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Ulta Salon, Cosmetics & Fragrance, Inc. (NASDAQ:ULTA)

Q4 2013 Results Earnings Conference Call

March 13, 2014, 05:00 PM ET

Executives

Laurel Lefebvre - VP, IR

Mary Dillon - CEO

Scott Settersten - CFO and Assistant Secretary

Janet Taake - Chief Merchandising Officer

David Kimbell - Chief Marketing Officer

Analysts

Aram Rubinson - Wolfe Research

Oliver Chen - Citigroup

Ike Boruchow - Sterne Agee

Gary Balter – Credit Suisse

Matthew Fassler - Goldman Sachs

Bilun Boyner - JPMorgan

Daniel Hofkin – William Blair & Company

Neely Tamminga - Piper Jaffray

Morey Marcus - Oppenheimer & Co.

Jason Gere - KeyBanc Capital Markets

Evren Kopelman - Wells Fargo Securities

Mark Altschwager - Robert W. Baird & Co.

Jill Nelson - Johnson Rice & Company

Dana Telsey – Telsey Advisory Group

Operator

Greetings, and welcome to the Ulta Beauty Fourth Quarter 2013 Earnings Conference Call. (Operator Instructions). As a reminder this conference is being recorded.

I would now like to turn the conference over to your host, Laurel Lefebvre, Vice President Investor Relations. Thank you Ms. Lefebvre. You may begin.

Laurel Lefebvre

Thank you. Good afternoon and thank you for joining us for Ulta Beauty's Fourth Quarter 2013 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 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 the 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.

We also refer to non-GAAP sales and earnings growth in 2013, adjusted for the 53rd week of fiscal 2012 and severance.

I'll now turn the call over to Mary.

Mary Dillon

Thank you, Laurel and good afternoon everyone. Ulta Beauty achieved excellent sales growth in the fourth quarter supported by continued momentum in our e-commerce business. We delivered solid EPS growth in keeping with our expectations that we would need to invest in margin dollars to drive market share gains during the promotional holiday season. We also made significant forward progress in each of our five key strategies.

To recap the headlines, we grew sales 14.4% or 23.3% adjusted for the extra week in the fourth quarter of 2012. We delivered a 9.2% total company comp on top of an 8.6% comp in the fourth quarter of 2012, both including the impact of online sales growth. Our e-commerce business performed very well driving 82.5% comp sales growth which contributed 260 basis points to the comp.

Similar to the rest of the year prestige cosmetics and skincare were the strongest categories while we continued to see weaker industry trends in the nail and fragrance category. We were encouraged to see improvement in the transaction trend with a sequential improvement compared to the third quarter. While still slightly negative for retail stores transactions increased about 1% including e-commerce despite difficult traffic trends in the retail environment overall.

Our comps continued to be mostly driven by ticket, about a third of increase coming from units per transaction and about two-thirds coming from average selling price. Earnings per share were up 9% to $1.09 or up 14.7% adjusted for the 53rd week last year. Scott will provide more details on our financial results for the quarter and on our guidance for 2014 in a couple of minutes but first I want to update you on the recent progress on the five components of our growth strategy; new store performance, new product services and brands, our loyalty program, marketing and ulta.com

Starting with real estate, we opened 11 stores during the fourth quarter to complete the most ambitious store opening program in our company’s history. We are very proud of our growth and development team’s execution in delivering this new store program as well as the hard work of the store operations, merchandising, supply chain and HR teams to get these stores staffed, merchandised and ready to serve our guests.

New store productivity continues to be strong. We are on track with our plans to open about a 100 stores in 2014 representing about approximately 15% square footage growth. This is a purposeful decision on our part as we said last quarter to moderate our pace of store growth. New stores continue to provide excellent returns and will continue to be an important part of our growth strategy.

We expect about 40% of these new stores to be a new market and about 60% are planned for filling in existing markets. We anticipate about one-third of the stores to be in new real estate and the remaining two-thirds are planned for existing shopping centers. We expect about 15% of the 2014 class of stores will be in enclosed malls adding to the 52 mall stores we have in the portfolio today. The rest will be in power centers or strip malls.

In terms of the pace of new store opening, we expect to open 19 in the first quarter, 19 in the second quarter, 43 in third quarter and 19 in the fourth quarter. We also plan to open two 5,000 square foot or small format stores during the second half of the year in smaller markets with fewer households than what's typically required to support a 10,000 square foot store. We are in the early stages of developing and testing this model but we are very encouraged by the potential to expand our store growth and delight more new guests with the great Ulta Beauty experience.

We also plan to remodel about 12 stores to our latest store format this year and re-flooring that cosmetics planograms in about 60 stores to replace some dated fixtures and to create a more vibrant and consistent shopping experience in that category. Today we have only 38 stores in older formats, about 5% of the fleet. We are very proud of our consistent and contemporary store portfolio.

Now turning down to merchandising I am delighted to announce that Janet Taake was recently promoted to Chief Merchandising Officer. Janet and her team have done a phenomenal job expanding our portfolio with new brands, products and services over the past several years and developing valuable partnerships with key vendors. They have also worked in concert with our marketing, e-commerce, operations and replenishment teams to make sure we launch new brands and products effectively.

The recent launch of Urban Decay's Naked3 eye shadow powder is a great example of this, where the merchants, CRM, e-commerce, supply chain and stores teams worked together with our vendor partners to ensure customer has got excited about the new products and had a great experience buying it from Ulta.

Our merchant team delivered a strong fourth quarter with strong comp gains in prestige, color and skincare offset by softness in traditional gift giving categories like fragrance, bath and personal care appliances. While industry weakness in fragrances and nail polish have been well documented there were several bright spots including the successful launch of the fragrance One Moment by One Direction driven by a major 360 degree launch including print, email, social media, PR and digital marketing.

We also saw strength in lower price point items like lower box fragrances and we made improvements for our holiday gift and purchase program which helped drive sales in the fragrance category despite industry softness.

We were also pleased with our January performance with prestige skincare taking center stage with our skin event featuring daily in-store events. From a trend standpoint our lip category continues to be a standout and delivered excellent growth. Skincare and anti-aging products remain high growth categories as well with new brands and products from Perricone, Meaningful Beauty and Philosophy contributing to the category's strong performance.

Looking ahead we are excited that IT Cosmetics and Mally launched last year in selective stores will be rolling out to the entire chain later this quarter. Our customers have enthusiastically embraced these brands in our stores in our line.

Turning to services, our Salon team delivered solid results in the fourth quarter to cap a great year where they contributed to the total company comp by improving retention of Salon Associates and refining offers to drive trial and awareness. In the fourth quarter we rolled out eyelash application services in all stores. The Salon's artistic team created a lot of excitement by representing Ulta Fashion Week in New York in early February where they created the model hair styles for various designer Broadway shows.

Looking forward we expect to add new services at our Salons this year and roll out enhancements like text confirmations for appointments and 24X7 online appointment booking. We will also feature Salon services more prominently in our direct mail campaign to communicate to our customers that Ulta is a destination for trends like hair, skin and brow services.

Now moving on to an update on our loyalty program and customer relationship platform, we now have 13 million asset loyalty members who shopped with us within the past twelve months. We recently converted all of our customers to the ultimate rewards program and the team executed a very smooth transmission. Having all of our customers on one program which uses points as currency will enable a more efficient use of our CRM platform for targeted offers.

Now we’ve been working with our CRM platform for just over a year now and we continue to test and fine tune our offers as wells as we are also talking with our vendors to develop compelling CRM campaign. As a result of our improved ability to segment and target customers we’ve been able to grow our conversion rate and drive more sales from marketing contacts which in turn helped us to deliver strong comp growth in the fourth quarter.

Now turning to marketing first I’d like to announce that Dave Kimbell has joined Ulta Beauty as our Chief Marketing Officer, Both the marketing team and e-commerce team report to Dave. Dave brings to Ulta his extensive experience in building consumer brands including beauty products with Proctor & Gamble and brands like Quaker Foods and Seventh Generation. Dave was most recently CMO with U.S. Cellular where he oversaw the team responsible for advertising, digital and e-commerce, retail design, pricing promotion and consumer insights and analytics.

Dave brings a seamless integrated and multi-channel customer experience which drove strong e-commerce growth. Dave will lead our efforts to drive greater awareness and clarity about the Ulta Brand and create customer acquisition and optimize the balance across promotional and brand building activities over time. In addition Dave will lead our Omni-channel marketing and e-commerce efforts.

Now turning to the marketing highlights from the fourth quarter, we were encouraged to stabilize the trend in transactions with our increased promotion to drive traffic and protect market share. During the holiday season we also expanded our beauty sales programs with hot offers and social media in ulta.com. In January our signature mother skin event supported with a fully integrated digital and print campaign drove the strong finish to the quarter.

Looking ahead to the first quarter we are excited about our continuing digital brand building efforts, our direct mail campaigns featuring our spring trend reports and our highly anticipated 21 days of beauty promotion later this month with an amazing array of offers and events.

Now wrapping up with our fifth growth strategy, our e-commerce business, the fourth quarter was very strong for ulta.com with particular strength in prestige cosmetics, skincare and holiday promotional products. We benefited from our improved e-commerce platform that was launched in the fall as well as increased fulfillment capabilities with the expansion of our Northeast distribution which began shipping e-commerce orders this fall. With 83% comp growth for the quarter ulta.com exceeded our expectations.

While Black Friday and Cyber Monday were very successful the team maintained strong momentum post-holiday as well. We are confident on e-commerce business will continue to deliver rapid growth in 2014 but we’ll likely begin to moderate off a larger base with top line growth expected in the 50% to 60% range.

So this wraps up my update on our five growth strategies. Before I turn it over to Scott I’d like to also give you a progress report on our strategy work and share my thoughts on our guidance for 2014. Ulta is a great business, I am very optimistic about our future. We are well positioned in the marketplace and our core business model remains strong. I want Ulta to be the most popular destination for beauty products services and experiences for women when and however she wants to shop.

The long range strategy we are developing will ensure that we deliver on this vision. We will chart a course that allows us to continue to deliver an exceptional guest experience, be a terrific place to work and drive profitable growth for years to come.

We have a wonderful foundation to build on. We operate in the large and growing beauty industry, we offer many popular and exclusive brands, we have a track record of performance that's one of the best in retail. We offer a differentiated guest experience that involves products as well services. We have excellent store economics. We also have a powerful and developing CRM capability and of course a great leadership team and passionate associates.

That said we cannot stand still. We see a clear line of sight to continue growth in the near term. However we also need to invest in the strategy that will drive growth for the long term. Doing this now while we are operating from a position of strength will enable us to drive healthy long term performance for Ulta. In our strategic planning work we are taking the long view, projecting the consumer category in competitive environments well into the future refreshing our visions in how Ulta needs to continue to evolve our business model and developing a five year growth plan.

Through this work we'll create a [play book] anticipating the guest’s changing needs in a unique and differentiated fashion and deliver profitable growth for our investor. Again we are in an exciting, we are in a very exciting growth business with passionate guests and associates and terrific vendor partner, a great basis for our future.

Now once we've completed this work in the fall we’ll share the results and vision, strategy and five year financial targets. This work has already given us some clear insights that have helped inform our view for the current year with clarity about some of the investments I believe will drive future growth.

Two of our biggest opportunities focus on the customer, acquiring new guests and making sure we continue to deliver relevant and differentiated guest experience. As you are all well aware retail is changing rapidly and customer expectations continue to rise and change as well. We need to invest in a most effective way to increase awareness of Ulta, to drive new customers to our stores and website and to become less reliant on discount over the long run. We also need to build Omni channel capability that customers expect us to have and provide even better service in our stores.

With our tremendous growth in prestige cosmetics and skincare over the past few years customers today have higher expectations for our product knowledge and service standards and we need to reaffirm that. We believe that these investments in 2014 will help us to prioritize the best strategies to drive comp growth as well as margin improvement. Our plan is to deliver mid-teens earning growth in 2014 allows us the flexibility to make important investments today and we believe will set us up for future growth and success.

With that I will hand it over to Scott.

Scott Settersten

Thanks, Mary. Good afternoon, everyone. We recorded total sales of $868.1 million compared to $758.8 million last year, an increase of 14.4%, excluding the impact of approximately $55 million sales in 53rd week last year sales growth on a 13-week to 13-week basis was 23.3%.

Comp store sales increased 9.2%. The retail comp was 6.6% and e-commerce growth of 83% added 260 basis points to the comp. Salon contributed slightly to the overall comp. I would like to remind you that this comp performance benefited by more than 200 basis points through the comparisons to 2012 Super storm Sandy negative impact and the timing effect of the extra week last year. Recall our comp compared weeks 40 to 52 of last year to the same week this year and excludes the 53rd week which was an unusually large sales week for us. The underlying comp excluding these factors was more like 7%.

Gross profit dollars increased 13.1% to $293.6 million and gross profit margin declined 40 basis points to 33.8% from 34.2% in Q4 last year, driven by strength in our prestige categories offset by higher than expected promotional activity to drive growth.

SG&A expenses rose 15.4 % to $177.6 million, up 20 basis points on a percentage of sales to 20.5% due to planned investments in supply chain, e-commerce and store labor that are bit better than expected driven by strong expense controls. For example, we were more efficient with marketing spend by distributing more offers digitally, via email and social media rather than printing direct mail business.

Pre-opening expense was $1.8 million compared to $1.9 million in Q4 2012 driven by 11 store openings during the quarter compared to 13 new stores opening during Q4 of last year.

Operating margin decreased 60 basis points to 13.1% versus 13.7% in Q4 of the prior year. Net income increased 9.5% to $70.7 million or $1.09 per diluted share versus $64.5 million or $1 per diluted share last year. EPS grew 9% or 14.7% excluding the approximately $0.05 attributed to the extra week in 2012.

Turning to the balance sheet inventories were $457.9 million at the end of the quarter compared to $361.1 million at the end of Q4, 2012, up 3.3% on a per store basis. This is consistent with our plans were after making permanent investments in inventory at the end of last year to improve in-stock levels and continuing to invest in prestige boutiques we expected to see inventory per door growth below comp growth by year end.

Capital expenditures were $49.1 million for the quarter, driven primarily by our new store opening program and depreciation and amortization for the quarter were $28.7 million. Capital expenditures for the full year were $226 million. Roughly 60% of our capital spend was for new stores, remodels and relocations. The remaining 40% was for merchandise fixtures including prestige boutiques, supply chain investments primarily related to the e-commerce expansion at Chambersburg as well as IT investments including ulta.com and maintenance CapEx. We generated about $102 million of free cash flow for the year and ended the year with $419 million in cash.

Turning now to guidance for 2014. We expect to open about 100 new stores this year and will increase our remodel programs with about 12 stores. We anticipate comparable sales to increase in the 4% to 6% range. This is expected to yield top line growth in the mid-teens range for the year. P&L investments for the year include supply chain expenses to support the planned 2015 opening of a fourth DC, marketing to convert 50% of the countries to the ultimate rewards loyalty program and investments in increased training for both store and Salon Associates to improve the customer experience.

In addition as Mary mentioned all of the strategy work we've done so far identifies significant opportunities to acquire new customers and drive higher awareness of our brands. We also need to create a better customer experience with more Omni channel capabilities and more knowledgeable associates. We intend to allocate a pool of dollars to test and measure initiatives that we believe our critical to our long-term growth as-well-as invest in some headcount to move these key initiatives forward.

These initiatives to explore future growth are expected to impact EPS by about 10 points. As a result we expect that earnings per share will grow in the mid-teens percentage range this year, including those incremental initiatives representing $0.10 of earnings per share and excluding any potential accretion from share repurchases. As a reminder we have an authorization in place with about $113 million remaining. This outlook assumes the current economic and consumer environment remains stable in 2014. If macroeconomic conditions improve we expect to do better.

We expect to invest about $265 million in capital in 2014 with approximately $115 million earmarked for new stores, remodels and relocations, $30 million for merchandised fixtures for existing stores, $50 million for IT systems, including e-commerce, $50 million for supply chain and about $20 million for maintenance CapEx.

Turning more specifically to the first quarter of 2014, going forward we will give quarterly guidance for sales, comps and EPS but will no longer breakout our expectations for gross margin and SG&A. We expect sales to increase in the range of $693 million to $704 million versus $582.7 million last year. We expect comparable sales to increase in the range of 5% to 7%. Pre-opening expense is expected to come in about $2.5 million with 19 stores planned to open in our first quarter. We expect to achieve earnings per share in the range of $0.70 to $0.75 compared to $0.65 in Q1 of last year.

You may be expecting Q1 to be our strongest quarter relative to an easy gross margin comparison from Q1 of last year. In fact we will see certain expenses hit Q1 that will make it a tougher quarter relative to the rest of the year. We will have costs related to the changes in the senior management team and consulting expense related to our strategy projects with a significant portion of the work occurring in the first quarter. We are also incurring incremental marketing expenses related to the conversion of our loyalty program. At the same time the first quarter represents the greatest headwind in terms of P&L deleverage due to the large number of younger stores that are still left and fully productive.

Our tax rate is expected to be approximately 38.3% and our fully diluted share count will be approximately 64.9 million excluding any share repurchase activity.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line of Aram Rubinson with Wolfe Research. Please proceed with your question.

Aram Rubinson - Wolfe Research

Hey, thanks for taking my questions. Can you hear me okay.

Mary Dillon

We can.

Aram Rubinson - Wolfe Research

Okay, great. Question around, well two things really, one is if you can help us tell us what you learned about your customer from fiddling with the promotional cadence in Q4? Just wondering whether it's mass or whether it's prestige kind of what the customer response was to changes in promotional strategy on either side of the store?

Mary Dillon

This is Mary, let me just say couple of things. One is that we -- I guess I would say that there is probably a tale of two customers that we see overall in our business. There is folks that are feeling probably pretty upbeat about their earnings and about the overall economic environment tending to buy prestige we saw and our ticket, pretty strong uptake in ticket. So there are folks certainly that are less promotional and buying our higher margin prestige items.

There is other folks I would say kind of the other part of our consumer base that are it's going to be more sensitive to promotion, more sensitive to the economic environment and probably more attractive to promotion. So those folks were as we ramped up our promotional cadence we think that was the right thing to do for that customer.

Now overall for the quarter we saw an improvement in traffic but still most of our result was confidence driven by ticket. So as I noted that overall that it's part of our test and learn it we want to continue to dissect further what are the best drivers of incremental profitable growth as we use promotions more or less to drive results in any given period.

Aram Rubinson - Wolfe Research

Thanks and just to quickly follow-up can you tell us what that increase in ticket looked like in the fourth quarter and also what promotional environment is embedded in ’14 if you are expecting to become more or less or the same as 2013? Thank you.

Mary Dillon

Yeah, right now I think we don’t have any reason to think that ’14 will be different than ’13 and so that’s we are assuming something pretty similar to that. In terms of the transaction versus tickets, so again I would say really pleased that we saw a sequential improvement in transactions in the fourth quarter, we were up about a 1.2 in transaction and 8 in ticket for the total comp of 9.2. Transactions in the retail store were slightly down in stores and there were offset by growth in Salon and e-commerce.

Aram Rubinson - Wolfe Research

Well, thanks so much, good luck in this quarter.

Mary Dillon

Thank you.

Operator

Thank you. Our next question comes from the line of Oliver Chen with Citigroup. Please proceed with your question.

Oliver Chen - Citigroup

Hi congratulations on outstanding quarter and great finish in the year. Regarding your guidance for first quarter and in your comps, February has been pretty rough on everybody. Are you thinking that March and April could be better than February and are there any kind of thoughts around the dynamics you saw in February? Also is e-comp kind of experiencing similar trend with respect to how the weather has impacted or is there a dynamic that you could share with us, that would be great.

Scott Settersten

The guidance that we were providing of 5% comp guidance includes, as it always has, in the past everything we know laid up for the last kind of 5% to 7% excuse me, which includes the current consumer environment and what’s going on in the category. To the part of the question about e-commerce, funny enough when we saw some of the toughest weather days in January we didn’t really see a huge spike in the e-commerce business, which kind of flew in the face of common sense, from our vantage point.

So we do think like we have a good momentum there, we have made a lot of progress in our ability to merchandise that and expanding the assortment online, we have made good progress on expanding our margin rate there as well. So we’re very happy with the overall performance of that business.

Oliver Chen - Citigroup

Great, and on the promotional strategies, what’s your best strategy there in terms of things you should highlight a few kind of offset or mitigate or what seems to be a continuation of the promotional slate?

Mary Dillon

Well I will say couple of things, one is that you know we continue to learn from everything that we do and so finding, as we think about even promotion for holiday for next year we’ll step back and look at what worked well and what didn't work as well and we’ll continue to refine our strategies for that, understanding the shift in consumer shopping patterns for online and see how that plays out in a holiday period.

Speaking about holiday we look at all things from like gift giving versus buying for herself, those are offering that we are considering as we think about how to continue to refine. But we certainly know that at the core that we’re going to continue to be aggressive to grow our market share and so I would expect it to continue to be a promotional time.

Another thing I would say though is one of the test and learn things that we are working -- we are going to do right away is we are going to do deeper analytic work to quantify overall setting aside holiday, just incremental sales and profit impact of all of our promotional initiatives which will help us to get even more efficient and affective with that area of spending, so that’s going to be an important area for us as we look to the future and how we balance non-promotional traffic and volume with promotional.

Oliver Chen - Citigroup

Thank you. Best regards.

Mary Dillon

Thank you.

Operator

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

Ike Boruchow - Sterne Agee

Hi, everyone. Thanks for taking my question. I guess for Mary the comments that you made about the investments into the brand, is there anything you can tell us about the studies you have done, you can kind of see where your unaided brand awareness is today versus some of your peers and maybe how you think that could change over time? And then I guess one quick one for Scott. On the comp guidance for the year can you help us think about what’s embedded in that in terms of ticket and traffic?

Mary Dillon

Yeah I’ll start with the -- I am not going to say specific numbers but certainly we understand where we are both in terms of aided and unaided awareness and I consider this to be a great opportunity for us. We’re not as high as we can be and both in terms of awareness and I would say understanding the brand equity of Ulta, what is it that we represent, what do you experience about, so both of those are areas that we know there is plenty of room to drive awareness in both the store, what we offer in store, the fact that we have the salon and services.

All of that is going to be key areas for us as we try to learn this year because to drive awareness consumers are bombarded with lots of messages all the time, so we have to be very purposeful in what and how we try to drive awareness and new guests to Ulta. Fortunately there is plenty of ways to do that and one of the ways that we are going to be testing and learning is around more sophisticated customer acquisition efforts, for example as well as more traditional CapEx, so there’s I think some good opportunity there for us.

Scott Settersten

And Ike I would say in the near term we don't see any drastic changes as far as the makeup of the comp is concerned. So in the near term we still expect ticket to be primary driver of the comp although some of the growth initiatives that we talk to we’re going to be focused on ways of trying to drive increased traffic, so either brand awareness activities or rather things that we can do within the store.

Ike Boruchow - Sterne Agee

Thanks and one quick follow-up. You guys are actually one of the rare retailers that haven’t used weather as an excuse for the quarter. Is there anything you can mention about store closures or weather may be negatively impacting the comp for the quarter and what it could have been I guess if you could just give some color around that I would assume it was slightly negative to your traffic and your comp.

Mary Dillon

Well we certainly weren't immune to the weather. I think we have 400 store closure days. You know fortunately a lot of our transactions are replenishments and items that perhaps our guest, that she can buy that they will come back and buy another day so we didn't feel that -- could we have done somewhat better for holiday while we didn't see weather is a big, the biggest impact in our performance.

Ike Boruchow - Sterne Agee

Thanks. Good luck.

Mary Dillon

Thank you.

Operator

Thank you. Our next question comes from the line of Gary Balter with Credit Suisse. Please proceed with your question.

Gary Balter – Credit Suisse

Thank you. Mary you wrote in the press release, you mentioned it that you had 25 significant new brands that helped in the comps. Can you talk about what under the bigger brand additions were?

Mary Dillon

Yeah. Thank you, Gary. It's actually one of the, I think most exciting parts of our story is that our guests are -- they want to come and find new things at Ulta and Janet and her team have done a great job at that. So I am going to ask Janet to take that question.

Janet Taake

Hi, Gary. Just quickly some of the things that we've launched last year we launched Perricone around this day, last year which was a nice add to our skincare portfolio, we added Meaningful Beauty in the third quarter last year and other skincare brands. In color we launched IT in about 50% of our doors last fall and as Mary mentioned in her prepared remarks we are taking into all doors in this quarter. We've put Mally in a handful of doors but we have lipstick, cream we have many other several different brands throughout the entire store. We also launched Jane in the mass arena, so we added brands across of the businesses including professional hair care.

We talk a lot about prestige but we really added brands across all categories. Those were some of the highlights.

Gary Balter – Credit Suisse

Thank you. And just, Scott a query, could you go into bit more detail possibly on the product gross margin and how we should think about what the impact was in the fourth quarter and how we -- I know you said -- I think you already said you are not going to talk about the gross margin but if you want us give us any thoughts about how we model it out for this year?

Scott Settersten

Yeah, I guess I can reference -- give you a little color on the fourth quarter. So with gross profits they were down 40 basis points and as we talked about in our third quarter call we're always ready to invest a bit on margin rates to protect our market share gains. And we did that, we had to do it in the fourth quarter, we also -- how it shook out. I would say that the 40 basis points, just to give you a little more specificity on that, it wasn't -- part of that was due to mix in the business overall.

So as e-commerce continues to grow at an accelerated pace and becomes a larger part of our overall growth profile, while we've been very successful increasing our margin rate in that business as you look at individual year-over-year it does put a bit of [byline] over our margin rate because it does contribute at somewhat lower rate than our bricks and mortars.

Gary Balter – Credit Suisse

And going forward?

Scott Settersten

We would expect that phenomena to continue at that; although we will continue to focus on merchandising there and other marketing tactics and e-commerce to help drive a better margin rate in 2014 as part of our plan.

Gary Balter – Credit Suisse

Okay. Thank you.

Operator

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

Matthew Fassler - Goldman Sachs

Thanks a lot. Good afternoon. My first question relates to the loyalty program conversion. I guess it's great to hear about this happening with no hedges and no evident costs given that I think the second stage of the conversion and the prior stage had been a bit more challenging. Can you talk about what improved in your process as you converted the rest of the country to the current model of the loyalty program?

Scott Settersten

Yeah. We've talked about this a number of times before explaining to people some of the hard lessons we've learned on the first time around, Matt. And I am sure we've had these conversations with you as well. So the team we were just better prepared, we had a better communication strategy to our customer, we kind of transitioned them out of the old certificate program into the points program in a more seamless manner so it's clear to them. And it was communicated as a big step up for them an improvement in the loyalty program overall.

So we are very happy, the team did a great job getting us through that in a very transparent and fluid way. To just be clear on the margin rate we talked about loyalty and it is a bit of a headwind our margin rate for next year as we -- and yes we've discussed this in the past. But in the long-term it drives incremental comp sales and incremental gross profit margin dollars.

Matthew Fassler - Goldman Sachs

Great, and then my second question Mary a call or two ago you spoke about the changes that you are making in supply chain -- that you had made in supply chain and human resources after the call, then another company and not a competitor talked about hiring someone who had been your CIO and just curious any other changes -- any changes in the management team since the last conference call, as I know you have been centrally organizing the team with your vision?

Mary Dillon

Right, absolutely Matt, thank you. Well first of all as I mentioned two changes in our in our folk who are in the room here was us today. So Janet Taake being promoted to Chief Merchandising Officer and then the addition of Dave Kimbell as the Chief Marketing Officer. And yes and right now -- a fellow named Steve Junk is our Interim Chief Information Officer. Steve's been in Ulta for many years and has a great and deep experience. Our CIO went to another company and fortunately Steve was able to step in and play that role for us and he's doing a fantastic job and overtime we’ll probably look at somebody in that role for the long term but right now Steve is running the ship for us and doing a great job.

Matthew Fassler - Goldman Sachs

Great, thank you so much.

Operator

Thank you. Our next question comes from the line of Brian Tunick with JPMorgan Chase & Company. Please proceed with your question.

Bilun Boyner - JPMorgan

Hi, thanks for taking my question this is Bilun Boyner on for Brian today. I guess I first wanted to ask about supply chain DC and the Omni-channel investment that is still in your $0.10 incremental SG&A impact guidance. Clearly they are ongoing investments but where would you say we are in that process, are we towards the tail end of a big chunk of those investments? I guess by our models they impacted earnings last year by about $0.03 to $0.04, so do you think it is reasonable to expect a similar impact this year from those and then they should start to minimize into next year?

Mary Dillon

Yeah, let me take that one, the $3 that you refer to in 2013, the way we describe it to folks was that, that was kind of a down payment on a longer term supply chain project that we have that we talked to with investors quite a bit in 2013. So that was consulting work to help us kind of blueprint what the future supply chain would look like. Now we are shifting into actually constructing a supply chain. We are looking at a new, a fourth building coming on-line in the middle of 2015.

So now we are moving on to more of a CapEx kind of phase of the project there as we find a location, put up a building and get it staffed up and pre-opening as we go into 2015. So that will be the first step on a longer range supply chain re-formulation I would call it, we are going to look and make some significant improvements in the way we do business and we expect that to drive significant efficiencies across the supply chain over the long term and it's going to be a multi-year project and it's going to include going back and looking at some other existing facilities and perhaps doing some retrofit work there so…

Bilun Boyner - JPMorgan

Okay that’s helpful. And then my second question is on the Salon and Ulta Brand. Clearly there are big differentiating factors here. Can you help us better understand what your vision is for them and where you see the opportunities? Maybe how we should expect to see you really play them to your strength going forward and in 2014?

Mary Dillon

I am sorry did you say Salon…?

Bilun Boyner - JPMorgan

Yes.

Mary Dillon

… and Ulta Brand? Yeah you know right now the services part of our business is not that big but we consider that it's a very strategic asset in that for the long term having a place to go to get great haircut and color, skin services where all the different kinds of services we can imagine adding will be something that really differentiates us. And as well our Salon guest is our best guest. She comes frequently and she purchases more than just the services. So that’s the great part of your business as we are looking at our strategic planning work we’ll consider options around how we think about that going forward.

With the Ulta as well we’ve got a really nice brand, the product are very large brand of color, skin care and sun care and we launched many of those in big packaging, we are going to be merchandising them even more effectively in 2014. And that’s what we think it's a good base off of which to grow as well.

Bilun Boyner - JPMorgan

Great, thank you, best of luck.

Mary Dillon

Thank you.

Operator

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

Daniel Hofkin – William Blair & Company

Hi good afternoon. Nice job navigating a noisy environment with a healthy comp. Just wanted to understand a little bit better may be bridge the kind of the updated EPS growth guidance for 2014 with the prior guidance from December. So all of the $0.10 is incremental correct?

Mary Dillon

Yes and I will just state that really the change in our view from December is really centered around our belief that we have the opportunity to leverage our position of strength right now and invest in initiatives that we think are important to drive their future best way to drive future long term and profitable growth. So that is our incremental analytics around the different areas that we described, which is brand awareness, getting more new guests, improving the guest experience as well as making sure that resource our company with the talent and skills that we need to drive that long term success.

Daniel Hofkin – William Blair & Company

And the $0.10 includes all of those items?

Mary Dillon

Yes.

Daniel Hofkin – William Blair & Company

Okay, so if my math is right that’s about three percentage point impact, let’s say going from previously give or take around 20% expected growth to now about mid-teens, give or take one to three percentage points additional and I am just wondering if you can kind of bridge that remaining gap a little bit. Was it -- are you expecting kind of little more gross margin investment base what you saw through the holiday period you that kind of thing or just maybe help tying it up?

Mary Dillon

No, I mean what we said is that we would be around high teens similar to 2013 and we are guiding to mid-teens right now.

Daniel Hofkin – William Blair & Company

Okay, maybe I didn't catch that right before. I thought the previous thought was around 20% at the midpoint. Okay, I’ll…

Mary Dillon

Dan we were trying to not give a single point estimate for the guidance, to say that the next year we are going to be very similar and not try to give you know very detailed guidance but in that range. So you are right if it was exactly the same it would be there but with more of a range in mid-teens that three points is really the difference between our view then and today.

Daniel Hofkin – William Blair & Company

Okay, fair enough. Thanks very much.

Operator

Our next question comes from the line of Neely Tamminga with Piper Jaffray. Please proceed with your question.

Neely Tamminga - Piper Jaffray

Sure. Neely Tamminga from Piper Jaffray. Mary I was just wondering if you could talk a little bit about mobile maybe get in to a little bit more than indicating some of your specific initiatives for mobile in 2014. You guys are making great strides in and out over the last six months and those starting to tie royalty there. I am just wondering how you are seeing your mobile shopper interplay your more engaged shoppers, how are they using the app and are they adopting to the technology and what more key offer them in 2014? Thanks.

David Kimbell

Yeah, hi it’s Dave Kimbell. I will take that one. Mobile has been an increasing part of our business and as part of our total e-commerce sales platform and it’s now representing about probably quarter of our total e-commerce sales so it’s a bigger part and growing very quickly. The new app as you said has been a big improvement for us and we’re going to continue to find ways to drive that to market differently within the mobile space to look for different offers in different times.

Of course mobile does provide us with some unique opportunities to reach our consumers in very relevant places at relevant times. We are looking at creating some in-store applications, expanding Wi-Fi in our stores which will also allow her to use those services more seamlessly within our stores and continue to new find ways to improve the effectiveness of the app across different platforms, including phone and tablet.

So we see that as a big platform. We’ve been very successful, it’s growing but we also think we are just scratching the surface on fully maximizing the opportunity in that space.

Neely Tamminga - Piper Jaffray

Dave could you actually again looking at implementing from [i-beacons] potentially in 2014?

David Kimbell

I am sorry, some what?

Neely Tamminga - Piper Jaffray

I-beacons

David Kimbell

That isn’t necessarily in our pipeline but we are going to look at everything that’s available to us as we look at new ways to create that experience. Mary talked about broader Omni-channel and of course mobile is a big part of that. So as we look at there’s a robust pipeline of ideas that we have both in this year and over the next three years to try to create more seamless experience but we’ll look at all those things and trying to drive that go forward.

Neely Tamminga - Piper Jaffray

Thank you.

Operator

Thank you. Our next question comes from the line of Joseph Altobello with Oppenheimer. Please proceed with your question.

Morey Marcus - Oppenheimer & Co.

Hi, this is Morey Marcus in for Joseph. My first question just going back to incremental investment and going back to 2013 back into Q2 you discussed that’s going to be around $0.13 what it actually end up being?

Scott Settersten

It ended up being at roughly $0.13. Again the pacings during the quarter change little bit throughout the year as we kind of go back and forth with some of these things, and you'll recall we talked about supply chain, the $0.03 that was related to supply chain will slow down a little bit during the course of the year so quarter to quarter it changed a bit.

Morey Marcus - Oppenheimer & Co.

Okay, great. And then going back to the headwinds at the loyalty program for 2014, I know you said you won’t go into margins that much but can you talk about I guess the timing of that impact, do you expect it to be evenly distributed throughout the year or is kind of again all in the same quarter?

Scott Settersten

I'd say it's evenly distributed throughout the year. So the way the margin rate headwind comes in again, it's the way they earn points and the way they would gain points so it's kind of evenly spread throughout the course of the year.

Morey Marcus - Oppenheimer & Co.

Okay.

Scott Settersten

And by the time we cycle through a full year cycle is where we expected to be kind of back of break-even from a few dollar standpoint, so at that point is where the comp increases start to materialize and we start seeing better gross margin dollars.

Morey Marcus - Oppenheimer & Co.

Okay and then my last question and next is, did the reduced reliance on price promotion have a significant impact on the quarter and also how do you possibly read out the strategy going forward?

Scott Settersten

No, we actually were more commercial in the fourth quarter than we had originally expected earlier in the year and a bit more than we were expecting even when we gave guidance for the fourth quarter. So with the top validated we invested where we thought it was appropriate.

Morey Marcus - Oppenheimer & Co.

Okay, perfect, thank you for your time.

Operator

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

Jason Gere - KeyBanc Capital Markets

Thanks may be I’ll dovetail off of that last question. So I know you are not giving specific guidance about the gross margin SG&A. But just kind of want to talk a little bit about this past year gross margin little bit more promotional it's flat year-over-year, the year before you had strong gross margin. So as we think about the cost of doing business do you think the levels that we are seeing now will kind of stay intact and as we think about operating margin expansion overtime which I know you’ll talk about in the fall is this really going to be relying on the SG&A leverage, especially as I guess we kind of anniversary some of these higher investments that you need to make over this year and I don’t know if potentially next year as well.

So just wondering if you can just maybe kind of maybe guide a little bit on that?

Scott Settersten

Yeah Jason, I would say directionally if we look in the first quarter this year we expect to see some merchandise margin expansion. So the whole notion of us trying to do a better job with on offers with customers and trying to toggle back and forth in fourth year and try to pull back a bit on its amount of discount to drive the business we are still on that path. We believe in that last year we saw good response to that early part of the year when we saw a bit of rough waters we reacted to that in the fourth quarter.

So that’s still part of our plan and still expect to see some merchandise margin expansion in 2014.

Jason Gere - KeyBanc Capital Markets

So we should see gross margin then somewhere between ’12 and what you achieved in ’12 and ’13, I mean obviously not putting exact number to it but there will be gross margin expansion this year.

Scott Settersten

I wouldn’t go quite that far, I finished my thought here. We are going to see merchandise margin expansion that’s going to be offset by fixed or cross deleverage, especially the first half of 2014 we’ve got a 125 new stores coming in into the maturity curve here and it's still very early days for those stores, will put pressure on us, [more so] over the end of the first half of the year. When we look out longer term it's not really a story of SG&A leverage, I mean we expect that to be part of operating margin expansion over the long term but we -- the key drivers are really prestige mix to the business, again it's a richer part we expect that to add, albeit probably not at the same rate we’ve seen over the last couple of year.

We expect e-commerce, again better merchandising there and marketing tactics we expect that to improve operating rate here in the future and supply chain investments. We are making a lot of significant investments there now, they are creating some headwinds for us over the near term but over the long term they are going to create a lot of efficiencies for us across the chain.

Mary Dillon

Yeah and I would just add that back to the customer theme here, over the longer haul we know we can and will focus on how can we drive demand for Ulta in a way that people are more profitable over time right. So whether it's about new guests who discover us more footsteps in the store, more targeted promotions of more of a balance on spending the drives awareness and new guests versus price discounts. Those are the kind of things that -- it's all part of the business and that’s also part of what we are going to investigate test as we go forward as they how can we continue to get even more efficient in terms of how we create demand across the business.

Jason Gere - KeyBanc Capital Markets

Okay and just for clarification of the $0.10, how much hits SG&A? How much is gross margin? Can you just -- is there any break down there?

Scott Settersten

The majority of it hits the SG&A line.

Jason Gere - KeyBanc Capital Markets

Okay and the last question is housekeeping, just with fewer stores open this year how should we think about the pre-operating expense for this year? Is there can you guide at least on that for the full year? I know you gave for the quarter but just wondering if…

Scott Settersten

I think we provided the store comp by quarter right, for the full year, I think you guys can probably do the math on what the average is and…

Jason Gere - KeyBanc Capital Markets

Okay. Fair enough. Okay. Thanks a lot. I appreciate it.

Operator

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

Evren Kopelman - Wells Fargo Securities

Thank you. Good afternoon. Two questions, first on the Lancôme and Clinique do you plan to add any more of those boutiques this year and what's kind of the long-term thinking there on the expansion and maybe what have you seen in terms of the impacts of the stores that they are in? The second question is on the share repurchases. We've only seen you repurchase stock once on opportunistic basis. Should we expect a more regular program or kind of expect you to continue to be opportunistic there? Thank you.

Mary Dillon

I'll take the first question on Clinique and Lancôme. Just a reminder we opened over 80 boutiques last year between Clinique and Lancôme. So from a sales perspective we will get benefit but those stores are still ramping and the stores that we opened in them. And basically we wouldn't breakout specific information beyond that. What I'd say is we are very pleased with platform of all the boutiques that we have between Clinique and Lancôme and we are hopeful that we will be expanding both those brands in the future but today I have nothing to really announce or share with you at this time.

Scott Settersten

And as far as the repurchase is concerned management and the Board continues to review best uses of excess cash and returning value to the shareholders. We will continue to buy back shares opportunistically and we will be maintaining our investment discipline and returns on that kind of thing.

We will be framing up our long-term capital allocation and shareholder return methodology here, that's part and parcel of our strategy work that we are in right now and that you can expect that we will be sharing details with you on that in the fall when we communicate the entire strategy.

Evren Kopelman - Wells Fargo Securities

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 - Robert W. Baird & Co.

Good afternoon and congrats on the strong finish to year. I just wanted to touch quickly on the trends with fulfillment. Can you talk about where you are with in-stock rates in the stores and how much opportunity is there to drive better conversion through the supply chain investments and improvements in that area? And similarly can you talk about how you are going to balance the breadth and depth of the SKUs as you test these smaller format stores?

Mary Dillon

Yeah, those are all great questions. Certainly our view on the supply chain investment overtime is to do several things for us; to build the infrastructure that we need for growth, capabilities to meet guest expectations across channels, optimize our end-to-end efficiency, certainly a piece of that is stronger allocation forecasting and replenishment capability. So all of those are areas that we know and plan -- have a plan for in terms of how we continue to improve.

Our in-stock position we feel is good, we look at that obviously every day, every week. There is some transitions happening as we start the year in terms of some planograms and new brands and et cetera and that creates a little bit of some transition. But overall we are very pleased with our in-stock rate this year. Our supply team worked really hard against some pretty tough weather situations as we entered the year and we came out feeling very good about our position.

Mark Altschwager - Robert W. Baird & Co.

Great, thanks. And then just the balancing of the breadth and depth with the smaller format?

Mary Dillon

Yes, great question. We are in the early stages of nailing that down and that's something that it's something that will obviously be working on as we finish our plans to open up the two small stores this year, small format stores. The overall idea here, I mean there's certainly been some thinking on that already but it's to bring an Ulta experience to our guest in a smaller way in a smaller format way. So obviously that's going to take some curating, the number of SKUs that we offer. But we expect that it will continue to be the kind of experience in which you have everything from prestige to mass brands, if she has a salon that she can use. So all that will be in the experience set and it's a matter of how do we curate from there.

Mark Altschwager - Robert W. Baird & Co.

Thank you.

Operator

Thank you. Our next question comes from the line of Jill Nelson with Johnson Rice. Please proceed with your questions.

Jill Nelson - Johnson Rice & Company

Good afternoon. Just have a couple of quick clarification questions, did you mention in the fourth quarter that gift items were weak or were you just mainly talking about kind of the fragrance which is the main gift category for holiday?

Mary Dillon

Well I would say items that are typically gift giving that we would see are more softer in terms of the category, so fragrance personal care appliance et cetera, that was I think a broader industry trend not just an Ulta trend.

Jill Nelson - Johnson Rice & Company

Okay and did you see any regions or categories that you did increase the promotions, just trying to see if you saw some nice correlation with traffic when you did increase promotional activity?

Mary Dillon

Yeah, I would say it was just pretty much across the board.

Jill Nelson - Johnson Rice & Company

Okay, and then just a question on inventory plans how should we look at the inventory growth for the remainder of the year, looking to have a growing up store bases below comp expectations?

Scott Settersten

Yeah we would, Jill we would expect it to in 2014 to continue on the trend that we have seen at the end of the year. We expect our comp -- our inventory per door to be well below comp store growth. We believe we’ve got good processes and systems that people in place to maintain the discipline here. During 2013 we were kind of lacking some unusual items with some inventory investments that we saw, that caused some variability early in the year but we’ve got that now back on track where we want to be.

Jill Nelson - Johnson Rice & Company

All right and then just some given of the recent management changes, is there any positions that remained open or are you looking at new folks still? Thank you.

Mary Dillon

No, I am really pleased with our management team, I think we are [joining] really nicely and right now I think we are in good place. Our business is always changing evolves, so you never say never but we are good.

Jill Nelson - Johnson Rice & Company

Thank you.

Operator

Thank you. Our next question comes from the line of Dana Telsey with Telsey Advisory Group. Please proceed with your question.

Dana Telsey – Telsey Advisory Group

Good afternoon everyone. Can you talk a little bit -- any more color on the new store productivity levels? What you saw and how does it compare to the prior year? And then just lastly what type of comp do you need to leverage expenses? And it's very exciting about all the new brands in 2013, how many brands in 2014? Thank you.

Scott Settersten

Hi Dana as far the new store productivity is concerned we continue to be very pleased with productivity in new stores and the investment returns that it's generating for our shareholders. If you adjust the comp, the 9.2 comp for e-commerce and super storm Sandy measurement, the calendar shift the stores are generally in the same vicinity as they were back in the third quarter and the way they were for most of 2013. So the new store model is intact, new stores are comping just the way we are expect in years one through three. And some of the older stores of course are in the healthy low single-digit range.

So kind of where we expect them to be and frankly with the environment that we are in right now we are fairly happy with that performance. We think we can do better on that, that’s a focus on 2014 for us to try to figure out how to better drive comps in some of our more mature stores.

Janet Taake

As far as new brands as Mary mentioned it's rolling to outdoors and beyond that I would really refrain from mentioning any new brands coming in. But we are always working on new brands, new products, exclusive products for our guests to surprise and delight her so there will be more coming down the pipeline.

Dana Telsey – Telsey Advisory Group

Thank you.

Operator

Thank you. There are no further questions at this time. I’d like to turn the floor back to management for closing comments.

Mary Dillon

Thank you. In closing I’d like to thank all of our Ulta beauty associates who worked very hard to drive excellent top line growth and deliver solid earnings growth in 2014 despite a very volatile consumer environment. We opened a 125 stores, dramatically improved our e-commerce business and continued to enhance our merchandise assortment, royalty programs and marketing capabilities all while laying with ground work for continued strong performance.

Thank you all for your interest in Ulta Beauty and I look forward to speaking with all of you soon.

Operator

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

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Source: Ulta Salon, Cosmetics & Fragrance's CEO Discusses Q4, 2013 Results - Earnings Call Transcript

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