Greetings, and welcome to the Ulta Beauty Fiscal Third Quarter 2012 Earnings Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Laurel Lefebvre for Ulta Beauty. Thank you. You may now begin.

Thank you. Good afternoon, and thank you for joining us for Ulta's third quarter 2012 conference call. Hosting our call are Chuck Rubin, President and Chief Executive Officer; and Scott Settersten, Chief Financial Officer. Before we begin, I'd like to remind you of the company's safe harbor language. The statements contained in this conference call which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. We may make references during this call to the metric free cash flow, a non-GAAP financial measure defined as cash provided by operating activities minus purchase of property and equipment. With that, I'll turn the call over to Chuck.

Thanks, Laurel. Good afternoon, everyone. I'm pleased to announced very strong third quarter results. Ulta continues to drive significant market share gains across all of our categories as we delivered 22.4% top line growth. Same-store sales increased 8.4%, maintaining solid top line momentum, lapping a 9.6% comp in Q3 2011 and a 12.2% comp in 2010. We expanded gross margin and leveraged SG&A more than expected, driving operating margin up 140 basis points from 10.7% in Q3 of last year to 12.1% this year. Earnings grew 40% to $0.59 per share. These excellent results position us to deliver sales and earnings performance for the full year well above our initial expectations. At the beginning of the year, we expected to see same-store sales at or slightly above 5% and to achieve earnings per share growth of approximately 30%. We now expect to achieve about 8% comp growth and about 40% earnings growth for 2012, assuming we achieve the midpoint of our Q4 guidance. We delivered these numbers through our team's disciplined focus on the 5 components of our multiyear growth strategy: accelerating store growth; introducing new products, services and brands; enhancing our loyalty program; broadening our marketing reach; and increasing our digital focus, including ulta.com. Our consistent execution of these strategies continues to drive meaningful market share gains in the beauty industry across all of our major product categories. I'd like to recap a couple of our accomplishments in each of these 5 areas during the third quarter and touch on what's ahead for the fourth quarter. First, store growth. In Q3, we opened 49 new stores, representing about 10% of our store base, which is a record number of new store openings for us and a tremendous accomplishment in a single quarter. We ended Q3 with 537 stores in…

Thanks, Chuck. Good afternoon, everyone. Ulta's third quarter results were once again driven by strong top line growth, coupled with operating margin improvement. Total sales increased 22% to $506 million, with strength across all categories. Same-store sales increased 8.4%, on top of a 9.6% comp in Q3 of last year. Traffic was the major driver of the comp, representing more than 90%, with average ticket up slightly. Gross profit dollars increased 24% to $185 million, with gross profit margin up 60 basis points to 36.7%. Roughly half of the improvement was driven by better merchandise margins, with the remainder attributed to leverage and fixed cost on our strong comp. As planned, fixed store leverage was lower than what we achieved earlier in the year due to the large number of stores we opened in the last 2 quarters, 22 in Q2 and 49 in Q3 this year compared to 21 in Q2 and 28 in Q3 last year. The Northeast DC continues to perform well. We expect to see a slight benefit from our improved network during the fourth quarter and a more meaningful benefit to margins in 2013. SG&A expenses increased to 16.8% to $118 million, down 120 basis points as a rate of sales to 23.3%. We leveraged operating expenses on a strong comp and consistent cost disciplines. Preopening expense increased in line with our accelerated store opening program at $6.3 million compared to $4 million last year as we opened a record 49 new stores, remodeled 11 stores and relocated 1 store in the third quarter compared to 28 new stores, 1 relocation and no remodels during the third quarter of 2011. All in, operating margin improved by 140 basis points to 12.1% versus 10.7% in Q3 of last year as we continued to deliver strong operating…

Thanks, Scott. Before we start the Q&A session, I would like to thank our 15,000 associates for all they do to make Ulta a winning formula that is rapidly gaining market share in the beauty industry. Our team always works hard. But I'd like to recognize in particular all the efforts of our field teams and our corporate associates to prepare for and then to recover from the historic storm impacting the East Coast just 1 month ago. I thank them for all they did to take care of each other, to take care of our guests. I'm always very proud of this team, but never more so than when seeing their commitment and engagement to overcome this challenge. Now, let's turn the call back to the operator to open up for your questions. Operator?

[Operator Instructions] Our first question comes from Brian Tunick from JPMorgan.

I guess, Chuck, I know it's a late holiday this year and people might be a little behind the 8-ball given what they've said about some November comps out there. But just curious of your view of the overall promotional environment, either from what you're seeing on the department store side or on the drugstore side. And then the second question is, you talk about a 1,200 store target long term. You're obviously accelerating that here. But what's the thought between how much of that has to come from existing or reconfigured real estate versus when are we going to need to see new store development begin to ramp up?

Brian, let's take the second one first. I think that clearly for the 1,200 stores, there is going to be a need for new construction. Obviously with our announcement today, we feel really good about 2013, and most of those stores are existing real estate. Now the pipeline into 2014, believe it or not, we've already approved some sites for that year. It's a little early to look at it at that point, but there are some seeds of new development starting to show up. And we do have high hopes that the real estate market does start to show some new development as you move into the out-years. But clearly, to get to the 1,200, we will need some new development. But we do think that, that will start to materialize. In terms of your first question on the promotional environment, there does seem to be a wide range of activity in retail today, and it goes beyond the beauty market. Clearly, our performance this quarter continued to gain market share, so the customer continues to vote that they like what we do. We're well positioned in our strategy for the fourth quarter between the breadth of our offering, everything from mass to prestige, from cosmetics to skincare to hair care, across price points using our loyalty program, we are well positioned to add value to the customer and we are seeing that she is shopping for value. As Scott mentioned in our prepared comments, our Black Friday weekend and Cyber Monday were terrific. They were very big and -- but she was looking for value. But we have a very sound offering to be able to cater to that, using some of the things we talked about in the script.

Our next question comes from Matthew Fassler from Goldman Sachs.

I want to talk for a moment about gross margin. First of all, if you look at the fixed leverage that you've generated, it was on the lower end of what you've typically been doing with the pretty good comps. So how much of that was absorbing issues like Chambersburg and the prestige investment, and perhaps offsetting what would have been better natural leverage on occupancy given the comp that you put up?

Yes, Matt, the leverage that you're referring to, I agree it's a little bit unexpected. But the drivers of that were additional labor that we pushed through the supply chain and other additional costs that were related to these inventory investments that we made during the third quarter.

And to the extent that, that labor shows up in gross margin, would that happen kind of in the DCs?

Exactly, a little bit of deleverage in the DCs.

And again as Scott mentioned earlier, don't forget the number of stores that we've opened. We had a record number of stores in the third quarter, so that had a little bit of a drag on us as well on not being able to leverage as high in this fixed store expense.

Understood. And then Scott, just to clarify, the gross margin expansion you talked about for Q4, I want to make sure I didn't mishear, is that 30 basis points?

That's right. 30 basis points at the midpoint of the range.

So if you think about that relative to the trend in recent quarters, that would be a bit lower as well. So can you talk about -- I'm understanding that your guidance is [indiscernible] conservative, if you look at the components of the budget to take it to that level, how should we think about that?

Well, we're thinking about the hurdles that we're jumping over from last year. You have to remember that the comp last year was significantly higher with 11-plus percent for the quarter and a 12% plus during that very important 6-week holiday selling season. So as we look at it year-over-year, we see that merchandise margin relatively flattish and a little bit -- a pressure on the fixed store leverage because of the large number of new stores that we just put in place over the last 2 quarters.

And does the extra week help that at all? Or is that kind of a nonevent for...

It's really a nonevent.

Matt, I just -- I would add, keep in mind on the merchandise margin that in the last roughly 2 years, we have added close to a couple of hundred basis points on the merchandise margin. And what we've said is long term, there's opportunity both on SG&A as well as on the margin side of the equation. It won't always be equal. They'll vary between the 2 of them quarter-by-quarter. On the long term, we think that they do somewhat mirror themselves. They'll be about equal in their contribution or our overall operating margin.

Our next question comes from Joseph Altobello from Oppenheimer.

Just first quick housekeeping question. You mentioned Sandy. What was the impact on comps this quarter, and what are you expecting to be the impact on comps in the fourth quarter?

The impact that we envision in the fourth quarter is included in the guidance that we gave, at 5 to 7. It's tough to be very specific about that, Joe, because you clearly have the impact of when stores were closed. And we had close to 20% of the store base that was affected and closed from either 1 day or 2 to a number of days. But then you have the aftereffect. Once the store is back open, it still takes a little bit of a recovery time to get back in the business. And for those stores, we weren't the first thing that people affected by Sandy were going out to purchase. So to our best guess from what we've seen thus far, we think that this is going to impact the quarter up to 100 basis points, 50 to 75 up to 100 basis points.

This is for the fourth quarter?

Yes.

Okay, okay. And then just switching gears to the real estate opportunity. Obviously next year, you're looking to do another 20, I guess 3% square footage growth. What's driving that opportunity? I mean, is it just more real estate coming your way, more centers being built? And then secondly, how are you guys handling that internally? Because you added 100 or will add 100 doors or so this year and 125 next year, and the numbers are getting pretty big. So are you guys adding people? Or how are you adding capabilities to keep up with that opportunity?

Yes, we've added people. Obviously, you can't grow a retail chain without adding people to it. We've added obviously the people in the stores, but we have more construction people, we have more store set people, we do have more inventory people [indiscernible].

I mean, on the real estate side, Chuck, sorry.

Sorry?

On the real estate side, sorry about that.

On the real estate side, the team is a little bit larger, but not extensively. The real estate team can flex with some good flexibility because you do use other third parties to help find sites. There's a broker community that we leverage extensively. I've talked before that our real estate group is a very strong part of our company, our real estate and construction teams and store set teams. So we've got very, very strong capabilities on this. And clearly, as we've ramped up the store count, we've added additional people to help get that executed. But the core team, the core leadership team of our store set teams, construction, the real estate teams, the dealmakers, it's just a very strong core group of people. To your question, the first part of your question, I think we said in our comments that about 80% of the chain -- 80% of the stores rather for 2013 are existing real estate. So there are seeds of new development, but it's not a heavy influence into next year. And I've talked about this publicly a number of times, our team's very creative in going out to find opportunities for stores. We still have tremendous white space in the country for stores to go in. And the fact that we have become much larger and more successful, we are a very attractive tenant for landlords. So you put all of that together, and that's what has allowed us to find these opportunities. And clearly, as evidenced even by these results for the third quarter, these new stores are performing very well. And it is part of our DNA that we will not pursue quantity above quality. We just happen to be finding both right now.

Our next question comes from Neely Tamminga from Piper Jaffray.

So I have 1.5 questions, I think, here. So going back to the real estate composition of the markets, may -- I absolutely get kind of the new center development versus existing center? But can you give us a sense of when we look into that 2013 on the 125 stores, how many new markets will that represent or to existing markets to this year?

I don't know if we want to break into that just yet. There's a fair number of new markets, but depends on how you define the market as well, Neely. So I use this example quite often, you take San Francisco where we have, I don't know, 10, 12 stores. It's a market that can support significantly more than that. So as we put more stores in San Francisco and it's -- into the San Francisco general market, a new store is 10 miles away from an existing store, is that considered new, a new market or not? So it -- our point is that there's a lot of greenfield out there. There are some of the stores for next year that are going into single market -- single store or 2-store markets. But a lot of them are infilling into these bigger markets as a whole. So it's kind of a broadbrushed approach that we've got here.

Okay. And then your loyalty program, unless I missed it, did you actually -- say, do you fully convert to the new program on all markets? Are you still -- where are you in that process?

Yes, we still have half the chain on the new program and half the chain on the legacy program. We had converted -- we converted a number of stores earlier this year, and our goal is to get to the 1 program, the points-based program. We're pleased with how the transition's going. But there are changes to the program where we want to get through a full cycle of customer shopping pattern so we understand all the components to it. So we're still half and half.

Would that be more of like a spring revisit sort of situation at this point?

We'll see. We still have another, I don't know, close to 6 months I guess to go before we anniversary the conversions. So we're making good progress, and we're pleased with the new program. Honestly, we're pleased with the old program. It continues to fuel a lot of goodness for us. We will get to the 1 program, but we just haven't announced the timing exactly.

Great. And I just -- I actually have one more on fragrance. I think it's really interesting what you're saying about fragrance and the strength that you saw in Q3. And is that historically been a really pretty good predictor for holiday? And then maybe even carrying it further into Valentine's Day, if you think about kind of the key selling seasons for fragrance? I mean, when did fragrance really -- remind us, when did fragrance really start to get lit up a little bit from a category perspective?

Well fragrance is -- what happened in Q3 was there was a lot of newness. So we have a lot of new fragrances that have been introduced. We'll see how it goes for fourth quarter. It's -- we haven't really hit the main stride for the fragrance category yet. That does tend to peak very quickly as you get close to the holiday. But newness is important. And between that, and there's a lot of newness, there's a lot of core fragrances that we've had, and our GWPs continued to be wreathly [ph] well received in this fragrance area. So too soon to tell how the fourth quarter's going to shake out on that, but we think our plan is really well laid out.

Our next question comes from Daniel Hofkin from William Blair.

Just a couple of questions. I guess first, maybe you touched on this earlier, but can you say anything about sort of the flow of store openings in 2013? Obviously, I would expect it to be somewhat smoother compared to this year, but correct me if I'm wrong about that.

Obviously, when we get to March, Dan, we'll give you a better predictor of how the store rollout schedule is going to work for next year. I don't think you'd be too far off base if you use 2012 as kind of the proxy as far as store rollout for 2013 at this stage.

And just sort of can I gross it up proportionately, you're saying basically?

Yes, right. That would be your best bet at this point in time.

Okay. And then my next question is, with the -- I guess in the near term, the -- you're seeing more contribution from the SG&A leverage. You've had huge improvement the last several years in gross margin. If we look forward over the next 2, 3 years and still -- you guys are still thinking in terms of a mid-teens operating margin, how do you see the contribution splitting up between gross and SG&A?

Again, as we've progressed, look to the future, we're still working on achieving our mid-teen operating margin in the next few years, Dan. And again, it's going to be balanced between both gross profit and SG&A leverage. So again, it's going to move in tandem over the quarters. It's not necessarily going to be in perfect balance each quarter. There's going to be a little lumpiness along the way. But again all in, that's where we're headed on target.

Okay. So I mean, would it be just, all else equal, fair to say that you'd expect because the DC will be further in the ramp up next year and I guess the rate of store growth is similar in terms of percentage, you'd expect potentially more gross margin improvement year-over-year in 2013 than in 2012?

We're not ready to get into that quite yet today, Dan. We'll be prepared to give you a little bit more detail on that when we talk to you in March.

Our next question comes from Erika Maschmeyer from Robert W. Baird.

The ticket increase that you saw this quarter was slightly lower than it has been. Any factors to call out there?

I missed the beginning. The what increase?

Oh, I'm sorry. The increase in your ticket?

Yes. No, most of the increase has been driven off of traffic. Last quarter was a little more balanced between ticket and traffic. But we've said all along that long term, we think the traffic will be more the driver, and this quarter was generally in line I think with that mix. We're very pleased. We do think it's a much healthier and sustainable comp driver when most of that's coming out of traffic, not ticket.

I completely agree. That all makes sense. And then can you talk a little bit about your in-stock levels, maybe grade yourself there? Kind of how are you thinking about that? And what types of initiatives are you investing in to continue to improve in that area?

Well, Erika, our #1 goal is to provide our guests with the best in-store experience that we can. And obviously, part of that is maintaining high in-stock levels. As we came out of a spectacular fourth quarter last year with the high comps that we had, we found that we had some in-stock challenges as we worked our way post-holiday and into the January, February timeframe. We've also noted -- noticed over the years that some of our smaller vendors are having a -- having more of a challenge keeping up with our out of stocks as our store base continues to grow. So the investments that we're making are in core high-velocity SKUs with no obsolescence risk. We will remain highly disciplined and continue to prudently manage our inventory levels as we have in the past. Again, there might be a little upside to comps in the January, February timeframe. But this, in our view, is a long-term investment. It's going to help the business in the long term.

And just to add to that, Erika, if you go back and look at our per store inventories, they generally have been relatively consistent quarter-by-quarter. This -- the end of fourth quarter this past year, we dipped down. So the additional inventory that were -- that Scott talked about were -- this year, we're expecting our per store inventory at the end of fourth quarter to be up low double digit. It is kind of a one-timer just to get the per stores by quarter more comparable. And to Scott's point, this -- the additional inventory that we've bought and anticipate continuing to buy, it's not really specific to holiday. It's core. And hence, we're not overly worried about obsolescence of this stock.

Our next question comes from Evren Kopelman from Wells Fargo.

I wanted to ask as you're opening more and more -- as you have been opening more and more new stores each year, have you seen any changes to the store maturity model that you've shared with us in the past?

We're opening stronger than we have been before, so -- but there's still the maturity curve that we've talked about before, so...

And the new store class -- I would add, the new store class in 2012 is operating, delivering at above our expectations. And again, I think we may have mentioned this previously, yes, the older stores and the new store comps are built into our guidance. The older stores are turning a bit above those post 5-year comps that are part of our standard store model.

Oh, great. Okay. And then for next year, thinking about the preopening expenses with the higher number of new stores, is it fair if we just looked at about per store investment this year and extrapolate? Or will there be further savings as you're opening more stores, on the store investment?

I think I wouldn't anticipate a lot of additional savings per store. The market continues to evolve, and it's an interesting scenario. Compared to a couple of years ago, there were far fewer suppliers, contractors, et cetera. So the supply of resources has tightened up a bit. Therefore, some of the cost savings that we've gotten before, we're not going to lose. But I'm not sure that we'll see as much additional savings there. But -- so I think I would model it to be relatively consistent to this year.

Okay. And then lastly if can ask on the balance sheet, with a growing cash balance, any further thoughts on use of cash after all your clearly store opening plans? Given the upcoming tax rate changes, any thoughts on special dividends or stock buyback programs?

Evren, we discuss the cash balance and the best uses of cash with our board on a regular basis. As you know, we paid a special dividend back in May of this year. At this point in time, we've determined collectively that the best use of cash is in -- to continue to invest in our new store program. That's what generates the best returns on that balance.

Our next question comes from Jason Gere from RBC Capital Markets.

Just I guess kind of a quick question. What do you estimate is the blended beauty growth category rate in the U.S.? I mean, I know your mass, your prestige, your salon, but if you kind of had to aggregate that together, what type of category growth do you think you're seeing right now? That's kind of the first question.

What we're seeing or the industry is seeing?

Well, the industry, but I mean -- it'll lead into the second question. But I mean, yes, the -- what do you estimate the industry growth to be right now?

It's -- firstly, I'll give you an answer, but let me give you some disclaimer to it. It's a pretty broad industry from everything from prestige to mass to hair care to appliances, et cetera. With -- so I'll give you that as the backdrop. I think if you put all of that together, you're probably seeing low single-digit kinds of increases.

For including everything together? Okay, okay. Seems a little bit modest, but -- okay. But I guess the question is, as you ramp up the square footage and as you get some of these new stores into kind of year 2, year 3, I mean, thinking about the comp -- and I respect the conservatism that you have with your long-term 3 to 5. But when you look at the comp trends right now, what's to say that it is ever going to go back to that 3 to 5? I mean, the CRM program, similar to what it did for Sally Beauty was a strong contributor for their same-store sales. You've got some great new products in the stores. So I guess, can you just talk me out of that thinking?

Well, I think that when we talk about the 3 to 5, we're trying to highlight that this is a profit-generating, cash-generating business with 3 to 5 comps. That's the first point. Secondly, our growth has been and will continue to lead the market. We will continue to gain market share in the beauty industry. The growth that we've seen, as to be expected, I think as in this quarter and last quarter, we were lower than the previous quarters. To expect double-digit kinds of comps endlessly, it would be probably an unwise conclusion. So the 3 to 5 that we have in our long-term financial model is just that. It's a long-term financial model to ensure that we continue to generate the kind of strong shareholder returns that we have been. We work to exceed that, so obviously, we have been doing that quite consistently for the past couple of years, and we're going to continue to strive to do that as we go forward.

Okay. That's a good answer. And then I guess the other kind of longer-term question is just on the margin target. And can you just remind us how you benchmark? You say the mid-teens. But which are some of the specialty retailers out there that you guys look at? I know that I think it's been said in the past, maybe not by you, that you don't compare yourself to Sephora. But how do you kind of gauge what the real margin potential is in this business?

Well, that's a tough one to answer. No, first of all, Sephora only carries prestige fragrance, cosmetics and skincare. We're a much broader retailer. There are other large big-box operators out there that have terrific businesses and they're mature and generate terrific returns. Their business is different than ours. I think what we've said before is that getting into the mid-teens is what we're working towards now. If you go back a couple of years ago, we were in the single digits. And back then, I'm not sure that anybody would have believed that we have the potential of getting for the mid-teens. When we get there, our challenge will be to continue to grow that. So I wouldn't suggest that's the ceiling on us. I would suggest that's what we're striving for to get there in the next x period of time. But there -- and I wouldn't compare it to necessarily to other retailers that we directly compete with.

Okay, great, Chuck. And then just the last, I guess it's my 1/2 question. When you -- some of the, I guess, gift with purchases that you're doing this year, can you just remind us on who's funding some of that? So that the luxury robe, I actually saw that with the purchase on fragrance. Can you just put a little color on that? Is that funded by you, or is that -- how -- can you -- I guess I'm just a little bit curious like how much you kind of have to step into that promotion? Or is that kind of vendor funded for some degree?

No, Jason, we wouldn't get into that. We run a multidimensional merchandising and marketing program. And we work closely with our vendors to develop exclusive product, to provide input into the product that they're going to offer on a broad range. We work with them on promotions. I don't see any great value of getting into the details of any specific program. I will reinforce to your point that the robe has -- goes into effect this weekend officially. And we would invite everybody on the call to be sure to get to one of our stores or online and enjoy that as a gift with their fragrance purchase.

Is that velvet? Terry cloth?

It is not velvet. But for you, maybe we can arrange.

Our next question comes from Jill Caruthers from Johnson Rice.

A quick question, just on the Black Friday approach. You mentioned that Black Friday and Cyber Monday were -- they beat the highest record that you've posted. And any different approach that you did with doorbusters or type promotions that you'd want to call out year-over-year?

A couple of things. One is, the merchants did a great job of putting an offering together that was profitable, had a lot of exclusivity to it and was really well targeted to our guest. And then, the stores did a terrific job of servicing. So we also -- this year, we did open a lot of our stores earlier than we did the year before to go along with what was happening in the center with our other retailers that we co-habitate with. So when you put it all together, the offering, the marketing was quite effective and the experience in the store, it led to a really good Thanksgiving weekend.

Okay. And then, question on new -- the Lancôme and Clinique boutiques. I know it's very early. Just wondering, how are you informing the customer of those new boutiques that you've got in the store, given it's not storewide so you can't really -- I don't think you can run it in a print circular or what have you. Just kind of wondering how you're informing the customer at this point in time.

A number of ways, just to touch on a couple. Clearly, you can go out to our website and find it on on-store locator. We're using digital communications, and we are putting them into versioned additions of our print marketing, so -- and we've done other direct marketing that has been exclusive to Clinique around the stores that have carried it. So it has been pretty multidimensional in terms of how we're getting the word out.

Okay. And do you feel at this point that you're gaining some new customers from that? Or is it just too early?

We have -- we believe that we are and we believe that will continue, yes.

At this time, we have no further questions. I'd like to turn the call back over to our speakers for any closing comments.

Well, let me just thank everyone for your interest in Ulta and joining us today and wish everybody a happy holiday season, and we will look forward to speaking with you soon and hopefully seeing you in our stores or online even sooner. Thanks so much.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.