quarter with 765 stores.

We remodeled five stores in the third quarter, and relocated two.

We've already completed our 100-store program this year, with an additional 10 stores opened early in the fourth quarter.

And after closing 1 later in Q4, we expect to end the year with 774 open stores.

This represents an increase in square footage of just under 15% for the year.

New store productivity remains strong with the class of 2014 stores outperforming its sales budget.

Looking ahead to 2015, we expect to open 100 full-size stores, and we have already approved close to 90 sites.

In terms of the small store test, we opened two 5,000 square foot stores in September, one in Vernal, Utah, and one in Morganton, North Carolina.

The stores feature a curated assortment, with every major category represented, lower fixture heights for increased visibility, and a full guest experience, with a three-chair salon, Dermalogica skin services and a Benefit brow bar.

In these two stores, we're piloting a new capability for guests to order in store on an iPad and have the product shipped for free from our DC to their home, in order to give our guests access to our full assortment.

We continue to monitor the performance of these stores.

And in our initial weeks, they were exceeding their sales budget and confirming our hypothesis that these stores would be extremely well received by guests, and that they are likely to have a higher mix of prestige product sales versus the chain.

We expect to learn a lot about operating small stores during this test to help us be successful in rural and urban markets in the future.

On the e-commerce side, Ulta.com's growth of 46.7% contributed 130 basis points to the total Company comp.

E-commerce is expected to represent about 5% of total sales this year, on our way to our goal of growing to 10% of our business in the next five years.

We are now anniversarying the significant improvements to the new website that we launched just over a year ago.

So we expect the top line to moderate over time, but we continue to add more content and enhance the site performance.

And we also expect to see improved fulfillment capabilities as we execute our supply chain project.

Which brings me to our sixth strategic imperative, investing in infrastructure to support our guest experience and growth and capture scale efficiencies.

The Greenwood, Indiana distribution center is under construction, and is expected to open mid next year.

We're currently looking for a location in the South for our fifth DC to open in 2016.

These buildings will have all new systems and operating models, driving more efficiency, increasing replenishment speed, and improving in-stocks, while making it easier for store associates to stock shelves and free up their time to spend with our guests.

Other noteworthy efficiency projects include our new point-of-sale system.

The chain-wide rollout was completed at the end of the third quarter.

The new POS simplifies the cashier role, enables omni-channel capabilities, and reduces costs.

We're also piloting a mobile app for store associates to streamline receiving and inventory functions in 10 stores, and a store management tool in 13 stores.

This completes my update on our strategic imperatives, so now I will hand it over to Scott.

Thanks, Mary.

Good afternoon everyone.

Third-quarter sales were $745.7 million, compared to $618.8 million last year, an increase of 20.5%.

Comparable sales increased 9.5%.

The retail comp, which includes salon, was 8.2%.

The total Company comp was driven by a healthy combination of transaction and ticket, with transactions up 5.4% and ticket up 4.1%.

The ticket increase was driven entirely by average selling price, as our business continues to mix up to more prestige categories, and we succeed in our efforts to rely more on our CRM capabilities and targeted offers, versus broad-based couponing.

Retail-only comparable transactions were up a solid 4.4%.

Gross profit dollars were up 21.6% to $281.8 million, and gross profit margin increased 40 basis points to 37.8%, from 37.4% last year.

The primary drivers of this improvement were leveraged on fixed store costs on a strong comp and higher product margins, offset by incremental supply chain costs, due to our expanding e-commerce business.

SG&A expense increased 19.7% to $181.1 million, down 20 basis points as a percentage of sales to 24.3%, versus 24.5% last year, or 24.2%, excluding the severance charge last year.

Despite our investments in the test and learn initiatives like the payroll and brand awareness marketing test, we were able to leverage SG&A due to the stronger than expected top line, which drove payroll and marketing expense leverage, offset by deleverage in corporate overhead expense.

The corporate overhead deleverage was primarily driven by a higher variable compensation expense, due to better-than-expected performance, as well as depreciation of IT systems and consulting expense.

Pre-opening expense was $6.6 million, compared to $7.5 million last year, driven by 50 store openings, compared to 55 new stores opened during Q3 2013.

Operating margin increased 80 basis points to 12.6% versus 11.8% last year.

Interest income was $254,000 net of credit facility fees.

Our line of credit remains undrawn.

Our tax rate was 37.3% versus 37.7% last year.

This tax rate favorability added less than $0.01 of earnings per share, and was due to the impact of equity compensation on our tax rate.

Net income increased 30.1% to $59.1 million, or $0.91 per diluted share, versus $45.4 million, or $0.70 per diluted share last year, or $0.72 per share, excluding the severance charge last year.

Turning to the balance sheet and cash flow.

Inventories were $709.7 million at the end of the quarter, compared to $582.3 million at the end of Q3 2013, up 5.8% on a per store basis.

We achieved our goal of keeping inventory per door growth below comp growth, despite investing in additional inventory on bestsellers ahead of the holiday selling season, to keep pace with our strong sales momentum.

In-stock levels are strong, and we have not experienced any meaningful issues from the recent West Coast port delays.

Capital expenditures were $78.4 million for the quarter, driven by our new store opening program, supply chain investments and systems.

We're on track to spend $265 million in capital for the full year.

Depreciation and amortization for the third quarter were $33.7 million.

We ended the quarter with $395 million of cash and short-term investments.

The Company repurchased approximately 86,000 shares, at a cost of $10 million during the quarter, under our 10b5-1 plan, as part of our program to return cash to shareholders.

In terms of specific guidance for Q4 2014, we expect to generate sales in the range of $997 million to $1.014 billion, compared to $868.1 million last year.

We anticipate achieving comparable sales increase in the range of 6% to 8%, versus 9.2% last year.

Recall that comp performance from last year's Q4 benefited by approximately 200 basis points, due to the negative impact of Superstorm Sandy, and the timing impact of the 53rd week of FY12.

New store openings in the fourth quarter are already complete, with 10 stores opened versus 11 stores opened in Q4 last year.

So pre-opening expense is expected to be flat.

Earnings per share are expected to be in the range of $1.21 to $1.26, versus $1.09 for Q4 of 2013.

We anticipate a tax rate of 37.9%, and a fully diluted share count of approximately $64.6 million.

Turning to the outlook for the full year 2014.

Based on the strong performance of the first three quarters, we are raising our earnings growth expectation to the low 20s percentage range for the full year Full-year comparable sales are expected to be in the range of 8% to 9%.

As a reminder, the long-term plan we announced in September laid out our five-year financial targets.

We expect to open 100 stores per year, grow e-commerce to 10% of our sales, drive comparable sales in the 5% to 7% range, and grow earnings per share in the low 20s percentage range each year.

However, we expect a reduction of this growth rate in the mid-single-digit percentage range in both 2015 and 2016, due to planned supply chain and systems investments.

Operating margins are expected to remain flattish for the next couple of years, before heading up towards our long-term mid-teens target.

We plan to provide specific guidance for next year, as usual, on our Q4 call in March.

And finally, for FY15, we plan to accelerate our earnings announcement calendar to be more in line with our peers, and expect to announce our quarterly results about one week earlier than our historical practice.

The dates for next year's earnings announcements are posted on the investor relations page of our website.

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

Operator?

(Operator Instructions)

Simeon Gutman, Morgan Stanley

Thanks, it's Simeon Gutman, Morgan Stanley.

Nice quarter, everyone.

Two questions, first on gross margin and gross margin management.

You talked about getting better at promotions and targeting and being more selective.

If you do what you did this quarter to drive some of the improvement, and you run it out over the next few, should we see gross margin expansion similar to what we saw in this quarter?

And then my second question is, if you see next year better gross profit dollar growth, either through sales or through better gross margin, are there investments either -- you mentioned supply chain and systems.

Are there any of those investments that you can accelerate, just to pull them forward, if the business is performing better?

Yes, Simeon, I guess I'll take a crack at the first one here.

As far as gross profit expansion was concerned for the third quarter, as I look out at the next couple, specifically the fourth quarter, I wouldn't expect to see the same kind of expansion that we just saw in the third quarter.

The fourth quarter, I think you know, the holiday season is a little bit different animal for us, with the competitive set changing.

We have, again, a large number of new stores entering into the overall base here, so there's a bit more fixed store cost deleverage coming in the fourth quarter that will drift the next couple quarters, as well.

So again, we think our guidance includes all those ramifications, and we think it's prudent under the circumstances.

As far as thinking forward a little bit about investments, it's -- you heard us describe all of this at our analyst day back in October.

It's a pretty aggressive plan.

There's a lot of heavy lifting, as far as the investments are concerned, over the next couple of years.

I think we're probably as accelerated, probably, as we feel comfortable at at this stage in the game.

Of course, we would always course correct as we see things change in the business.

Thank you.

Gary Balter, Credit Suisse.

Hello, it's actually Andrew on for Gary.

Congrats, too, on a fantastic quarter.

My question is regarding prestige brands wins.

This quarter, your market share gains from department stores seemed to accelerate.

And in response, we heard companies like Estee Lauder mention that they are going to expand their assortment with the specialty channel.

Could you just comment on your outlook for prestige brand wins, particularly as a smaller format store is less in channel conflict?

Thank you, Andrew.

Yes, we're really thrilled with the performance of the brands that we've been adding to the mix.

And I think I talked about one example.

IT Cosmetics was a big win for us in the quarter, with the expansion of the brush line and whatnot.

There's many examples of that.

We continue to just look forward at our growth, and we think we are a great place to grow.

We are pleased with the performance we have with our brands, and we will always look to continue to really, I guess, best meet our guests' needs.

And as she continues to be interested in more prestige brands, we'll continue to look at those, as well.

So thank you.

Congrats.

Aram Rubinson, Wolfe Research.

Thanks.

Two questions.

First, now that Q3 last year is in the rear view mirror, can we do a little postmortem on what exactly happened then?

Didn't know if you give any extra clarity as you cycled through it?

That's your first question.

Okay.

Hi, Aram, thank you.

So I guess there's a few things going on there, right?

One is that last year, we had this -- I guess you'd call it the fiscal cliff effect that we think had an impact on traffic and consumer sentiment that we saw at the end of the quarter.

And we were also cycling up against a very promotional year-ago quarter.

And so some of those factors, we think, actually -- that, in conjunction with, we were starting to pull back a bit on some of our promotional intensity.

Put those together, we think those are some of the factors that drove some of the impacts to the comp that we saw in that quarter.

This year, as we look at it, I think it's obviously, overall, much healthier consumer sentiment happening.

While there's still pressure on household budgets in a lot of ways, obviously, the overall economic outlook and economy; jobs are more positive.

And we are still continuing to really be cautious but smart about balancing our investment in targeted offers with price discounts.

We think we are getting a little bit better at that, probably more knowledge, as we have done this a little bit more over time.

So those are the things -- those -- in each year, every quarter has something new as it relates to new products, and some are going to perform better than others, right?

So that's always a part of the equation.

So we feel like we have a pretty good understanding of all that, and confident that the drivers that got us to this quarter result are ones that we can -- we think we can continue to drive in the future.

Thank you.

And the follow-up was -- I don't think this was asked at the analyst day.

But can you tell us how likely you are to try and incubate brands in something like a VC format?

And maybe if so, timing or monies you might allocate to such an endeavor?

Certainly, the notion of having a really robust pipeline of product, so products and brands that our guests want that they know of already, and brought -- and products and brands we can bring to market with partnership or invest in, are all in the consideration set for us.

We want to really be known as the beauty authority, and certainly, the more things that are exclusive to us, the better over time, right?

I don't think that will ever be the highest part of what we do, but certainly we will want to grow that.

Having said that, we're just really, I think, beginning to develop that capability, takes some investment of time and people to do that.

And so that is certainly a focus for us in 2015 is to build out strategy, capability and plans there.

Because I think it's very exciting and interesting to think about consumer insight, combined with great merchandising and retail execution, as part of our strategy.

But it's early for us yet to be -- we have so many other priorities right now, frankly, that -- what we are focused on.

Okay, thanks so much.

Best of luck, and happy holidays.

Thank you.

Ike Boruchow, Sterne, Agee & Leach.

Hi everyone.

Congrats on a great quarter.

Thanks for taking my question.

Two quick ones.

I think the first one for Scott.

In terms of the next 18 to 24 months on the investment side, is there going to be -- as we model out our quarters, is there going to be some lumpiness that we should keep in mind?

You guys talked about the next distribution center opening up and the timing of that.

Just curious how we should think about timing on SG&A?

If there's anything you can add?

And then also Mary, when we think about ticket growth of 4%, can you comment, is that a function of category mix to prestige?

Is that a function of less discounts?

Is it both?

Is it more one or the other?

Just trying to understand that a little bit better.

Do you want me to start with that one, because that's easier, which is that it's -- it really is a combination of both.

I would say it's a mix up to prestige, it's less discounting.

Those together have really been the drivers.

And as far as the investment cycle is concerned here over the near term, the next 18, 24, 36 months.

So you're -- again, clearly, we're going to -- Indianapolis is underway here.

That building is slated to be online mid-2015, shortly followed thereafter with a new distribution center in the South going online approximately the same time of the year in 2016, kind of a carbon copy.

So the short answer is yes, we do expect our quarter-to-quarter performance to be a bit lumpier than it has been historically.

I know we have talked to many investors about that over the last couple of years.

That's one of the reasons why we have backed away from more detailed guidance that we've done in the past.

As a reminder, most of the investment is going to be flowing through the gross profit line in the P&L.

There will be a minor part, I think, flowing through SG&A for some consulting things.

But by and large, all these capital investments will amortize through gross profit.

Thank you.

Daniel Hofkin, William Blair & Company.

Hi, good afternoon.

Can you hear me okay?

Yes.

Okay, great.

I'll add my congrats on a great quarter.

Just a couple quick questions.

First, as you think about pulling back on some of the broad-based, as you called it, coupon advertising, what, as you see that, where is that manifesting itself?

Is that just showing up in a little bit higher average ticket?

Or is there any other impacts through the ticket or traffic dynamic there?

That would be my first question.

I would say a couple things.

One is that this is not a dramatic wholesale pullback on discounts.

We're doing it carefully, I think smartly.

What we're doing is looking at frequency and depth of circulation of price-related discounts, but reducing that.

But on the flip side, really leveraging our CRM platform and our loyalty platform to incent our guests in a more personalized and targeted, we think more effective and efficient way, right?

So it's a little hard to measure all of those impacts at any one moment in time.

But certainly, where we can see that play out is in ticket improvement, margin improvement.

And we think that's working for us.

But again, I've said this before.

I believe in walk before you run.

So Dave Kimbell and his team are doing a lot of work around just really making sure we continue to fine-tune, test and learn, understand all the demand dynamics, so that we can be -- we always need to be of value to our guests, is a way to think about it.

And that's -- there's no one exact way to define that.

But the more relevant we can be with the offerings, and then how we position those and communicate those to her, the more that value equation is less about just come in because you have a coupon or a discount.

That said, a lot of our guests like our coupons and our discounts, right?

So it does play out, in terms of the ticket dynamic.

And we think it's -- obviously, it's one of the assumptions we have built into our long-range plan, is that we'll continue to be able to do that.

Because the other place that this plays out is that less money spent on discounting, within the context of our P&L, offers us more opportunity to spend on driving awareness.

And that whole new guest acquisition part of our strategy, which is, we think, an opportunity.

We know it's an opportunity, as we go forward.

New guests don't discover you just on accident.

Sometimes they do, because we open up a store, which is great.

But we're investing and testing and learning in actually marketplace programs already that are about using all forms of ways to communicate, whether it's traditional or new media, to drive new guest acquisition.

So some of that efficiencies there will be used to drive new guest growth.

That's great.

And then it looked like there were a couple other brands that maybe you are testing out a little bit.

It looked like Clarins in one of your markets in skin care.

Is that specific brand?

Or is that something that you are thinking about as a potential for broader roll out over time, or others like that?

I'll ask our expert head merchant here to weigh in on that one.

Janet?

(laughter)

Sure.

We did just recently refocus on Clarins in our stores.

We've had Clarins, but what we did do -- so technically, it's not new.

But once again, we really focused it more in our Chicago area.

It's a beautiful brand, and we're also very thrilled to offer it on our website as well.

And that's -- no further information other than that than we're just really excited to learn more about this beautiful brand in our assortment.

Great.

Thanks.

Best of luck in the fourth quarter.

Thank you.

Joe Altobello, Raymond James.

Thanks.

Hey guys, good afternoon.

I guess first question is on the site, the Ulta.com site.

What percent of visitors to your site are loyalty members?

And how successful do you think that site has been so far at funneling those visitors into your brick-and-mortar stores?

I will ask Dave to take that for us.

Dave?

Yes, I don't think we'll have the exact percentage of guests versus non-guests that visit our site.

We know we over-index on our site in our ability to attract new guests, so we get a greater percentage of new members from our site than it represents of our total sales.

So it is a strong channel for us to continue to attract new guests.

And as we shared a little bit in our analyst day, we have a small percentage of our guests that are actively shopping between the channels today.

But we are doing a lot to encourage them, and we're seeing growth in that activity.

So we continue to bring initiatives into the marketplace designed specifically to get an online guest into our stores, to try to drive her in to use a salon service or to shop one of our brands in stores.

And vice versa, when we have a brick-and-mortar customer, make sure that she's aware of our online.

Because those guests are some of our best guests.

And we are going to continue to try to drive that integration across channels.

Okay.

But is that something that you guys are tracking and measuring, on a quarterly basis or a monthly basis?

Yes, we are certainly tracking that.

Okay.

Got it.

And then secondly, in terms of the consumer environment, I think earlier, you guys mentioned that you're very encouraged by what you're seeing so far from a consumer standpoint.

This holiday season, how does it look from a promotional standpoint versus last year?

This is the crystal ball part of the show, right?

(laughter) Just kidding.

But certainly, the -- I would say a couple things on the consumer sentiment.

I think it's a mixed bag a little bit.

There's certainly a positive economic news that creates this more upbeat climate.

Stock market, employment, GDP.

But there's also a lot of pressure on household budgets.

So if you look at increased costs in healthcare, food, rent, technology -- and incomes aren't growing that fast.

So I think the good news is, either way, Ulta is really well positioned because of our breadth of assortment, our overall value proposition.

So we're seeing that play out.

As it relates to holiday, then I think as the same thing rolls forward, we expect it to continue to be a very competitive time.

It's always that time of year that we compete in a broader, I guess, competitive frame, because it's more about gift giving, and beauty as part of that, right?

It's not only that we're competing against beauty retailers.

Certainly, the last couple of years, they've been very promotional.

I think what we've been reading, in terms of what other retailers are saying so far about the start to the holiday season, is we can expect that to continue.

So I think that some guests will have more money to spend, and some less.

But everybody's going to be competing for that share of wallet during the holiday period.

We expect that.

We feel well positioned with what we've got ready for holiday.

I will just add that.

We've got a really great lineup, in terms of our product offerings and our marketing plans.

Our stores are ready, our DCs are ready, our e-commerce platform is really performing well.

So we feel good about it, but we expect it.

And that is put into our guidance that we expect that.

Okay.

Thanks, Mary.

Appreciate it.

Matthew Fassler, Goldman Sachs

Thanks a lot.

Good afternoon, and congratulations on a great quarter.

The first question I want to ask is essentially a follow-up to that.

So you spoke about the different promotional tools that you have available to you, and how you have deployed them to your advantage.

Do you expect to continue to stick with those in the fourth quarter, when perhaps the promotional environment tends to intensify, and you face more players?

Or you feel like you can use some of your -- or do you have to revert, if I may, to some of the more traditional marketing tactics that you would have used in years past?

Yes, our plan for the fourth quarter is to continue to build on what's working.

So certainly, the -- one of our best tools is our CRM capability, and that holds true even more so during holiday, right?

When people are very busy, and trying to sort out what to purchase, in terms of gifts.

One of the things that we've done is, we've really -- we've taken our website and organized it around the theme of Give Gorgeously as a section.

And it really makes it easy for people to understand, if you are looking for gifts for teens or for men or whatever.

So we can communicate to our guest directly via email about gifts, and certainly hot prices and great products, and we're doing that.

And that said, there's also other tactics that we'll continue to use that are about driving traffic, and about great prices.

So it's really, I think, a combination or a continuation of what we've been doing, with an expectation that there's more competition, and has a little bit more promotion than another quarter.

That's helpful.

And then two quick follow-ups for Scott.

Scott, can you talk about the magnitude, at least directionally, of merch margin or product margin expansion that you saw here in Q3 relative to what you saw in the earlier part of the year?

Yes, we started off the year, I think, guiding the expansion and margin over the course of the year.

Again, in the early part of the year, it was a smaller part of the mix overall.

And we're happy to see that play out the way we expected.

So we saw 10 basis points of expansion in merch margin year over year in the third quarter.

We don't expect that necessarily to repeat in the fourth quarter.

We will see how it plays out.

We have good plans in place, we think, to try to maintain our momentum there, and try to do what we can to expand it.

But it is a bit of a different animal in the fourth quarter, and we'll do what we have in the past to protect our market share gain.

And then finally, just ballpark inventory thought process, as we model out year end?

Yes, we're very happy with -- overall, with our inventories.

Again, we're up 5.8% year over year, which is a little elevated from what we have seen earlier in the year.

But we are very confident those are A&B SKUs that we're buying aggressively.

Because the business is strong and we're confident that that's going to continue through the fourth quarter.

So --

Thank you.

Evren Kopelman, Wells Fargo Securities, LLC.

Thank you, good afternoon.

I wanted to ask a little bit about industry product trends.

We haven't talked about that very much so far.

Sounds like color cosmetics have been an area of strength.

Do you expect that to continue for you in the next few quarters?

Any other trends you are seeing, from a product perspective that we should be watching?

Thanks.

Sure.

From prestige, it has been strong for us, quarter over quarter, for some time now.

And a lot of that has really been driven from the evolution of our portfolio over the last several years, the addition of new brands.

And we still have brands we've introduced this year that will continue to have increases in next year, because we haven't comped over them yet.

So there will be opportunity there.

And it has been a strong category for us, and we feel that it will continue.

And as far as any trends, there are a lot of different trends.

But in color specifically, brow has been a very strong trend this year, continues along with lip.

Some of these that we may have mentioned in the past in face.

All categories in color have been strong, some of it new brand introduction, some of it new innovation.

Along with skin care, mask and serums continue to trend very strong.

And there are other things, but those are probably the highlights.

Thank you.

And then on the test and learn initiatives you had in place, are those continuing into Q4 and Q1?

Or are they being replaced by other tests?

Just asking, more from a -- how to model it from an expense perspective.

Thanks.

Yes.

Just in terms of the actual tests themselves, they are -- pretty much was, as the third quarter, was where we did the testing and spent most of the money.

There are some that's into the fourth quarter, but a small part of it.

Test and learn ongoing is going to be part of our mindset.

But I don't expect it to be the kind of investment that we made this year, frankly, because we really were -- really trying to do a lot at once, and it wasn't planned in our budget.

As we look forward, it's part of, again, how we're going to run the business, and its already built into our guidance and the five-year plan.

Just to put a point on that, Evren.

So of the $10 million that we described starting out the year, most of that now is in the rear view mirror.

There's a bit that's still embedded in the fourth quarter, but it's not worth discussing.

And as Mary said, there will always be -- we will always have an increment built in in future years for test and learn.

It won't be to the same magnitude that it was in 2014.

Got it.

Great, thank you.

Happy holidays.

Thank you.

Mark Altschwager, Robert W. Baird & Company.

Good afternoon, and thanks.

And congrats on a great quarter.

Could you talk a bit more about some of the site enhancement you have made?

The Get Inspired Beauty Consultation Share and Play?

Just what are the early learnings there?

And any metrics you can share on traffic and conversion that you've been able to attribute to these initiatives?

Yes, I don't think we've shared specific metrics related to some of those elements.

But I will tell you what -- we're very happy with how the site enhancements are -- have continued to improve the experience overall.

And we have invested, as you mentioned, a couple of [those].

But continuing to look for ways to both engage our customers more in beauty and our brand through our content destination, yes, the beauty destination that you talked about, video content that we've been bringing online, shop-able videos.

A variety of different ways to try to get consumers to see us as -- increasingly see us as a beauty expert and a leader in the space.

And we see content as a way to do that.

And that we know has driven traffic and engagement on our site.

We've also looked for ways to enhance that shopping experience once we get them there.

So things through our cart overlay, and how we are enhancing that.

We did that through the third quarter.

Even programs like our salon appointments that Mary mentioned in her script.

We have enhanced how we are describing and highlighting promos through some different fly-out capabilities.

So we're continuing to both enhance and expand the guest experience to attract her there.

And once she's there, convert her.

And we believe, and we know, through all of our tracking, that it's working.

It continues to drive.

We had, as you saw in the results, a very strong quarter.

And that was driven at least in part by these enhancements and the continued improvement of our site performance overall.

Great.

Thank you.

And then Mary or Scott, could you just address what you saw in the business around Thanksgiving week and Black Friday?

How did your approach differ versus last year?

And just biggest take-aways overall from that week?

Thank you

Yes, sure.

We're really pleased with our merchandise offers, our marketing communications.

I'd say relative to last year, we just continue, I think, to get more honed at understanding our guests and what she needs, and really picking our spots.

And so I'm pleased with -- I think the team did a great job.

And the traffic and sales that came from it that it drove, we are pleased with.

Scott already talked about inventory.

We're happy with our in-stock position, which is great, with our website performance, which Dave just touched on.

Our e-commerce fulfillment capabilities worked really well for us.

So the guidance that we've given for Q4 does embed already what we saw at the holiday, and we are pleased with it.

Steph Wissink, Piper Jaffray

Hi.

Good afternoon, everyone.

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We can't hear you very well.

Steph?

Operator, why don't we go to the next question, and we will see if we can get Steph back in a bit.

Jill Nelson, Johnson Rice & Company.

Good afternoon.

Could you talk about maybe some initial learnings you have gained from the higher staffing model?

I know it's in the early stages, but any initial insights?

Yes, we are going to -- we are still in the process of really looking at the trend out data, the customer satisfaction metrics.

We tested a couple different staffing type models at different levels.

I just have to say, we are pleased with the results.

Certainly, we had a hypothesis.

I don't think it was hard to confirm, but -- that the more guest facing time that we can give our stores the better in terms of conversion and ticket.

And we saw that really -- now, it's really just a matter of, to what extent do you want to invest and how much is the return?

But we know over time, with the supply chain investments and IT investments, that these -- the customer-facing hours will naturally become more available to our associates and stores.

It will just take a while for those to play out.

So as we build our plan for 2015, we'll certainly be taking those learnings into consideration.

I don't expect that there will be a wholesale dramatic change to our store staffing model, but certainly, whether it relates to markets, volume levels, categories, there's a lot that we can play with there.

Okay.

And then just a follow-up.

You talked about 100 full-size store openings for 2015.

Could you talk about what that implies about that smaller 5,000 square foot box?

Is it still in test mode?

Or could that be maybe an incremental add to the 100 plan for next year?

Yes, it's still -- our overall plan, in terms of our store growth, really was about the traditional store format, the large store format.

And we have always said that the small store, we would see as incremental to that.

I'm not sure exactly when we're going to start doing more of them.

So far, we have two.

The test is early.

We're really pleased with the results, but it is a different operating model.

Everything from learning about how to manage the fact that we have fewer SKUs in the store, so making sure we can allow our guest to be able to order from the store and have it shipped to her home.

A different kind of labor model, certainly a different kind of replenishment model.

So all those things will take a little time.

We like what we are seeing, but we really want to make sure that, as we expand this concept, and we are encouraged about that, but that we really set ourselves up for great success as we do that.

And it's really key for us, we want to monitor during the holiday season now, because of the spike in sales and the number of footsteps that come through the door, to make sure we can manage all that, and to the levels that we want.

But we are encouraged.

Yes.

Thank you so much.

Dana Telsey, Telsey Advisory Group.

Good afternoon, everyone.

As you think about the services component, if you have a percentage of sales target from services, and as you look beyond brow bar, are there other services that you may add?

And how their margin and contribution is versus product?

And then lastly, given that these salon customers spend 2.5 times more than non-salon guests, and shop more frequently, do you see -- how do you see that interacting with the loyalty program?

Since now they represent less than 7%, could it be more?

Thank you.

Yes, absolutely.

We -- one of the reasons that it's one of the pillars that we put into our strategic plan is that we're very excited and committed to the notion of services as a growth driver for us in the future, for all the reasons that you understand, right?

So I think, Dave, we mentioned this.

This is our best guest.

The service salon guest comes more frequently, and spends more than any other guest.

And it really enhances our beauty authority.

And it also enhances the sort of bricks and mortar reason for being.

There's many others than just that, but it is certainly part of the equation that we think is part of our unique proposition, right?

The services and the breadth of categories and types of brands all in one place.

So we have just started, I'd say, in this.

We're already doing some CRM to make our -- get our current loyalty members aware.

And we've seen positive response on that.

We've added this online booking tool, which drove a lot of new guest acquisition, which was great.

A small number so far, because we just started, but 80% of those folks booking online were new guests to us.

So I guess the other thing to think about, in terms of the types of services, we want to be really known and great at what we're really known and really great at, which is salon, which is about hair, our brows and our skin services through Dermalogica.

There's a lot of growth that can be had within all of those, and that's what our focus is going to be, versus continuing to add new services.

New services would be added within the context of the service pillars that we already offer.

So for example, in hair, you can imagine there's lots of things, whether it's even doing even more blowouts, which we do today, or special occasion hair.

In brows, we just started doing something just for holiday, which is about blinging out brows.

Did I get that right, Janet?

(laughter) But besides tinting, doing fun brow services that add a special holiday sparkle, I guess I would call it.

So there's lots of ways to -- I think to grow within the service core that we have today.

Thank you.

Steph Wissink, Piper Jaffray

Hi, good afternoon.

Sorry about that.

Just a question quickly on your mobile traffic to your site.

Have you been tracking that?

Anything you are learning from your mobile app?

Thank you.

Yes, we absolutely continue to see that taking -- becoming a bigger and bigger part of our overall business.

And the -- yes, strong growth in the third quarter.

And we've seen that actually continue.

So we launched a new iPad app in the third quarter.

We've seen that increase.

We will expect to see during peak periods that both traffic can be up to 50% of our traffic can be through our mobile applications, any of our mobile applications.

A little less of the orders, but certainly the traffic engagement and learning of our products would be increasingly on one of our mobile applications.

And so we're investing heavily to make sure that's a strong part of our plan going forward.

Ladies and gentlemen, at this time, there are no further questions.

I would like to turn the floor back to Management for closing comments.

I just want to say thank you all for your attention and interest in Ulta.

And to all the Ulta Associates for a great job in the third quarter, and your readiness and execution for the holiday season.

So thank you very much.

Thank you.

Ladies and gentlemen, this concludes today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.