ULTA's (ULTA) CEO Mary Dillon on Q1 2014 Results - Earnings Call Transcript

Jun.10.14 | About: Ulta Salon, (ULTA)

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

Q1 2014 Results Earnings Conference Call

June 10, 2014 5:00 PM ET

Executives

Laurel Lefebvre - Vice President, Investor Relations

Mary Dillon - Chief Executive Officer

Scott Settersten - Chief Financial Officer

Janet Taake - Chief Merchandising Officer

Dave Kimbell - Chief Marketing Officer

Analysts

Kayla Berg - Piper Jaffray

Aram Rubinson - Wolfe Research

Gary Balter - Credit Suisse

Oliver Chen - Citi

Bilun Boyner - J.P. Morgan

Matthew Fassler - Goldman Sachs

Daniel Hofkin - William Blair

Ike Boruchow - Sterne Agee

Evren Kopelman - Wells Fargo

David Wu - Telsey Advisory Group

Joe Altobello - Oppenheimer

John Kernan - Cowen & Company

Jason Gere - KeyBanc

Jill Nelson - Johnson Rice

Mark Altschwager - Robert W. Baird

Operator

Greetings. And welcome to the Ulta Beauty First Quarter 2014 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A brief 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, Laurel Lefebvre, Vice President, Investor Relations. Thank you. You may begin.

Laurel Lefebvre

Thank you. Good afternoon. And thank you for joining us for Ulta Beauty's first 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. I am pleased to report a strong start to the year, with better than expected sales and earnings growth in the first quarter. The team’s accomplishments included driving continued momentum in our online business, successfully rolling out new brands, completing the smooth conversation of our loyalty program onto one platform and closely managing inventory.

In addition, transactions and comp retail stores turn positive, reversing a slight decline in the second half of 2013. We are also making excellent progress with our strategic planning work and we are on track to deliver long-term vision in five-year financial target, which we planned to announce on our second quarter earnings call in September and follow-up with an Analyst Day in October.

As I said last quarter, the strategy work is designed to refresh our vision and chart a course for an evolution of our business model and to create a playbook for sustainable profitable growth.

To recap the numbers for the first quarter, we grew sales 22.5% and delivered an 8.7% total company comp on top of the 6.7% comp in the first quarter of 2013, both including the impact of online sales growth. Our e-commerce business performed very well, driving 72.3% comparable sales growth.

Similar to the past several quarters, prestige cosmetics and skincare was a strongest category. We were pleased to see transactions turn positive at retail, with the healthier balance between transactions and average ticket driving the strong comp in the quarter. Earnings per share were up 18.5% to $0.77 versus $0.65 last year, driven primarily by better than expected sales and some planned expected shift later in the year.

Scott will cover the detail financial result for the first quarter and our guidance for the second quarter and fiscal 2014 in a momentum. But before that I would like to provide an update on our five growth strategies, new store growth, new product, services and brand, our loyalty program, marketing and ulta.com.

Starting with real estate, we opened 21 stores during the quarter, ending the first quarter with 696 stores. We are on track to deliver our planned 100-store program this year for an increase in square footage of approximately 15%.

New stores continued to open up strong and the class of 2014 stores is exceeding it sales budget. Thus remains stable and we continue to sell our real estate pipeline with high-quality sites.

For the remainder of the year, we expect to open 20 stores in the second quarter, 50 in the third and nine in the fourth. We also expect to complete 12 remodels this year and are planning to complete a smaller scale remodel of our mass cosmetic planogram in about 60 stores over this summer.

We haven’t seen anything in the market or in our stores performance to change our long-term view on the potential for 1,200 of our full sized 10,000 square foot stores in the U.S. Today, we view the potential for smaller stores largely incremental to the 1,200 store target, but of course, we expect to learn a lot about the potential for smaller buys once we open up two 5,000 square foot test stores later this year in smaller market.

Turning now to merchandizing, our merchant teams delivered a strong first quarter, with a strongest comp gain in prestige color and skincare. IT Cosmetics and Mally launched last year in selective stores are now fully rolled out to the entire chain. Also the only retail chain offering this popular brand and our guest is delighted to find their product in our stores and online.

We also expanded space for Urban Decay in all of our stores, showcasing the naked franchise. Our nearly 500 benefit boutique continued to perform very well with new product launches and the rollout of brow tinting services to additional stores.

Newness is always a significant driver of our comps with contributions from recent brand additions such as Japonesque, Meaningful Beauty and SheaMoisture. The fragrance category was energized by two big launches, Dolce & Gabbana Dolce and Ralph Lauren Midnight Romance.

Now turning to services, our salon team drove solid results in the first quarter, maintaining good topline momentum and contributing to the total company comp. The strong business with strong comp were driven by both increases in average ticket and positive guest count, retention of salon managers and stylist continue to improve, bolstering a strong performance as tenure is highly correlated with sales in the salon business.

We executed several successful promotions focused on hair, color and skin treatment to drive awareness and trials and develop a strong integrated services message for salon services and Benefit Brow services in our direct mail and email communications.

Moving onto an update on our loyalty program and customer relationship platform, we now have 13.4 million active loyalty members who shop with us in the past 12 months and we have completed the conversion of all members to the ULTAmate Rewards program as of the end of February.

We see a great deal of excitement about the program from our newly converted guests regarding the benefit and the flexibility of the program, as well as the new benefit of the loyalty program, offering a free Ck One mascara on guest’s birthday.

So far we have seen strong performance in comp store sales and margin dollar growth from the recently converted regions, driven by both transaction growth and higher average ticket.

Our loyalty program provides a valuable database of customer and purchase information that we can use to deliver increasing personalized offers. Having all of our guests under point-based program enables more efficient use of our CRM platform and will continue to improve the effectiveness of our targeted campaign.

Now turning to marketing, continued partnership between our merchant and marketing teams is enhancing the effectiveness of our communication, including direct mail, website and promotion, which we believe is helping to drive comps.

During the first quarter, we executed successive programs like our signature 21 Days of Beauty featuring beauty steals and in-store events with an increased focus of social media. Our trends of spring report position Ulta as a beauty authority and we enhance our Mother’s Day promotion with the stronger gift with purchase program and several new fragrance launches.

Our marketing collateral continues to evolve as we build a more compelling and emotional connection with our guests. Our marketing team is also making good progress on refining our brand positioning, carrying out a marketing mix analysis, and executing the test and learn initiatives we talked about last March, all with the goal of driving Ulta’s continued profitable growth to new guest acquisition and less reliance and discounts.

Wrapping up our fifth growth strategy, our e-commerce business, ulta.com continued to see strong sales momentum in the first quarter, with topline comp growth of 72.3% contributing nearly 2 points of comp to our same-store sales.

We continue to enhance the online shopping experience to new releases of the platform, the latest improvement include a product Q&A platform called Ask Ulta on the site and the addition of brand stores to highlight collections and rest of assortment, as well as promote services like the Benefit Brow Bars.

We continue to invest in omni-channel capabilities like the newly launched feature called Find in Store which enable guests to check the availability of many popular SKUs in their local stores. We also continue to increase fulfillment capacity to support the rapid growth in our e-commerce business.

This completes the update on our growth strategy, so I will now hand it over to Scott.

Scott Settersten

Thanks, Mary. Good afternoon, everyone. First quarter sales were $713.8 million, compared to $582.7 million last year, an increase of 22.5%. Comparable sales increased 8.7%. The retail comp which includes Salon was 6.8% and e-commerce growth of 72.3% added 190 basis points to the comp.

The transaction and ticket contributions to the total company comp were more balanced, the transactions up 2.5% and ticket up 6.2%. The ticket increase was driven by roughly 20% unit and 80% average selling price. As our business continues to mix up to more prestige category which are generally at higher price points. We were very pleased to see that retail-only comparable transactions increased 120 basis points, almost a 2 point sequential improvement from Q4.

Gross profit dollars increased 20.6% to $246 million. As we expected, gross profit margin declined 50 basis points to 34.5% from 35% in Q1 of last year. While retail product margins were strong, the overall product margin rate was down about 40 basis points, driven by a number of factors, including a higher mix of ulta.com sales, some product mix shifts within prestige and the impact from converting the remaining 50% of the country to the ULTAmate Rewards program, which delivers more gross margin dollars but at a slightly lower rate.

For the full year, we anticipate product margins will be slightly higher than last year based on some of the newness in the category mix we are planning for the rest of the year.

As a reminder, the ulta.com impact to our margin rate is primarily due to sales mix. As most of you know, we do not currently sale the full assortment of our professional hair care products online. So having a lower mix of that higher margin product online, does dilute our e-commerce rate somewhat compared to bricks and mortar.

However, from a margin dollar perspective, we believe that a significant portion of our e-commerce sales are incremental, as we have seen that our guest to engage with us across both channel also spend more in store.

While it is natural to focus on the margin rate as a standalone measure we are focused on the big picture, which is that, we are capturing more beauty dollars overall and that is good news for both Ulta and shareholders.

We are delighted with the tremendous growth and market share gains we are seeing in prestige cosmetics and skincare, while high margin, they are not as high margin at some of the other prestige categories we sell. In the first quarter, those mix shifts had a slight impact on overall margin rate. We expect to see these mix impacts mitigate as we go through the year.

I would also remind you that having all our guests on the ULTAmate Rewards program has a modest impact on gross margin rate. We know our guests are much more engage with this more flexible attractive program, so they use it more. We expect the program to deliver higher sales and gross margin dollars, but the margin rate is a bit lower than our previous certificate-based program.

The remaining 10 basis points of deleverage relates to fixed store costs, which we expect to continue for the full year, as we add 100 new stores this year on top of 125 last year and 100 in 2012.

Taking a long-term view, the modest deleverage we expect to see in 2014 is minor in comparison to the increase market share we are capturing with these stores. In the long-term gross profit and cash flow these investments will generate in the coming years.

We are very happy with new store productivity. Our 2012 and 2013 classes of new stores continued to exceed our internal sales and investment return targets, and store openings in the first quarter of this year exceeded their grand opening sales targets. Our store model has proven to work well in all geographies and we continue to review and approve high-quality sites consistent with our historical practices.

Back to the P&L. SG&A expenses rose 22.1% to $162.4 million, flat as a percentage of sales at 22.8%, due to planned investments in marketing, supply chain, e-commerce and store labor, but better than expected driven by strong expense controls and some planned expenses that were delayed and pushed later in the year.

Pre-opening expense was $2.6 million, compared to $3.2 million in Q1 of 2013, driven by 21 store openings during the quarter, compared to 28 new stores opened during Q1 of 2013.

Operating margin decreased 30 basis points to 11.3% versus 11.6% in Q1 of last year. Net income increased 19.4% to $50 million or $0.77 per diluted share versus $41.8 million or $0.65 per diluted share last year. EPS grew 18.5%.

Turning to the balance sheet, inventories were $531.4 million at the end of the quarter, compared to $442.1 million at the end of Q1 2013, driven by 120 net new stores opened since May last year.

Inventories were down 50 basis points on a per store basis. As our supply chain and store teams have done nice job keeping inventory very clean through our large number of product transactions.

Capital expenditures were $39.1 million for the quarter, driven primarily by our new store opening program, as well as supply chain and IT investments. And depreciation and amortization for the quarter was $30.4 million. We generated about $34.6 million of free cash flow for the quarter and ended the first quarter with $457 million in cash on the balance sheet.

Now we delivered the first quarter above expectations and have a solid start to our second quarter, we believe it is prudent to maintain our view of full year guidance until we get a bit more of the year under our belt. If the environment remains stable we would expect to do better.

We expect to open about 100 new stores this year along with 12 remodels. We anticipate comparable sales to increase in the 4% to 6% range and total sales to increase in mid-teens range for the year.

As a reminder, 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 ULTAmate Rewards loyalty program and investments to increase training for both store and salon associates to improve the guest experience, as well as some test and learn initiatives around brand awareness and new guest acquisition, most of which are occurring in the back half of the year.

We expect that earnings per share will grow in the mid-teens percentage range this year, excluding any potential accretion from share repurchases. Our existing authorization has about $113 million remain.

We expect to invest about $265 million in capital in 2014 with approximately $170 earn marked for new stores, remodels and new locations, $28 million for merchandize fixtures, $50 million for IT systems including e-commerce, $45 million for supply chain projects and about $25 million for maintenance CapEx.

Turning more specifically to the second quarter of 2014, we expect sales to increase in the range of $706 million to $717 million versus $601 million last year. We expect comparable sales to increase in the range of 5% to 7%.

Pre-opening expense is expected to come in around $3.4 million, with 20 stores planned to open in the second quarter. We expect to achieve earnings per share in the range of $0.78 to $0.83, compared to $0.70 in Q1 of last year.

Our tax rate is expected to be approximately 38.4% and our fully diluted share count will be approximately 64.8 million, excluding any potential share repurchasing activity.

Before we move on to the Q&A, I’d like to give you an update on our supply chain investments. In April, we signed a lease for our new distribution center near Indianapolis, which we expect to open in mid 2015. This facility will be about double the size of our existing building and we will have all new warehouse management and control systems.

The new facility will also have more sophisticated material handling technology and ultimately a more efficient operating model compared to our current facility. This model will take inventory lead time our of our supply chain by allowing more frequent shipments, which will improve store and stock and inventory turns. It will also create labor efficiencies in the distribution center and allow us to deliver more shelf ready product to our stores.

Having the product delivered more frequently and shelf ready will allow our store associates to get the product on the shelf faster and more efficiently, and improve in stock and product presentation.

The new [EPM] (ph) systems are the first phase of a multi-year network optimization work project, as we continue to evaluate our supply chain capabilities and capacity to support future growth.

We expect this project to generate a good return on investment over the loner term and benefits including speeding up the supply chain, improve labor efficiencies and providing more inventory flexibility to drive improved inventory turns. This is clearly an important investment and we are all highly focused on execution to ensure that it delivers the expected operating and finical benefits.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Thank you. Our first question comes from the line of Neely Tamminga with Piper Jaffray. Please proceed with your question.

Kayla Berg - Piper Jaffray

Great. Good afternoon. This is Kayla Berg on for Neely Tamminga. Just wondering digging deeper into your e-commerce sales, can you guys tell based on your loyalty data how your customers choosing e-commerce versus a store visit? Said another way, within your loyalty base, how much is she using the site by product versus going into the store? And with that example, what is her purchasing behavior look like online versus in-store again looking at your loyalty customer base, maybe looking average transaction size and dollars or units. And how does that look differently online versus in-store? Thanks.

David Kimbell

Hi, Kayla. Yeah, this is Dave Kimbell. We absolutely see a lot of cross purchase activity within our membership database between the website and our stores. I don’t think we’re prepared to share specific details around some of the specific questions you have. But as our e-commerce capability has grown over the last 18 months and become a bigger part of our business, one of the things that we’re particularly excited about is our ability to reach her where and when she wants to shop with us.

So importantly our members are finding that to be a very convenient way for them to shop. So they are visiting both stores and e-commerce and that’s certainly something that we’re encouraging as we continue to leverage e-commerce as a way to drive customers back into our stores.

Kayla Berg - Piper Jaffray

Great. Thanks.

Operator

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

Aram Rubinson - Wolfe Research

Hi. Thanks for taking my question. Great job on the results. Two things, first of all on the new store productivity, I know historically you’ve talked about 70% during that range. Our calculation for this quarter was around 74 and to get to your guidance for second quarter, I think I needed at least 75. So the question is what are you doing differently there? And is it function of also opening fewer stores that maybe we can share it, they are just the best. And if that’s sustainable, then I had a follow-up?

Mary Dillon

No, Aram, I wouldn’t say there is anything specific that we’re doing any differently to drive new store productivity. I think we’ve just seen a natural maturation of the stores we put in place over the last two years. Notably, we observed that first quarter this year, the stores coming out of the gate, the 21 new stores in the first quarter were just exceptionally strong. So nothing special there we’re doing other than our normal great day-to-day activities to support new store openings.

Aram Rubinson - Wolfe Research

Okay. Sometimes when you chose fewer stores, you get a better hit rate, I guess, is kind of what I was trying to get at, that’s now what you’re seeing just yet you’re saying?

Mary Dillon

No, we’re not seeing that.

Aram Rubinson - Wolfe Research

And then my second question is in the 10-Q, it says our long-term strategy is to drive operating profit is expected to increase as a result of our ability to expand merchandise margin and leverage our fixed cost with comparable store sales increases and operating efficiencies offset by incremental investments in people et cetera. Wondering if that would offset is kind of to be read fully offset or partially offset?

Scott Settersten

Aram, my response to that would be partially offset. And I think we’ve shared that with many, many investors that we’ve talked to over the course of the last year. We still believe that in mid teen’s operating margin target is a reasonable one for Ulta and one which we’re capable of achieving over the longer term.

Again we’ve got some investments that we’re making in the near-term notably within supply chain, e-commerce, cycling our hyper growth new store program here over the course of the last couple of years. We feel like once we get through that, we’re going to see benefits coming from those investments. And we’re also going to see continued mix up in the prestige part of our business which we think will drive new improved operating margins over the long term.

Aram Rubinson - Wolfe Research

And comps of 8.7 don’t hurt either. Thanks for taking my questions.

Scott Settersten

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. I don’t think I read the press release as closely as Aram, so (indiscernible) details. Two questions, one is you mentioned that obviously traffic went up. How much of that is high end with the relative of the royalty program the ultimate rewards to all the customers and what does that imply for future quarters?

Mary Dillon

Gary, it’s Mary. Thank you. I think there were several factors that we believe drove the transactions and we’re encouraged to see that improvement. Over the long term, we’re going to want to continue to have that kind of balance. But it’s really a combination of things, 500 process just one thing but certainly growing up the royalty program as part of it. But we’ve also had some great newness in brands that we’ve talked about like IT and Mally, space expansion, more compelling marketing and merchandising I see overall in our materials and stores and online. So really a combination of those things, altogether we believe is what drove that to happen.

Gary Balter - Credit Suisse

Thank you. And Mary, just following up, you mentioned when you talked about the really strong results in e-commerce. But you had the new release of the platform or some upgrade. Where are you in the commerce rollout of your platform and what do we expect in the future? Thank you.

Mary Dillon

Sure. I’ll ask Dave to take that.

Dave Kimbell

Yeah. Absolutely. We’re continuing to expand our capabilities. So as you’re probably aware last year, late last year we launched our new site that has been performing very well and is one of the drivers of our success. And we continue to add new capabilities. I think couple of things that Mary referred to earlier are brand stores, with the new capability in partnership with some of the key brands.

We have a new feature around Ask Ulta where customers can engage with us and ask specific questions on our products or beauty tips. And then we continue to expand our capabilities. We’ve got -- as Mary mentioned, our inventory availability, online both on our site and then within Google, which is we found to be a great convenient store. Our customers in Q1, we’ve had about $25,000 million abuse of inventory on our site. And that’s important not only if connect with our customers today but to set up ourselves up for future Omni-channel capabilities.

We’ve built in some live chat capabilities. We’ve really designed our loyalty and guest services. So there’s a variety of things as we continue to build our web and digital experience that we think will be critical to continue the strong growth that we’ve had in that space.

Gary Balter - Credit Suisse

Thank you.

Operator

Thank you. Our next question comes from the line of Oliver Chen with Citi. Please proceeds with our questions.

Oliver Chen - Citi

Thanks. Congratulations on a great quarter. Regarding your comments on the evolution of gross margin, what is going to drive the category mix positive impact there? And also the breakout in getting the 20% unit growth was impressive. Is that a trend that will continue and could you just give us color on what’s working on the unit growth side?

Dave Kimbell

Hi Oliver. Thank you. First on the gross profit margin, you’ve only just started at high level as Scott described as a few different items that drove some margins deleverage in the quarter and some of those headwinds will continue to for the year. But we dos expect to see modest improvement for the full year. And it really is a couple of things, one is newness that we see have in the pipeline and also as we continue to evolve our promotional strategy and pull back on some discounts carefully, we think that those two things will help us.

Oliver Chen - Citi

Thank you. And on the unit front, do you expect the momentum in kind of breakout to continue at this rate between AUR versus units?

Mary Dillon

Yeah. I think we’re trying to really drive a healthy balance of all that over time. So some of the test and learn programs that we are doing this year are really trying to see how we can lever that sales equation even further. So we’re looking across the board. So part of this is obviously first and foremost getting new guests to Ulta and then having our current guests come more often, shop more often. So whether she’s buying more units for transaction or higher-priced items in her bag, all those are frankly good leverage for us to explore that we think all are going to be part of our future growth.

Oliver Chen - Citi

Thanks. And Mary, on the customer acquisition front, what would you prioritize as the top catalyst for the continued momentum in terms of realizing opportunity there. And we’re looking forward to Investor Day. So if you could just give us a few thoughts on the nature of what we may expect to hear about, that would be great? Thank you.

Mary Dillon

Well I can’t preview Investor Day but I can’t tell you is that consistently we’ve said that and we know from a data perspective that awareness of Ulta just as a retailer is lower than really it can be. So it starts with just getting more guests that are in our sort of sweet spot of our target to become aware of Ulta. And as we become aware of what we’re about, so -- really the long-term work that we’re doing, it’s really about how do we (indiscernible) relaunch the brand to people who maybe have not been in Ulta for long time and maybe never been in Ulta or ultimately know we’re like right now versus what we were perhaps a long time ago.

So giving us a lot of opportunity there and it starts with awareness clarity what we stand for and then it’s about continuing to do what we do really well which is offer her a differentiated experience in the stores, most importantly within a ray of great products and service that you can only get at Ulta. So all the things together, I can’t prioritize only one because they’re all, I think, exciting opportunities for us.

Oliver Chen - Citi

Thank you. Best regards.

Mary Dillon

Thank you.

Operator

Our next question comes from the line of Brian Tunick with J.P. Morgan. Please proceed with your questions.

Bilun Boyner - J.P. Morgan

Hi. Good afternoon. This is Bilun Boyner filling in for Brian. Thanks for taking our question. We want to ask about your product introductions for the rest of the year. Are there any product launches or emerging trends you’re really excited about for the rest of the year. And do you have any updates to your Clinique and Lancôme shop-in-shop rollout events?

Mary Dillon

Thank you for asking the question. As far as future, any new products have rolled out, we would not share at this point in time. Of course, we always are focused on newness whether it’d be products, courses or new brands that I would not be specific. And that’s a Clinique and Lancôme. We opened significant amount of doors last year. I think I mentioned on our last call and we’re very pleased with that business. And we continue to monitor but it’s like a new store. It ramps over time. So we’re partnering with our vendors to make sure that we maximize the business together.

I really don’t have other updates other than that that we’re very pleased with those businesses. And as far as trends, some of the trends continue. Lip has been very strong. We see that continuing this year and as we move forward into fall. Also anti-aging continues to be strong for us. And we’re all seeing complexion of face being very strong as Q1 ended and I think it will continue.

Bilun Boyner - J.P. Morgan

Thanks. And can you update us on the store maturity of Carol. I know you mentioned new stores exceed expectations but I wanted to see if there’s a change in your comp assumptions by store age particularly given the product mixes somewhat changing and e-commerce is now our growing part of the business?

Scott Settersten

Yeah. There hasn’t been any change in the core model and what we see the performance of those new stores compared to what we share in our standard kind of investor desk. So -- no store is still very productive in line with our expectations and the stores that are beyond five years old, again in a healthy comp environment, they are additive to the comp. They are all comping, very healthy low to mid single digit range.

Bilun Boyner - J.P. Morgan

Great. Thanks. Best of luck.

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. I have two questions. The first relates to gross margin. You made some comments about the mix within Prestige and the notion that the Prestige products that you sold more than Q1 might be a little lower margin than some of the Prestige products perhaps that you’ve sold in the past than you expect to sell going forward. Any color as to drivers of that trend, what changes you expect to see that will make Prestige more of a peer positive to the gross margin range?

Mary Dillon

Hi Matt. Well, I would say Prestige was a pretty big category, right. There is a lot of different brands that we have that are in the place that we call prestige and some of them have different margins. All of them are good strong margin and good high price points right but within that there are certain brands that are somewhat higher or lower. So it’s really just about that. It’s little bit of shift within that. As we look at our pipeline for the rest of the year, what we expect in terms of newness, we believe that we’ll moderate and shift up positive.

Matthew Fassler - Goldman Sachs

So you have visibility to launch in such that that you feel like that way?

Mary Dillon

Yeah.

Matthew Fassler - Goldman Sachs

Great. And then my second question, I believe at the outset of year you talked about $0.10 of investment, most of it in SG&A in the initiatives that you’ve spoken about in the past and again today. Scott, if you haven’t done so and I may have missed it, could you quantify how much of that $0.10 you booked in Q1. And to the extent you said, some investments were deferred to later in the year. How much of what you’re originally expected to spend in Q1 that you push out to later in 2014?

Scott Settersten

We’re virtually zero in Q1. I can’t answer the question directly. And it’s all back-half loaded to 2014. I would say directionally it’s heaviest in Q3. That’s where we really could not able to get some actions in place and it will continue on into the fourth quarter.

Matthew Fassler - Goldman Sachs

Great. Thank you so much.

Operator

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

Daniel Hofkin - William Blair

Hi. Good afternoon. Congratulations on a great result. Just a couple of follow-up questions, one if I could ask Clinique and Lancome question slightly differently. Would you at this point -- do you feel like over time there is still a meaningful opportunity to add one or both to those brands or others of that stature to the meaningful part of the chain that don’t already have them?

Janet Taake

This is Janet. So thank you for the question. We are pleased with the business. As I said, there is opportunity and we are hopeful that we will continue to expand those brands and there is opportunity for others. So that’s -- and at this point, as I mentioned, that I have no further update.

Daniel Hofkin - William Blair

Okay. And then just a follow-up on the thoughts around the promotional cadence. You didn’t call it out in the first quarter, so was it fair to say it was not a meaningful difference year-over-year in the first quarter?

Mary Dillon

Well, part of -- we actually slightly pull back on our promotions versus year ago. I wouldn’t say it’s so significant that it’s super meaningful yet, but it’s a trend that we are encouraged by, because strategically we think it’s important. And one of the things, I believe it is just sort of just walk before you run on something like this, right. So value is important to our guests and we need to make sure that we offer value, but we have done some things to sort of modify our mix and our offer strategy. Dave talked about our CRM platform. We are leveraging that to deliver more relevant offers. We are expanding a digital reach to drive awareness. And now we feel we are balancing the value equation with offers that are more relevant, more personalized, perhaps even more emotional connection you might say to our guests. So we are making some changes there, but are having improvements in terms of our promotion level. That’s going to be difficult for analysts I think to track that going forward, because as we get more segmented and more personalized, it won’t be as obvious to everybody what we’re doing, because we won’t be doing the same offers to everybody, but we are encouraged by that. And again, that’s very important part of how we think about the long term for the business.

Daniel Hofkin - William Blair

Okay. So, I mean, basically you are also clearly aiming at more effective and higher payback on the promotions that you run so that seems to be part of it to.

Mary Dillon

Yes.

Daniel Hofkin - William Blair

And then just thinking about as the year progresses, the reason I asked the question is, obviously second half of last year and there were some unique external dynamics that worked at all retailers or grappling with. But what, I guess, at this stage, is there something about the second half this in -- this coming second half that you would expect to allow you to be maybe less promotional than you were in the second half of last year or at least similar year-over-year based on maybe even new -- the full year rolled out ultimate rewards program or other more targeted promotion that kind of helps that?

Mary Dillon

Right. Well, I feel good about where we are and I feel really good that everyday we’re raising our gains as it relates to our ability to be more fine-tuned with our promotions. And as you said use that to drive more incremental profitable sales. That’s the ultimate gain here. So really if I look at our full year, it’s still early in the year and we feel it’s prudent to hold where we are until we get deeper into the year. To your point, we don’t really know what holiday holds, but I do think that I feel good about where we are and if we’re going to continue to raise our gains. If our sales momentum continues and if our upcoming newness performs better than expected, we could see some upside.

Daniel Hofkin - William Blair

Great. Well, best of luck in the second quarter and look forward to the update in the fall.

Operator

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

Ike Boruchow - Sterne Agee

Hi. Congrats everyone. Thanks for taking my question. Quick clarification. Scott, did I hear correctly that even ex the e-com business that your traffic levels were positive for Q1, I think 1%, is it?

Scott Settersten

Yes, that’s correct, 1.2% actually, right. So that’s 200 basis points improvements from what we saw in the fourth quarter.

Ike Boruchow - Sterne Agee

Right. Okay. So I guess my question is, I think most retailers saw a sequential deceleration or a lot of retailers saw sequential deceleration in the traffic trends, is there anything you can point to in terms of what you guys did to improve that your own traffic levels from Q4?

Scott Settersten

Yes, when you say there is any one particular thing as Mary mentioned, the way we’ve seen it and measured it, it looks like it’s a combination of things, right. So it’s some of the great new products we introduced in the first quarter, whether it’s expanding Urban Decay or did cosmetics and adding to what we offer in the box, continuing to improve our marketing and merchandising inside the stores. We expect that the back of the year we will have some easier comparison. We would expect the transaction trend being positive to continue to the rest of the year.

Ike Boruchow - Sterne Agee

Okay, great. And then just one more on the gross margin line, so it looks like the comps came in couple of points above your guidance, but the gross margin looked a little weaker to us. I think you clarified this, but just want to double check. It sounds like your like-for-like retail margins were just like you planned them and this was just a function of your sales came from different channels and different products and because of that the profitability was a little less. Is that a fair assessment of the gross margin for Q1?

Scott Settersten

That’s fair. I mean, again, the retail product margins as we defined which is 90% of the business, I mean we are very healthy. Mary mentioned slight pullback on some of the promotional there, so it’s helped us to be able to maintain margin rate on that. But it’s just some of the other mix items that we saw occurred in the first quarter. And, again, we see a number of those things being able to either mitigate or moderate as we get further into the year.

Ike Boruchow - Sterne Agee

To that point, can you give us some color on Q2 and give us the comp and the sales and EPS, but in terms of how you expect gross margin to play for second quarter?

Scott Settersten

Sorry, Ike, we are not getting into that level of detail on guidance any longer. So we kind of stopped doing that when we kicked off 2014.

Ike Boruchow - Sterne Agee

You would expect those headwinds to dissipate is what you are saying on the gross margin line?

Scott Settersten

Well, directionally that the royalty headwind is going to be with us for the rest of the year. E-commerce, we would expect that to moderate because we are going to continue to expand our assortment there and the business continues to scale, so we would expect some moderation there. And then on the product mix, again directionally we expect that to improve as we get deeper into the year, because we do have some nice newness in the Q, which is going to be rate accretive to us in the back half.

Ike Boruchow - Sterne Agee

Got it. Congratulation guys.

Scott Settersten

Thank you.

Operator

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

Evren Kopelman - Wells Fargo

Thanks. Congratulations from me as well. First question is, can you compare contracts, the environment that you saw in the first quarter compared to the fourth quarter, if you need it to be more or less promotional, if others around, either in the beauty category or other product categories you can keep with, you could share some thoughts on that, that would be great?

Mary Dillon

Well, certainly the fourth quarter of last year was really promotional as we saw across all retail, right. So in gift giving categories that we might compete with, we compete with everybody at that time of the year, right. So even with outside of beauty, we also are very promotional quarter. This year, I would say that within beauty, I would say it’s not necessarily less promotional and this is very competitive environment as you know and everybody is fighting for share. We’ve gotten I think better every day as it relates to how we do our promotions and how we target them and use them to get our guests to come in and buy more often and buy with less discounts. So I think certainly I would say the broader promotional environmental, less intense, but within beauty pretty competitive.

Evren Kopelman - Wells Fargo

Okay. Another question is, have you seen any changes in your kind of the pace of new customer additions compared to prior years and how do you anticipate that to change going forward?

Mary Dillon

Well, let me say one thing which is that the big part of this test run that we’ve referenced and we will be running some of these awareness in new guest acquisition tests as we get further into the year. The whole goal of that is to drive new guest acquisition but do it in different ways, right. So right now, we’ve got a great 13 million plus people on our loyalty program and it’s a strong program, it’s driving the majority of our sales which is great. We think there is opportunity to have a lot more people if loyalty members to open in the future, right. So to do that, you have to actually make sure that you are communicating in an effective and efficient ways to get people’s attention and to get them aware of Ulta, right. So that’s why we are doing those tests to see is there an opportunity for us which we believe there is to drive new guest acquisitions to a range of tactics from traditional media to social media and search optimization. So there is plenty of ways for us to do that. And we think that’s going to be the big learning for us to this summer and into the fall that we can then leverage as we look forward.

Evren Kopelman - Wells Fargo

Thank you. One last one is on the mature stores and the older stores, how is that, maybe you could share some color on how those stores perform relative to the rest of the chain? Thank you.

Scott Settersten

Again, our new store model is intact. New stores are performing as expected. And again it’s a healthy comp increase year-over-year. And as we would expect those older stores are contributing to the comp increases. So we are seeing healthy low digit into the mid digit kind of comp year-over-year in some of those more mature stores. So we are very happy with the productivity of those stores right now.

Operator

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

David Wu - Telsey Advisory Group

Thanks. Hi. Good evening. And congrats on the great quarter. Can you elaborate more on the two 5,000 square foot stores that you are planning to test in the smaller markets and any color around the expected overall profitability and merchandising differences versus the full size stores?

Mary Dillon

Right, David, well, if I had to keep it at a pretty high level because we are still in the planning phases and we haven’t really publicly communicated a lot about this yet, but I will say, we are all very excited about the opportunity. It’s really an opportunity to go into right now I would say just consider them smaller markets, similar sort of in some ways to where we operate today but just smaller markets with less dense populations. The stores will be 5,000 square foot stores. We think about it as really bringing the Ulta experience into a market where frankly we think our women targets are going to be very excited, women futures guests are going to be very excited about having that Ulta experience. So it will be curated down certainly with less space, but we will have a salon in every store. We will have a mix products similar to what we have today in every store. It gives us an opportunity to experiment a little bit with fixtures and lighting and things like that, but most importantly it will for us to learn about the economics. We feel like we are very confident the economics will be strong and good, but we need to learn that. We also need to learn about labor model and service model. So more to come on that.

David Wu - Telsey Advisory Group

And are those locations also based in power centers?

Mary Dillon

I don’t know if I want to disclose where they are exactly, but yes, similar real estate strategy today.

David Wu - Telsey Advisory Group

Got it. And obviously maybe too early to tell, but what do you think the smaller format store potential could be over time?

Mary Dillon

Yes, too early to tell would be a good way. I mean, it’s really something, we modeled it certainly as we see that it looks like it will be quite accretive I guess I would say. We see it as an incremental opportunity to our real estate strategy and overall business strategy. So part of what we’re defining in our five year plan to these tests is what is that potential.

David Wu - Telsey Advisory Group

Excellent. Thank you very much.

Operator

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

Joe Altobello - Oppenheimer

Thank you. Good afternoon. Just want to go back to something that you mentioned, Scott, about the sort of directional cadence in the gross margin this year maybe even next year. If I understand you correct, it sounds like this year you are looking for a little bit of gross margin expansion, but most of that’s going to be offset by the investments you are making on the SG&A side. As you look ahead to ’15, I would imagine the headwinds that dissipate later this year eventually go away effectively, so you are going to get better gross margin expansion next year and then the $0.10 of most SG&A investment to happen this year probably dissipates as well. So would you guys expect to see even greater gross margin expansion next year given what you’re investing this year?

Scott Settersten

Joe, I don’t think I’m prepared to go all the way out here with you on that line of questioning, but I would clarify on the gross profit line. We did mention product margins, so retail product margins we expect to be slightly up year-over-year for full 2014, but that’s going to be offset somewhat by some other investment headwinds that will roll through that line, most notably fixed store cost deleverage for the full year.

So gross profit maybe slightly up for the year but in the flat to just slightly up kind of area I would say. And that $0.10 worth of SG&A, you’re right, that’s where it goes, that’s were test and run is. It’s hard to say right now how that’s going to play out. We want to see what the results are and then take actions from there on what we want to invest in near future or what path we’d like to follow.

Joe Altobello - Oppenheimer

Okay. I thought to give it a shot, that’s all. But in terms of the evolution of the promotional strategy, obviously it sounds like you’re easing up there a little bit. And I know one quarter is a very small sample size because a lot of how that plays out will have to do with what your competition is doing etcetera. So are you guys worried at all that your core customer base has become a custom to promotion? And as you ease up on that lever that they may look to go elsewhere or is that not a concern at this point? Thank you.

Mary Dillon

Well, that’s exactly why I would say walk before you run on this kind of thing. And so far I think it looks very encouraging again. Value is part of the equation the guests have come to expect from Ulta. It’s really across a lot of different dimensions if with purchases, free samples, beauty feels, and then of course a loyalty program. And then there’s been discounts like coupons and postcards.

So as we’re pulling those apart and we’re doing analytic work to pull it apart as well as just experimentation, I really very much believe that early data would suggest that we are not -- we don’t have guests that are ultimately reliant. There may be segments that is like, that’s probably true for every business. But for the most part, we are confident that as we understand her better and we personalize offers to her more and we bring in the thing that she is excited about trying and buying that there is a lot of runway there.

Joe Altobello - Oppenheimer

Okay. Great. Thank you.

Operator

Thank you. Our next question comes from the line of John Kernan with Cowen & Company. Please proceed with your question.

John Kernan - Cowen & Company

Hey, good afternoon guys. Thanks for squeezing me in and congrats on a very nice quarter. Scott, I think in your prepared remarks, you talked about that the environment remain stable. You expect to put a little bit better than your outlook for the year. Does that imply you need to keep doing 9% comps or is there just some type of line item, you think you have good visibility into that could drive some upside to the current outlook?

Scott Settersten

No, we’re just looking the glass is half-full, right? We're looking at business where we’re just coming out of our great first quarter. You know what our guidance especially on the comp line with a little ahead of our full year guidance target. And again, we’re doing the same with the second quarter because sales are strong, we’re seeing good strength in some of the newness that we’re introducing to our guests. So we just want people to realize that if things continue on, the plane that we are on today, we would expect to see some upside as we go through the year.

John Kernan - Cowen & Company

Okay. That’s helpful. And then just I think it’s obviously been a big driver to comp. can you remind us what inning you think you’re in, in terms of that continuing to be a comp drivers as the Prestige becomes a bigger part of the mix? Thanks.

Scott Settersten

We would expect again big picture. We are focused on trying to have a nice healthy balance between ticket and traffic drive in our business. So we see ticket recently over the last three or four quarters has been a heavier contributor to the comp. We’re starting to see now transactions right or traffic trying to get back in balance here. We would expect that phenomena to occur as we get through the rest of 2014. We think, we’re on track to have more normalized and a better balance between the two comprising our total balance.

Mary Dillon

And the one thing I would add is it’s not only about shifting more of the mix to Prestige, it's also about more units per transactions for our guests. We have a lot of items in the store, plenty of opportunities for her to pick up more in her basket every time she shops, so we think we can drive that balance over time.

John Kernan - Cowen & Company

Okay. Very helpful. Thank you.

Operator

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

Jason Gere - KeyBanc

Okay. Thank you. I guess, just noticed in the balance sheet and all the cash that you’re sitting on $7 a share, so can maybe you update us just on the thinking in terms of the uses of cash at this point? Is this something maybe you’ll talk more at the Analyst Day, but clearly with no debt and you have a very attractive (indiscernible) EBITDA. I was just wondering first off if you can just maybe give a little color on how you can put that cash to work.

Scott Settersten

Yeah. Jason, we discuss uses of cash and capital allocation with our Board on a regular basis. Right now our current, our best thinking is the best investment is to continue to drive organic growth in the business. So we’re investing in new stores. We’re expanding our supply chain capabilities and driving our e-commerce growth as best we can. So we’re assessing capital allocation as part of the long-term strategy work that we’re doing as a group and we will be able to give you more color on our plans for the future and long term when we meet with you in the fall.

Jason Gere - KeyBanc

Okay. That’s good. And then second question, as e-commerce gets a little bit better and forgive me if you did talk about this earlier. Can you talk about what the average, I guess, purchase size was online versus in the store? And the reason why I’m asking is just when I think about the customer coming into the store, usually they have -- they know they’re looking for, but there’s always those impulse items too. When you’re online, sometimes you don’t have the time for the impulse items. So I was just wondering, as you see the shift move, how do you get that customer to shopping online to kind of buy more than what they’re just looking for?

Dave Kimbell

Yes. And absolutely, it’s a big opportunity for us. I’d say you are right in general that the e-com has -- there’s opportunity for us to continue to grow that. I think we’re pleased with really all measures within our e-commerce business right now on traffic, conversion and average order. But as we get smarter with our cadence of promotion to communication on the web, we think, we’ll have opportunity to continue to drive that.

And so much of that will be driven by our deeper understanding of our customers and targeting message and communication through some of the new capabilities I talked about within our website. So yes, we do have opportunity to continue to grow average order in our e-commerce. We’ve made progress on that over the last several quarters as we’ve launched our new site and continue to see opportunity there.

Jason Gere - KeyBanc

Do you -- I mean, can you quantify the difference between average order online versus average order of the loyalty card member versus the non-loyalty card member? Is there something that you can provide, just to give a little color so we can see what the potential opportunity may be?

Scott Settersten

Yeah. Not on the loyalty side of things but generally speaking, where the bricks-and-motor transaction is round numbers, call it $35 a ring normally and e-commerce is north of 50. And a lot of that is the free shipping offers and things like that which generally tend to drive up average order value.

Jason Gere - KeyBanc

Okay. Great. Thank you for the question.

Operator

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

Jill Nelson - Johnson Rice

Hi. Sorry to add another gross margin question. But just trying to understand first quarter decline on the merchandise margin line, given last quarter, I’m sorry -- last year in the first quarter you were hit by kind of a one-time event with gifts and purchase issue. And so just trying to compare that to how you performed in the first quarter and then just in contrast that the improvement you’re expecting for the remainder of the year?

Scott Settersten

Yeah. A new quarter, a new set of challenges, right, and opportunities to manage. So I was hoping I would never have to talk about one quarter last year, the GWP and (indiscernible). Thanks for reminding me, Jill. I would just reiterate what I said previously, which is the core retail product margin that we see in the business, which again 90% plus of our business is in really good shape and part of it is our ability to kind of slightly back off on promotional level as well as continue to improve the mix of the overall box with adding additional prestige kinds of brand and items to our mix overall.

So that’s a great things for the business. I did mention that loyalty, there is a bit of a rate hit that we take on that. And I would expect that continues for the rest of the year. And again, that’s a long term good for Ulta. Loyalty is one of our best biggest most important assets that we have.

E-commerce, we’ve talked about that for the last year or so. I mean, that’s the nature of that business. We continue to build the assortment out there. We’ll continue to do that throughout 2014 and we expect the rate to improve there in the long term with better assortment and more scale for that business to help cover some of the investments planning we had to do.

And then lastly, the product mix, the shift we saw in Prestige, we expect that to moderate as we get deeper into the year. And again, I just say again, we’ve got some nice things in the queue. I’m looking at Janet, my merchant partner, here we get some great things in the queue for the back half of the year that we expect to help margin range.

Jill Nelson - Johnson Rice

All right. Appreciate it. Just last question, inventory per store were down this quarter, how are you looking at that metric for the remainder of the year?

Scott Settersten

Yeah. We -- that’s another, I think, we’ve kind of grappled with for the last year or so. I mean, we’ve made some important investments in inventory, both to help general in stock levels in the stores and then with the boutiques we’ve made some significant inventory investments as well. Those have been good for the business, good long-term investments for us. We’ve kind of cycled all that now and so we feel like we’re in a really big position and we expect per door inventory increases to be well below the comp increases for the year.

Jill Nelson - Johnson Rice

Appreciate. Thank you.

Operator

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

Mark Altschwager - Robert W. Baird

Great. Thank you and congratulation. You touched on the mix shift going out within prestige. But could you update us on the performance of math versus prestige? And whether you are seeing any evidence of broadening the strength across price points?

Scott Settersten

We haven’t seen any shift really in the total box shop so to speak. So we still, customers coming into shop prestige that’s what’s drawing her into the store. But we also know, when she checks out there is still mass items in her basket. She’s cross shopping the store and that’s really one of the secrets to Ulta success, as we can capture both parts per shopping trip.

Mark Altschwager - Robert W. Baird

Great. Thanks. And then could you just talk a little bit of the store experience and you have been investing a lot in training. What metrics are you looking at to gauge whether these investments are translating into a better more differentiated experience?

Mary Dillon

Right. Well, we’re early on the test and learn of those, so we’re doing a couple of things, one is just increasing moderately our overall base level of training for associates. But really as we look at the test and learn, its really about how learning about if we were to ramp that up even further and frankly, have more, guest facing time, even more knowledge to our associates, maybe through technology and these are just key measures, of course, will be does that drive incremental profitable growth.

So we have to measure that over some period of time. But we’re pretty confident that while our guest does not want to be -- she sometime doesn’t want some help, another time she does.

We believe, we know the right way to do that, but we believe that, for many of our guests is more knowledge, more recommendations from associates. She may increase the units per transaction and we’ll measure that closely and make sure that that kind of investment would work overtime.

Having said that, a lot of our supply chain investments will also be hope overtime allow our associates to have more customer facing time. So with our incremental investments, we believe that’s also going to be one of the ways that we can drive growth.

Mark Altschwager - Robert W. Baird

Thank you.

Operator

Thank you. We have no further questions at this time. I would like to turn the floor back over to Mary Dillon for closing remarks.

Mary Dillon

In closing, I’d like to thank all of our Ulta Beauty associates to deliver a great quarter while working to refine our strategy to drive sustainable long-term growth. And thanks all of you for your interest in Ulta Beauty. I look forward to speaking with you soon.

Operator

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

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Ulta Salon, Cosmetics & Fragrance (ULTA): Q1 EPS of $0.77 beats by $0.03. Revenue of $713.77M (+22.5% Y/Y) beats by $14.26M. Shares +6.14% AH.