Ulta Beauty Inc (ULTA) 2015 Q2 法說會逐字稿

Greetings and welcome to the ULTA Beauty second-quarter 2015 earnings 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 second-quarter 2015 conference call.

Hosting our call are Mary Dillon, Chief Executive Officer and Scott Settersten, Chief Financial Officer.

Also joining us is Dave Kimbell, Chief Merchandising and Marketing Officer.

Before we begin I would like to remind you of these companies Safe Harbor language.

The statements contained in this conference call, which are not historical facts, may be deemed to constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the Company's filings with the SEC.

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

During the Q&A session, we kindly request that you ask just one question to allow us to have time to respond to all of you during the hour scheduled for this call.

I'll now turn it over to Mary.

Thank you, Laurel.

Good afternoon, everyone.

I'm pleased to report excellent second-quarter results for ULTA Beauty with strong sales momentum and better-than-expected earnings growth.

To recap the headlines sales grew 19.4% and we achieved a 10.1% total Company comp on top of a 9.6% comp in the second quarter of 2014.

Transaction growth accounted for about two thirds of our comp with average ticket growth contributing about a third.

We continue to gain market share across all of our categories with both prestige and mass color cosmetics achieving the strongest growth.

Each of our businesses contributed healthy comp sales: an 8.8% comp in retail, a 10.1% comp in salon, and 43.4% growth in e-commerce.

Earnings per share increased 22% to a $1.15, compared to $0.94 in the second quarter of last year.

Scott will share the details of our second-quarter results in a few minutes, but first I'd like to provide our quarterly business update through the lens of our six strategic imperatives, the framework we're using to drive sustainable sales and earnings growth and long-term shareholder value.

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

Our loyalty team is driving great performance through the critical ULTAmate Rewards platform, which drives well over 80% of our sales.

We now have 16.1 million active members, up 18% over the prior 12-month period.

Our store associates are doing a fantastic job converting guests to loyalty members, and they achieve a significant increase in conversion, leading to an acceleration in new member growth.

Member retention rate increased and we continue to see higher frequency of purchases, higher average ticket and higher average sales per member.

As part of our efforts increase awareness of and clarity about the ULTA Beauty brand, we've re-launched our brand communications across all touch points to create an integrated message and consistent visual look and feel that positions ULTA Beauty as delivering the fun side of beauty.

We believe this work sharpens and differentiates ULTA Beauty in the marketplace and shapes our brand equity through a coordinated approach across all of our marketing vehicles, including advertising, emails, ULTAmate Rewards materials, web site and mobile apps, digital ads, store signage, social media and customer magazines.

Based on our successful 2014 test market comp our plan is to include national television advertising to support our upcoming 21 Days of Beauty next month, as well as again for the important holiday season.

This national television advertising campaign marks a first in ULTA Beauty's history, an important step towards driving a strong and sustainable brand position, while increasing awareness among beauty enthusiasts and driving new guest acquisition.

The second strategic imperative is to differentiate by delivering a distinctive and personalized guest experience across all channels.

We continue to make progress here with in-store technology, associate training and evolving the labor model to increase guest facing time.

We've also had some nice ways of enhancing personalization through our marketing tools.

Let me give you a few examples.

As we continue to improve our ability to personalize our emails and make them more relevant to our guests, we are seeing very positive results.

By leveraging insights about customer preferences and behaviors, we are able to tailor our communications to be more targeted and more motivating to our guests.

During the second quarter, sales per email delivered increased significantly year over year as a result of this approach.

We launched personalized display ad in the second quarter to better target ads that are relevant to customer attributes and shopping behavior, moving away from predominantly static ad formats towards more dynamic ad formats.

In addition, we are leveraging offline and online customer insights to make our online advertising more effective.

Now turning to ULTAmate Rewards loyalty program, we continue to reward our best guests with a differentiated experience, driving increased engagement and satisfaction.

In the second quarter, our Platinum members, our guest to spend more than $400 with ULTA Beauty during the year, received many perks including Platinum-only beauty steals, Platinum bonus points offers, early access to new products, a Platinum social contest, free shipping offers and targeted surprise and delight gifts.

Now moving to the third strategic imperative, which is to offer relevant, innovative and often exclusive products that excite our guests.

News and innovation was strong in the second quarter and Prestige Color Cosmetics remained our best comp in category.

Sales growth was driven by newness across the board, including innovative foundations from Too Faced and Smashbox, Urban Decay's matte lipsticks in the excited Naked Smoky Palette, as well as continued rapid growth in It Cosmetics and It Brushes for ULTA.

The contouring trend is still going strong and the newer transfer strobing, or highlighting, drove comps in contouring kits and highlighters with newness from Anastasia, Lorac, Laura Geller and Tarte among the best performers.

We continue to rollout Clinique, Lancome and Benefit boutiques and all these brands executed very strong product launches, such as Benefit's Roller Lash mascara, Clinique's Pop lip color and primer, and Lancome's Cushion compact foundation.

In addition, we are planning on expanding our Lancome presence by launching five of their best selling items into every store, not just those with Lancome boutiques, starting next week.

This full chain expansion is a further demonstration that our business model is successfully driving incremental growth for key brand partners.

Mass cosmetics continues to grow as well.

Performing well above industry growth rates.

Mix, Maybelline and L'Oreal were growth stand outs, driven by newness and innovation.

We also introduced two popular indie brands from the UK, Makeup Revolution and Catrese into our mass cosmetic assortments on ULTA.com and in a limited number of stores.

The mass category was also helped by solid growth in private label.

We reset the ULTA Beauty collection in more than 300 stores at the end of the quarter with enhanced presentation, as well as new formulations.

The well presentation is updated with color shelf strips and tester tile graphics, making it easier to shop, as well as more efficient for our associates to stock the fixtures.

We also introduced a Fresh series of ULTA beauty kits, offering great value and products that leverage current trends, including contouring, primers and brows.

The hair care category was also a big focus for us in the second quarter.

We kicked off the quarter with our Love Your Hair event in May featuring daily Beauty Steals, in-store events and live chats.

July was headlined by our leader event featuring great fields on jumbo sizes of hair care products across all categories and brands.

We also executed an extensive reflow of our Pro Hair planogram at the end of the first quarter, which refreshes our assortment and introduce clear solutions based signage to improve the guest experience.

We believe this helps us set the stage for the most successful leader event in our history.

Our merchants inventory and store operations teams worked closely together to ensure strong execution and in-stop levels throughout the event.

And this drove significant acceleration in the growth of core brands like Redken.

This is a great example of how we can optimize growth on existing brands through a combination of guest insights, brand partnering and strong internal collaboration.

Other second quarter brand launches included several fragrance introductions, Sanzia hair care appliances and Pacifica skin care products.

Next our fourth strategic imperative, which is to deliver exceptional services in three core areas hair, skin health and brows.

Our salon business continued to grow nicely achieving total sales growth of 19.7% and comp growth of 10.1%, as we continue to improve our offerings and sharpener messages to our guests.

Capital categories were haircuts and color, blowouts and makeup services.

Our comp was driven by about two thirds guest count growth and about a third by average ticket.

Particular strength in new guest acquisition was driven by online booking and CRM campaigns with targeted offers for first-time guests.

We continue to track new guests by offering services like blowouts and quick skin services.

Promotions included offers to get the perfect blowout, special events featuring Living Proof's Perfect Hair Day products, and 25% off our 20-minute Dermalogica microsome skin treatments for first-time salon guests, all very successful.

But during the second quarter we also trained all of our salon associates on the new fall and winter trends, which were developed in partnership with Redken and renowned stylist Rodney Cutler in support of high quality training materials, which integrate new styles for haircuts and colors with makeup trends for the very first time.

This included product recommendations and technical instructions to how to get the various styles.

And I'm sure you might be winter with some of those might be, so a couple of examples: tortoiseshell hair with a suede eye and a rose blonde look with a petrol eye.

Now these enhanced training sessions were very well received by salon associates.

We are now presenting these looks and trends in our integrated marketing plans across all associate and guest touch points.

Turning to our fifth strategic imperative to grow stores and e-commerce to reach and serve more guests, we opened 20 stores during the quarter and ending the second quarter with 817 stores.

New store productivity continues to be very strong for the class of 2015 new stores, which are comfortably exceeding their sales plan.

We remain on track to open approximately 100 net new stores this year with plans to open 44 stores and in the third quarter and about 15 in the fourth.

The real estate pipeline for 2016 looks very good as well and we've already approved a significant number of sites for next year's store growth plan.

The two 5,000 square foot rural stores, which we opened last fall, continue to perform very well.

We are encouraged by the results and we are still gaining insights on operating a smaller box efficiently.

We intend to open more of these small stores when we have the systems in place to make this format more scalable.

Meanwhile we've opened several stores in smaller than average markets with our 10,000 square foot format that are exceeding expectations, like our new store in Pikeville, Kentucky.

So we are very confident that rural markets represent a significant and incremental opportunity for our store opening program.

Insights from operating smaller format stores will also benefit us as we look ahead to urban and other market opportunities.

On the e-commerce side ULTA.com continues its rapid growth, with sales up 43.4% contributing 120 basis points of the total Company comp of 10.1%.

The ULTA.com and loyalty teams continue to see excellent results from implementing more targeted, digital marketing strategies to drive traffic to the site and guest insight to drive trial offers and incremental purchases.

Sampling is a key driver of growth on ULTA.com.

Along with our brand partners, we've had strong success with our signature online offers, such as our monthly beauty bags with deluxe eye samples and limited time Beauty Steals that drive awareness and trial.

Our beauty enthusiast guests love these offers and brand partners also enjoyed working with us through our CRM platform to get their samples to the right targeted segments of our customer base.

We continue to score other areas to drive trial and discovery as well.

The website has been rebranded to incorporate the new elements of the brand personality and color palette and guests have responded very positively to these changes to the online experience.

We also continue to benefit from new brands that we've added to our website including Lancome, Redken, Matrix, Pureology and It's A 10.

And finally, we have much to report on our sixth strategic imperative to invest in infrastructure to support our guest experience and growth and capture scale efficiencies.

We celebrated the grand opening of our Greenwood, Indiana distribution center on August 3. We started the first small number of stores and e-commerce orders.

We launched with six stores and we are now gradually ramping up the facility, which is operating on a completely different model from our existing DCs, and includes all new systems and material handling equipment.

While it's still early, we are delighted that the DC is off to a smooth start, the culmination of two years of hard work and collaboration across supply chain, IT, stores and the e-commerce teams.

This DC will ultimately ramp to service 400 stores and 45,000 e-commerce orders when it reaches its full capacity over the next few years.

In addition to a more efficient operating model within the distribution centers, our stores will receive fewer, fuller and more stable cartons, shipments will feature greater categorization, which makes it easier for our store associates to get product from carton to shelf, freeing up labor hours for customer-facing activities rather than tasking.

So we're also implementing a number of core merchandising systems and tools to drive productivity as part of the overall supply chain initiative.

For example, this fall we'll launch a product information management system that integrates vendor information into ULTA Beauty systems and aligns product information across all channels to improve data governance.

We also plan to rollout a vendor scorecard to collaborate with our brand partners to drive improvements in performance, such as improved inbound lead time consistency, leading to better in-stock levels and an improved guest experience.

We'll also start to rollout our demand forecasting and inventory optimization tool, which provides forecasting replenishment models to improve supply chain capabilities.

This tool will help us drive higher sales and less clearance and improve vendor fill rates, as well as lead to better in-store presentation and higher in stock levels.

We plan to launch one category this fall, then rollout the system to all categories next year.

And finally we are on track to open up our fifth distribution center in Dallas next summer and all the merchandising systems and tools that we're in the process of implementing will work together to support our growth plans and improve the guest and associate experience.

In the aggregate, these new distribution centers, projects and systems are expected to drive significant long-term efficiencies to optimize our supply chain for product source to guests and help us deliver the financial results we've committed to in our five-year plan.

That wraps up my update on the strategic imperative, so now I will hand it over to Scott

Thanks, Mary.

Good afternoon, everyone.

Second-quarter sales were $877 million compared to $734 million last year, an increase of 19.4%.

Comparable sales increased 10.1%.

The retail comp was 8.8%, the salon only comp was 10.1% and e-commerce growth was 43.4%.

The total Company comp was driven primarily by traffic strength, with transactions up 7% and ticket up 3.1%.

Similar to the trend we've seen for the past few quarters, ticket was driven by higher average selling price as a result of strong sales and prestige categories and less reliance on broad discounting.

Retail only comparable transactions were very healthy, up 6.3%, even stronger than what we achieved in the first quarter.

E-commerce growth was driven primarily by traffic, but average ticket also increased.

Gross profit dollars were up 18.2% to $306.5 million, but gross profit margin de-leveraged 40 basis points to 34.9% from 35.3% last year.

Gross profits benefited from improvement in product margins due to higher mix of prestige products, offering a more complete assortment on ULTA.com and less discounting overall.

These benefits, however, were offset by planned supply chain investments, including the startup of our new distribution center in Greenwood, Indiana.

SG&A expense increased 16.6% to $183.9 million, down 50 basis points as a percentage of sales to 21% versus 21.5% last year.

The key driver of this improvement was marketing expense leverage, partly due to stronger-than-expected sales, but also as a result of concentrating more of our marketing expense later in the year.

We still plan to keep marketing as a percentage of sales flat for the full year, since we will be ramping up our marketing spend in the second half to drive brand awareness through national television and radio campaign.

Pre-opening expense was $4.1 million compared to $3.6 million last year, driven by 20 store openings, one relocation and two remodels during the quarter, compared to 19 new stores opened and four remodels completed during Q2 2014.

Operating income increased 20.9% to $118.5 million.

Operating margin was up 20 basis points versus last year to 13.5%.

Our tax rate was 37.5% versus 38.1% last year, driven primarily by the impact of accounting for equity compensation transactions.

Net income increased 22% to $74.2 million, or $1.15 per diluted share versus $60.8 million, or $0.94 per diluted share last year.

Turning to the balance sheet and cash flow, inventories were $705.7 million at the end of the quarter, compared to $541.5 million at the end of Q2 2014, up 14% on a per store basis.

Excluding the investment in inventory to stock the new DC in Greenwood, inventory per door was up 10.9%, roughly inline with our comp growth.

This increase was related to maintaining strong in-stock levels for fastest turning SKUs to support our rapid sales growth, the addition of new brands and the rollout of Clinique and Lancome boutiques.

Capital expenditures were $80.6 million for the quarter driven by our new store opening program, merchandise fixtures and supply chain and systems investments.

We are on track to spend about $300 million in CapEx this year.

Depreciation and amortization for the second quarter were $39 million and are expected to be about $170 million for the full year.

We ended Q2 with $475 million of cash and short-term investments.

The Company repurchased approximately 291,000 shares at a cost of $46 million during the quarter under our 10b5-1 plan, as part of our program to return cash to shareholders.

As of the end of quarter, $286 million remained available under the $400 million share repurchase program.

We expect to continue to offset dilution with our 10b5-1 plan and still have the flexibility to repurchase opportunistically beyond that.

Turning now to guidance for 2015, in terms of our outlook for the full year, based on our strong performance in the first half, we are raising our sales and earnings expectations for the year.

We expect to open approximately 100 stores in 2015 and remodel four stores.

We plan to grow e-commerce sales in the 40% range.

We expect to drive comparable sales in the 8% to 10% range.

We expect to deliver earnings-per-share growth in the high teens from the $3.96 of adjusted EPS we delivered in 2014, which excludes the $0.02 nonrecurring tax benefit in Q4 of last year.

This guidance includes planned supply chain and systems investments, and assumes we continue to repurchase shares to offset dilution.

We expect to deleverage on the gross profit line and modest leverage on the SG&A line and operating margin is expected to be about flat.

As a reminder, much of the investment related to our supply chain project will hit gross profit, including higher depreciation expense, which you'll really begin to see in the third quarter.

We expect our tax rate to be approximately 38%.

We expect to spend capital on a $300 million range and to generate free cash flow similar to last year's performance.

We are very pleased to raise our annual comp guidance and earnings outlook, to deliver high teens earnings growth while making significant investments in the business to drive sustainable, long-term market share gains in shareholder value.

Moving onto specific guidance for the third quarter, we expect sales to be in the range of $869 million to $883 million, compared to $745.7 million last year.

We anticipate achieving comparable sales in the range of 8% to 10% versus 9.5% last year.

We expect to open 44 stores in the third quarter versus 50 stores opened in Q3 last year.

So pre-opening expense expected to be down slightly.

Earnings-per-share expected to be in the range of $1 to $1.05 versus $0.91 for Q3 last year.

We anticipate a tax rate of 36.9% and a fully diluted share count of approximately 64.2 million.

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

Operator?

(Operator Instructions)

Stephanie Wissink, Piper Jaffray

Thank you.

Good afternoon, everyone.

A few question for you.

Mary, if you could just start with some of the new brand initiatives.

We've seen some of the rollouts in-store as well as some of your digital communication.

Can you talk about some successes there and how you're thinking about strategically deploying across some new initiatives for the back half?

And then just a question on the DC.

Can you remind us, once that DC is fully up and fully running what the total store capacity will be of your existing infrastructure and when you may need to invest again to support the next rollout of some of the smaller format stores.

Thank you.

Well, let me just say that the newness that you asked about, I think it's really -- we constantly know that our guests are interested in news and innovation, and as I mentioned there are several things that were quite successful in the quarter.

So brands like Benefit and Urban Decay with the Smoky Palette, brands like Anastasia, across all categories Redken Frizz Dismiss, Mix is a hot brand, so there was really a lot of newness, as well as existing brand newness, new brands and just core brand growth.

And how that works in terms of our platforms, in terms of marketing, is that is really where we bring it all together.

It's just making sure that our guests get to understand what we have that's new and exciting.

I think our marketing tactics are breaking through the herd in even better ways all the time.

So that's going to be a core part of what we do, and I think we're getting better at it all the time, more efficient and more effective.

In terms of distribution centers, this new DC will serve the 400 stores, 45,000 e-commerce orders, we are planning another distribution center that's in development and construction right now in Dallas.

It will open next year, and that will be sufficient for the capacity that we need for some period of time.

We'll continue to evaluate that.

Whether it's small or large stores, we would anticipate that to be covered in the network that we're defining, but certainly that's fluid as we continue to grow and look out to the future, we'll continue to evolve that strategy and our needs.

Thank you.

Best of luck.

Thank you

Oliver Chen, Cowen and Company

Congratulations on really spectacular growth here.

Regarding the holiday plans and inventory optimization, which categories are most ripe for that process and will that impact holiday?

Some retailers are potentially, in different categories, are potentially over inventoried in the marketplace, so how should we think about the main catalyst for you and holiday at large, and what might be most different on a year-over-year basis?

Well thank you, Oliver.

I'd say broadly speaking holidays season we've been focused on for months.

We are excited about it, it's clearly something that is important to us and to our guests, as well.

I guess what I would say is that we just try to be clear about making sure that we've got adequate inventory for what we expect to be our top volume items, and we think we're in good position to do that.

So I would say that we look at that as a core part of how we do business.

Given our growth trends and, I think, our ability to really understand what's going to move, we don't have big concerns about things that don't work during holiday.

I think historically we've able to manage that really well and have a low amount of products that don't work well, so I think we're good shape there.

Is there anything you would add?

I would just add that we don't really have any concerns about our inventory position.

Again, very little in the way of seasonality and what we carry in our stores.

I think we probably have one of the best-in-class in retail as far as the ability to work through discontinued product or clearance things and partnering with our brands vendors to do that in the most profitable way possible.

Okay.

Just a quick follow-up on the mobile front.

Where are you in the aims of innovation there, and what are the next chapters for us to look forward to as this customer seems really engaged on the mobile frontier, as well?

I'll take let Dave take that.

That's great, Oliver.

Mobile, obviously, is continuing to grow for us and it's increasing in the way consumers want to engage with brand and shop.

For us in the second quarter, about 60% of our traffic came through on our mobile applications, mobile website and about 25% of our sales.

We're well past early innings on the impact that it's having in the marketplace and we're continuing to optimize the experience in our total digital footprint, of which mobile is a critical one.

Where we are improving our app pretty significantly and trying to make that shopping experience easier once she's on our mobile website, all the changes that we're making around trying to increase conversion and increase average order, that were doing both on the desktop service as well as mobile are having an impact.

So we're trying to sharpen how the offers that we're highlighting, maybe we can personalize emails and drive her to the mobile website.

So a lot that were doing, and it will continue to increase, it's clearly the way that she wants to shop and it's a big area of focus for us going forward

Thank you.

Best regards.

Daniel Hofkin William Blair

Good afternoon, I'll echo the terrific results.

Just a little more color, if I could, in a general trend within retail and omni-channel retailers, obviously, e-commerce sales and sometimes coming at the expenses of the in-store business, clearly that does not seem to be happening with you guys seeing, actually, an uptick.

Just curious what you feel like -- you talked about marketing are there any couple things that you feel like are incrementally resonating even a little bit more with the consumer?

And then, lastly, I just editorialize, I'm assuming that the Donald Trump look is not one of the fall and winter looks that you guys are considering.

We took that one off the table.

Funny.

On the e-commerce omni-channel, let me start broadly and then maybe I'll ask Dave to add some specifics.

But I think a couple things, one is that we're clear that for us, two things, one is that the multi-channel shopper is our best shopper.

She's driving a lot.

It's really pretty incremental business for us and the core insight is that the experience to go shop for beauty is one that largely women want to have happen in the physical bricks and mortar space.

And we're trying to make that store experience so inviting with the right products and the right level of service across the board and we think that's working for us and is very sustainable.

She likes to come and explore and to try and spend time there.

With services as well, obviously that's something you can't get done online.

So for us, we see that as the core part of our Business.

E-commerce is working in a way that's kind of neat because it's pretty incremental.

So the shoppers that we have that are shopping both online and in store are by far our best shoppers.

There, for example, maybe coming nine times a year versus store only, which is like four times a year and that's only a small percentage of our guests that are actually doing that, so we like that.

We think growth in e-commerce, obviously, is going to be incremental and profitable for us and fits with the consumer insight in the model that we're building.

Yes.

I'll just add to that.

Certainly we look at a total omni-channel customers as the one we are most focused on continuing to grow, and so most of the marketing efforts that we're doing are driving both online and in-store activities.

So, Mary mentioned some of the advertising programs in the second quarter a fair amount of radio advertising, enhanced digital advertising, both of which through our analysis drives both in-store and online activities.

Certainly within the digital space itself, our social media activity is increased quite a bit.

Our PR is much stronger, we're doing more with social influences to drive greater engagement and then as we roll, as Mary mentioned, to the third quarter, beyond into other tactics that we historically haven't used, like TV.

We think all of those will contribute to drive integrate a more loyal guest.

She is very attracted to our loyalty program and that behavior then gets her shopping in both channels, and that's the way that we want to continue to drive, and we've had some success to that so far

That's great, thanks.

Best of luck

Simeon Siegel, Nomura Securities International (America).

Thanks, good afternoon and congratulations.

Sorry if I missed it.

Within the traffic increase can you share the breakdown between new customers versus increased frequency of existing shoppers.

And then maybe can you talk about where you're still sourcing those customers from?

And then just, Scott, giving the moving pieces, can you help with the magnitude of the gross margin impacts of the next several quarters?

Thanks.

Yes.

I guess I'll start.

We don't really breakout new customers versus existing.

I mean we bifurcate the top and we talked about the fact that the majority of the comp, two thirds of it was transaction or traffic based, with the remainder being average ticket.

And that was primarily driven by average selling price.

So units were relatively flat year-over-year; more prestige again, less promotion, which is driving the basket increase overall.

I'd say we are excited, really pleased with our new traffic, our new guest acquisition rate.

Mary, in her comments, mentioned our membership grew to 16 million guests, so about 18%.

And that was driven by healthy increases in new guests, as well as strong retention, increase in retention of existing guests.

So we feel like we're attracting new and keeping even more of our existing guests engaged in our proposition.

And a little color specific to Q2 as far as margin goes.

We're very happy to see core product margins in our retail business, which again is more than 90% of our total sales, continued to expand.

Prestige Mix helped less promotion overall helped.

We did have a little bit of headwinds.

We didn't have as much of fixed or leverage in the second quarter as what we saw earlier in the year or what we saw in the year ago period.

We also had a litany of other smaller items that affected the quarter.

Again we normally don't get into this level of detail, but salon, for example, we mentioned in the script, Mary did, about some training for our salon associates for the fall trend look.

We pulled forward some expenses there.

So that was a bit more of a headwind than what we expected.

And we also had the start up of the DC, which negatively affected gross profit in the quarter.

Great, thanks a lot.

Best of luck for the rest of the year

Thank you

Rupesh Parikh Oppenheimer

Good afternoon, this is Erica Eiler on for Rupesh.

Congratulations on the really, another nice quarter.

So I just want to get back to e-commerce here.

I mean it sounds like you've clearly done a lot to enhance the customer experience online.

I was hoping, maybe, you could talk a little bit more about what you're seeing from consumer purchases online.

Specifically, maybe, what that the mass Prestige mix of products looks like online versus in stores.

And then also just wondering if perhaps consumers are buying more staple-like products, maybe their foundations, or go-to mascaras versus maybe shaded goods or skin care products that consumers may want to experiment with in stores.

That would be great.

Thanks.

Yes.

Great questions.

Again, we are very pleased with our overall e-commerce success, and we see a lot of runway going forward.

Specifically on some the questions, we don't really breakdown between categories, but what I would-- but your question about mass versus Prestige, what I would say is that a key part of our total proposition, e-commerce anywhere, in our brick-and-mortar, e-commerce stores, is all things beauty all in one place.

The breadth of assortment, the breadth of price points, the breadth of categories, that certainly is what drives our business and differentiates us, and we see that within the e-commerce space.

So largely I'd say the assortment and the engagement that we have in our brick-and-mortar stores is largely reflected on e-commerce.

There were some categories in e-commerce that we talked about in the past that we didn't have as full of assortment, but that much of that gap has been closed, largely in our professional hair care.

So we see that really reflecting what we see in the in-store environment.

As far as staples versus trying new things, I'd say it's a bit of both.

We certainly don't see only staple replenishment type items being bought online.

That is happening, but what we find, particularly with those guests that we talked about that are omni-channel guests, that are really our best guests, she's shopping more frequently in total across both retail stores and our e-commerce site.

And she's buying items that, yes, she can -- maybe are replenishment, but she's also indulging in things that she hasn't tried, that are new items.

She wants to get it first.

She wanted to go online right when new offers are up and available.

So she's doing a bit of both and that's absolutely the types of things that we're encouraging.

We'll find it, make it easier for her going forward to replenish those favorite items, but also continue to highlight news and exclusive and first-to-market items that get here excited when they come out.

I'll just add, and I mentioned this in the script, our CRM capability gives us the ability to experiment a lot with how to get more personalized and more customized on what we email to whom and really allow her to try things whether it's Beauty Breaks or emails that introduce her to new products.

So it's really a nice way for our guests to learn about new products and try new categories that they wouldn't have before.

Great, that's really helpful, thanks for the color.

Simeon Gutman, Morgan Stanley

Thanks, nice results.

Mary mentioned evolving labor model in your prepared remarks, can you update us on your thoughts there?

I think at analyst day you suggested you might experiment in some areas in the labor model.

And then connected to it, your being very successful with CRM and marketing, curious in places where you're testing increased labor if you're seeing a benefit above and beyond some of the success you're seeing with CRM and targeting.

Thank you, Simeon.

Just stepping back.

Only just kind of big picture wise, I guess what I would say, is that as we think about it Kecia Steelman, who's our head of store operations and her leadership team, we've got a very experienced set of store operators and we're really focused on continuous improvement in excellence and operations and guest service kind of across the board.

So while the payroll test is kind of a piece of it, just to give you a broader perspective we're really kind of thinking about how do you, but the guests and the associates servicing the guests in the center of everything we do and really a holistic approach to improvements whether it's people, processes or tools.

So that's everything from identifying the right talent, training and development, store processes, best use of labor hours, since we can talked about there, all to just really improve that guest experience.

So the payroll test is just a part of it.

We're learning things, we've extended it to another 60 stores, we've got some specific learnings.

Some things that we're trying that work differently.

I don't want to give more specific on it than that because were still learning, but certainly we are measuring impact on sales and units per transaction and whatnot.

It's a combination of art and science, it will be core to just what we do all the time.

So there's no big a-ha in one specific thing coming out of it, but think about it, it's just a piece of a broader focus on how to get better every day at what we do in the store to serve our guests.

Okay thank you

Matt McGinley, Evercore ISI

Thanks for taking my question.

My first one is on the inventory.

When we look at that 30% inventory growth you had, I think you said 16% of that was related to getting a DC in stock, and I assume some of that would be safety stock.

So I wonder what of that 16% how much is in-stock versus safety stock, and does that normalize over the year?

Or do we really need to get past the DC that opens in 2016 to see those growth rates drop?

And the second one is on advertising.

With the testing you were doing last year, I know you're happy with those test and you expressed how good they were in the test market stratagem, so my question is, as you didn't do as much advertising in the second quarter, did those markets where you did the tests in continue to outperform the rest of the Company or the Company average?

Yes.

I'll start with that.

I wouldn't want to comment about all the specific learnings.

Clearly we feel good about what we've learned it's been -- we've been modifying our marketing mix for some period of time under Dave's leadership and his team.

So what I'm excited about is that our marketing is getting more efficient and effective every day and that's really critical for us in the long term, to drive short-term results and to create a long-term strong brand and brand equity.

So that -- I'd say in the last quarter seeing we added radio advertising, we did a lot of PR, we did a lot of digital.

We also continued tactics that we've always done like tabs and magazines.

All of those are getting more effective and efficient with less reliance on discounting.

In addition now, as I mentioned, really starting next month we're going to layer in national television advertising.

We learned from in-store tests that that was going to be effective for us, so we're going to add that to the mix.

So I feel confident in saying we got a lot of good learnings out of the test and now we're moving forward, implementing all those learnings as we go.

But, you know, it's again art and science, there's never actually one answer and it's never any one stopping point, right?

We'll continue to evolve as we go.

With respect to the inventory, it was roughly $20 million at the end of the quarter, which I'd say is all safety stock because we weren't servicing any stores out of that DC at that point in time.

Right.

We started subsequent to quarter end.

So I would say we expect that to be kind of the high watermark on a per door basis for FY15.

We expect to see some moderation now the second half of the year and should stay roughly in that zone as we cycle through next year with another DC stacked on top.

So once we get through 2016, again with the fall of the systems we are putting in place, the DC forecast and replenishment, other floor planning tools, we expect all of those to help contribute to improved inventory flows and improved turns.

Okay, thank you.

Chris Horvers, JPMorgan

Thanks.

Good evening.

So wanted to follow-up on the gross margin question.

How significant was the DC startup costs and the 50 bps and would you consider it one time?

And then on a related note, can you provide some color on the magnitude of the marketing shift out of 2Q and whether those dollars spread roughly equally in the back half.

Yes, I guess with respect to the gross margin, I'm not going to quantify the basis points here.

We tried to steer away from specific P&L line guidance.

But it's going to be much more significant in the third quarter than it was in the second quarter.

Okay?

So just directionally.

Second quarter, a lot of payroll cost, right?

We've got rent expense running through the P&L because we're in startup mode.

But the depreciation doesn't really start and that's really going to be the significant incremental cost running through the gross profit line starting in the third quarter.

All right.

For all the investments and, again, we called that out in our investor communications, right?

It's upwards of $60 million, so it is a significant step up from what we've done historically.

Marketing, along the same lines, we are not trying to get too specific on what dollars moved where, but it's significant.

We saw some of the first quarter we called that out.

We saw more in the second quarter.

And, again, it's a result of us being smarter during the quarter.

We're seeing sales trends, and if we see an opportunity to pull back, we will do that, and we'll keep the dry powder for when the ducks are flying so to speak.

So, fourth quarter there's a lot of shopping, a lot of new guests coming into a lot of new stores that were opened during the course of the year, and we're going to deploy the marketing where we think it makes the most sense.

And just going back to the gross margin question.

So, understood, the depreciation steps up, but you don't necessarily have the other items sitting in there, like the salon training, which would pressure gross margin.

What I'm trying to understand is, could gross margin in the back half be down in similar magnitude as it was in the second quarter?

I don't think I want to get to that level of detail.

Again, I would just say though, there's always every quarter is standalone.

There's ins and there's outs and the salon we mentioned this time because that was a bit of an unusual item.

E-commerce was strong, right?

That leader event, that's another one-off.

It was stronger than we thought it was going to be online, which was great.

There were incremental sales, but we had additional freight costs.

It's heavier product, it costs a little bit more to ship.

We don't think it's productive to get into reconciling the basis points every quarter.

The one thing I would point out is if you're looking at next year, we got a new distribution center coming online next year, right?

Where we're going to have a lot of these startup costs and the same.

So I wouldn't expected to create the same a level of headwinds, just because you're lapping a big event like that this year, but it will be additional headwind next year.

Thanks very much.

Joe Altobello, Raymond James

Thanks.

Hi, guys, good afternoon.

First question, I just want to go back to the inventory line for a second.

I think, Scott, you mentioned earlier, obviously, that that's going to remain a bit elevated here with the new DC coming online.

When do you expect the year-over-year increase in improved inventories to migrate back to basically same-store sales growth?

Is that next year?

Well, I'd say we're going to be in the neighborhood this year, I mean look at the comp that were posting.

It's an 11 comp, so you're looking at x that 20 million of startup inventory, I'd call it.

We're at the comp level, so it's not -- I wouldn't view the inventory as being out of control in any way, shape or form.

I mean we feel very comfortable with the inventory that we have, again there's little seasonal or fashion risk in the inventory.

I mean to be frank, we spend most of our time trying to figure out how to stay ahead of the trend.

Usually we're chasing inventory.

So we are, with the cash and the balance sheet strength we have, we're not going to be shy about making some bets going into the fourth quarter on hot products.

So I would say, generally speaking, there's nothing to see here, right?

We're very comfortable with our inventory position.

Okay, that's good to hear.

And then, secondly, in terms of your decision to go into national TV advertising for the first time, why now?

Is this something that you view as a natural extension of your marketing strategy, or was this something that was debated internally or was this just an obvious move on your part?

Thanks.

You know it's really been part of our thinking all along.

It's really a part of our five-year plan.

The first strategic imperative that we described is driving new guest acquisition and more sales from our current guests.

We know that we have a gap in awareness of our brand relative to our competitors, whether it's aided or unaided.

And that television advertising is one of the tools, one the fastest tools, to drive awareness and we've been two years into it now.

So it's wasn't like we're just going to jump and do that overnight.

We carefully developed brand positioning, creative; tested it, tested the media plan.

So I feel confident the time is right.

Also I would say, we all know it's a very competitive marketplace.

It's always been, it probably always will be.

So striking while the iron's hot.

We're in a position to build a long-term sustainable business model here, and we think this is a key part of it, is to really keep pressing ahead with the marketing tools to drive both short-term and long-term results.

And we feel it's right time to do it.

We're ready to do it.

Great, thank you very much

Kelly Halsor, Buckingham Research

Hi, thank you for taking my question and congratulations on another great quarter.

I was wondering if you could talk a little bit more about this Prestige skin care category.

It's been a few quarters since you have called it out as a top performing category.

So what are you seeing in terms of trends and newness of products and brands beyond the roll out of the branded boutiques?

Are there any opportunities to add new brands, especially in light of some of the well known brands recently announcing plans to get into the specialty multi-channel in a bigger way?

And then secondly, could you provide any more color around the cadence of the DC and the store ramp up?

How many stores do you need to get to start to see some leverage on costs associated with that facility and just any timing around that would be helpful as well.

Thanks.

I'll start with Prestige skin care.

Prestige skin care, as you're probably aware, is not -- it's been a little slower than historical over the last few years.

It has gone down as a category, although we see it as a critical central category to our overall proposition, and we're excited about the potential.

I think it's a mix of great partners that we have in place today; some of our biggest, strongest brands like Philosophy, Dermalogica, Clarisonic.

Dermalogica with our partnership with skin services is a key strategic platform for us to continue to engage our guests and not only have her engaged in products, but have her engage in services.

So we see those largest brands continue to grow and provide opportunity, both today and some of the innovation, a pipeline that we know that they're going to try going forward.

There are additional brands in our box that are relatively new or newer, or up and coming.

So a brand like Juice Beauty is a nice brand that we're excited about and is performing quite well.

There are, to your question, there are certainly additional brands that we don't carry today.

I'm not going to talk about any of them, but specifically, but certainly our brands that we're continuing to explore.

We have a full team dedicated to exploring, figuring out which ones would make most sense in our proposition and in our box going forward.

So we'll continue add innovation in the skin care category.

We see it as a mix.

You're right that there's been a fair amount of, I guess, consolidation.

We're (inaudible) is playing a bigger role in Prestige skin care.

We think that's probably only good to get greater emphasis on a category, some new resources and we think it will drive growth going forward

And, Kelly, the short answer on the leverage question on fixed cost, is we would expect we expect to see benefits from the Greenwood facility.

We expect to see some benefits next year.

Of course, those will be masked somewhat by adding another new DC in the Dallas area.

Meaningfully, 2017, I think, is where you would we be able to see more presence of leverage on the P&L overall.

Mark Altschwager, Robert W. Baird

Good afternoon and great quarter.

Kind of a bigger picture question and, Mary, we've seen growth in popularity of these beauty subscription services, I think one of your competitors actually has recently announced a launch in that area.

Can you just give us your thoughts on the merits of that model?

Is it something ULTA loyalty guests are asking for?

Something you could see ULTA doing in the foreseeable future?

And, maybe, any comment on where your capabilities lie there given the new DC investments?

Thank you.

Yes, I'll take that, Mark.

We see the real benefit of that whole space as fundamentally driving trial and discovery of products for our guests and that's something that we've been focused on for a while.

We do a lot in that space, we do not currently offer a exact subscription-based model, similar to some of the other ones that are out there.

And we'll explore all our options going forward, although I would say what we're really focused on finding what we think are probably even better ways to drive that discovery and trial.

You know we do a lot with our guests to provide products.

We do programs through our e-commerce platform, Beauty Breaks, which are weekly limited time offers that give half prices and samples associated with it.

We have Beauty Bags that are extremely popular, that give premium size samples to our guests.

And we feel they're more targeted and more relevant, we often partner those with buy-ins on certain products, so our customers are more engaged in it, they are expecting these products to come along with it.

So their usage, we think, is really good.

We are also experimenting in another variety of different ways, again trial and discovery.

For example, recently we had program, with a very popular YouTube blogger created a sample bag with her favorite items that was exclusively made available to her followers with a buy-in on our website.

So we think it not only drove business, it drove engagement, it sampled products and discovery.

So the whole space around trial and discovery is one that we think we're very active in.

We've reached hundreds of thousands of guests with those kind of programs.

We'll continue to drive that kind of program going forward because it excites our guests.

We get them engaged in more and more of our products going forward.

Thanks, Dave, and best of luck

Dana Telsey, Telsey Advisory Group

Good afternoon, everyone, and congratulations on the terrific results.

As you think about the new guests that are coming in, whether going to the salon or even in the store with Prestige, do you think these salon guests, how many of them are coming from loyalty programs, how many of them are coming from the marketing efforts that you're putting into place and what does this mean for conversion into loyalty members going forward?

Thank you.

I'm glad you asked that because it's an exciting area for us in terms of future growth because really a small percent of our loyalty guests today are using the salon.

We are doing a lot.

I'd say it's coming from a lot of things.

One is we've offered a new online booking service that we know is driving largely incremental new guests, thousands of them in fact.

And then also our marketing programs right now are getting more and more focused on integrating makeup and hair and trends and they're very exciting.

I think we're actually bringing to our store associates this kind of trend training that we talked about, bringing it to life inside the store.

And certainly every get that comes into an ULTA store whose a potential new loyalty member, our associates in-store are doing great job of converting them into the loyalty program, because they understand that that's important for the business.

So all those items will work together, we think, and will continue to be a key part of our growth story.

Thank you.

Mike Baker, Deutsche Bank

Mike, did you have a question?

Hi, sorry about that.

I did the old mute thing.

You talked about in prepared remarks a metric of sales per email sent out, which is an interesting metric.

Can you give us more color on that?

How long have you measured that?

Has the growth accelerated at all, or what does that look like in the past?

Thanks.

We won't get real specific numbers on it, but it is something that we've measured for a while and we are seeing really, really healthy growth.

And that growth in effectiveness of our email campaigns is really fundamentally coming from, I'd say, two places.

One is better targeting, so we are understanding our consumers' desires, we think, a little bit better, and personalizing the emails to them.

And then the offers, the items and the creative that surrounds them we think is better as well.

So the emails themselves are better, better items, better offers, better programs that are personalized in much sharper ways, and those things have really worked well.

So we are sending out more emails, but we're getting much more effective and efficient in doing it and we think it will be a big growth driver for us going forward.

Okay, thanks, that makes sense.

If I can ask one other.

Just on the supply chain, I assume we're still in line for that hit this year to be 5 percentage points relative to your earnings growth and does that peak?

It seems like that's going to peak probably around the third quarter.

Is that right?

That's correct, you got that.

Yes.

Third quarter when we flip the switch at the beginning of the third quarter, and that's when it was, right, just doing a store or two and now we're to ramp it up, and it will get more efficient over time.

And as we get into the fourth quarter, it's going to service 130, 140 stores.

So at that point it will be more productive and be contributing more or less drag overall, I guess I should say.

Understood.

Thanks very much.

Appreciate it.

Aram Rubinson, Wolfe Research

Hello, thanks for taking my question.

It looks like we're in overtime here.

A lot of retails have struggled with trying to reduce promotions and still hold sales.

You are one of the few where you've actually pulled back on promotion and sales have held or accelerated.

I know you're still using pretty blunt instruments when it comes to CRM and customer knowledge.

I'm just wondering is there potentially another round of that as you look at kind of the response that your customers have had to it?

Do you think that if we, or you, decided to pull that lever again you might be able to go another round, perhaps a bit more surgical, but almost repeat that same exercise?

You know I would say that I don't know that I envision another big change here.

This is a gradual process, that we've been working on really for some period of time, which is the kind of the careful experimentation, testing and learning, trying things differently and changing such that our marketing mix now -- I wouldn't say it's blunt instruments so much anymore.

I mean, I understand your question, but I think we now have a really robust array of tools that are getting better and better as it relates to effectiveness and efficiency.

So I would just consider this a core part of how we're going to always do our Business, which is constantly look for how can we be driving long-term brand equity, which is really important if you understand what ULTA is and they're aware of us.

They understand that we are all things beauty, all in one place.

And then lots of surgical tools to drive the short-term, day-to-day results that we need.

So it's an ongoing piece of how we're going to do the business, Dave and his team are all over it.

And that's how we look at it.

Let me ask you another way, if you were to look at your level of promotion today versus the brand equity you think ULTA deserves or warrants, do think those two are in balance now or are they still a little out of balance?

And which way?

Well, we're really just starting the national television advertising, as you know.

So that's another kind of shift in the balance of the mix.

I envision that we'll be able to hold our A-dash ratio pretty consistent over time with the mix being getting more in balance, but I'd say it's getting there gradually.

It is not wildly out of balance.

I think we're moving into a place that will be pretty sustainable for the long term.

Thanks.

Good luck with the new DC.

Thank you.

Ms. Dillon, it appears there are no further questions at this time.

Would you like to make any closing remarks?

Yes.

In closing, I'd just like to say I'm very proud of the excellent results that the associates across ULTA Beauty are delivering while making significant progress on all of our initiatives, marketing, merchandising, supply chain.

I want to thank you for your interest in ULTA Beauty and we look for to speaking with you again soon.

Thank you.

This concludes today's teleconference.

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