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Executives

Laurel Lefebvre - VP, IR

Chuck Rubin – President and CEO

Gregg Bodnar – CFO

Analysts

[Ike Borgia] - JP Morgan

Daniel Hofkin – William Blair & Company

Jill Caruthers – Johnson Rice

Joseph Altobello - Oppenheimer

Jason Gere - RBC Capital Markets

Jacob Zitter - Robert W. Baird

Evren Kopelman - Wells Fargo

Amanda [Siglin] - Jefferies

Ulta Salon, Cosmetics & Fragrance (ULTA) Q1 2012 Earnings Call June 5, 2012 5:00 PM ET

Operator

Greetings, and welcome to the Ulta Beauty’s first quarter fiscal 2012 earnings results conference call. [Operator instructions.] It is now my pleasure to introduce your host, Ms. Laurel Lefebvre, president of investor relations for Ulta. Thank you. You may begin.

Laurel Lefebvre

Thank you. Good afternoon, and thank you for joining us for Ulta’s first quarter 2012 conference call. Hosting our call are Chuck Rubin, president and chief executive officer and Greg Bodnar, chief financial officer. Before we get started, I would 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 will 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.

With that, I’ll turn the call over to Chuck.

Chuck Rubin

Thanks Laurel. Good afternoon, everyone. I’m very pleased to announce that 2012 is off to an excellent start. Following our strong performance in 2011, the momentum continued in the first quarter with better than expected sales and earnings growth.

Just to recap the headlines, we grew the top line 23% and drove same-store sales of 10.1%, on top of double digit comps in Q1 in the two previous years’ first quarters. We achieved 200 basis points of operating margin improvement driven by our double digit comp and our team’s consistent and disciplined execution of margin expansion strategies, translating into 46% EPS growth for the quarter.

We delivered this profit growth while investing in the business with the addition of 18 new stores, moving our improved loyalty program to 50% of the stores, and opening a new distribution center to enhance our supply chain capabilities.

All of these investments position us to continue to gain market share over the long term. We are driving our business forward by executing on our five-point growth strategy of accelerating store growth; introducing to our guests new products, services, and brands; enhancing our loyalty program; broadening our marketing reach; and increasing our focus on ulta.com.

These strategies delivered results in the first quarter and we believe will continue to fuel our growth into Q2 and beyond. Let me spend a few minutes detailing the progress we’ve made on each component of our growth strategy.

First, we are accelerating our store expansion and are on track to open about 100 new stores this year, representing 22% square footage growth. With the 18 new stores we opened during the quarter, we ended Q1 with 467 stores in 44 states.

We’ve been very pleased with our real estate strategy and the productivity of our new stores, and have just completed a robust analysis to update the store network potential. We now view the opportunity for our prototypical 10,000-square foot store in the U.S. market to be approximately 1,200 stores, up from our previous estimate of 1,000 stores. As such, we are currently less than 40% penetrated into the new store plan.

Just to give you a sense of the methodology behind the analysis, our real estate team has a terrific record of identifying great sites and getting stores open on time and on budget, and they have a tremendous amount of data on trade areas and customer purchasing behavior that have allowed us to refine our view of the opportunity for the U.S. market’s potential for our full-sized, 10,000-square foot stores.

Our updates analysis takes into consideration about a dozen demographic factors. We look at population density, household income, and retail presence in a market, as well as valuable information mined from our loyalty program. This analysis is layered on top of deep knowledge of the local retail markets. A third layer of analysis consists of using performance data of the existing stores and our portfolio based on their market and site characteristics as a reliable predictor of performance with similar characteristics.

Our new 1,200-store plan does not include smaller store formats or the potential for expanding outside of the U.S., both of which are incremental, longer-term opportunities. Looking ahead to the second quarter, we are on track to open 22 stores and complete about 10 remodels. Our 2012 store plan is locked in, and we are already developing a robust pipeline of sites for the 2013 opening program.

Our real estate team just came back from the ICSC real estate conference very optimistic about the long term opportunities in the market. We believe the discipline we have in selecting sites and opening stores enhances the potential for great returns for shareholders.

I’d like to emphasize that we will not, however, open stores for the sake of hitting a number. We always value quality over quantity, but we are very optimistic that very attractive real estate opportunities exist for us to achieve our 1,200-store buildout for our current format.

Let me talk about our second growth strategy, the addition of new products, services, and brands. In the first quarter, we continued to add excitement to our guest offering, which allowed us to gain market share across all major categories by providing the newness that our guests value and expect.

The three components capturing that newness through our focus on trend: adding new products from existing brands we already carry and introducing new brands to our portfolio. In Q1, we saw particularly strong trends in anti-aging, mascara, lipstick, and BB creams.

This last category of BB creams is a very hot trend. These all-in-one products deliver protection, priming, coverage, and flawless finish. We’re seeing strong growth in this category, with BB creams from Too Faced, Stila, Smashbox, Boscia, and Garnier.

The second newness factor is adding new products in existing brands. Here we saw continued strength in prestige cosmetics in particular. The new Naked2 Palette from Urban Decay was a standout. Also strong in Q1 was the launch from Benefit of liquid foundation. In fact, this was one of Benefit’s most successful product launches ever.

I’d also like to note that in our service business we saw strong performance from our Benefit Brow Bars, which are now in about 300 stores. We believe we have more Brow Bars than anyone else in the United States, which provides our guests a fun and fast service for about $20.

Turning back to product, we introduced our exclusive Ck One cosmetic line to 50 Ulta stores along with Ulta.com and are pleased with its performance. The Clarisonic line of skin cleansing tools continued to perform well in addition to everything else I’ve talked about.

This do-it-yourself at-home category also saw expanded success during Q1, with strong sales in Red Carpet gel manicure sets and the Remington i-LIGHT hair removal system. Our online business in this personal care appliance category, where we’ve tested some of these innovative personal care products which sell at a higher retail price, was particularly strong.

During the first quarter, we also added several new product brands to the assortment. Juice Beauty, an organic line that boasts scientific research supporting the efficacy of their products, was launched during the first quarter. Our guests are looking for organic products that deliver results, and Juice Beauty is a sought-after brand with limited distribution. We also launched bath products from the Body Shop, Carol’s Daughter skin and hair care products in the prestige skin category.

As we look to Q2, the newness in our offering continues. In prestige cosmetics, we are introducing Tarte’s Maracuja oil and Maracuja foundation, a new Benefit “Snow White and the Huntsman” kit, 68 shades of Urban Decay eye shadow with a build-your-own palette, and the new Supernatural trend collection from Bare Escentuals.

Light technology continues to drive innovation as well, and we will add personal care products from Remington and Tanda to the assortment, targeting hair removal, acne treatment, and wrinkle-reduction. The BB cream trend will be an area of focus, with a new endcap in all stores featuring BB creams across all categories, from masks to prestige.

Finally, in our prestige product offering, I’m pleased to tell you that we plan on adding Lancome boutiques to 50 additional stores, bringing the total number of stores offering Lancome to 79. We expect to open the vast majority of these new boutiques starting in the third quarter and completing before the important holiday selling season. These new boutiques are geographically targeted to enable us to market most effectively.

Additionally, in select stores, we plan to invest incremental capital and operating expenses in the prestige area, which will allow us to expand our prestige brand offering and add additional prestige boutiques to these stores. We expect to provide more details on this during our next earnings call.

We are very excited about these actions, as they will continue to strengthen our guest offering in the prestige part of our business, which has been growing quickly and capturing market share. In a few moments, Gregg will detail the short term capital and P&L impacts of these long term investments.

Let me touch on our service business briefly. Salon continues to perform well, and we’re very pleased with the strong positive comps we achieved. Newness was also a key driver of this strength. We launched Chromatics hair color by Redkin in the first quarter, which sparked strong sales in cut and color services as well as new guest acquisition. During Q1, we also finished the rollout of the gel nail service by OPI to all stores, which continues to add incremental sales as guests gain awareness of the offering.

Moving on to our third growth strategy, enhancing our loyalty program, with now well over 9 million active loyalty customers, this continues to be an incredibly valuable asset for Ulta as loyalty program customers shop more often and buy more with us overall. Just as important, the program gives us a highly effective means to communicate directly with our guests.

At the end of the first quarter, we converted our central region to Ultimate Rewards, which brings the number of stores on this new program to about half the chain. Our legacy loyalty program is certificate-based and at certain times during the year guests choose a free gift from a list of predetermined products, based on how much they earned during that timeframe. The new Ultimate Rewards program is a points-based program, which is far more flexible, since guests can use their points on anything in the store, whenever they want.

While we have been offering Ultimate Rewards for a number of years, we recently made several enhancements to the program to add greater value to our guests. Since the points program is easier to understand and gives our guests more choices, we believe customers will appreciate the value of the program more. While still early, thus far they’re telling us they greatly enjoy the enhanced, points-based program. We hope to move the balance of the stores to the new Ultimate Reward program over the next 12 to 18 months.

As I have discussed previously, our loyalty club database provides us with a tremendous amount of information about our customers’ shopping behaviors: what she buys, when she buys, where she buys. This is a significant asset for our company. The opportunity to harness that information in our guest targeting and communications is enormous, as we seek a higher share of wallet. We are good today, but we will significantly improve this capability over the long term.

Looking to the second quarter, we will continue to build on the personalization benefits that the loyalty program provides by launching an online reward center that allows our guests to proactively manage their loyalty account. We also will enhance our POS terminals in store to allow our cashiers to recognize and engage with our loyalty guests on a more individualized basis.

Our fourth growth strategy is to broaden our marketing reach beyond our historical strength in print advertisements. During Q1, we were pleased with the success of our “21 Days of Beauty” promotion, which focused on prestige color, skin, and special events in store. We saw solid performance of our gift with purchase offers for Valentine’s Day and Mother’s Day.

We are also branching out into new areas to improve our marketing effectiveness. During the first quarter, in the “21 Days of Beauty” event, we supported it with radio, deeper public relations, and social media. We continued to run national magazine print campaigns to remind customers of Ulta’s brand positioning, “Welcome to Fabulous,” with targeted ads focused on beauty and spring trends.

We are benefiting from the valuable relationship we established with Conde Nast about a year ago to communicate authority and credibility and position Ulta as a leader in beauty trends. During Q1 we conducted a multichannel editorial integration with a spring trend event curated from the beauty editors of Allure, Glamour, Lucky, Self, and Teen Vogue. This featured an integrated marketing program, with direct mail, in-store signage and handouts, sweepstakes, emails, and social media.

On the public relations and digital media side, we drove brand awareness with participation in New York’s Fashion Week; celebrity events with Katy Perry, Faith Hill, and Tim McGraw; increased activity with Facebook, Twitter, and Pinterest; and appearances on national television on shows like “The View.”

In the second quarter, we’ll continue to focus on expanding our marketing reach. Kicking this quarter off, in partnership with Lucky, a Conde Nast title, we beat the Guinness Book of World Records for completing the most makeovers in 24 hours, and were rewarded with seven minutes of airtime on the “Good Morning America” morning program.

Also in the second quarter, we held our “Love Your Hair” event, 14 days of special events and great deals that showed our guests how to get and maintain the latest hairstyle and color. This type of unique event, which leverages our product and service offering, is what our guests want, and we believe we are the only national retailer that can bring this to life for her.

For the balance of the second quarter, we’re planning a strong Father’s Day season with a compelling gift with purchase fragrance offer, offers for back to school season late in the quarter, and a national print advertising campaign for BB creams. Our marketing program will continue to harness print, direct mail, email, digital, social, and broadcast. Also, a new store endcap program that highlights new brands, new trends, and great value will make our experiential shopping environment more exciting.

The fifth leg of our growth strategy is our focus on Ulta.com. The opportunity is not only to generate higher ecommerce sales, but to become a true multichannel retailer to drive the Ulta brand, both in the physical and virtual environments. From a small base, Ulta.com continued its strong momentum in Q1, with solid increases in sales and traffic.

During the quarter, we continued to see good performance with our Wednesday limited time Beauty Break offers, which we’ve worked with our vendors to strategically place around certain launches, new items, and seasonality.

On the technology side, I mentioned that we have built and launched a rewards portal, and we are working on further system enhancements to ensure a highly stable platform, faster page loads, and improved site-monitoring analytics. Looking ahead, we are investing in people, customer service, and technology to build a strong web presence that supports the Ulta brand and delivers a consistent multichannel customer shopping experience.

With a great start to the year, we believe that 2012 will again deliver strong growth in sales and earnings for Ulta, as we continue to provide a unique offering and in-store experience that is fueling consistent market share gains. The five pillars of growth we’ve been executing on are still in the early stages.

With many years of anticipated store growth ahead, an excellent pipeline of new product and service launches adding new brands to the portfolio, a compelling improved loyalty program to roll out to the rest of the chain with a significant opportunity to improve the effectiveness of customer data mining, plenty of opportunities to drive customer awareness and acquisition in all of our markets, and a dotcom business still in its infancy, we believe all of these drivers will fuel our growth in 2012 and in the years to come.

We will also continue to be very disciplined in expense management and maintaining a healthy balance sheet, enabling self-funded growth and free cash flow generation.

With that, let me turn the call over to Gregg for a more in-depth review of the financials.

Gregg Bodnar

Thanks Chuck. Our first quarter results were driven by better than expected sales and margin performance. We delivered a 22.8% increase in total sales, with strength across all categories, reflecting continued market share gains.

Same-store sales increased 10.1% on top of an 11.1% comp in Q1 of last year. Consistent with previous quarters, the comp came primarily from traffic, up 8%, with a 2% increase in average ticket.

Gross profit dollars increased 27% to $171 million, with gross profit margin up 110 basis points, to 36%, driven by continuing improvement in merchandise margin and leverage in fixed store costs on a strong comp.

SG&A expenses increased 17% to $111 million, down 110 basis points as a rate of sales to 23.4%. This improvement was driven by leverage from strong comps and execution of our margin expansion strategies.

Preopening expense was up $1.3 million to $2.5 million as a result of our accelerated store opening program, with 18 new stores compared to 5 in Q1 2011 negatively impacting EPS in Q1 this year by about $0.01.

Operating margin improved by 200 basis points to 12.1% versus 10.1% last year, driven by our team’s relentless focus on disciplined execution and delivery of our margin expansion strategies.

Interest expense was immaterial, primarily representing fees associated with our credit facility, which remains unused.

Our tax rate was 39.3% versus 40.1% last year. The slightly lower tax rate was driven by a decrease in nondeductible stock option expense. Net income increased 49.7% to $34.9 million, or $0.54 per diluted share, versus $23.3 million, or $0.37 per diluted share in last year’s first quarter.

Now turning to the balance sheet and cash flow, merchandise inventories at the end of the quarter were $332.1 million, compared to $255.5 million at the end of the first quarter last year, up about 9.6% on a per store basis.

We continue to effectively manage our inventory, and we’re happy to maintain inventory growth slightly below our comp growth, particularly in light of the fact that we delivered a stronger than expected comp and successfully opened our new northeast distribution center.

The majority of the 9.6% per-store average inventory increase was to support the opening of our third DC. Excluding the investment to open a new facility, per-store average inventory increased approximately 4%, well below our comp growth of 10.1%.

The northeast DC team has executed an excellent launch and as the facility ramps up their operations, our incremental DC inventory investment will subside as we rebalance between the facilities in the back half of the year. All of this effort is part of our plan to integrate the new DC into our overall supply chain. As a result, we will continue to manage our per-store inventory growth at a rate well below our comp growth rate, as the new DC becomes fully integrated into our supply chain.

Chambersburg is already delivering excellent productivity and is on track to enable our expanded distribution network to achieve meaningful reductions in transportation costs. We expect to see these benefits from our network improvements in Q4, contributing to our overall margin expansion strategies.

Capital expenditures for the first quarter were $24.8 million, compared to $19.5 million in Q1 of 2011, driven by our accelerated store opening program. Depreciation and amortization was $21 million.

Now turning to our outlook for the second quarter, we currently estimate sales in the range of $466 million to $473 million, versus $395 million last year. We anticipate the comp store sales will increase in the range of 6-8% on top of the 11.3% comp in Q2 of 2011, for a two-year comp in the range of 17.3-19.3%.

New store openings are expected to be 22 versus 21 new stores in Q2 of last year. We expect our earnings per share will be in the range of $0.49-$0.51, including $0.02 negative impact from the planned addition of prestige brand boutiques and the expenses associated with the startup of our Chambersburg DC. This compares to EPS of $0.38 in Q2 of 2011.

Gross profit margin is expected to increase approximately 80 basis points, at the midpoint of the guidance range, driven by improvement in merchandise margin and leverage of store expenses, partially offset by the costs associated with our new DC and accelerated depreciation for the previously mentioned expansion of prestige brand boutiques.

SG&A is expected to decrease around 50 basis points as a rate of sales, at the midpoint of the range, versus last year’s 23.0% rate.

Preopening expenses are expected to be approximately $4.3 million, up $500,000 compared to last year’s second quarter. As a result, operating margin is expected to increase approximately 130 basis points, at the midpoint of the range.

We expect our tax rate to remain at approximately 39.5% and we anticipate the fully diluted share count to be approximately $64.5 million.

Looking ahead to the full year of 2012, given the strength we saw in Q1, we expect to deliver strong results ahead of our long term financial goals. We expect to achieve comp store sales growth in the range of 7%-8%, about 200-300 basis points above the high end of our long term goal of 3-5%.

As a reminder, fiscal 2012 is a 53-week year for us. The extra week is included in the fourth quarter, and represents approximately $35 million in sales. We expect to deliver net income growth above the high end of our long term target of 25-30%, including the negative impact from our accelerated new store program, the new DC, and the addition of new prestige brand boutiques.

The full year impact of these factors is approximately $0.08-$0.09 per share of additional operating expense. Partially offsetting these impacts is the benefit of the 53rd week operating results, which is approximately $0.03 per share.

We are on track to open about 100 stores and to complete 21 remodels in our plan for this year. In terms of store openings by quarter, after pulling some stores forward into Q1, we currently expect to open 22 stores in Q2, 48 stores in Q3, and 12 stores in Q4. Preopening expenses will be about $4.3 million in Q2, $7.5 million in Q3, and $2 million in Q4.

Our real estate team has been very successful in pulling as many store weeks forward as possible, with the goal of getting stores opened earlier in the year and ramped up to benefit as much as possible from the Q4 holiday selling season.

Total preopening expense for fiscal 2012 is expected to be approximately $16 million, compared to approximately $10 million in fiscal 2011, representing an incremental $0.06 per share impact in 2012.

Capital expenditures in 2012 are expected to be approximately $180 million, which is about $51 million higher than our capital expenditure program in 2011. This increase is driven by the acceleration of our store expansion program, store remodels, and about $10 million incremental capital investment for the expansion of the prestige brand boutiques.

Depreciation and amortization will be approximately $90 million. As you know, we paid a special dividend of approximately $62 million in May. We have ample liquidity to continue to invest in the business. We expect to generate free cash flow again this year, and as always, we will evaluate the best use of any excess cash position.

Looking ahead to next year, we expect the investments we’re making in the business this year to allow us to build upon our current success, continue to gain market share, and be a leader in the beauty retail space. We’ll benefit in 2013 from the acceleration of store openings this year, with about 100 new stores, which will contribute to total sales, comps, profitability and cash flows versus the 60 stores benefiting 2012. We’ll see our investment in the new DC pay off in 2013, after being a drag on earnings this year, and we’ll also see the benefits of additional prestige brand boutiques.

In summary, we’re investing appropriately to continue to drive performance in 2013. With that, I’ll turn the call back over to Chuck.

Chuck Rubin

Thanks Gregg. In closing, I’d like to thank all of our associates for making Ulta a compelling shopping environment for our guests. It’s a result of their hard work that we gained market share, delivered excellent financial performance, and further positioned Ulta as a true beauty destination.

With that, I’d like to turn the call over to the operator so we can open up for questions.

Question-and-Answer Session

Operator

[Operator instructions.] Our first question comes from the line of [Ike Borgia] with JP Morgan. Please go ahead.

[Ike Borgia] - JP Morgan

Chuck, I guess this one’s for you. When you look at the business, it’s been really very consistent with the comps in the double digit range for a little over two years now I think. I think last year you benefited a lot because you were on trend with the nail products and nail services, which were hot. Is there anything new out there today that you’re seeing that’s really trendy, and are you going after that? Just trying to see what’s driving that comp right now.

Chuck Rubin

As I mentioned, some of the things in the first quarter, anti-aging products, BB creams, mascara, lips were all big trends. We think that that continues, and we’re excited about the back half of the year. There’s a lot of new product launches in the third quarter that are still coming, and into the fourth quarter.

So it’s a combination of the new products from existing brands that we’ve talked about, some of the new services that we’ve put in. Our salon business comps have continued to improve. They’re running very well. And then it’s the new brand introductions. So all of those things continue to be very good.

One thing I mentioned in my prepared comments that I should call out, these at-home tools like Clarisonic, the hair removal, the acne treatment that I talked about that’s coming, it’s a small part of our business, but they’re high ticket and we’re selling a good number of units, and it’s having a nice impact to our overall sales dollars. So that’s also a trend that we started to see emerging stronger in the first quarter.

[Ike Borgia] - JP Morgan

On the store rollout, you mentioned you’re taking it from 1,000 to 1,200 domestically. You said that does not include international markets. On a high level, Chuck, could you talk about what potential down the road several years from now opportunities there could be in international markets? Does your format really work in other countries? And then I guess to that note, on the store base, when we look out to 2013 should we be thinking about 100 stores as kind of the run rate? Or is 20-22% growth kind of the run rate for the business going forward?

Chuck Rubin

Let me answer the second one first. What we said is that our business model is built on a 3-5 comp, 15-20% square footage growth. So we’re pleased with how 2013 is setting up right now, but it’s still early for that. So we’ll update you as the year progresses. But our long term guidance is that 15-20% growth. This year, being 2012, we are growing at 22%, so obviously higher.

If we can find the sites that are very attractive, and I stressed in my comments that we’re looking for quality, not quantity - if we can find those sites we have the balance sheet to be able to do it. We have the capability to do it. And most importantly, there’s the customer demand to do it. So we will pursue it as we see appropriate. And we’re encouraged by what we’re seeing, but it’s still early for 2013. So just remember our 15-20% long term guidance.

As far as the international, yeah, I think there is an opportunity for Ulta’s model overseas, but I would stress that when you look at the three big buckets of opportunity, those being U.S. stores, the second being U.S. digital, and the third being international, clearly that third bucket of international is the lowest of the three, and it’s the longest term.

So we have significant growth opportunities for a number of years ahead of us to get to that 1,200 store count. There’s the potential for a smaller store format. And clearly while our digital business is growing quickly, it is on a small base, so that U.S. business, digital and physical, is really what our focus is for the near to mid-term timeframe.

Operator

Our next question is from the line of Daniel Hofkin with William Blair & Company. Please go ahead.

Daniel Hofkin – William Blair & Company

If I look at the new store economics model that you guys have provided periodically, and clearly the cost side of it in recent years has certainly improved, as has the total sales volume, if you will. I guess one question would be, just based on the mass and if you look at the percentage of stores that are in different age groups, it would seem like you would likely be exceeding your plan right now kind of across various [age] buckets, that you would be exceeding that model. Is that fair to say? And the reason I say that is if you just sort of use the numbers in the model in terms of year one or year two comp sales growth, you’re left with very high comps in year four or year five and beyond. And I’m just curious what your thoughts are on that.

Gregg Bodnar

The way to think about that is stores that are five years and older are performing meaningfully above what you would expect kind of over the long term, or the normal, if you will. Those stores in our model, six, seven, eight years out, we expect to produce more like low single digits.

The fact of the matter is all of the strategies that Chuck referred to that have been driving our business, have a meaningful impact on mature stores. And you could argue have one of the largest impacts on mature stores because a big part of that is reaching out to our loyal customer base where the largest quantity is in a mature store, five years or older.

So back to the macro on the store model, yes, the costs have come down. We’re still building them for $900,000. The productivity of sales per square foot is getting slightly better. As we improve company operating margins, not all of it, but a significant part of that, contributes to the single store returns, because a big part of that affects the four-wall contribution of a store. So the store model keeps getting better.

Daniel Hofkin – William Blair & Company

And then one follow up would be if you can share anything about your expectations at this point for the incremental Lancome boutiques in terms of looking out a year. Do you expect that to show up materially in the aggregate at comp sales number now that you’d be at a larger number of stores [unintelligible]?

Chuck Rubin

We added the 29 doors last fall with Lancome, so we’re very pleased to be adding these 50. We’ve commented before that we’re pleased with our performance with the iconic brands. These 50 will get up starting in the third quarter. We expect to have them all done as the heat of the holiday season is upon us. I think the impact for this year is minor. It’s negligible. I think that as you look out into future years, we believe that it is a nice addition to our offering. We’ll be in 79 doors once these 50 are open. We’ll see what happens from there, but we’re very pleased, as is Lancome, with the level of sales and the type of guest that we’re introducing to Lancome that’s good for both us as well as the brand.

Operator

Our next question is from the line of Jill Caruthers with Johnson Rice. Please go ahead.

Jill Caruthers – Johnson Rice

Following up on the last question, the incremental $10 million of capex you’re devoting to expansion of boutiques and whatnot, can you talk about is that just supporting Lancome, or is it supporting existing prestige, or potential upcoming new prestige brands?

Chuck Rubin

It’s a little bit of all. So obviously opening the 50 boutiques for Lancome is costing us capital and some opex to get those open. But as I said in my comments, in a select number of additional doors, we are making some investments into the prestige arena, which will accommodate our ability to expand future boutiques. So that all is included in the $10 million that Gregg called out.

Jill Caruthers – Johnson Rice

And then just a follow on on the increased long term store potential domestically. The incremental 200 stores that you found through further evaluation, is it focused on particular regions, or just basically broad-based?

Chuck Rubin

It’s broad-based in the contiguous U.S., the 48 states.

Operator

Our next question is from the line of Joseph Altobello with Oppenheimer. Please go ahead.

Joseph Altobello - Oppenheimer

First, in terms of the new counters for Lancome, what brand or brands are they going to be displacing? And then secondly, what are the price points of these products relative to department stores?

Chuck Rubin

The price points relative to department stores are the same. This isn’t so much a price-based business. This is an experience- and service-based business. So the retail prices, everyone prices it as they see fit, but typically our prices are consistent to what you would find at a department store. But our service model, we believe, is, for our guest, a better one.

As far as displacement, I think we’ve talked before that our store, the average store size is about 10,000 square feet, and it’s a pretty flexible store format. So we can move things around. So we go through an ongoing review of product and brand performance, and there are always things being added and things being removed.

So I wouldn’t call out specific brands that are going out, but I would say that the addition of Lancome into these 50 doors is a bit of the same process that we go through on an ongoing basis of refining the productivity and continuing to add new brands and new products and eliminating things that aren’t performing.

It’s that process maybe a little bit on steroids, but it’s an ongoing effort that we’ll follow to get the space for these 50 boutiques.

Joseph Altobello - Oppenheimer

And in terms of the new DC in Chambersburg, you guys have mentioned that it’s supposed to weigh a little bit on gross margin this year, and I would imagine be somewhat beneficial next year. Could you quantify maybe how much that’s going to reduce gross margin this year, and maybe how much it will help 2013?

Gregg Bodnar

We said for the full year it will have a slight negative impact, so about 10 basis points. And then for next year, I would expect that negative 10 basis points could be 20-30 basis points positive, depending on how fast we can get it ramped up headed into next year. Typically, a DC in its first 12 months is where it gets its biggest productivity gains, but that’s kind of where it’s maturing cycle is. So it takes 12-plus months to get to the productivity on an existing DC. Certainly we’ve put some equipment in this distribution center just to kind of better the operations versus our current distribution center. So overall, I’d expect its productivity to meet and surpass the other DCs.

Joseph Altobello - Oppenheimer

So by next year you’ll be back to reducing inventory on a per-door basis I would imagine.

Gregg Bodnar

Not inventory, Joe. This is operating costs. So this is driving margin improvement.

Joseph Altobello - Oppenheimer

Right, but I would imagine this would also help on the inventory side as well.

Gregg Bodnar

Not necessarily. You do wind up with a little bit of benefit, because you have a distribution center that’s closer to stores. It reduces a little bit on lead time, but it’s not material.

Chuck Rubin

Just to add to that, Joe, right now if you look at the overall numbers that we put out, our inventory increased on a per-store basis by about 9% versus our 10% comp, so they were relatively close. If that’s what you’re talking about reducing, I think you’ll see the gap between inventory per-store growth and comp to be larger. If you take that 9%, though, and remove the northeast DC impact, the per-store inventory was up about 4%. So I think that’s where Gregg’s going, that if you extract that northeast DC part, that’s how you should really consider that. Inventory per store will move in line with sales comps.

Gregg Bodnar

So walk that forward Joe. In my prepared remarks, I said that when you pull out the northeast DC, the end of the first quarter inventory, the effect of that, for seeding it, to start shipping stores, we were up 4% on a 10% comp. As we work that DC into our network and rebalance inventories across the three DCs, adding stores into that Chambersburg facility, taking them out of other DCs, we’ll continue to rebalance that inventory across the chain. But it still does take some incremental inventory as we add stores in our supply chain.

When you go to next year, our philosophy will remain consistent. We need to make sure that we’re providing a superior experience for guests, appropriate in-stocks, presentations, etc. So I expect that our inventory on a per-store basis will continue to be below our comp growth, but I don’t expect it to decline. You certainly will get a little bit of an abnormal comparison in the first quarter next year, because you’ll be cycling against the 9.6[%] for the new DC this year.

Operator

Our next question is from the line of Jason Gere with RBC Capital Markets. Please go ahead.

Jason Gere - RBC Capital Markets

I guess the first question, thinking about the trends, the comp sales, over the quarter, when you look at February, March, April, I know we’ve heard some retailers saying that hey, some of the strong trends we saw in February and March kind of reversed a little bit in April. So I guess I was wondering if you could provide the cadence of maybe the quarter, and then maybe how March kind of shaped up. And then I have a follow up question.

Chuck Rubin

For a lot of reasons, we don’t report comps on a monthly basis. So we don’t get into the cadence during the course of the quarter. We’ve never done that. We move the marketing calendar around from time to time, so there can be impacts that are driven by, as we optimize the marketing of that and the market calendar. So we don’t get into intra-quarter comp flow.

Jason Gere - RBC Capital Markets

Could you just maybe qualitatively say, is there anything in the May period that would give you any reason to pause that there’s anything out there macro-wise. It doesn’t sound it, but I guess that’s just something obviously that everybody’s kind of fearing right now with the U.S. economy too.

Chuck Rubin

You mentioned May. May is in our second quarter. And that would be incorporated into the guidance that we gave. So I would remind everyone that, firstly, this is a pretty resilient business model. We have a lot of levers that we can pull. We have a broad range of prices, a broad range of product categories. We feel very good about the things that we can control.

Obviously we live in a broader economic environment, and we understand some of the things that are going on in the world in general. To the best of our ability, that’s all incorporated into our guidance that we gave in the second quarter. So we wouldn’t break it down into what we’re seeing thus far that’s reflected already in the guidance we gave.

Jason Gere - RBC Capital Markets

Fair enough. And then I guess just the other thing, Gregg, I’m not sure if you talked about the timing of the remodels, the 21 over this year. We didn’t see any in the first quarter. What’s the flow of that through the course of the year? If you said it, I apologize.

Gregg Bodnar

No, I didn’t. 10 in Q2 and 11 in Q3.

Operator

Our next question is from the line of Jacob Zitter with Robert W. Baird. Please go ahead.

Jacob Zitter - Robert W. Baird

I’m calling in for Erika Maschmeyer. First, could you just quickly break out the components of gross margin expansion in the quarter?

Gregg Bodnar

Sure. We were up 110 basis points and about 80 basis points of that was coming from , merchandise margin, and the rest coming from fixed store expenses.

Jacob Zitter - Robert W. Baird

And then just a follow up on the prestige initiative. These stores, are these the ones that have already been remodeled, but maybe not to the latest level seven format?

Chuck Rubin

There’s a cross-section of stores. I would tell you that out of our store base at the end of the first quarter, about 85% of those stores are either a level six or a level seven. We consider those our current format. That roughly 85% of the mix being in level six or seven compares to about 75 a year ago. So between the combination of new stores and the remodels that we’ve done, we’re making very good progress. Lancome and these other prestige investments that we’re making, they will not go into anything older than a level six store. So they’ll all be in a six or a seven. So essentially they’re going into our current format.

Jacob Zitter - Robert W. Baird

And then just lastly, it sounds like the salon business is picking up steam. Did the comps sequentially improve there? And do you think maybe services like the OPI nail gel is lifting other parts of the salon business?

Chuck Rubin

Yeah, I think a few things. The newness in the salon, the OPI nail gel, the introduction with Redkin of this Chromatics hair service, a lot of programs of training in some greater marketing that we’ve done in the salon - I think all of them have contributed to some of the improved performance. Clearly in general this is a tough business in the industry as a whole, when you look at other public companies as they release their results. We’re very pleased with our performance and it’s been an improving part of our business over the past few quarters.

Operator

Our next question comes from the line of Evren Kopelman with Wells Fargo. Please go ahead.

Evren Kopelman - Wells Fargo

I wanted to ask if you’re seeing any demographic changes, in your new additions maybe to your loyalty program age-wise or ethnicity-wise.

Chuck Rubin

No, we run a pretty broad demographic customer base. We go from teens to 60s. Obviously the sweet spot is in the 30s, but both quantitatively and qualitatively, you really do see a broad cross section of people. It’s not a typical spiky kind of bell curve. When you stand in our store and you watch, you typically see women shopping in groups. It’s either a mother and a daughter or two friends shopping. So pretty broad, widely distributed in terms of age.

Certainly the ethnicity represents the market that we do business in. Our average income customer tends to be upper income. Our average income is in the $70,000 range, a little bit above. And that really continues to be the case with the new customers as we open new stores, as well as expand our loyalty database.

Evren Kopelman - Wells Fargo

And then when we look at the store maturity, what it used to be historically, as your brand awareness continues to increase, are you seeing maybe a faster store maturity pace? And lastly, with the accelerating new store openings, how is the rent environment that you’re seeing?

Gregg Bodnar

On the store maturity, as the brand grows in awareness I think there’s much more opportunity in front of us. Even with 467 stores, with that 1,200 target for the U.S., there’s much more opportunity to drive comps all the way through the maturity curve by increasing brand awareness. So I think more of that opportunity is in front of us than we’re realizing today.

As far as rents go, it’s been pretty even. You know, we have a concept that the customer seeks and the developer community seeks. We have a strong balance sheet that ensures that the developer is actually going to see execution in the leases and get payment. So I think it provides a good balance for our deal-makers to negotiate in this environment.

Operator

Our final question comes from the line of Randy Konik with Jefferies. Please go ahead.

Amanda [Siglin] - Jefferies

Hi, this is Amanda [Siglin] on for Randy. Just a question around the new 1,200 store target. Your in depth analysis around that, just curious if it opened up new markets for stores, or if it’s more going to be you see that you can cluster stores more in certain markets.

Chuck Rubin

I think both. As the cost of getting these stores opened has improved, as we’ve continued to add more data to our loyalty file, as we’ve continued to learn more about refining the market size that we can operate a store in, all of those have demonstrated that there are markets that potentially a couple of years ago the company thought were too small to support an Ulta, but we believe now they can. Or we can congregate them into a market a bit tighter than had been thought of at one point.

So just giving you some sense of the depth of that analysis, a lot of work and thought has gone into it, and we’re very encouraged that the 1,200 number is out there. We’re also very confident that it can be realized over time.

Gregg Bodnar

And keep in mind, that’s also based on the data that we have and based on the actual performance in those examples that Chuck’s citing.

Amanda [Siglin] - Jefferies

And then just to follow up on the ecommerce business, trying to get a sense of kind of how longer-term that could fit in as well. I know it’s fairly small today. I guess are you doing any different to drive traffic to your website, and kind of in the next three to five years, how big do you think it could be overall as part of your business?

Chuck Rubin

Well, it can be a lot bigger. I would remind you of the following. One, it is growing very quickly, but it is a small base. I also would remind you that it serves two purposes. Our digital effort serves two purposes. One is clearly there is more ecommerce revenue to be done, and that number should be significantly higher than what we have today in terms of our revenue. But the second is to reinforce Ulta as a brand to our customer, and bring to life our brand to that customer and augment what we do in stores. So the buzz terms out there are multichannel or omnichannel.

The reality is in our business, which is a very emotional experiential category, digital complements what we do in our stores and what we can do through our ecommerce effort. What we need to do digitally is bring that experience to life for our customer, whether that’s shopping, actually enabling her to spend money, or whether it’s providing a community for her to talk to and learn from, whether it’s providing trend information. Provide that physically in our stores, but virtually through our digital efforts as well. And that’s the second purpose of our ecommerce effort, our Ulta.com effort.

So one is the revenue increase, which should be significant, and the second is to bring the Ulta brand to life to the customer where and how she wants to engage with us.

Operator

We have no further questions at this time.

Chuck Rubin

Okay. Well, let me thank everybody for your interest in Ulta and joining us on the call today, and we will look forward to speaking with you at the end of next quarter, in September. Thanks so much.

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