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Ulta Salon, Cosmetics & Fragrance Incorporated (NASDAQ:ULTA)

Q4 2011 Earnings Conference Call

March 8, 2012 5:00 PM ET

Executives

Allison Malkin – ICR, Inc.

Chuck Rubin – President and CEO

Gregg Bodnar – CFO

Analysts

Brian Tunick – JP Morgan Chase

Neely Tamminga – Piper Jaffray

Daniel Hofkin – William Blair & Company

Erika Maschmeyer – Robert W. Baird

Sam Panella – Raymond James

Jill Caruthers – Johnson Rice

Christina [ph] – Oppenheimer & Co.

Connie Edwards [ph] – Wells Fargo Securities

Operator

Greetings and welcome to the Ulta Salon, Cosmetics & Fragrance, Incorporated Fourth Quarter 2011 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.

It is now my pleasure to introduce your host, Allison Malkin of ICR. Thank you, Ms. Malkin. You may begin.

Allison Malkin

Thank you. Good afternoon. Before we get started, I would like to remind you of the company's Safe Harbor language, which I'm sure you're all familiar with.

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

Now, I would like to turn the call over to Ulta's President and CEO, Chuck Rubin.

Chuck Rubin

Thanks, Allison. Good afternoon, everyone. Thank you for joining us to discuss our fiscal 2011 fourth quarter and full year results. On the call with me today is our Chief Financial Officer, Gregg Bodnar.

Following my opening remarks, Gregg will review in more detail our fourth quarter and full year financial results and provide our outlook. I will then offer some closing comments and turn the call over to the operator so that we can answer the questions you have for us today.

The fourth-quarter concluded another outstanding year of growth at Ulta. We surpassed the sales and earnings guidance we provided in our holiday release in January, and delivered our second consecutive year of double-digit comp store growth, while growing our operating margin and net income at a rate far faster than our sales growth. Our consistent strong performance validates the success of our customer offering, the motivation of our marketing, and the power of our operating model.

I’m proud of all that we have accomplished in fiscal 2011, and equally confident in our ability to continue our favorable performance in 2012 and beyond. Briefly touching on the highlights of our fourth quarter results, net sales rose 23% to $582.5 million from $473.7 million last year.

Comp store sales increased 11.5%, following a comp increase of 10.4% last year for a two-year comp gain of 21.9%. Comp growth was mostly driven by traffic increases, with average selling price rising slightly.

Gross profit margin rose 100 basis points, inclusive of a 40 basis point expansion in merchandise margin. Strong sales growth, combined with expansion in gross profit margin and leverage in SG&A, led to a 49.5% increase in operating income, with operating margin up 230 basis points to 12.6% of net sales.

Net income increased by 53.8% and income per diluted share increased to $0.73 from $0.49 in the fourth quarter last year. Our strong sales resulted in additional market share gains during the quarter across all of our major categories, as more customers continue to choose Ulta instead of other shopping venues for their beauty needs and wants. Our growth during Q4, as well as all of 2011 was driven by our 5 key growth initiatives. Let me provide some color on each.

First we continued our new store expansion by opening seven stores in the quarter for a total of 61 new stores open in 2011. This represented a 16% net expansion in square footage in 2011, and resulted in a year end store count of 449. Additionally, we remodeled 17 stores for the year. We are very pleased with the performance of both our new and remodeled stores. Our second growth initiative is the continued enhancement of our guest offering, especially through the addition of new products, new brands and new services.

During Q4, our sales were strong across categories with prestige skin, prestige make-up and fragrance leading the way. A few noteworthy strengths included our new and exclusive holiday gift sets from Urban Decay, Benefit, Tarte, bareMinerals, and Ulta. New fragrances from Fendi, Vera Wang Princess Night and continued strength from Justin Bieber's Someday, and Taylor Swift Wonderstruck and the successful growth of new brands and products introduced in Q3, including Laura Geller, Art of Shaving, and Mia 2 from Clarisonic.

Our third growth initiative of expanding our marketing reach also contributed to our strong sales. During Q4, we enhanced our special eventing that combines our product and service offering into a fabulous guest experience that highlights our unique beauty offering. Our January skincare event, our brand specific days that we have in our stores, and our lunchtime specials at ulta.com are all examples of our marketing events, which animate the experiential shopping experience that Ulta offers.

Our Q4 marketing program also included blockbuster gift book purchases including our popular holiday rope [ph], along with the new ice bucket and wine glass gift set. Our Q4 sales were also supported by our first national holiday radio campaign that reinforced our Ulta brand awareness, in addition to driving urgency for the holiday shopper. And finally, we built upon our already strong direct mail efforts by utilizing our loyalty club database.

Leveraging this growing royalty club membership is our fourth growth initiative. During the fourth quarter, we surpassed 9 million active members. As I have previously said, harnessing the power of this rich pile of customers is a long-term focus for us, which will allow us to better personalize our marketing outreach while driving higher sales. We made solid gains in Q4 through better customed targeting of all of our direct mail marketing pieces, including our first-ever prestige fragrance mailer.

Finally, our fifth growth initiative, to build our e-commerce and digital capabilities continue. Our digital sales during the quarter were strong, albeit still off of a modest base. We continue to better integrate our marketing campaigns across all our customer touch points to consistently reinforce the Ulta experience across channels, from brick and mortar, to e-commerce, to social media. We have great opportunity in this area and are only in the early stages of maximizing our potential.

Turning to Salon, we achieved a solid positive comp in the quarter, in part driven by more frequent marketing and new service offerings. One example was our service launch of nail gel by OPI to approximately 200 stores. This is a new incremental service that augments the salon experience we offer our guests. We are pleased that we were the exclusive national retailer to launch this service, and based on our strong initial results we are rolling out to the balance of the chain in Q1.

Turning to the balance sheet, our year-end position is very strong with $253.7 million in cash and no debt. Inventory was down 3% on a per store basis, and we generated over $90 million in free cash flow. In recognition of our ability to generate strong cash flow, while investing in our accelerated store opening program, in the people and infrastructure to support our long-term growth, our board of directors approved a $1 per share special dividend payable to shareholders of record, as of March 20, 2012.

2011 certainly was a fabulous year for Ulta. Total sales increased 22.1%, with comp store sales up 10.9%. Operating margin expanded 280 basis points to 11%, moving us closer to our mid-teens goal, and diluted earnings per share rose to $1.90, up 63.8% over 2010. Looking ahead to 2012, we are excited about the opportunity ahead as we continue to focus on our core growth initiatives. We know we’re less than halfway to our previously communicated 1000 US store potential.

For 2012, we will accelerate our store openings beyond our long-term goal of 15% to 20% annual square footage growth, as we plan to open approximately 100 new stores. This represents approximately 22% square footage growth. Our real estate team has done a terrific job of identifying high-quality sites that meet our stringent criteria. We are also pleased with our early stage 2013 pipeline, and feel confident that it will deliver the 15% to 20% square footage growth consistent with our long-term growth targets.

Of course, if additional attractive real estate opportunities are identified, we will consider accelerating our store growth just as we have done in 2012. We will continue to offer newness and excitement to our guests through the introduction of new brands, products and services, as well as line extensions for those existing brands our guests love and rely on us for.

During the first quarter, we plan to introduce new brands including The Body Shop, Carol's Daughter, and Doctor Brand [ph]. We will also highlight new products and services, including eyelashes from Katy Perry, Urban Decay’s Naked 2 palette, our exclusive your starting line-up kit from Bare Essentials, our exclusive launch of Ojon super sleek hair treatment, and Chromatics, a new hair coloring service from Redken, that provides more vibrant color and healthier hair benefits than other color services.

We are proud to be the exclusive national retailer to offer this service.

Our marketing will continue to focus on promoting and animating our stores and website through fun, guest friendly events like our Q1 spring beauty inspirations, held in conjunction with the editorial authority of Conde Nast, and our 21 days of beauty, and finally our upcoming Frederic Fekkai hair blow-out events. We also will continue to leverage our successful and growing loyalty program.

As mentioned on our last call, in 2011 we completed our necessary technology platform improvements to begin the migration to one loyalty program from the two we operate today. In late Q1, we expect to convert approximately 130 additional stores to our enhanced points-based loyalty program. When this phase is complete, approximately one half of our stores will be on the points-based program. The enhancements of this program provide greater choices and greater freedom to our guests, which we believe overtime will lead to higher guest engagement and greater loyalty.

And finally, we will continue to invest in our digital efforts with continued upgrades to our e-commerce site, including more products available for auto replenishment, improved customer service, improved search engine optimization, and an enhanced customer experience via our mobile say [ph].

Before I turn the call over to Gregg to review our financials in more detail, and provide our outlook for the first quarter of the year, let me say how proud I am of Ulta’s 2011 accomplishments. Let me also thank our 14,000 associates across our stores, distribution centers and home office that worked diligently to provide the most unique and compelling experience to our beauty guests. We are all focused on building upon the success in 2012 and beyond. Gregg.

Gregg Bodnar

Thanks Chuck. We are very pleased with our fourth quarter results, which were driven by better-than-expected sales and margin performance.

During the quarter, we delivered a 23% increase in total sales, an 11.5% increase in comp store sales, a 100 basis point expansion in gross profit margin, and leveraged SG&A by 130 basis points. This performance delivered a 230 basis point increase in operating margin to 12.6% for the quarter. We also delivered a 49% increase in fourth quarter earnings per share.

Turning to a review of the income statement, fourth quarter net sales increased 23% to $582.5 million. Comp store sales rose by 11.5%, representing a two-year increase of 21.9%, consistent with the trends that we saw through the course of 2011. As Chuck mentioned, our strong sales performance was broad-based and we believe resulted in market share expansion, reflecting the (inaudible).

During the quarter, we opened 7 new stores and at quarter end, we operated 449 stores, expanding square footage by 15% from last year's fourth quarter.

Gross profit dollars increased 26.7% to $198.5 million from $156.7 million last year. Gross profit margin increased 100 basis points to 34.1%. Our gross profit margin expansion was primarily driven by 70 basis points of increased leverage and fixed store cost due to our comp store sales increase and 40 basis points of improvement in merchandise margins.

SG&A expenses were $124.2 million or 21.3% of net sales, compared to $107.2 million or 22.6% of net sales last year. The leverage in SG&A expenses is primarily attributable to comparable store sales growth and our cost management discipline.

Fourth quarter fiscal 2010 included a non-recurring compensation charge, which impacted SG&A by 20 basis points. Preopening expenses totaled $1 million in the quarter, which compares to $0.5 million in the fourth quarter last year, reflecting 7 new store openings during the quarter versus 5 new store openings last year.

Our strong sales growth and margin expansion, (inaudible) resulted in operating margin expansion of 230 basis points to 12.6% from 10.3% last year.

Interest expense was $91,000 and represented fees associated with our credit facility which we did not utilize this year. The income tax rate for the fourth quarter was 36.7%, down from 38.3% last year, primarily driven by year-end tax adjustments, including some Federal and State tax reductions and credits.

Net income for the quarter increased 54% to $46.3 million or $0.73 per diluted share. This compares to $30.1 million or $0.49 per diluted share last year.

Now turning to the balance sheet and cash flow, merchandise inventories at the end of the quarter were $244.6 million, compared to $218.5 million at the end of the fourth quarter last year. The 3% decrease in average per store inventory was consistent with our plans. Capital expenditures for the fourth quarter were $30.9 million and depreciation and amortization was $20.3 million.

For the full year 2011, just a couple of highlights. Net sales rose 2.1%, inclusive of a 10.9% comp increase. We opened 61 new stores, representing a 15% increase in square footage. We continue to be very pleased with the performance of our 2011 new stores. Operating income margin expanded 280 basis points to 11%, achieving a double-digit operating margin. Earnings per share increased 63.8%, and we delivered free cash flow of $92.3 million, finishing the year with 254 million of cash and no debt.

Now regarding our first quarter 2012 outlook. We currently estimate net sales in the range of $452 million to $460 million, compared to actual fourth quarter 2011 net sales of $386 million. This assumes a comp store sales increase of 6% to 8%, representing a two-year increase of 17.1% to 19.1%, following last year's increase of 11.1%.

We plan to open approximately 13 new stores in the first quarter 2012, compared to 5 new stores last year. Income per diluted share for the first quarter is estimated in the range of $0.46 to $0.48. This includes a $0.10 per share impact driven by incremental preopening expense from our accelerated new store program. This compares to actual income per diluted share of $0.37 in the fourth quarter of last year.

In addition, we expect gross profit margin to expand by approximately 40 basis points at the midpoint of the guidance range from last year's gross profit margin of 34.9%. Gross profit margin expansion in the first quarter will be driven by merchandise margin. As previously mentioned, our distribution centre will have a slight negative impact on gross profit, primarily in the first half of the year.

We will also incur some additional accelerated depreciation associated with the increase in our 2012 remodel program, which will impact gross profit in the first quarter by approximately 20 basis points. Again, with all of these initiatives, we will continue to (inaudible).

We expect SG&A as a percentage of net sales to decrease approximately 70 basis points at the midpoint of our guidance range from last year’s rate of 24.5%. As the result of the aforementioned drivers, we expect to continue to expand our operating margin during the first quarter by approximately 90 basis points. We also expect the following for the first quarter, pre-opening expenses to be approximately $2.3 million, an effective tax rate of approximately 39.5%, and fully diluted share count to be approximately 64 million.

Looking forward to the full-year fiscal 2012, we expect to deliver strong results in relation to our long-term financial goals. As a reminder, our business model has been built to generate 25% to 30% annual net income growth through the achievement of 3% to 5% annual comp stores sales gains, square footage growth of 15% to 20% annually, and operating margin expansion as we progress through our mid-teen operating margin target.

We are very pleased with the start of our year. For the full year 2012, we expect to deliver annual comp stores sales growth at the high end to slightly above our 3% to 5% long-term growth target. We expect net income growth at the high end of our 25% to 30% growth target, even after absorbing approximately $0.07 to $0.08 per share in incremental expenses related to preopening costs associated with our accelerated new store program, and expenses related to the opening of our third distribution centre.

This net income growth expectation also includes a $0.03 per share benefit from the 53rd week. (inaudible) details regarding our 2012 expectations. We have a very robust new store pipeline for 2012, with the expectance of opening approximately 100 new stores, delivering square footage expansion of approximately 22%. As you are aware, our total sales include comp store sales, non comp sales from the prior year openings, and sales from new stores opened in the current year.

Given the acceleration of our store openings in 2012, we thought it might be helpful to provide you with our store openings by quarter, and the expectations for new 2012 sales volume in each quarter. By quarter, store openings are expected to be approximately 13 new stores in Q1, 23 in Q2, 48 in Q3, and 16 in Q4.

Total 2012 store sales are expected to be approximately 5 million in Q1, 15 million in Q2, 40 million in Q3, and 80 million in Q4. Preopening expense for fiscal 2012 is expected to be approximately 16 million compared to 10 million in fiscal 2011. By quarter, this breaks down as follows, approximately 2.3 million in Q1, 5 million in Q2, 6 million in Q3, and 2.5 million in Q4. As you know, our new 2012 stores will start to roll into our comp base in 2013.

In addition, they will positively contribute to total sales, comparable store sales growth, profitability and cash flow in 2013. We will also expand our remodel program in 2012 to 21 locations, compared to 17 locations completed in 2011. You may remember we generate a return on investment from our remodel program primarily driven by the additional selling space gained by the remodel.

We remain on track with our third distribution center project. We expect the third DC to result in a (inaudible) to gross profit primarily in the first half of the year. Specifically, most of this activity will occur in the second quarter, as we prepare to ship from the new DC in Q3. This should have a 10 basis point to 20 basis point impact on gross profit margin in the second quarter. Again, we expect to expand gross profit overall each quarter.

Starting in the fourth quarter, we expect a modest benefit to gross profit margin as we ship to more stores from the new DC, and therefore realize the expected transportation cost benefit. As you may recall, we opened our second DC very successfully on time and on budget, and we will apply the same disciplined execution as we bring this operation online.

Capital expenditures in 2012 are expected to be 170 million, which is approximately 40 million higher than our capital expenditure program in 2011, driven by the acceleration of our store expansion program. Depreciation and amortization will be approximately 89 million. We will continue to appropriately manage inventory levels, as we have demonstrated in the past.

At the end of the first quarter, inventory on a per store basis is expected to increase in the mid-single digit range, largely driven by the inventory to open our third DC. This inventory growth will still be below expectations for our comp growth, and will trend lower as we move towards the end of the year. We expect this improved inventory productivity to drive higher turnover. We remain comfortable with the composition of our inventory, and will continue our inventory discipline.

We will continue to expand operating margin, and expect to be well into the low double-digit range, building from the 11% we delivered in 2011. We continue to be very confident in our long-term mid-teen operating margin target. 2012 represents a 53rd week for us. The extra week is included in the fourth quarter, and represents approximately 35 million net sales, and approximately $0.03 per diluted share in earnings.

In 2012, we expect to deliver free cash flow while making additional investments to accelerate our new store program to approximately 100 stores, or 22% in adding our third DC. Again to summarize, in fiscal 2012, we expect comp store sales growth at the high end to slightly above our long-term target of 3% to 5%, and expect net income growth at the high end of our 25% to 30% long-term growth target, while absorbing $0.07 to $0.08 per share of incremental costs related to the acceleration of our new store program, and the opening of our third DC.

As Chuck mentioned earlier, our board recently approved a $1 per share special cash dividend payable to shareholders of record as of March 20, 2012. We are confident we have ample liquidity, including $254 million in cash at year end and our unused $200 million credit facility to continue to invest in our future growth and drive meaningful shareholder returns.

We expect to continue to generate significant free cash flow in future years. We will continue to invest cash generated appropriately in the growth of our business, and will continue to evaluate strategies for the use of excess cash beyond our planned needs.

And now, I'd like to turn the call back over to Chuck.

Chuck Rubin

Thanks, Gregg. 2011 was another remarkable year for Ulta as we posted higher sales and profits along with strong cash flow. By providing our guests with the product and services they seek in an exciting and fun shopping environment, we gained market share and new guests, and further solidified our position as a key beauty destination.

I want to thank everyone at Ulta for their hard work and dedication, and I look forward to another year of sales and profit growth in 2012. Finally, you likely saw our press release announcing that we will begin a search for a new CFO as part of a CFO succession plan. This results from Gregg needing to relocate to Michigan to address a family health issue. In the meantime, I am pleased that Gregg will continue in his current role, as well as assist in the hiring and transitioning of his responsibilities to his successor later this year.

Gregg has been a terrific partner of mine and contributed greatly to Ulta’s growth. While I regret his decision, I respect his desire to put his family needs first. I’m confident in the team he has built, and know they have the proven abilities to continue Ulta’s strong performance.

Before we open the call to questions, I know Gregg would like to make a few comments as well. Gregg.

Gregg Bodnar

Thanks Chuck. While I know I’m making the right decision for my family, this is a very difficult choice for me. I have enjoyed my time with Ulta, and I’m proud of what we have accomplished and even more excited about the company’s future opportunities. Chuck, the management team and the board of directors have an exciting vision and all the talent required to continue the company’s success well into the future.

I am pleased to continue on in my current responsibilities and assist with the hiring and transition of a new CFO to provide seamless and orderly succession. And with that, I would like to turn the call back over to the operator to open the call, and we will take your questions. Operator.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Brian Tunick with JP Morgan Chase. Please proceed with your question.

Brian Tunick - JP Morgan Chase

Thanks. Good afternoon guys.

Chuck Rubin

Good afternoon.

Brian Tunick - JP Morgan Chase

And Gregg, we are definitely going to miss you. So best of luck Gregg.

Gregg Bodnar

Thank you.

Brian Tunick - JP Morgan Chase

I guess, so I guess two questions here, I guess first one Chuck sort of bigger picture, thinking about market share right, either by vendor sort of how do you think about it or where is the share coming from, and is that changing as you have changed your marketing from I guess (inaudible) about that. And then maybe, some discussion about the comp drivers going forward, you know, do you think it is more important for new brands, or is it the newness within the brands that you think give you the most confidence?

Chuck Rubin

Brian, three things, one you don’t have to miss Gregg just yet. He’s going to be here through the transition. So you will have more opportunity…

Gregg Bodnar

I will continue to torture you Brian.

Chuck Rubin

Exactly. Actually that is something – we both enjoy doing that. To your questions though, on the market share, we are gaining share across the board. So we’re gaining it in our prestige area, in our mass area, in our what we call personal care appliances. So it is coming from a variety of places. I can’t identify which specific retailer it is, but I know that we’re growing across our business base faster than the industry as a whole.

In terms of your second question, it is newness that is the real motivator here. And newness can be defined in different ways. It can be a new brand that we are adding in, as I mentioned some of the new brands we are adding into the first quarter, and some of the brands that we have added in the past couple of years, they continue to mature in some ways almost like the new store matures. It is still, you know, you have the new brand in one quarter, and you still see growth even a year later as it continues to mature.

But new brands is only part of it. New products within brands, new trends, new services, I think that is what we have done so good with putting into our offering and communicating through our marketing to our guest is the newness. She comes in and discovers the things that she relies upon us for day in and day out and has for years. But she is also finding the new product or the new services or the new brand when she comes in, and even the new marketing events that we have added into it.

So I wouldn’t isolate it just to brands. I would tell you that the word new is really the motivator that we are seeing accelerate our business.

Brian Tunick - JP Morgan Chase

And just a final question on what kind of customer acquisition thought process as you have shifted now from marketing from mostly being a newspaper insert to obviously moving more towards digital and radio, so are you bringing a new customer or is it a different view?

Chuck Rubin

Well, print is still a good part of our marketing mix, and we’re getting significantly better at our abilities in direct marketing as a result of our loyalty program. So the content that the merchants are putting out there is improving the targeting of our marketing that the marketing group is putting out there is improving, and the experience in store is improving.

As far as attracting a new customer, I believe that our sales performance is driven by – grabbing additional share within existing customers, so she is spending more of what she spends in the beauty space with us, although still only a fraction, which is encouraging because we know we can still capture more sales from our existing customer base. But we also are adding new customers. Clearly when we open a new store, we expand our base, but we are adding new customers in comp markets as well.

This is – as I said this was a fabulous year in 2011, and we saw good performance from new and existing customers across the board throughout the year.

Operator, did we lose Brian?

Operator

Mr. Brian, your line is still live.

Brian Tunick - JP Morgan Chase

I am all set. Thanks and good luck.

Chuck Rubin

Thanks Brian.

Gregg Bodnar

Thanks Brian.

Operator

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

Neely Tamminga – Piper Jaffray

Hi, thank you. And I know this isn’t the end of our time with Gregg, but I do want to thank Gregg very much for your service to Ulta and its shareholders. I do wish you the best with you and your family, and your impact on this roadmap of the public company will not be forgotten, and this afternoon’s release is certainly testimony to that. So congratulations. Hi, so the question here on stores, you have 100 here in the pipeline on the opening side, just wondering if you are thinking a little bit differently on the prototype. Obviously level 7 is the most recent prototype that you guys have out there, but will they still be anchored with the usual benefit velocity [ph], or do you start making room for the Lancome in that, just wondering how that looks in terms of roll out.

And then Chuck, a little bit of a clarification question on the loyalty program, so as you open those new stores, will they automatically be adopted into the loyalty program the new ones, or do you have to wait for that market to get this rolled out?

Chuck Rubin

Yes, let me take the second one first Neely, the conversion of the stores is a geographic conversion. It is not based on the store age. So existing stores in the markets that we are converting, as well as new stores that we opened in the market will Startup on the new program.

As far as the first point, we are still working in level 7. We have made a number of enhancements to it, and we continue to both in the visual appearance of the store, as well as the space allocation and you know, the allocation of space to different brands and different categories. I think what you will see us continue to do in stores is similar to what we have done in the rest of the business; we had a very good base. We just continue to evolve that, listen very closely to what our guest tells us, what products, what brands, what categories are out there that she is interested in, and we continue to evolve.

So as an example, you will see later in the first quarter, the end caps of our fixtures throughout the store will become much more exciting than they have been before. They will be much more statement oriented, either around new product or a new trend or something that we want to do a better job of highlighting than we have historically. So while we still consider it a level 7, sometimes I refer to it as a level 7 on steroids. We have made a number of improvements to that. So that is what we will continue to – we’re putting all of that into the new stores we are opening this year, but we are also going back to the existing 7s and doing the same thing.

Neely Tamminga – Piper Jaffray

Chuck that is very helpful. Thank you. And just one quick follow up on the manicure service that is being rolled out, do you have to do anything differently with the store payroll or labor-management, or is that just a plug and play with the…

Chuck Rubin

It is kind of plug and play. You know, there is some downtime for our stylist. It is the service provided by our stylists that are in store now. They have some downtime between guests. They also have downtime even when working with a guest. If they are waiting for a treatment to – while they complete the service, they have a little downtime with that same guest.

So that is what is exciting about it Neely. This is an incremental service. It is not taking away from anything we offer today, and it can help fill into some time gaps that we have in the salon.

Neely Tamminga – Piper Jaffray

Great. 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

Good afternoon, and just another terrific year. Gregg let me echo others comments, certainly very sorry to see you go when that happens, and I hope everything takes a turn for the better with your family. Just a quick question regarding traffic and ticket expectations, obviously in 2011 including the fourth quarter, I gather traffic was the vast majority, do you expect a similar kind of relative dynamic, or might that mix change a little bit going forward. That is my first question.

Chuck Rubin

Yes, Dan. We don’t break that out in detail, but clearly we do expect traffic to be the motivating factor in our comps this year, as it has been over the foreseeable past.

Daniel Hofkin – William Blair & Company

Okay. And in terms of just number of visits or conversion rate as well, some of [ph] mostly number of visits that is driving the transaction?

Chuck Rubin

Yes, I don’t know how much detail we want to get into that. What we have provided in the past, what I can tell you is traffic has been the driving force in our sales, and with the growth of our loyalty file, what we know is she is shopping with us more often, and she is spending more money in total on each of her visits, she may spend a little bit less, but because she is coming in more frequently the aggregate of her spend with us is increasing. So, I would expect that we would see that as we go forward.

The loyalty program, both of the loyalty programs are very good, solid attractive program. We obviously believe that points program is better and hence the reason for the conversion. So we have high hopes of this loyalty program continuing to drive our business as we go forward.

Daniel Hofkin – William Blair & Company

Okay, thanks and as it relates to let us say incremental sales, what you are seeing right now, or what you expect for drop through right to the margin line, operating margin, kind of what is a good rule of thumb, or that we can think about at this point?

Chuck Rubin

You know, probably the easiest way to translate that Dan is if you look at our point of comp, based on our guidance range, so our point of comp translates to about a penny of earnings.

Daniel Hofkin – William Blair & Company

That being at the quarterly, I am sorry, that is on a quarterly basis, correct?

Chuck Rubin

Correct.

Daniel Hofkin – William Blair & Company

Okay and that is – so fairly similar even kind of outside of the range I would assume?

Chuck Rubin

Correct.

Daniel Hofkin – William Blair & Company

Okay. So, talking about like second, third, fourth quarter?

Chuck Rubin

Yes.

Daniel Hofkin – William Blair & Company

I guess last question if I could, on the 53rd week, so that is obviously included in the guidance. I was a little bit surprised because I thought it might be a higher margin week, but is there other things that affect the margin, and the single week I know it is a small number for the overall year?

Gregg Bodnar

No, you know, it is a normal week for us. You know, we go through the sort of exhaustive exercise of making sure, which I think a lot of retailers do, but maybe not all of them, the exhaustive exercise of making sure that week has all of the incremental costs associated with it, which is the proper way to do it. So it has all the variable costs, it has all the fixed costs. So it is a more normal operating margin week in the month of February.

Daniel Hofkin – William Blair & Company

Okay. Got it. Thank you very much. Best of luck.

Chuck Rubin

Thanks Dan.

Operator

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

Erika Maschmeyer – Robert W. Baird

Hi, congratulations on another great quarter, and then Gregg also very, very sorry to hear about your departure and family situation.

Gregg Bodnar

I am going to be around for a long time Erika, until we find the right successor. So…

Erika Maschmeyer – Robert W. Baird

That is good. That was what I wanted to ask about, I guess have you set a date for how long you will be willing to stay around, and then on the search, are you looking internally or externally, or both?

Gregg Bodnar

I will take the first one, I’m going to be around till we find the right successor. You know, I have an incredible passion for this company, a passion you know, about what we have delivered in the past, a passion for the opportunities that are in front of us, which I think have never been stronger. We’re going to take the time that it takes, and I have the flexibility to make sure that I am around until we find that right successor.

Chuck Rubin

As far as the search is concerned, obviously we are just beginning that, and we will consider all candidates internal as well as external.

Erika Maschmeyer – Robert W. Baird

Okay. And then on the loyalty program rollout, any plans outside of the 130 in Q1, do you expect all stores by year-end, and then can you talk a little bit strategically on the promotional front, I know you have been working to move away from store discounting, and I guess kind of where kind of examples of where you have had success, and then how the new loyalty program can help you move that goal forward further?

Chuck Rubin

We haven’t yet laid out publicly the full conversion schedule. So we’re going to take the 130 stores, and as I mentioned in the script, that will have half of the chain on the program by the very end of the first quarter. It is actually the last week of the quarter. There are natural points to convert this over because we have to convert the old program and the redemption windows that we have for that. So, we will talk more about the rest of the company as we proceed into the year.

As far as the benefit of converting to the one program, it does provide us a lot more flexibility to adjust our promotional format, because today it is difficult with two programs to be able to offer a lot of loyalty based incentives nationally in lieu of price discounts. So, you know, what we have done is altered some of our promotional mix. We clearly have offered our coupons. We will continue to do that, but as we move more and more to the points based program, you will see us utilize additional points as incentives to our guest.

But ultimately you have also seen as 2011, and it will continue in 2012 that newness is highlighted more and more in our advertising as well. You know, price is not the ultimate driver in our business. It is a factor, but unlike other types of businesses it is not the leading factor. It goes back to everything what Brian was asking about earlier, it goes back to the newness. So you know, you have seen some examples of that and when you go through our ad pieces, whether they are print or digital you will see as we go through 2012 us highlighting the newness, whether it is fun, fashion, function around that newness, you will see us highlight that more in our advertising.

Erika Maschmeyer – Robert W. Baird

It is very helpful. Thanks so much.

Chuck Rubin

Thanks Erika.

Operator

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

Sam Panella - Raymond James

Hi, good afternoon everyone, and let me add my congratulations as well, and Gregg wish you and your family the best here. I guess, I apologize if I missed this, did you break out what the traffic and ticket increases were in the fourth quarter?

Chuck Rubin

We said mostly traffic, slight increase on ticket.

Sam Panella - Raymond James

Okay, and in terms of your acceleration of your store growth, can we talk about the opportunities that you are taking advantage of, obviously this is further acceleration from what we discussed in the last call, and just wondering given your store economics are much stronger now than they were say three, four years ago, is this something after maybe new real estate opportunities for you?

Chuck Rubin

I will take the first part and throw the second to Gregg. You know, the real estate team has been really creative, really aggressive in finding opportunities. There is obviously not a lot of new construction that is happening, but there is real estate that has been out there, whether it has been other retailers who have freed up their full real estate foundation, or just others who are looking to scale down on some space.

So, for instance, in the first Borders [ph], we have taken some sites from them. We have taken some excess space from Best Buy. But I want to give the real estate team a call out for the outstanding work that they have done. They also have been very creative in working with existing centers, and existing landlords to try to put together small stores and try to merge them together to get our 10,000 square foot box.

So it is a very different way you have to approach real estate today for new stores than it was a few years ago, when a few years ago you could almost sit and wait for developers to call you, and today you have to be very proactive, very creative. And I think our real estate team has done a great job as evidenced by the 100 sites. It is also important to note that we are very pleased with the 100 sites that we have been able to get for this year. We have not sacrificed quality whatsoever. I think we have talked about this, but Gregg and I have talked about this repeatedly, we will not pursue quantity in lieu of the quality. But that is what makes 2012 so exciting, we have been able to find both of them and we are very excited about what is ahead.

Gregg Bodnar

And we do have an incredibly rigorous real estate evaluation process, as well as the talent in the team that knows the right sites to pick. I think one additional point there too is you know, the larger we get, the more attractive and more visible we get with developers kind of across the country. So, the dealmakers have been incredibly creative, and the receptivity of developers to rearrange boxes et cetera to accommodate our needs has been equally as attractive.

As it relates to the payback, you are right. Over time, we have accelerated the cash payback in the model. We have reduced the opening cost as well as improved the operating margin. So what is really exciting about this opportunity to accelerate the new store program even though a lot of it does come into the back half of the year, is there will be a pretty significant 2013, 2014 benefit, because these stores pay back pretty quickly, and you know, they get a nice lift when they start to roll into the comp base. They generate additional incremental free cash flow and earnings. So it will be a nice comp line to 2013 and 2014 and certainly beyond that.

Sam Panella - Raymond James

Great. Thanks for all that clarification, and best of luck. Thanks.

Chuck Rubin

Thanks Sam.

Operator

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

Jill Caruthers - Johnson Rice

Good afternoon. I want to extend my best wishes Gregg to you and your family in ’12. A question on a comment you made earlier, knowing only a small percentage of the customer’s weekend [ph] spend is at Ulta, maybe I know it is a generic comment, but maybe could you talk about where you feel the missing parts are that Ulta isn’t driving?

Chuck Rubin

Well, I’m not sure it is any particular product category that we are not grabbing, but no one in retail gets 100% of any one’s spend in their respective categories. So we believe given the strength of our model, the breadth of our offering from master prestige, to salon products, to the salon services, and how we have improved upon that, we think we are giving our guest that much more reason to be able to spend her purchase with us, spend her money with us.

So, you know, it is not any particular place that I think we’re weak on. I think it is just somewhat a convenience issue because to be shopping elsewhere and pick something up. But it speaks to the opportunity that we have because of the breath of what we offer, unlike other players in our space who are much more limited in the breath of their offering and the scope of their offering, we can satisfy most things that a woman wants in a beauty store. So that is why we believe we do have that upside potential to grab more share of an individual’s.

Gregg Bodnar

And Jill, I think you know the other way, in addition to think to about it too is loyalty program, and the flexibility that comes with this, and the attractiveness that she has in using this program I think will drive higher share wallet and higher loyalty. In addition to that, it also leads to the capabilities we are continuing to develop on the digital side.

So we can be more personal and more top the mind to her. So the more frequently at an appropriate level that we can personalize messaging to here, and it is a very impersonal world today, that is going to leave us a higher share of mind and leave us with higher share of wallet I believe because we know that the other things we are doing, she is significantly enthusiastic about as demonstrated by the kind of traffic and loyalty growth that we are getting today.

So I think there is multiple levers as we continue to build out these strategies that are going to continue to help us drive our share of wallet, and the customers who we already have higher share of wallet, and a bigger opportunity for those as you kind of move down the ladder from that. So that is kind of the way I would think about in addition to what Chuck said where the opportunity continues to come forward. And then as we become larger, again that voice as a national retailer becomes much more prevalent as well.

Jill Caruthers - Johnson Rice

I appreciate it, and just a quick follow on on the real estate, kind of what are you seeing out there in the rental rate forecast out there?

Chuck Rubin

You know, pretty consistent with what we have seen in the past. You know, no upward pressure, no significant downward pressure. Again, you know, the way we think about it is we know with – as odd as this may sound, with incredible procession, based on we have this large royalty club customer base in a very sophisticated analytical model to identify what the potential sales volume is and how that will grow over time for a particular trade area, seeing what the size and shape of that trade area is.

So we know exactly what we can pay and what we won’t pay to deliver a profitable store as we have been delivering. And obviously our deal makers have incredible experience as to what market there is as well. So it leaves us a very strong negotiating position, and a lot of precision in terms of what the right rental structure is to deliver the economics.

Jill Caruthers - Johnson Rice

Thank you.

Operator

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

Christina - Oppenheimer & Co.

Hi, this is actually Christina [ph] in for Joe. I was just wondering if you can give an update on the Lancôme and Clinique [ph] tests, how many doors you are in now?

Chuck Rubin

We are in the same number of doors that we have been in. We are very pleased with the performance of both brands, and you know, before you ask your next question, we have nothing to announce about an expansion, but we are very pleased with how both of them are doing.

Christina - Oppenheimer & Co.

Okay. Have you seen a comp lift from either one of the brands, or you are not going to comment on that?

Chuck Rubin

We are very pleased with how we are doing with the brand. We think it augments the offering as a whole. We are pleased with how the store overall is performing, those stores that have had Lancôme and Clinique added to them. So, up-and-down, [ph] it has not been cannibalizing other parts of our offering.

Christina - Oppenheimer & Co.

Okay, great. Thank you so much.

Operator

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

Connie Edwards - Wells Fargo Securities

Hi guys, this is actually Connie [ph] in for Evren. My question is, I know you touched on kind of your real estate selection process, but given the ramp up in new store openings, do you have any color into how may be some of the newer markets have been performing relative to some of your more mature markets, have you seen any signs of cannibalization between your stores?

Chuck Rubin

You know as we always have for many, many years as we build out a new store annual program, we balance our openings intentionally so between new markets and existing markets. And in some cases in those existing markets, it will create some cannibalization, and in other cases it won’t. At the same time, you obviously get incremental operating margin leverage by all the natural efficiencies as you know, go along with that. All of that is built into our historical performance. We have been doing that sort of forever. And all of that is built into our store model as well.

Gregg Bodnar

I will also remind you that when you have less than half of your potential store build out that is up and running, cannibalization will be a factor in some cases. But you have a lot of runway open, a lot of wide space for us to satisfy guest demand by opening a store in those markets.

Christina - Oppenheimer & Co.

Thanks so much, and best of luck to you Gregg.

Gregg Bodnar

Thank you.

Operator

There are no further questions at this time. I would like to turn the floor back over to management for closing comments?

Chuck Rubin

Well, let me thank everyone for joining us today and Gregg and I will look forward to speaking to you to discuss our first quarter results in June. Thanks again.

Operator

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

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