Ulta Beauty, Inc.
Q4 2014 Earnings Call Transcript

Published: 13 Mar 2015

[Operator:]

Greetings, ladies and gentlemen, and welcome to the Ulta Beauty Fourth Quarter 2014 Earnings Conference Call. At this time all participants are in a listen-only mode. A 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. Thank you, Laurel. You may begin.

[Laurel Lefebvre:]

Thanks. Good afternoon and thank you for joining us for Ulta Beauty's fourth quarter 2014 conference call. Hosting our call are Mary Dillon, Chief Executive Officer, and Scott Settersten, Chief Financial Officer. Also joining us are Janet Taake, Chief Merchandising Officer, and Dave Kimbell, Chief Marketing Officer. Before we begin, I'd like to remind you of the company's Safe Harbor language. The statements contained in this conference call which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. We make references during this call to the metric free cash flow, a non-GAAP financial measure defined as cash provided by operating activities, minus purchases of property and equipment. I'll now turn the call over to Mary.

[Mary Dillon:]

Thank you, Laurel. Good afternoon everyone. Ulta wrapped up a very strong year of sales and profit growth, actual performance in the fourth quarter. The whole Ulta team and I are very proud to celebrate this as our first $1 billion sales quarter. To review the numbers, sales grew 20.7% and delivered an 11.1% total company comp on top of a 9.2% comp in the fourth quarter of 2013. Our best comp of the year was driven by our strongest traffic growth of the year. While average ticket also contributed nicely to the overall result. The key drivers of our performance were continued strength in prestige and mass color cosmetics, a successful holiday selling season, execution of more effective marketing and CRM strategy, double-digit comps in our salon business, 55% comp sales growth in e-commerce. Earnings per share were up 24% to a $1.35 compared to a $1.09 last year. Scott will cover the details of our financial results for the fourth quarter as well as our guidance for fiscal 2015 and the current quarter in just a few moments. But first I would like to provide an update on our six strategic imperatives. This is the long-term strategic framework we developed last year designed to deliver continued market share gains and strong sustainable sales and earnings growth. The first imperative is to acquire new guest and deepen loyalty with existing guests. Our loyalty program and growing CRM capabilities continue to be highly effective tools to increase loyalty and grow our share of wallet with our members. As of the end of the fourth quarter, our ultimate rewards program had grown to reach 15 million active members. Having all of our guests at a single platform for all almost all of 2014 delivered significant benefits to us. Customer reaction has been overwhelmingly positive. Sales per loyalty member increased about 6% in 2014, driven by both higher purchase frequency and higher spend per transaction. We also saw healthy increase in member retention last year. And finally we were successful in targeting less engaged segments of our loyalty customer base with specific offers to engage those customers. While we are delighted to acquire millions of new loyalty members last year, we believe there are lot more beauty enthusiasts out there waiting to discover Ulta, so increasing brand awareness is a continued opportunity for us. We were encouraged by the results of our TV advertising tests in select markets last fall, where we saw comps increased versus the control group, as well as an increase in new member sign ups. Message testing demonstrated that our campaign was relevant and memorable. We also launched a national holiday radio campaign which reached millions of prospective new guests and resulted in strong consumer recall. We also heightened our focus on earned media with outreach to long-lead publications and beauty bloggers to increase awareness of our holiday offering. As a result of these efforts, aided awareness of Ulta jumped up seven points year-over-year. Looking ahead, we expect to implement radio, TV and digital advertising campaigns in conjunction with various promotional events throughout the year. We plan to fund these brand awareness building activities by reducing Sunday newspaper inserts and other print vehicles, as well as through our ongoing efforts to reduce our alliance on broad price discounting in favor of more targeted marketing activities. During the fourth quarter we experimented with CRM offers focused on acquiring new customers in our salon business. Fewer than 7% of our active loyalty members are salon customers which provides us a great opportunity to mine our loyalty customer base. In fact, we were able to acquire thousands of new salon customers by testing various offers and marketing channels with targeted customer segments. We believe our focus on new customer acquisition in conjunction with an elevated presentation of our salon business in direct mail pieces and then our website, contributed to be a significant increase in new salon guest count and an acceleration in our salon sales performance. Our second strategic imperative is to differentiate by delivering a distinctive and personalized guest experience across all channels. Investments in in-store technology provide solutions that help our store associates to be even more effective. We've tested and are rolling out to the entire chain a task management solution and an inventory management application, both delivered on mobile devices. These tools are designed to optimize productivity, and create efficiencies for our store associates which importantly will allow them to spend more time assisting our guests. We are also leveraging in-store technology to support a more personalized guest experience with our new client telling app which is currently being piloted in 30 stores. The app will replace the paper based consultation process and enable store associates to interact with guests on the floor in a number of ways that were previously only possible at point of sale. Associates us the app to sign up guests for ultimate rewards, can review point balances and past purchases and create guest profiles with their preferences and interest in order to better recommend products. We are also implementing the learnings from our recent payroll test-and-learn initiatives to enhance the guest experience. We continue to study the impact of adding additional labor hours to create more guest facing time in various types of stores and different areas of the store. And we are planning to implement additional hours in another 60 stores this year. We expect this additional labor expense to be self-funding to higher sales and conversion. The third strategic imperative is offering relevance, innovative and often exclusive products that excite our guest. While we continue to see great customer response to our recent launches like IT Cosmetics and our exclusive IT Brushes that were strong news in innovation throughout the Prestige Cosmetics assortment. During the fourth quarter we partnered with bareMinerals to ensure successful launch of their new product Complexion Rescue. Urban Decay, Benefit, Anastasia, Tar and Too Face were top performing brands featuring lots of newness such as Anastasia’s blockbuster contouring palette and Urban Decay’s limited edition Naked On The Run palette. Clinique and Lancôme brands were also very strong. Following on the success of our Clinique and Lancôme boutiques we are continuing to partner with both of these great brands and are rolling out additional boutiques throughout 2015. We are also excited to expand a number of stores offering Clarins skincare products after launching in a small number of stores in online in the third quarter. Another standout was the mass cosmetic category. Here we achieved growth well above the industry and delivered double digit comps. Brands like Nick and the overall lip category drove the performance. Now, we also had a strong holiday selling season were we increased focus on Ulta as a great gifting destination. The categories are personal care appliances, fragrance and bath all performed very well. In addition to a strong holiday product assortment and offers, we invested in customer facing payroll and inventory on a most popular items to enhance the guest experience. Another highlight of our holiday season was the significant lift in sales of Ulta gift cards. We created new designs, utilized more display locations and boosted the presence of gift cards in direct mail, emails, our website and social media. This focus drove strong sales performance and retentions contributed to our sales momentum post-holiday. Professional Haircare also performed well in the quarter, driven by customer engagement with our semiannual leader event, featuring compelling prices on jumbo sizes of Professional Haircare products. In January following the success of our newly branded Happy Healthy Hair Starts at Ulta, we launched a new campaign for skin called Growing Gorgeous Skin Starts at Ulta. Our goal was to distinguish Ulta as a skincare authority by delivering a cohesive guest experience and programming 21 days of daily events, featuring new products from our top skincare brands, including new high-tech tools featured on skin rejuvenation. Next, our four strategic imperative, delivering exceptional services in three core areas

[Scott Settersten:]

Thanks, Mary. Good afternoon, everyone. Fourth quarter sales were $1.048 billion compared to $868 million last year, an increase of 20.7%. Comparable sales increased 11.1%. The retail comp, including salon, was 8.8%. The total company comp was driven by a healthy combination of transaction and ticket, with transactions up 7.7% and ticket up 3.4%. The ticket increase was driven by increases in average selling price, driven by strong sales of prestige categories and less discounting overall. Retail-only comparable transactions were very strong, up 5.7%. Gross profit dollars were up 19.1% to $349.7 million and gross profit margin decreased 40 basis points to 33.4%, from 33.8% last year. There were two primary drivers of this decline. Increased costs associated with the ULTAmate Rewards loyalty program and the impact of e-commerce margin. We have previously discussed with you all of the great benefits associated with our loyalty program, and importantly, since early 2014, having all of our guests on the same loyalty platform. But as expected, while it drives more sales and gross margin dollars, it is a bit more expensive on a rate basis, since guests are much more engaged in the program and take advantage of the benefits to a higher degree than the previous certificate programs. We've now anniversaried the loyalty program conversion that took place in February of 2014, so we don't expect to experience this level of rate pressure going forward. On the e-commerce side, the deleverage comes from Ulta.com's lower margins due to product mix, less efficient supply chain capabilities, and shipping costs. Offsetting this mix impact were improved retail product margins, reflecting reduced reliance on price discounting, and modest leverage on rent expense. SG&A expense increased 18.6% to $210.7 million, down 40 basis points as a percentage of sales to 20.1%, versus 20.5% last year. The key drivers of this improvement were payroll and marketing leverage on stronger than expected sales, offset by investments in people to drive our strategic initiatives, as well as increased depreciation of IT systems. Pre-opening expense was $1.6 million compared to $1.8 million last year, driven by 10 store openings during the quarter, compared to 11 new stores opened during Q4 2013. Operating income increased 20.4% to $137.5 million. Operating margin was flat to last year at 13.1%. Interest income was $231,000, net of credit facility fees. Our line of credit remains undrawn. Our tax rate of 36.6% included about $0.02 of earnings per share benefit, related to a non-recurring deferred tax adjustment. Net income increased 23.5% to $87.3 million, or $1.35 per diluted share, versus $70.7 million or $1.09 per diluted share last year. Excluding the non-recurring tax benefit, net income increased 21.6% to $86 million, and earnings per share increased 22%. Turning to the balance sheet and cash flow, inventories were $581.2 million at the end of the quarter compared to $457.9 million at the end of Q4 2013, up 10.7% on a per store basis. We have been fairly aggressive in investing in our highest velocity SKUs to keep up with the strong demand we're experiencing. We're pleased with the quality of our inventory coming out of holiday, and thus far, we have not seen any material impact from the West Coast port issues. We continue to stay close to our vendors to assess and mitigate any potential impact down the road. Capital expenditures were $76.6 million for the quarter, driven by our new store opening program, supply chain investments and systems. We spent $249 million in capital for the full year, slightly lower than planned. About 45% of our 2014 capital spend was for new stores, remodels, and relocations, about 15% was for merchandising, store maintenance and other capital. The remaining 40% was for supply chain systems and e-commerce investments. Depreciation and amortization for the fourth quarter were $35.7 million and $131.8 million for the full year. We generated about $148 million of free cash flow for the year and ended the year with $539 million of cash and short-term investments. The company repurchased approximately 235,000 shares at a cost of $30 million during the quarter, under our 10b5-1 plan, as part of our program to return cash to shareholders. We spent about $40 million on share repurchases in 2014, since implementing our plan in September last year. Effective March 17th, our Board has approved an increased authorization for our current repurchase plan, adding $100 million to our existing $300 million share repurchase authorization put in place last year. 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 our guidance for 2015. In terms of our outlook for the full year, we expect to achieve results in line with our long-term guidance provided last fall, updated from the new 2014 baseline, reflecting our earnings upside in the back half of the year. More specifically, we expect to open 100 stores in 2015 and remodel four stores, grow e-commerce sales in the 40% range, drive comparable sales in the 6% to 8% range, and deliver earnings per share growth in the range of 15% to 17%, from the $3.96 of adjusted EPS we delivered in 2014, which excludes the $0.02 non-recurring tax benefit and Q4. This guidance includes planned supply chain and systems investments and assumes we continue to repurchase shares to offset dilution. We expect deleverage on our gross profit line and modest leverage on the SG&A line and operating margins are expected to remain about flat. Our tax rate is expected to be approximately 38%. We expect a bit more variability in our quarterly earnings performance due to the timing of our supply chain investments, the addition of prestige boutiques, and the fact that we will be comping over some very successful product launches in the second and third quarters of 2014. As a result, we expect stronger performance in the first and fourth quarters and somewhat softer earnings performance in the second and third quarters. We expect CapEx to be in the $300 million range and to generate free cash flow similar to our 2014 performance. In terms of specific guidance for Q1 2015, we expect sales to be in the range of $833 million to $847 million compared to $713.8 million last year. We anticipate achieving a comparable sales increase in the range of 7% to 9%, versus 8.7% last year. Again, we have our easiest comp comparisons in Q1, so we expect comps will moderate a bit after the first quarter, as we lap some of the terrific brand and product launches, like IT Cosmetics, IT Brushes and a new foundation from bareMinerals that helped drive strong comps, starting in Q2 of last year. We expect to open 20 stores in the first quarter, versus 21 stores opened in Q1 last year, so pre-opening expense is expected to be relatively flat. Earnings per share are expected to be in the range of $0.88 to $0.93 versus $0.77 for Q1 of 2014. We anticipate a tax rate of 38% and a fully diluted share count of approximately 64.4 million. With that, I'll turn the call over to our conference call host to begin the Q&A session. Operator?

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Oliver Chen with Cowen & Co. Please proceed with your question.

[Oliver Chen:]

Hi. Congratulations on a really spectacular conclusion to the year. Regarding your comments in the opportunities ahead on the supply chain side, could you characterize to us where you are in terms of where you see the longer term going? And specifically I was also curious about fulfillment, planning and allocation. And also related to your comment on e-commerce and supply chain capabilities, you see the margin improving as your capabilities improve in this discipline? I also had a question about awareness.

[Mary Dillon:]

Okay. Oliver, thank you. And let me just start with kind of supply chain, as you know, it’s a multiyear project and I guess I would just say really touches several assets to the business. So overall goal are going to be building infrastructure to support the growth that we have planned, also to enhance capabilities that we know we need from to be really relevant omni-channel retailer as our customers want to shop, and then also, of course, efficiencies over time. So really this multiyear plan has several benefits that we -- we are excited about. Examples, increasing delivery frequency to help and improve in-stock condition, having the cartons arrived at the stores and easier to stock to shelf kind of format, we call that store-ready. Even looking to see if we can be more efficient with our footprint and leverage, inventory across our footprint to fulfill omni-channel order. Forecast and replenishment, yeah, that certainly part of it. Down the road, if we have more store format like the small stores ensuring that that's easier to scale it to operate, that's also part of it. And also that we continue to improve processing time on our e-commerce business. So all of those are aspects and benefits that are expected and built into the five-year plan relative to the supply chain investments. E-commerce, yes, we do expect that margin will improve as we get more efficient, the two new distribution centers are really being built from the start with that in mind. So really fulfill e-commerce as well as store order is efficiently as possible. So as well as we continue to improve some of the mix of what we feel in e-com.

[Oliver Chen:]

Thank you, Mary. And also on the awareness front here, that's been a nice theme for your bigger strategic plan. Where do you -- where would conceptualize customers as coming from as you make these nice leaps? And as you post-game holiday, it was a really great execution. But if you had to think about it from post-game perspective, you know, are there any things that you just slightly did as you think about next year? Thanks a lot.

[Mary Dillon:]

Okay. Well, we are constantly in a mode of continues improvement seriously. So I think we are always looking at what worked well, what we could have done better. Honestly, we are very pleased with how the quarter turned out, but there is always -- there is -- we can continue to improve. Question about where the customers are coming from? We know that we have opportunity gap in our awareness relative to some of our competition and that's opportunity for us. And that's why we have been working to balance the mix of how we do our marketing to drive -- to have awareness generating tactics and that's proving to work for us. As you step way back, we have, as you know about just under 3% share of the beauty market in the U.S. So our guess is, you know, loved us and she is loyal and coming more often. But there are two sources. One is beauty enthusiast who perhaps have not been in Ulta ever and not been in Ulta for long time or current guests that are maybe spending money across, you know, different retailers early they spend everything all in one place for any one category, but if she is increasing giving us more of her share of wallet. And our loyalty program is a key part of that. It really provides a great incentive to spend your beauty dollar Ulta, because the points are valuable and, you know, more you spend, the more valuable they get for our guest. So it’s really current guests spending more with us as well new guests spending with us instead of other places.

[Oliver Chen:]

Thank you. Best regards.

[Mary Dillon:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.

[Simeon Gutman:]

Thanks. Good afternoon, congratulations. I have one question for you Mary, and then I don’t if Janet is there. But if she is not, I will ask that of you as well.

[Mary Dillon:]

Yes, she is here.

[Simeon Gutman:]

Great. Okay. Great. So first on the momentum in the business, very strong and I am guessing it’s combination of a lot of things. More curious about the marketing side, how effective you are getting a customer targeting. Are you able to attract the pulse of people responding to your offers and seeing a higher response rate and able to attract it on a real-time basis.

[Mary Dillon:]

Yeah, maybe David and Janet are both here. So perhaps we can ask them a little bit. But I would say the momentum on the business that we are seeing is really cut across a lot of dimensions which was great and our job is keep those levers all working. But really if you think about the new product launches and new product news was a big part of the fourth quarter. So Bare Escentuals, Urban Decay, Benefit, Clinique, Lancôme all good examples. Our loyalty program, all and everybody, our one program actually even improving our in-store sign up. And then yeah, so then this notion of our improved marketing strategies and tactics, it’s kind of this combination of using different type pieces of the mix as well as really positioning ourselves, I guess, is more of a beauty authority. So all of those combined and I mentioned in the script gift card as well. So really a lot of different things were working for us in the quarter. Anything on this, Dave?

[David Kimbell:]

Yeah, I think we have made -- we continue to do a lot of the things that have worked for us historically behind many of the print vehicles, our magazines worked well and reaching our existing guests. But we have also introduced an improved several of the taxes we go to market with. Mary mentioned in the script for the first time bringing radio into the mix which we think was a really strong addition to our promotional activity or key holiday season. We also -- to your question specifically about improving the effectiveness, there is a lot that we can read around our guest responsiveness our activities in one area in particular that I would highlight is the impact we are having with our email. So as we get better information around our guest, we are able to more personalize the communication offers, the type of information, the frequency of the information that we are delivering to her. And so we saw a dramatic increase in the effectiveness which has measured by essentially sales per email in that fourth quarter. So we feel like we are expanding as well as getting sharper in the types of things that we are doing.

[Simeon Gutman:]

Okay. And then for Janet, and congratulations on your retirement. I just want -- you have this unique six-year or so perspective at Ulta and dealing brands. And so I wanted to actually trying to something all-encompassing of sort of what's changed in brand perception of Ulta then versus now, how they look at online versus -- you mentioned one Lancôme, is that inevitable for prestige brands to allow Ulta to sale it, or do you think their own online ambition will get in the way? And then also do you think there is much an appetite for them to look outside of Ulta to other specialty retailers to sale the prestige product to?

[Janet Taake:]

That was more than one question.

[Simeon Gutman:]

It's all for you.

[Janet Taake:]

Well, thank you so much. First of all, I think that what I would say about vendor, as you know, my team has great relationships with vendors in the marketplace. Across all categories we do business with them and we had for some time and I think that continues to grow. Our vendor partners really enjoy our straightforward approach to how we run our business and also that it truly is a win-win for them. We hold our vendors accountable to our comps and we look at our business that way, every single day. Yes, we're a fast-growth retailer, but I really think they appreciate that we want to win at a comp level is so which important to us. But we really partner with them to try to make guests experience the best possible experience it can be. And with that I think that they are lot of interested and also based on the respect that we have in the marketplace which I am quite proud of. As far as online, we have made a significant progress as Mary has mentioned this past year. The largest gap just to refresh to refresh her memory was really in professional hair care and we added 12 brands in 2014 and then three at the beginning of this year. So we have products out there. And we are very, very excited about Lancôme coming online. We are truly closing the gap down with very few that are not saleable online at this particular point in time. But I am always hopeful that we will not get into zero for sure.

[Simeon Gutman:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Daniel Hofkin with William Blair. Please proceed with your question.

[Daniel Hofkin:]

Hi. Are you able to hear me okay?

[Mary Dillon:]

Yes.

[Daniel Hofkin:]

Okay. I will add my congratulations on a fantastic quarter. And just I wanted to delve a little bit possible into the gross margin in terms of buckets, and it sounds like -- is it fair to say basically in terms of the directional changes and even maybe the magnitude that most of the aspects of puts and takes were as good or better than expected despite some of the mix shift and the impact of loyalty in e-commerce?

[Scott Settersten:]

Yeah, I see that's right on target, Dan. I mean, it’s a -- there is always a few, right, unplanned surprises that you managed against during the course of any quarter or year. In the fourth quarter, Mary mentioned we had a few challenges in our e-commerce fulfillment side of the business, because again as always the demand always seems to exceed our expectations. So we had a few more, I would say, inefficiencies, labor inefficiencies there that we had to deal with and some additional freight expense to make sure we try to meet guest expectations as best as we could, so we reacted to that. But really I’d say that was probably the one, I’d say, on the negative side of the ledger. On the positive side, I mean, everything seem to work spectacularly in the stores, execution was good, in stocks were fantastic and so we are very pleased with overall performance on retail side of the business.

[Daniel Hofkin:]

And it sounded like you've said that the less discounting and certainly Prestige being among the strongest general categories. So fair to kind of infer that the general underlying product or merchandize margin trend is -- continues to be kind of a key component area, it sounds like. Is that fair to say?

[Scott Settersten:]

Yeah. Let me repeat that. The core retail product margins, so 90% plus of the business, they were better year-over-year and quarter-over-quarter. All right? So the core of the business is very healthy and we are just managing along in our e-commerce side of the business and the loyalty thing is kind of a one-time hit I would say and now they were anniversaried again we wouldn’t expect to see that kind of pressure on margin rate going forward.

[Daniel Hofkin:]

Okay. And then -- in terms of the brands you have, can you just provide a quick update on where we are at this point with Lancôme and Clinique. I know you said you are planning to add some of each and if there is any color you can shade on that at the beginning of the year that would be great. Thanks.

[Mary Dillon:]

Yeah. As I mentioned in the script and we are planning to expand our boutiques of both of those brands. I'm not going to get into specifics. But we are excited we've got great partnership, great momentum on the brands and we will be rolling out to more stores.

[Daniel Hofkin:]

Great. Well, great job and best of luck.

[Mary Dillon:]

Thank you.

[Scott Settersten:]

Thank you.

[Operator:]

Thank you. Our next question comes from line of Aram Rubinson with Wolfe Research. Please proceed with your question.

[Aram Rubinson:]

Hi there. Can you hear me?

[Mary Dillon:]

Yes.

[Aram Rubinson:]

Okay, great. All right. Thanks for taking the call. So want to ask you question about online. It looks like you had by our math about a $55 million increase in e-commerce sales in 2014 over 2015, it’s like the equivalent of about 13 stores. So I'm just kind of wondering, A, where the e-commerce shopper is coming from? Can you give us something about geography, demographics and maybe there is opening fewer stores kind of almost feed the business in a way, because you are getting to satisfy that customer without putting up the bricks?

[Mary Dillon:]

Yeah. Go ahead, Dave.

[David Kimbell:]

I -- no, I don’t think it’s associated with our store growth. Obviously, we opened 100 stores last year. And where that growth is coming from, where our best customer is coming from is we really get an incremental transactions from her. What we see is our -- those guests which is a more -- majority of our online business are coming in and buying both in-store and online. So we get actually close to -- actually little bit more than double the number of transactions from a guest that is actively buying online and in-store versus a guest who is just buying in-store. So really its fundamental and a key part of our overall Omni-channel effort is to be -- have the experience where and when she wants it and what we find is there is times where it’s easier for her to buy what she is looking for, she is attracted to something online and she is at home and she wants to get it. But we also know a big need for us is to get her into store and she is doing both. So we see that as really an incremental purchase and an incremental opportunity for us to drive growth and related to the store growth.

[Aram Rubinson:]

Thanks. If you had to just kind of pick a number of guest added, what kind of -- what comps are coming from existing customers versus new, is to ballpark?

[David Kimbell:]

Do you mean in the online space you’re talking…

[Aram Rubinson:]

No, I was thinking more in the stores. I'm just curious how many more new customers you seem to be bringing into the tent?

[David Kimbell:]

Well, we said we were attracting millions of new customers every year. Retention remains really high. So we have good strong retention. But we continue to attract new growth in customers. I will say one of our opportunities going forward -- it’s the reason we are trying to build awareness is to bring even more new guests going in. But we have high retention. We have high percentage of sales that come from our guests and that's a key driver of our business continuing to delight them and drive strong performance with that group.

[Aram Rubinson:]

And last thing just a little bit housekeeping, in Q1 in the guidance, what kind of investments does that include and then I will hand up.

[Scott Settersten:]

It includes of litany of things, many of those things Mary described in her prepared remarks. So there is new investments going in stores with test management system, we've got new mobile technology; app system is going in stores with iPads to allow us to be more engaging with our guests in the stores. Of course, the biggest investment is the Midwest, DC, which is going to ramp up. It’s ready to open in summer of 2015. So there is a fair amount of gross margin deleverage, that’s where most of that expense flows through the P&L and it will ramp up. I mean, it’s there in first quarter, but the heaviest -- it’s mostly backend loaded in 2015. Third and fourth quarter is the heaviest expense.

[Aram Rubinson:]

Thank you. It’s great to see the hard work pay off.

[Mary Dillon:]

Thank you, Aram.

[Operator:]

Thank you. Our next question comes from the line of Chris Horvers with JPMorgan Chase. Please proceed with your question.

[Christopher Horvers:]

Thanks and good evening. So I want to follow up on the email personalization opportunity. Can you talk about where you are from a segmentation process? How finely can you group your customer base in to different types of buckets that you are using? Can you get down to, let’s say, I know these 10,000 people are bareMinerals customers and so I'm going to send them an email and perhaps other buckets that you are using. And how personal will it be a year from now?

[Mary Dillon:]

So, Chris, I will tell you what that is part of the secret sauce in some ways that I want to be careful about how much we say, because it’s really an important lever for us. And I got to tell you I think our team is -- I know they are all over this and we are very deep in our knowledge, our precision, our ability to target and use this to various effects. But I wouldn’t want to say more than that, because it’s really an important tool for us. But we are excited about it. I think it’s just going to continue to be a great lever for us.

[Christopher Horvers:]

So I guess, maybe, you could characterize in terms of the classic basic, any insights. Where do you think you are versus let’s say best-in-class in retail not versus let’s say online retailers, but best-in-class in retail?

[Mary Dillon:]

Yeah, I think we’re probably still in early innings. Right. I mean -- so I think our capabilities that we -- we've had the loyalty program for a long time, but it’s really like now that we are at this one platform everybody that just simplifies our life and makes it more powerful and the team is really actively experimenting with lots of ways to leverage that. But -- so I think we are really in early stages.

[Christopher Horvers:]

Okay. And then as a follow-up you raised the share buyback program by 100 million and let’s say we assume the stock set at 1.60 tomorrow, that start 2.3 million, 2.4 million shares open to buy. Can you talk about how many shares you need to be repurchased this year to offset share dilution and is the idea of raising the authorization so early, is that to allow increased flexibility to be more opportunistic? Thanks.

[Scott Settersten:]

Yeah, we wanted to maintain maximum flexibility. So again, the plan -- the stated plan, our 10b5-1 plan, the focus is on offsetting dilution which we said I don’t know if I have the number of shares that it takes. But its roughly 500,000 I think was our early model. 500,000 shares a year roughly which equates to about 1%, that's how we set up earnings growth.

[Christopher Horvers:]

Thanks very much.

[Operator:]

Thank you. Our next question comes from the line of Evren Kopelman with Wells Fargo. Please proceed with your question.

[Evren Kopelman:]

Thank you. Good afternoon. Congratulations. My question is for Scott on the guidance. The first quarter comp guidance is the 7% to 9%; it’s very strong, of course, nothing to complain about. But it’s significantly below the 11% you just delivered. Is that just conservatism built into guidance or have you seen the business slow down the Q1 so far?

[Scott Settersten:]

Yeah, we don’t -- as you know we don’t talk about current quarter performance. But we had whether just like everyone else did in the February. Right? So we take everything into account at the current conditions reflect. So we feel very confident, strong momentum coming out of fourth quarter. We mentioned gift cards; there is carry over from that. Post January there is good newness in the pipeline coming online, there is good tailwinds coming from the new store classes that are starting to roll into the comp base. So, again, we try to look at all of the facts and all the levers at our disposal and try to come up with the most prudent guidance that we can.

[Evren Kopelman:]

Thank you. And then two housekeeping, one is, the quarterly store opening cadence is that going to be similar to 2014? And then in your EPS growth guidance for the year, does that assume that 64.4 million that you guided for Q1 or does it assume more buybacks to lower the share count?

[Scott Settersten:]

Yeah. I think the star program by and large pretty much in years 2014…

[Mary Dillon:]

We said 20-20.45 in 2015.

[Scott Settersten:]

Right, which I think is roughly above long-term last year, so it’s like-for-like more or less Evren. And on the shares, again, I think for the full year 64 -- you’re going to build in roughly 400,000 to 500,000 shares, right, off buybacks which would equate to the dilution effect that we described.

[Evren Kopelman:]

Perfect. Thank you.

[Mary Dillon:]

Thank you.

[Operator:]

Our next question comes from the line of Jason Gere with KeyBanc. Please proceed with your question.

[Jason Gere:]

Thanks. Good afternoon. Just a couple of questions. I guess, the first, a more clarification the gross margin, I guess, deleverage this year. Is that primarily because of the new DC in the second half of the year? I know you talked about the loyalty card anniversarying. So just wondering if there is anything else in there that we should be taking into consideration.

[Scott Settersten:]

No, Jason, that's primarily it, kind of, what we described as part of our long-term guidance that we expect to be continue to deliver very strong earnings growth going forward adjusted for the investments, primarily for the DCs. But there are other related investments in our round core systems around merchandizing and other store things that we described in our remarks that we feel we need to support, strong, healthy earnings growth in the future.

[Jason Gere:]

Okay. And then longer term, I know just back in the fall you gave the long-term EPS guidance that gets low 20% and obviously that would imply, start to see a pick-up in margins and this year I think we are implying really flat margins even though comps will be pretty nice. So I'm just wondering how you think about the long-term margin opportunity. Who out there in specialty retail really benchmark yourself to? Because certainly at 12%, kind of, operating margins, it seems to be you are under earning on that end and recognizing that there are investments now that will probably go on for another year or so. But really, where do you kind of benchmark yourself to and what could be kind of that longer term opportunity. I'm not asking you to quantify, but just kind of how you look at it?

[Scott Settersten:]

I think we still feel very confident with the guidance that we provided last fall which we think is very realistic to get to a mid-teens operating margin over the long-term, over the five-year period. Again, in 2015 and 2016 operating margins are going to be flattish because of some of the supply chain, DC and other core system investments that we will be making. But once we get pass that we expect it to be making significant progress towards that target -- mid-teens operating margin target in 2017 and beyond. So lots of good news coming out of these investments, that's what we expect. Unfortunately, we have to make the investments upfront and you’ll start seeing the benefits more in the outer years.

[Jason Gere:]

Okay, great. That will be it for me. Thanks.

[Operator:]

Thank you. Our next question comes from the line of Ike Boruchow with Sterne Agee. Please proceed with your question.

[Ike Boruchow:]

Hey, good afternoon everyone. Congrats on a great quarter. Thanks for taking my question. I guess, Scott, thanks for the help on the variability on how the year should play out. Can you help us when you talk about Q2 and Q3 being tougher. Is that more so on the gross profit and SG&A lines and on margins or should we assume that also -- because you mentioned some product launch compares, so we assumed that that’s also an impact on the comps.

[Scott Settersten:]

Yeah, it’s a mix of both. I mean, Q2 if you line them up, the stack year-over-year, you will see last year was a -- what a 30% EPS growth year-over-year. So when you just starting doing the math, you can see that it’s a tougher comparison. Part of it is being derived from the tough comp compares with some of these product launches which were very strong last year. And some of it is just to build on the deleveraging growth in supply chain cost that are going to effect the P&L. so it’s really a combination of the two.

[Ike Boruchow:]

Right. I mean, I ask because the strongest comp for the year was in Q4 this year and so you are saying Q2 and Q3 are the toughest compares, so that’s why I was trying to clear up if it’s just margin or it's also comp?

[Scott Settersten:]

No, it’s a combination of the two. I mean, margin -- I would say the margin piece is more of a Q3, Q4 and the sales is more of a Q2, Q3 timeframe.

[Ike Boruchow:]

Got it. Okay, thanks so much.

[Operator:]

Thank you. Our next question comes from the line of Joe Altobello of Raymond James. Please proceed with your question.

[Joe Altobello:]

Hey, guys. Good afternoon. Just a couple of questions on some of the tests you guys did this quarter. It sounds like the advertising test went fairly well with the comps above the control group. Was that the same for the increased staffing in the 60 stores you tested this quarter?

[Mary Dillon:]

Yeah. The payroll testing model, we’re really pleased with the learning, Kecia Steelman who is our Head of Store Operations, has really dug deep in all over this. It’s a actually little bit less of a clean test than an adverting test in some ways, right? The inputs are little bit different, because it’s about store-by-store, managing the payroll, hiring, getting the right people there and managing that to an outcome that you want. So what we saw -- and that's why we feel confident that there are sources we are going to after this and we’re going to increase labor hours because we believe it’s going to pay for itself in terms of increased sales, frankly, by having more guest facing time and more conversion. So but it’s also something that because it’s subtle, it’s a little trickier to manage. We’re going to walk before we run. So it’s not -- what we know is that over time as we continue to play out the supply chain investments for our associates in the stores, it will get easier to have more guest facing time, and that's exiting. In the meantime, we want to see if we can accelerate that, but we’re going to kind of take it step-by-step.

[Joe Altobello:]

Okay. So any learnings early on from that test at all?

[Mary Dillon:]

Just that -- particularly when we executed really well, where we held the General Manager accountable to new sales target with those new increased hours and whether that store was able to hire the right person quickly and get the right people trained in a position. It was efficacious for us. That’s why we are confident to add more labor hours in certain subset of stores because we think managed right it’s going to be a good investment for us. It’s really about that overall guest experience as well. And when our guest wants to interact with our associate, our associates want to be there to help them. And so it really is a flywheel that helps the business and we like where it’s going.

[Joe Altobello:]

Got it. Okay. And just moving on to the smaller format store test. It sounds like you guys are going slow there. If it’s successful how many locations you think you could have in terms of that smaller format over time?

[Mary Dillon:]

We talked about up to about couple of hundred stores incremental to the 1,200 stores that we've already mapped out for our large format. And, yeah, I mean, we love how they are performing. They are great stores, great team, the guests love them, and it’s really I believe in pacing, again walk before you run. So it’s a little tricky to operate a completely different store format which it is, but we’re really pleased with where it’s going.

[Joe Altobello:]

Okay, great. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Mark Altschwager with Robert W. Baird. Please proceed with your question.

[Mark Altschwager:]

Good afternoon. And let me offer my congratulations as well. Just a quick follow-up on the small stores, I know it's early, but any metrics you can share on just the productivity you are seeing there or average gross margins versus your typical store? And then separately, what pieces need to be in place from a distribution standpoint in order to enable the scalability of that concept?

[Mary Dillon:]

Yeah. I'm not going to share a lot of the details on this, because it's really early and I want to protect some of that insight. But I will just tell you that we set certain sales and productivity targets and we're exceeding them. So, they would be the normal targets that we set for any store. So we feel good about that. It's really about forecasting replenishment models that I think are going to be the key to getting us to a position to more easily run the store format. So, it's not that far off. I mean it's not like we're going to wait a super long time to do this, because we're excited about the prospect. And I'll tell you what the guests in these small towns were very excited that we showed up, so it's a great opportunity for us.

[Mark Altschwager:]

Great. And then just one more quick one, I think you're two quarters in with this new POS system. Have you seen any benefits from that? And any metrics you can share on that front? Thank you.

[Scott Settersten:]

We don't really have any metrics we can share. I would tell you that the rollout went very smooth. I mean this was one that was pretty high risk and we accelerated it, to make sure we could get it in before holiday, so things went very smooth, all things considered. We did get some step-up in the technology as far as cyber protection as part of that system, so we are very happy that we were able to accelerate the implementation of that.

[Operator:]

Thank you. Our next question comes from the line of Matthew Fassler with Goldman Sachs. Please proceed with question.

[Matthew Fassler:]

Thanks a lot. Good afternoon. I want to start by talking about the loyalty program. You spoke about the loyalty program having a diminishing impact on margins, as you have now cycled the move to a single platform. Can you talk about the typical sales maturation curve that you have seen from customers after they have ramped onto that platform? Is it a multiyear curve, is the big sales kick in year one? Just how we should pick about the impact on sales of cycling that, as well?

[Scott Settersten:]

Matt, historically, what we -- as you well know, we've been experimenting with this model for quite some time. So, historically, as we roll it out to new markets, we saw a sales hit in year one as people got comfortable with the program, and we saw that moderate over the course of the year. So, the going-in assumption was like a one year cycle time to get back to what I would call an equilibrium with the guests. This rollout, the conversion that we did with the 50% of the country in 2014, we didn't see that. We saw sales actually accelerate from our expectations and, of course that equated to more points being earned and more of a margin headwind, because of that, because people are more engaged and it's easier to understand. So--

[Matthew Fassler:]

And if you think about what year two has typically looked like and whether you think it will be any different for this round?

[Scott Settersten:]

Yeah. We haven't really seen that. Again, it's a different scale now. We've got the whole country on this program, and I can just tell you from the inside, we are very excited about what this program provides to the company and the opportunities that we're going to have to drive more engagement, more focused offers to our guests, by using our CRM tool. And again, we're in the very early stages of this.

[Matthew Fassler:]

And then one other question, you've dealt with this a number of different ways so far this afternoon. If you think about the acceleration that you saw, in the online business in the quarter where you have the highest volumes, that acceleration, is that much more meaningful, would you tie that in directly to CRM efforts and customer acquisition? And I guess you're seeing customer acquisition disproportionately commence online, or is it evenly distributed, or proportionally distributed across channels?

[David Kimbell:]

Yeah, a couple things. First we are seeing an over-index of new customer acquisition online, although it's still the minority of our customer -- new customer acquisition. The things that are driving our growth from an e-commerce, is absolutely a combination of a number of key factors. It is a great portfolio of products, first and foremost. They are really attracted to -- the same things they are attracted to in store, they are attracted to online. And we had great success behind many of the launches and the products that Mary touched on. We also, as Janet described, added several new products throughout the course of the fourth quarter and even into this year. We've been successful at driving traffic to our sites, so our customer acquisition and traffic driving activity has really been exceeding our expectation. And then once they get there, some of the changes we've made within the site experience to convert them have been working. And then, I would say the other activities for within loyalty, to your point, around email and other communication, even our magazines and really every touch point that we have, encourages her or reminds her to come online, just as much as it does remind her to come in store, so all that seems to be working.

[Matthew Fassler:]

Thanks so much, guys.

[Operator:]

Thank you. Ladies and gentlemen we have time for one more question. Steph Wissink with Piper Jaffray, please proceed.

[Steph Wissink:]

Thank you for letting me sneak one in and all the best wishes to you, Janet, really a remarkable finish to your ULTA career.

[Janet Taake:]

Thank you.

[Steph Wissink:]

The question is actually for you, specifically. Just to give us a status update on the percentage of SKUs in the mix now that crossover between stores and e-commerce? And then a big follow-up question to the panel. If you think about the influence of content, and I think, Mary, you mentioned this in your prepared remarks, whether it's your own content or content that's created by your vendors, how important is that, do you think, to building your competitive advantage in the marketplace?

[Mary Dillon:]

I will start with the content. And absolutely, we are very focused on that. And this is a category industry that is so driven by trend and content, new discoveries, so we're building content, we are working with our vendor partners to acquire more content and you'll see more of that to come from us for sure.

[Janet Taake:]

As far as online SKUs, basically now, with the additions that we made in Professional Haircare and Lancôme, we're well within a very high range of what we have in the store. We have over 20,000 SKUs in the store, so it would be comparable online. As I mentioned before, it's a handful of brands that are in store that are truly not online for sale today. So, we have made significant progress in 2014.

[Steph Wissink:]

Great. Best of luck to you all. Good bye.

[Mary Dillon:]

Thank you.

[Operator:]

Thank you.

[Mary Dillon:]

Okay. So, in closing, I'd like to thank our 22,000 dedicated associates for a really terrific 2014 and their tireless efforts to differentiate ULTA Beauty and to continue our strong momentum into 2015 and beyond. And thanks to all of you for your interest in our company. I look forward to speaking with you all again soon. Thank you.

[Operator:]

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