Ulta Beauty, Inc.
Q2 2016 Earnings Call Transcript

Published: 26 Aug 2016

[Operator:]

Greetings and welcome to the Ulta Beauty 2016 Second Quarter Earnings Results Conference Call. At this time, all participants are in a listen-only mode. An interactive question-and-answer session will follow the formal presentation. [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, Vice President of Investor Relations. Thank you. You may begin.

[Laurel Lefebvre:]

Thank you. Good afternoon and thank you for joining us for Ulta Beauty's second quarter 2016 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 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. During the Q&A session, we respectfully request that you please ask just one question to allow us to have time to respond to as many of you as possible during the hour scheduled for this call. I will now turn it over to Mary.

[Mary Dillon:]

Thank you Laurel. Good afternoon. Our team achieved another quarter of excellent top and bottom line performance, while making significant progress on many elements of our growth strategy. Highlights of the quarter includes the continued impact of a strong pipeline of newness and innovation in merchandising, progress in growing our brand awareness, reaching major milestones related to our loyalty program, continued rapid growth in our e-commerce business, and successful execution of our supply chain investments. To summarize our second quarter financial performance, total Company sales grew 21.9%, and comp sales rose 14.4% on top of 10.1% comps in the second quarter of 2015, driven by healthy gains in both transaction count and average ticket. Strength in cosmetics both mass and prestige continues to be the biggest driver of our growth, but our other major categories are contributing as well. e-commerce performance was very strong and the salon business achieve solid top line growth. We delivered earnings per share growth of 24.3% despite significant investments in the business, including the opening of our new distribution center in Dallas, implementing core merchandising systems, and rolling out a large number of prestige brand boutique and related store remodel. Let me cover some of the highlights driving our performance in the second quarter. Starting with our efforts to acquire new customers, our loyalty programs surpass the 20 million member mark and now boast 20.6 million active members, growing more than 27% year-over-year on a rolling 12 month basis. We believe our evolving marketing strategy with a growing focus on multimedia advertising and digital marketing is working to raise our profile in consumer awareness and to better define our brand. Once people discover Ulta Beauty our store associates continue to do a fantastic job, signing them up for our ultimate rewards loyalty program. Retention rate, sales per member, frequency of purchase and average member ticket remains very strong. We are also very excited to launch our new ULTAmate Rewards credit card program chain-wide just a few weeks ago. We now offer members an Ulta Beauty private-label credit card which can be used in any of our stores and at ulta.com and we offer a cobranded credit card which can be used wherever MasterCard is accepted. Our team is still working diligently on this project for more than a year designing a program we know our members will love, upgrading our POS systems, preparing our store associates, and developing a robust marketing program. It's a great example of enterprise-wide collaboration across multiple areas of the business. The credit card is designed to enhance our Ultimate Rewards program by offering greater benefits to our members, which we believe will drive increased engagements and loyalty. While we don't expect this new program to have a material impact on our results in the short-term, early indications are quite positive and we believe this will create tremendous value for our guests and our Company over the long-term. Our marketing mix continues to evolve with increased use of television, radio, digital, and social media and less reliance on traditional print vehicles. During the second quarter, we executed a successful Gorgeous Hair event, supported by national radio and visual campaign. Reflecting our 2016 focus on the lip category, we continued our Lip Happily Campaign and launched the hash tag ThisIsHowILip digital campaign with native content integration, influencers, dedicated emails, video and banners with mass reach beauty sites like Vivala, Refinery29, and POPSUGAR. Now turning to merchandising. Newness and innovation continues to drive the business. We are seeing ongoing strength in both mass and prestige cosmetics with impressive growth in Urban Decay, It Cosmetics, Nyx, Anastasia, Too Faced, Tarte, Clinique, Lancome, Benefit, Maybelline, Real Techniques and the Ulta Beauty collection. The professional hair care category was also strong, anchored by great execution of the signature Ulta Beauty promotion our leader event featuring compelling prices on jumbo sizes of salon hair care brand. New items contributed significantly to the overall comp. Noteworthy additions included Urban Decay's new assortment of 100 shades of Vice lip stick. The introduction of Anastasia's color cosmetics, the launch of Soap & Glory cosmetic, hundreds of new SKUs from Nyx, and innovation in the nail category with Essie's Gel Couture nail polish featuring up to 14 days durability. We added several new limited distribution brands including Shiseido, E.l.f., Gillette, Drybar, Maui Moisture and Vita Liberata. We also expanded clearance skin care to additional stores and rolled out BECCA cosmetics to almost the entire chain. The Ulta Beauty collection continued its rapid growth with new products and an upgraded presentation, which includes a new wall layout and improved graphics. We are also improving the shopping experience with our chain-wide tester program for the Ulta Beauty collection as well as Nyx within the mass cosmetic assortment. We are very pleased with the strong execution of a large number of Clinique and Lancome boutique installations that are planned this year and the stores are excited to introduce these prestige brands to our guests. We will continue to enhance the overall assortment with a strong pipeline of brands for the rest of the year and many more brands in the wings for 2017. Also we recently launched the iconic Estée Lauder brand our Web site and we'll roll it out to 30 stores in September with a broad expansion plan for next spring. To update you on our services business, our salon sales rose 14.3%, and comped 8% with strength in hair color, hair treatments, and makeup services. We saw strong response to CRM campaigns drive services and continue to develop additional strategies to drive new customer acquisition over the long-term. One example is, we’re testing enhancements to our online booking software and expect to roll out the new platform this fall. The new booking tool will make it much easier for our guests to select for service and schedule her appointment online where and when it's convenient for her. Also our salon stylists were excited to experience our fall winter training programs developed by our elite artistic team, featuring a glamping theme, which is designed to integrate on trend hair and makeup looks like Ron's hair color, a blend of coppery red and brown and Natural Darling makeup which is a fresh take on no makeup-makeup. We also introduced Bro Layage, the first time we feature a men's hair care color service. Our Benefit Brow Bar business continued its strong performance with brow services in 785 stores at the end of the quarter with more than 500 of these offering brow tinting as well. We also enhanced Benefit's product offerings during the quarter with the addition of 36 new innovative brow products which are merchandised in the boutiques, as well as on custom fixtures in our stores. Turning to new store growth. We opened up 24 stores and closed three stores in the second quarter. One closure was the Chicago State Street location and the other two were relocation. We are on track to complete our 2016 program of 100 net new stores and ended the quarter with 907 stores. New store productivity continues to be excellent with new stores performing well above their budget and their IRR target. In addition to the new store program, our growth and development team is very focused on ensuring high-quality execution of our prestige boutique rollout and we complete a large number of the more than 500 Clinique, Lancome, and Benefit boutiques planned for this year. We are taking advantage of this boutique expansion activity to further refresh our store fleet with improvements in fragrance, nail, and Ulta Beauty collection fixtures and looking ahead we’ve already approved 100 stores for next year's real estate program. Now moving on to ulta.com our e-commerce growth was very strong, up 54.9% and contributing 180 basis points to our total company comp. Site traffic accounted for almost all of the growth, as we continue to invest in digital marketing. E-commerce margins improved in part due to the more efficient fulfillment costs from orders delivered from our new Greenwood distribution center. Similar to our performance in stores, the fastest-growing category were prestige and mass cosmetic. Professional hair care was also a stand out as this category ramps up online, following the addition of many brands previously sold in store only last year. Our signature leader event featuring jumbo sizes of hair care products at compelling prices was very successful online during the quarter. To highlight our authority in hair care, we also conducted our first ever live beauty chat with expert salon stylists. These members of our elite Ulta Beauty artistic team answered guests questions on hair products, tools and tips. Turning to assortment newness, we launched Shiseido skincare products in the Web site ahead of our limited in-store launch. Continuing on our efforts to increase our portfolio of online brand, we introduced E.l.f., a popular value price cosmetics brand at the end of the quarter. This new brand features many new products exclusive to Ulta Beauty in the assortment and got off to a very strong start in the Web site. We continue to improve the guest experience in ulta.com with more content for the beauty enthusiasts and recently we launched a new feature called Ulta Beauty Mix with tips, articles and how-tos. The content is shoppable and we view this as our first significant step towards merging content and commerce. In addition, we’ve made several technical enhancements to the Web site including a search engine optimization URL rewrite. We also released updates for our iPhone, Android and iPad app, including support for Ulta Reward credit card applications and account management and improve loyalty program sign-up process, a new gift card purchase capability, and Apple Pay expedited check out. Turning to supply chain and systems, I'm very pleased to report that our new Dallas DC opened up on time in early July and is clearly fulfilling more than 90 stores and about 30% of our e-commerce volume. The Dallas DC is expected to ramp up a bit faster than Greenwood with plan to service more than a 130 stores and 25,000 e-commerce orders per day by the end of the holiday period. Similar to the benefits received from the Greenwood DC, the advantages of the Dallas operating model includes fewer, fuller and more stable retail cartons, increased categorization and improved labeling, and enhancements for e-commerce orders. The Greenwood Indiana DC now just over a year-old is serving about 220 stores and fulfilling almost 40% of our e-commerce orders. We still plan to end the year delivering to approximately 240 stores from Greenwood. On the system side, SWIFT, our new forecasting and replenishment tool has now been rolled out to all product categories. The space and floor planning and assortment optimization tool went live a few weeks ago and our teams have starting to use the new system to plan for holiday and next year's store planogram. The space planning system will be fully integrated with SWIFT and these processes will be integrated with our new master data system, which will automate the work and thus reduce the time needed to create floor plans and our increasingly complex spas. So needless to say, I’m extremely proud of how our teams have executed across these initiatives while supporting strong growth. Before I turn it over to Scott, I'd like to preview our upcoming investor conference in Chicago on October 13. I’m very excited to update you on our long-term growth strategies and looking forward to give you a deeper understanding of drivers of for business, the future growth opportunities we’re prioritizing, and also to give you insight into the talents and capabilities across our leadership team. You will hear about our view of category and consumer trends that support our confidence in growth in the beauty category. We will show how we plan to continue to elevate awareness and clarity about Ulta Beauty as a retail brand. We will provide an update on our loyalty program and how we're using data in new ways to drive greater share of wallet of our ultimate rewards members. We will discuss the pipeline of new brands we plan to add to our assortment and provide new insight about our products and services offering. We will describe how our supply chain and systems investments position us to drive cost efficiencies and higher service level. We will discuss the multifaceted real estate analysis we just completed that gives us confidence in many more years of store growth ahead, confirming square footage growth is a key part of our strategy to double our market share in the next several years. We will detail the margin drivers that give us great confidence in achieving our mid-teens operating margin target by 2019 and show you why we’re confident in achieving the long-term earnings growth targets we set as part of the strategic plan that we share back in 2014, even on a much bigger base of business than we forecasted in the initial plan. So now let's turn over to Scott to give us more details about our second quarter results and our outlook for the third quarter and the year.

[Scott Settersten:]

Thanks, Mary. Good afternoon, everyone. I will start with the income statement. Net sales for the second quarter increased 21.9% to $1.07 billion. And once again our top line was driven by a very healthy 14.4% comp and strong new store productivity. The total company comp was composed of 9.7% transaction growth and 4.7% average ticket growth. The retail comp of 12.9% was made up of 8.9% traffic and 4% ticket. The salon business comp 8% with all of the increase driven by ticket growth similar to trends earlier in the year. E-commerce growth of 54.9% was driven almost entirely by increased traffic with ticket growth up low single-digit. Gross profit increased 110 basis points. The improvement was driven by leverage of store, rent and occupancy expenses, as well as by healthy product margin expansion, partially offset by planned supply chain investments in our new distribution center. E-commerce margins also improved with strength in the high-margin, professional hair care segment. Moving onto SG&A expense, we deleveraged by 110 basis points driven by additional headcount to support our growth initiatives, as well as an unexpected charge related to a store closure. We recently closed our multilevel State Street store in Chicago. The store was temporarily closed back in May due to disruption from a construction in an adjacent building. The extensive damages to the store and the extraordinary amount of time and expense required to reopen the store resulted in our decision to permanently close the location, necessitating a significant impairment charge. This charge represented about a third of the SG&A deleverage in the quarter. We reassigned our impacted associates to nearby alternative stores and have assisted guests to minimize any disruption in their shopping experience. We are currently evaluating nearby relocation opportunities and expect to get a replacement store up and running soon. Turning to the balance sheet and cash flow. Inventories were up 18.7% on a per store basis, a bit higher than expected, reflecting the opening of our new distribution center in Dallas. Excluding the impact of the inventory for the new DC, inventories were up 14.5% on a per store basis in line with our comp. We continue to invest in inventory given better than expected top line growth, new brand additions, and the step up expansion of prestige boutiques. Going forward, we’re expecting to see total inventory per door growth more in line with comp growth by the end of the year and anticipate that the efficiencies from our supply chain investments, including new DCs and merchandise planning tools will become more evident in our financial results starting in 2017. Capital expenditures were $95.3 million in the quarter driven by new store openings, fixtures for the rollout of prestige brand boutiques, and supply chain investments. We ended the quarter with $304.1 million in cash and short-term investments. In terms of share buybacks, year-to-date including our ASR, which settled in the second quarter, and activity under our 10b5-1 plans, we’ve repurchased 1.27 million shares at an average price of approximately $199 per share. At the end of the quarter, approximately 193 million remained under the 425 million share repurchase authorization. Turning now to guidance for the third quarter. We anticipate sales to be in the range of $1.072 billion to $1.090 billion compared to $911 million last year. We expect comparable sales to increase in the range of 11% to 13% versus 12.8% last year. Online sales growth is expected to be in the 40% range. We plan to open about 40 stores in Q3 compared to 45 stores during the same period last year and preopening expense for the quarter is expected to be about $7.6 million. Earnings per share expected to be in the range of $1.25 to $1.30 versus a $1.11 for Q3 of 2015. We anticipate a tax rate of 37.6% and a fully diluted share count of approximately 63 million. Our supply chain investments, particularly the ramp up of our new Dallas DC, on top of the Greenwood building, still only fulfilling about half its planned capacity, will continue to weigh on margins for the rest of the year. We expect to see the largest impact in the third quarter with deleverage in the P&L reflecting the high water mark of our supply chain investments. We anticipate stronger earnings growth in the fourth quarter on higher sales volume. In light of the strength in the business in the first half of the year, we are raising our guidance for the full-year 2016. We now expect comparable sales to be in the range of 11% to 13% for the full-year versus prior guidance of 10% to 12%. We now expect to grow earnings per share in the low to mid 20s percentage range versus our prior guidance of low 20s percentage growth. We continue to expect that share repurchase activity under our 425 million authorization will contribute about two percentage points of earnings per share growth this year. The other elements of our full-year guidance are unchanged. We are on track to open approximately 100 net new stores, all planned to be our 10,000 square foot prototype. We expect to open about 40 stores in Q3, and 25 stores in Q4. We are also executing 12 major remodels and two relocation. We plan to go e-commerce approximately 40%. CapEx is on target to be about $390 million, driven by slightly higher capital for new store and the rollout of boutiques. As a reminder, we planned about $80 million for the boutique expansion and update with the rollout of over 500 Clinique, Lancome, and Benefit boutiques underway, as well as updates to our fragrance fixtures and the Ulta Beauty collection. I'll now turn the call over to our conference call host for the Q&A session. Operator?

[Operator:]

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] And our first question comes from Simeon Gutman from Morgan Stanley. Please go ahead.

[Joshua Siber:]

Good afternoon. It's Joshua Siber on for Simeon. I’m curious where are you guys in the investment cycle relative to where you thought you would be when you laid out your five-year guidance two years ago?

[Mary Dillon:]

I’d say we’re right on track with that. I mean, we describe that this year, last year and this year would be kind of the key years of investment relative to the new distribution centers in Greenwood and Dallas, all on track. Investing in new systems and capabilities all on track. So we’re pretty much right on track with what we’ve described.

[Joshua Siber:]

Okay. And with respect to your consumer, how are you seeing the average age trend? Are you skewing younger with more social media mix of advertising?

[Dave Kimbell:]

Sure. Hey, Josh, this is Dave Kimbell. Yes, we see strength really across all ages and demographics. We don’t look specifically -- we certainly look at the way demographics, but we’re actually more focused on psychographic around this beauty enthusiasts and we see that growth on all ages. Having said that, we’re excited about strength with Millennials and teenagers, a lot of growth there and strong performance of our brand awareness growing there and we see continued growth in that space. So really growth across all ages and demographics right now.

[Joshua Siber:]

Okay. Thanks a lot.

[Operator:]

Our next question is from Oliver Chen from Cowen and Company. Please go ahead.

[Oliver Chen:]

Hi. Congrats on solid results. We just had a general question regarding Amazon and your competitive advantages online in terms of what you’re offering versus Amazon. And also as direct -- as brands go direct to consumer, it would be great to get a brief there? And what -- on the long-term for online, what are your thoughts on margins in the context of just the changing customer expectations as online continues to evolve? Thank you.

[Mary Dillon:]

Thank you, Oliver. I will start and I will ask if Scott and Dave want to jump in so please do. Oliver, you know I guess I’d just step back and say we compete as you know with a lot of players, both brick-and-mortar as well as online, but really nobody brings together everything that we do in one place. So I don't think so much about head-to-head competition in any one place, even though we certainly look very closely at the competitive environment. So our online offerings now represent everything we have in the store and more, pretty much everything we’ve in store plus more we are starting to expand that. Our guests enjoy the online experience. We’re improving that, the shipping timeframe everyday and certainly as she participates in buying products online at Ulta Beauty, she gets points in that. It is the whole loyalty program she loves. So the more she buys from us the more she gets points that then she can redeem anywhere in the store. So certainly we compete with Amazon in some ways in beauty. I’d say we offer a great selection that our guests love. But of course as you know we also have a exceptional brick-and-mortar physical experience that our guests love and really the beauty enthusiasts that they’ve described love to go in person and buy beauty and experience and of course get our services. So, I look at them as part of the mosaic of competition, and I think our proposition for our guests is really superior in total. In terms of margin on e-commerce, that’s getting strong. I mean the big reason behind the investments that we’ve done in our distribution centers is to really improve the efficiency and effectiveness of that part of our business and that’s happening. I'd say the guest is happier with the speed of delivery and certainly the margins are improving.

[Oliver Chen:]

Thanks. Thanks for the details on the investor day. Looking forward to it.

[Operator:]

Our next question comes from Steph Wissink from Piper Jaffray. Please go ahead.

[Steph Wissink:]

Thank you. Good afternoon everyone. Just a follow-up question Mary on your comments around the prestige brand boutique. I’m wondering if you can give us a sense of once you rollout both boutiques and store, what’s the mix between prestige and mass will look like? And then, Dave this is a follow-up to that. How are you thinking about marketing, the localization of some of those boutique rollouts and drawing on your customer traffic in those local market? Thank you.

[Mary Dillon:]

Thank you, Steph. We don’t really break out the exact mix, but in total the part of the really compelling aspect of our proposition to our guests, while we see the case of this assortment of categories and price point and so while the shift to prestige has been happening over several years and we’re thrilled with the array of prestige brands that we’ve that we’re rolling out. I don’t anticipate that mix to change dramatically relative to mass in the future. What’s happening as we just have a great assortment of prestige brands to choose from and that's great and we love those brand partners. But again for our guests, it's very important that she always feel that she can come in and have that combination of categories and price points that she loves about Ulta Beauty.

[Dave Kimbell:]

And as far as the target in localization, I'd say a couple of things. First of all, we’re with the boutique brands, in particular, Clinique and Lancôme, Benefit, Bare, those -- we’re building boutiques at a fast pace. We are also expanding those brands Clinique and Lancôme into every store to present some SKUs in every store. And that allows us to market the brand at a total Company level, national level, because every store will have some SKUs, both of those -- really all of those boutique brands. But we also tailor and target mobilize our communication through our CRM activity. Email is a big part of that. Our magazines will also customize based on location and those are close to a specific store with a boutique, we will customize that communication. At the same time, our national advertising marketing is really talking about the total Ulta Beauty, all things beauty, all in one place messaging. Q - Steph Wissink\ Thank you. Best of luck.

[Dave Kimbell:]

Thanks.

[Operator:]

Our next question is from Kelly Halsor from Buckingham Research. Please go ahead.

[Kelly Halsor:]

Hi. Thank you for taking my questions and congrats on a great quarter. Just was wondering if you could dig in a little bit more on -- into the back half guidance. Should we look at the magnitude of the gross margin deleverage related to supply chain investments to be similar to what you saw in 3Q last year when you opened up the [Greenwood][ph] facility or are you kind of implying that maybe it’s a little bit more considering you have Greenwood and Dallas both open now? And then, just secondly on the SG&A cadence, how should we think about SG&A in the back half of the year now that you will start to be lapping the advertising investments that you made in the back half of last year? Thank you.

[Scott Settersten:]

Yes, so the deleverage on the supply chain is significant. Again, I don’t want to be reconciling basis points quarter to quarter. But it's kind of in the general zip code, I would say, that what you saw in third quarter last year. Net-net I think for the third quarter gross profit is kind of flattish year-over-year when you add up all the puts and takes, because we are still going to get a sizable fix store costs, leverage benefit in the quarter, we are going to continue to expand merchandise margins like we have earlier in the year and so that will kind of cover up some of the hurt, I guess I would say from the deleverage and supply chain. I don’t think most of the models include [indiscernible] the SG&A deleverage in the third quarter. It's much more significant than what most people are thinking. It's really a combination of the boutiques, the high water mark on the boutiques in the remodel programs and all the other things we have in process to drive growth for the business. So again, it's just a matter of sequence in the quarter. So a lot of it ends up in the third quarter this year. We’ve got some consulting timing that we move from earlier year to the back half to help us plan for the future as well to help us frame out growth drivers that will help us next year and beyond. And then there is another store impairment charge coming in the third quarter that was just a fairly recent development as part of the heavy flooding down in Louisiana. So that's another roughly a $0.02 charge that was unexpected that we have to record in the third quarter. So that's really the combination of things. When I think about the rest of the year, then moving on to the fourth quarter, again supply chain we start to get some benefits there, so we expect to get leverage overall on some of those supply chain investments. SG&A then we get back into a normal cadence. The heavier sales volume in the fourth quarter, the upfront costs from some of those boutiques are behind us now and we get leverage SG&A in the fourth quarter. So, that’s kind of how we end up full-year then with slight leverage coming from gross profit and slight deleverage on the SG&A line that gives us some all-in slight leverage for the year on operating margin.

[Kelly Halsor:]

Okay, great. And if I could just squeeze in one more, very excited to see that you are introducing us a -- it continue to be a pretty premier brand, cosmetics brand. Any opportunity there in terms of boutique opportunities similar to what you’re doing now with Clinique and Lancome?

[Dave Kimbell:]

Yes, we are excited to be launching -- introducing Estee Lauder that launched online within the last week or so and then we will be rolling that out into 30 stores next month. So with that point, you'll kind of be able to see the presentation that will be different than where we have done some other brands, we're really excited about. We are particularly excited about it is really focus on the strongest most iconic elements of that line, parts like advanced night repair, Double Wear makeup, complementing it with things, the Perfectionist Serum, Extreme Lash and we can do -- we’ve had a strong fragrance, Estee Lauder fragrance business for a while. So this will complement that very well. So we are going to watch it closely. It's one of the largest pursued brands in the world and so we're happy to have it in the store and we will learn and deliver to continue to expand that over time.

[Kelly Halsor:]

Okay. Thank you very much.

[Operator:]

The next question comes from David Schick from Consumer Edge Research. Please go ahead.

[David Schick:]

Hi. Thanks for taking my question. With the continued success you’ve seen in this country, how does it factor into thinking about the way you might attack other markets?

[Mary Dillon:]

Well, first I will start with the fact that we have got a lot of great opportunity here in the U.S. We're going to continue to be able to drive growth, we think for many years and as we start to think about International, we are starting to frame and look at possibilities. There is nothing to announce, but certainly we are looking at where it might have make sense from a consumer environment, and a competitive environment overall business environment, and we will make some decisions if we move forward, we'll do that in a way that would be let's learn about it first, and then decided if we would go further. So, in the analysis phase I guess it's the best way to think about it right now.

[David Schick:]

Okay. Thanks.

[Operator:]

Our next question comes from Dana Telsey from Telsey Advisory Group. Please go ahead.

[Dana Telsey:]

Good afternoon everyone and congratulations on the results. As you think about the new brands that you are adding to the mix, what's being taken out of the mix and as you look towards next year, what categories are rethinking about that you'd like to add to the mix and given the salon business and obviously now with the men's opportunity there, how do you see the growth of the salon business and the margin implication? Thank you.

[Mary Dillon:]

Yes, I’m attacking this with Dave and maybe I will just start with the salon piece. I'm glad you notice that, yes, Brolayage is our [multiple speakers] I want to see people line up at appointment on this call, but it's just with the creativity of our artistic team that really invented that idea of Brolayage for guys anyway. But I'm really -- our salon in overall services business are really critical part of our strategic imperatives going forward, right. So we have got hair services, skin services, and brow services and still in many ways quite small, but performing really well. I mean an industry in hair that’s flattish, we’re gaining market share and we’re growing. So we see that as an area that we'll think-- we are working on just how do you think about continuing to drive that as a growth lever, attractive driver, bringing in new guests. I’m sure you know that when a guest becomes a salon guest, she or he become one of our best guests, because they come frequently and they spend 2.5 times the amount of non-salon users. So more to come on that and we think it's going to provide not only growth, but also the ability to really position us a beauty authority for many years to come. On categories, [multiple speakers].

[Dave Kimbell:]

Yes, as far as assortments and managing that and looking at new brands, certainly as we add many other great new brands that we have talked about and that Mary mentioned, that does mean in many cases that we have to make room for that. And so really a focused approach on looking at sales and gross margin per square foot, Inventory turn, a bunch of metrics that really look for the most profitable usage of our space, but also focused on elements that are really delivering against our core proposition of all things beauty, all in one place. And so when we look at adding new brands, makeup is the fastest-growing part of the beauty business and certainly it’s within our portfolio. So continue to see makeup brands for sure, but we want to make sure that we're really focused on understanding how her needs are evolving and we are bringing innovation across all elements, both mass and prestige. We have a lot of innovation, great exciting innovation in fragrance, we have got Jessica Parker's fragrance coming out on Sunday, that's I think it's going to be great. So a lot of innovation continued in fragrance. Skincare is an area that had its ups and downs, so we see growth and potential within that and then certainly hair care and connected to our salon, it's a big, very important part of our business. The styling part, liquids, shampoos, conditioners, tools, our professional tools areas, personal tools area, so we'll continue to innovate across all parts of the store and optimize our assortments as we go forward.

[Dana Telsey:]

Thank you.

[Operator:]

Our expressing comes from Mark Alswager from Robert W. Baird. Please go ahead.

[Mark Alswager:]

Good afternoon. Thanks for taking the question and great quarter. Can you talk while little bit more about your partnership with analysis data in the private-label credit program. Just first, how should we be thinking about any revenue sharing or P&L implications over time. And then, you’ve already had a lot of success with your loyalty program obviously and the CRM initiatives, but how do you see that evolving as you start to leveraged the ADA's capabilities on that front? Thanks.

[Mary Dillon:]

Great. Thank you -- thanks for asking about that. I just want to give a little plug. I'm really proud about our team having really worked this for over a year and it's a very cross functional effort as you can imagine to prepare organization to launch something like this and we are off to a strong start. And the good news is we based it first and foremost on guests insight which is our guests are very interested in this program, because it gives them the opportunity to just -- to get more points at Ulta Beauty, but also for us obviously its creating more loyalty, more increasing per share of wallet going to us. So, that's all great and we're not going to get into parsing apart all the details of the deal. ADS is a great partner. I'll say they manage the program for us and take the credit risk, so that's great and more to come. So our CRM team is really the folks who really own this project and you could imagine they have a lot of ideas about how to leverage is going forward to drive growth. So more to come on that and we feel good about where we are.

[Mark Alswager:]

Okay. Thanks again.

[Operator:]

Our next question comes from Ike Boruchow from Wells Fargo. Please go ahead.

[Ike Boruchow:]

Hi, good afternoon. Thanks for taking my question. Just a quick one. I guess, Mary, you talk about your replenishment business being fairly small today. I was just curious how big is it Firenze and can do how do you view that part of the business longer-term? Is it a key focus for you or is it just -- are refocused on other parts of the business in terms of incremental growth from here?

[Mary Dillon:]

Thank you, Ike. Well, the good news is that everything we sell almost everything we sell is highly replenishable. But the great news is that our guest a beauty enthusiast is really not interested in just the same product every time. There is categories that she will need to replenish when she is out, there might be a couple of items which she is quite attached too, but I will tell you for the most part our guests are really coming in and loving to try new products. She loves trends, she loves newness, she loves great new product that are launched by our brand partners. So what we are finding is that very little of the business is one-for-one replenishment. And if that becomes bigger, perhaps in the future, we always looking at that to see if there is a way we can make it even easier for her. But what she seems to be responding to is the breadth of innovation and newness and if you look at for example our e-commerce guests, the guest will shop online and in-store, again some of our best guests they spend significantly more than somebody who is not buying online and what's she tending to buy is a response to things that we’re bringing to her attention via email. So it's usually new products or exclusives or new trends.. So again, I don’t have anything against replenishment, l love the fact that we're replenishing our products a lot, but the one-for-one piece is something that -- it's not a big part of the business.

[Ike Boruchow:]

Great. Thanks a lot.

[Operator:]

Our next question comes from Jason Gere from KeyBanc Capital Markets. Please go ahead.

[Jason Gere:]

Okay. Thanks. I guess residents. The first one did you say what your loyalty card membership growth was in the quarter and I just wondering as this continues to rise like how do you think about what the potential penetration can be? And on that point, what was a transaction size for loyalty card members versus non-loyalty card in the quarter?

[Dave Kimbell:]

Yes, we -- so our loyalty program did exceed that $20 million -- 20 million member mark to 20.6 million active members that’s a 27% growth rate. So we're really pleased with that. That's very strong. We've had very strong growth with that, and that will we think continue and we’re really happy with our new members. It's actually been a strong kind of lot of new members that are coming in, getting engaged with our program, understanding the benefits of the program. We will also be able to then talk to them about new elements like the credit card. So clearly a big driver for us going forward. The second part of your question was around …

[Mary Dillon:]

The basket for the loyalty guests. It basically represents what we quoted in our prepared remarks, Jason. So, I mean, again the loyalty program is more than 80% of total sales. And so when we are looking at those kind of metrics, that's basically what represent.

[Jason Gere:]

Okay. Fair enough. And then I guess the other question was, just given where the stock price is right now. Howdy guys internally think about maybe splitting your stock at this point. The only reason I say that is a big part of your story is kind of reaching out to that little customer and if the stock was let's just say, under hundred dollar maybe you will get more of your retail customers actually becoming shareholders as well?

[Mary Dillon:]

Yes, that something that we kicked around from time-to-time with our Board of Directors, again the about all options right on, being as shareholder friendly as we can't be whether its capital allocations or things like stock split. So surprisingly I have only gotten this question maybe two times in the three plus years I’ve been here at -- been at the annual shareholder meeting, right. So it's usually a local retail holder that would ask that kind of question. So generally speaking, most of our shares are hold my big large investment funds and hostels and most of those folks aren't that interested based on our Q&A with them about entertaining a stock split. So it's nothing that’s on the front burner, but of course it's something we will always be ready to consider.

[Jason Gere:]

Thanks.

[Operator:]

Our next question comes from Mark Astrachan from Stifel. Please go ahead. I’m sorry, Mark. Do you have a question to ask [indiscernible]?

[Mark Astrachan:]

Sorry, can you hear me now? Hello.

[Mary Dillon:]

We can.

[Mark Astrachan:]

Perfect. Great. Sorry about that and good afternoon everyone. Wanted to ask about thoughts on the sustainability of cosmetics growth given the contribution to comp, and how do you weigh newer smallish brands versus those from larger companies like Estee that you talked about and L'Oreal who are likely increasingly eager to work with you, considering trends in other channels like department stores?

[Mary Dillon:]

Yes, well let me start by saying, as a category beauty has being growing for multiple years. It’s strong. It's up last quarter. It was up 5%, prestige was up higher than mass, but all growing as you said makeup growing, the lead in terms of growth skin care, every category we saw growth last quarter. So the good news is, we are in a category that’s growing as we look at consumer trends going forward and Dave touched on this, but younger women, Millennials, Hispanic women, fastest growing segment of our population, there is a propensity we think for the beauty category for all those folks to continue to play a very important role in -- for overall spend of her money and how she spends her time. So that’s all good. And the great thing is that innovation comes from companies large and small. That’s probably the most exciting consumer category, I think that exists, because innovation comes from many different sources and we positioned ourselves to hopefully be a great partner for brands to do business with and we offer this variety of products categories and price points. So I think that also helps to sort of insulate us as the sub categories go up and down and Dave talked a little bit about those categories, we’re trying to look out multiple years, thinking where do we place our best. But knowing that really innovation is coming from all -- many sources and we think the foundation of growth is there for us.

[Mark Astrachan:]

Got it. Great. And just one follow-up. In the next quarter from a guidance standpoint, it looks like the two-year CAGR and even for the balance of the year back half gets a little stronger relative to Q2 trends. Is there anything in the timing, Scott, that may influence the rate of growth in comps in second quarter versus third quarter, fourth quarter?

[Scott Settersten:]

It gets a little -- you look at quarters and you try to stack them together. We look at the single to double, the triple stack, every way you can look at the comp. There is nothing extraordinary that sticks out in any one, I mean, each quarter is kind of a unique set of opportunities and challenges, I would say. Generally speaking, the back half of the year we just feel really great about the boutiques, right. The tail wind we’re going to get from that finally all being installed, there is a great pipeline of newness coming and we believe we got a great stack ready to go for holiday, both on the assortment and the way we’ve our stores set up and our gift card program, so we are very bullish on the back half of the year.

[Mark Astrachan:]

Thank you.

[Operator:]

Our next question is from Brian Tunick from Royal Bank of Canada. Please go ahead.

[Brian Tunick:]

All right. Congrats to everyone. I guess on the boutiques first, just thinking about the free cash flow going forward, I think you are earmarking $80 million this year for the boutiques, on the CapEx side. Should we be viewing that as a one-time number, or maybe that’s a peak number? And then the second question is, on your stated store targets and I know you will update us at the analyst day, but I guess if there is more department store closings coming or you guys think your e-com penetration can get to a certain level, how does that inform ultimately what you think the right size of the North America store base can be?

[Mary Dillon:]

Okay. Well, I will start with the store piece first and certainly this we will talk more about in October. I think the dynamics that have been happening for some periods of time in terms of how people shop for beauty. So that’s not new to us. It's encouraging to us as we look at the -- how our stores are performing today, the store classes getting stronger, even after this many years of being in business, that’s really encouraging, and we think that everything that surrounds how we’re doing business driving awareness, getting the great products and services all enhancing that. So I feel good about that. We had a -- we think that our 10,000 square foot store has plenty of growth ahead. We are also looking at smaller market, urban or suburban downtown type format. So all those things we feel given frankly the fact that really have a 5% share of this really enthusiastic beauty shopper provides us plenty of runway for growth. So, we will talk more about this, but we certainly have done a lot of work and analysis and feel confident that we can drive market share growth frankly both to a comp store growth as well as new stores.

[Scott Settersten:]

And as far as that CapEx related to boutiques, again I just want to remind folks that the boutiques were always in the plan back at 2014 where we rolled up the five-year financial target. There was an assumption in there for boutiques, over those five years. We just accelerated that, so we’re kind of pull this forward. '16 a big step up, roughly $80 million as we mentioned that will repeat next year in the 2017. So we are kind of viewing it as a two-year kind of cycle and at that point we will have again those two great brands in the majority of our comp stores and then it will be just about new store build up from that point.

[Brian Tunick:]

Thanks very much.

[Operator:]

Our next question is from Joseph Altobello from Raymond James. Please go ahead.

[Unidentified Analyst:]

Hi. This is Christina on for Joe. I was wondering if you could talk about the rollout of Honest Beauty this past quarter?

[Dave Kimbell:]

Sure. Yes, we’re really pleased with it. It’s a great brand of course from Jessica Alba's Company, and it off to a great start. I mean, it’s part of a Honest -- the Honest company has been a leader in broader trend around natural and it's great to bring that to the beauty segment. There is other brands that have been in that space for a while with us and we’re seeing a lot of growth across the area, but really pleased with that and think it will be continue to drive nice growth for us coming forward.

[Unidentified Analyst:]

Great. Thank you so much.

[Operator:]

Our next question is from Chris Horvers from JP Morgan. Please go ahead.

[Christopher Horvers:]

Thanks. Good evening. Mary, gave us a little taste of what you plan on talking about at the Analyst Day, and so I wanted to follow-up on one of your comments. You mentioned getting to the mid-teens operating margin by 2019, and of course we would like to parse words, and that buy stands out to this -- stands out to us. So does this imply that your original mid-teens forecast could be reached prior to 2019, because clearly the comps have exceeded expectations or does perhaps that long-term operating margin target see some upside?

[Mary Dillon:]

Yes, talk about parsing. I like that. We are not going to get into details on that today, except to say we feel confident about reaching the target that we set out back a couple of years ago and frankly had a much bigger scale of business today, with a lot more complexity. So I stand by that description.

[Christopher Horvers:]

Okay. We are Lip Happy here, so we like to …

[Mary Dillon:]

Okay. Hash tag we’ve probably lip [multiple speakers]. Thank you.

[Christopher Horvers:]

So then, since I didn’t get that one, can you talk about your in-stock rates, how they are improving at the store level, how they are improving online, and contributing to the comp growth? You mentioned that the two DCs are about 70% -- two new DCs are about 70% of the volume. Is the rest from the vendor and does that percentage go up over time?

[Scott Settersten:]

So with the e-commerce, just to be clear, so we service e-commerce at a four buildings today. So Chambersburg out East, Romeoville here locally in Chicago, and then the two new Greenwood and Dallas. So again nothing is coming direct from the vendor, so we’re doing all that. The new buildings are just much more efficient, right. They’re designed to actually do e-commerce, pick and fill and ship processes, unlike the older buildings, which were retrofitted and not quite as efficient. So we’re happy to see that and we’re showing the benefit show up in the P&L as currently and as we think about the future, so we’re very excited about that. As far as in-stock rates overall, that’s something that we’ve had kind of priority number one. We think about the guest experience in our stores and again that’s part and parcel of all the investments that we’ve been talking about for the last couple of years whether its distribution centers to help the throughput there, capacity and capability overall, but also we’re doing a lot of the work behind the scenes with merchandised planning tools, SWIFT we talked about. Master data, managing that better. Floor planning and space planning kind of tools are going online, as well as to help with in-stocks overall. And then our team internally here, there is a lot of individual projects, and look sees going on around how we can do a better job, just making sure we go extra heavy on A and B SKUs, so we don’t disappoint folks and how can we be more effective with some of the C,D, and F SKUs right in the stores and how we better align ourselves on that. So all oars are in the water when it comes to in-stocks and inventory productivity across the enterprise.

[Christopher Horvers:]

Thank you.

[Operator:]

Our next question comes from Rupesh Parikh from Oppenheimer. Please go ahead.

[Erica Eiler:]

Good afternoon. It's actually Erica Eiler on for Rupesh. Thanks for taking our question. So clearly another strong quarter from your team, and your results continue to stand out. But we’re seeing a mixed consumer backdrop out there. Is there anything that you're seeing from a consumer or even a geographical perspective that concerns you at all?

[Mary Dillon:]

Well, we’re not complacent about our results. So I will say that, but I will tell you that as we look at, our results have been pretty consistent, I would say across regions, period-to-period, pretty consistent. So then you just saw the kind of comps we deliver, so we’re seeing that a strong consumer sentiment right and I think it's because we continue to benefit from the fact that we are in a category that’s important to our guests and as I mentioned this earlier, it's replenishable, it's affordable indulgence and beauty is popular right now in many ways in terms of culture and social media. So you combine that with being in a range of categories and price point. So even somebody is a little bit more pinched, you can also get great product at a lower price from us and in partnership with our brand partners we are continuing to excite her with newness. So I feel like our results would say that there are certain pockets of consumer spending that are quite strong and obviously we see that macro for the category of beauty as well. But we will just continue to watch it closely.

[Erica Eiler:]

Great. Thanks for all of the color.

[Operator:]

Our next question comes from Omar Saad from Evercore ISI. Please go ahead.

[Omar Saad:]

Thank you. Good afternoon. Nice quarter. I actually wanted to follow-up on one of your earlier questions about the potential for category expansions in the future, and maybe ask more specifically about bath and home, and those types of related products, scents and soaps, if those are categories that you would look to going into I think, perhaps in a very nice overlap with the customer base and with all things beauty, as well.

[Dave Kimbell:]

Yes, yes. I would start by saying that we’re always looking across every element of the beauty space to find growth and we’re listening to our guests and finding opportunities in the -- our focus is on continuing to drive a lot of innovation and those most important biggest categories that we have, makeup, hairs, skincare, fragrance, nail is important. But we’re seeing some nice growth in additional categories one of which you mentioned bath and body space is one that is a nice category. Obviously not anywhere near as big for us as something like makeup. But we do see growth potential and we’ve added some new brands into that space, Fizz & Bubble, Soap & Glory, among others and we’ve got some great business the exclusive distribution of the Body Shop outside of their own shops is an example and so it's not huge for that total bath and body space isn't enormous for us, but that’s an example of what you’re talking about, we do see potential growth to continue to add to that and make sure that we’re delivering against what our guests is looking for. So we will look across all different avenues in addition to the big ones that were driving growth on today.

[Omar Saad:]

And then, while we’re on the topic of the product offering, I’ve heard you mention a couple times now in the last few quarters, prestige and mass. The areas of strength, almost a bit of a bar bell, high low. Are you evolving? Do you see yourself evolving the offering and the density of the price points around the high low strategy, or is this be a little bit more of a transitory effect?

[Dave Kimbell:]

Well, I make sure I understand your question, but the mass and prestige has been part of our business and is part of the original insight the Company was founded on and certainly it’s a critical part, key part of our strategy today. We’ve grown our prestige business pretty quickly over the last several years as we’ve added a number of brands, but we’ve also been focused on growing that. So the key part what our guests really responds to us is this idea of mass and prestige, because that’s -- while she shops, that’s how when you look at products that she had at home. Most women don’t have either prestige or either mass only, they have both. So providing both to her is a key part of our strategy. We will never kind of shift away from that. We want to see growth on both sides, because that’s what our guests wants and so we’re investing heavily in the experience, as well as bringing in new brands in innovation across both sides, the range of price points that we think is what our customers really want.

[Omar Saad:]

I understand. Thank you.

[Operator:]

Our next question comes from Simeon Siegel from Nomura. Please go ahead.

[Simeon Siegel:]

Thanks. Hi, guys and congrats. Any way to quantify what portion of the transaction growth came from new customers versus greater frequency of visits? And just sorry if I should already know this, but when you open-up new prestige boutiques, the general rules of profits [ph] is regarding geographically clustering those brands or just spreading them out, and if they are clustered, any color on how the existing boutiques have done after the new openings? Thanks.

[Dave Kimbell:]

On the customers, I don’t think we kind of broken out that level of detail. What I would say is there is kind of a few key elements that are driving our total customer growth. Retention is strong and healthy and as we look across as we understand loyalty programs not necessarily just in beauty, but loyalty programs, we think we’re in a very healthy probably it’s a leading level of retention. So that’s key and strong and we will continue to be. Reactivation, we talked about in the past and that also was strong in the second quarter which is essentially those that had not shopped, that had been members of our program, but had not shopped with us in the last year through some elements, our expanded marketing, advertising, new store openings perhaps we will get them in and driving that. But new -- totally new guests is absolutely still big growth driver of getting that -- attracting new guests across the country both obviously new stores, but existing stores bringing her in is a key part to our growth. So those three things are what’s driving that growth. And then boutiques was -- I don’t know if I fully understood the question about …

[Scott Settersten:]

The location.

[Dave Kimbell:]

Looking where we’re locating, it's really across the country. So yes, across the country, we’re looking at really stores as we continue to add these 500 boutiques, we’re seeing success in big market, small markets, all different regions of the country. We will continue to expand as Scott said, probably next year we will be in a large percentage of our total chain, so thereby being in most stores across the country.

[Simeon Siegel:]

Thanks. Best of luck for the rest of the year.

[Operator:]

Thank you. I’d now like to turn the floor over to Ms. Dillon for any closing comments.

[Mary Dillon:]

Thank you. I just want to thank everybody for your interest in Ulta Beauty and we look forward to seeing you in a few weeks at our Analyst Day. Importantly, I’d also like to thank all of the Ulta Beauty associates for delivering yet another terrific quarter. Take care.

[Operator:]

This concludes today’s teleconference. Thank you for your participation. You may disconnect your lines at this time.