Ulta Beauty, Inc. (ULTA) Q4 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the Ulta Beauty Fourth Quarter 2016 Earnings Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Laurel Lefebvre. Please go ahead.

Thank you. Good afternoon, and thanks for joining us for Ulta Beauty's Fourth Quarter Conference Call. Hosting our call are Mary Dillon, Chief Executive Officer; and Scott Settersten, Chief Financial Officer. Also joining us is Dave Kimbell, Chief Merchandising and Marketing Officer. Before we begin, I'd like to remind you of the company's safe harbor language. The statements contained in this conference call, which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. [Operator Instructions] I'll now turn it over to Mary.

Thank you, Laurel. Good afternoon, everyone. The Ulta Beauty team delivered very strong fourth quarter results, capping an exceptional year of sales and earnings growth while investing to drive market share gains and create sustainable long-term shareholder value. Let me start with a quick review of the headlines for the fourth quarter. We grew the top line 24.6% and delivered 16.6% comps on top of 12.5% comps in the fourth quarter of 2015, driven by strong traffic and ticket growth. Multiple factors, strength across our product offerings, our best-in-class loyalty programs, great in-store execution, investments in marketing and labor and steadily improving supply chain capabilities, all worked together to drive stellar growth across both our retail and online business. E-commerce growth exceeded our plans, driven by strong traffic and outstanding fulfillment execution during the holiday. Our services continue to gain share as we grow our business with existing guests and acquired new ones, significantly outpacing industry growth. In concert with above planned sales growth, earnings per share growth of 32.5% also exceeded our expectations. Before I dive into a detailed review of the fourth quarter, I'd like to highlight some of our team's accomplishments for the full year. In fiscal 2016, we drove top line growth of 23.7% and earnings growth of 30.9%, well above our expectations at the beginning of the year, achieving robust market share gain, solid execution and strong flow through on better-than-expected sales. We achieved a 15.8% comp with 13.4% comps in stores and 52% -- 56.2% growth in e-commerce, with healthy traffic and ticket growth each quarter during the year. Underlying this financial performance were the many significant accomplishments we achieved as we executed against our 6 strategic imperatives. We opened 100 net new stores and continued to deliver very healthy new store productivity. We completed more than 500 prestige brand expansions across new and existing stores and also executed updates to Ulta Beauty Collection fragrance area and nail fixtures. We added 69 new brands to our portfolio, reflecting the fact that Ulta Beauty is a great place for our brand partners to grow. We grew active memberships in our loyalty program by 5.2 million members to 23.4 million active members, an increase of 28%. We increased our aided brand awareness to 86% as we continued to drive marketing effectiveness and efficiency. We launched our -- successfully launched our Ulta Beauty Credit Card program. We continue to improve our supply chain capabilities, successfully opening a new DC in Dallas and further ramping the Greenwood DC we opened in 2015. Finally, we also seamlessly implemented several new core merchandising systems, which will improve our capabilities across the merchandise, planning and forecasting as well as space planning and allocation, driving higher in-stock as we continue to grow. I am so proud of this team and the terrific year we delivered. I'd now like to go into a little bit more detail on some of the key drivers specific to our fourth quarter performance. Starting with our first strategic imperative, which is to acquire new guests and deepen loyalty of existing guests. We increased active membership in our Ultamate Rewards loyalty program by 1.7 million members during the quarter, driven by compelling marketing communication and excellent conversion in-store. We continued to see strength in retention rate, sales per member, frequency of purchase and average member ticket. Our loyalty program allows us to execute compelling CRM campaigns which drove incremental sales and margin. We also more than doubled our sampling campaign, delighting our guests with free gifts while driving additional sales. Our Ultamate Rewards credit card program exceeded expectations, driven by above-plan new account sign-ups and higher average sales per cardholder. We also experienced very strong gift card sales, contributing to our sales momentum after the holidays. This spring, we plan to launch Ulta Beauty gift cards in major grocery chains across the country, which will allow us to reach thousands of locations with the new point of presence for the brand. Our team successfully executed on 3 key events during the fourth quarter: holiday; our haircare jumbo size promotion; and our signature Love Your Skin event. For the holiday season, we launched new creative for our television and radio ad, centered on our JOY TO THE GIRL campaign, which was integrated across all touch points. We increased our TV, digital video and cinema ads and dramatically increased impressions with content partnerships with POPSUGAR, Refinery29, CafeMedia and E! News freeSTYLE. We also made a big impact on social media with our #JoyItForward integration, delighting influencers and Ultamate Rewards members with custom beauty boxes. Post-holiday, we refined our long-standing and very popular haircare event featuring Leaders or Jumbo-sized products to drive sales and margin improvements with a fresh approach that sharpened the appeal and impact of the event. We also adjusted the cadence of the marketing and added radio advertising. These and other modifications led to the most successful Leader event in our history with strong growth across our largest brands, both in-store and online. Our business were very strong in January as well, anchored by our successful Love Your Skin event which drove growth in both mass and prestige skincare. We've focused our communications and merchandising to help our guests truly understand the benefit and features of the brands and products within the skin care arena, which can sometimes be overwhelming to navigate in light of the complexity of the category. Demystifying skincare was a key theme throughout our marketing messaging as we highlighted regimens for various skin care types to help guests discover our best-selling products. On the merchandising front, we continue to see trends similar to the preceding quarters during the year, with prestige cosmetics leading the way but with strength across all major categories and newness contributing significantly to our performance. Urban Decay, IT Cosmetics, NYX, Redken, Too Faced, Tarte, Anastasia, Clinique, Lancôme, Benefit, Ardell, Real Techniques and the Ulta Beauty Collection were notable among the best-performing bands for the quarter, with all brands providing terrific newness to the holiday season. While cosmetics were the biggest comp driver in the quarter, we gained market share across all major categories. Skincare, both mass and prestige, accelerated in the quarter with strength in mass, continuing interest in the Korean beauty trend and the recent addition of 3 major new brands: proactiv, Shiseido and Origins, contributing strong growth as they ramp up in the assortment. The power of social media influencers are driving particular strength in prestige skincare brands like Mario Badescu and Peter Thomas Roth. Our own Ulta Beauty Collection performed very well in the quarter, benefiting from upgrades to in-store presentation, formulations and packaging, all rolled out earlier in the year and from new product additions and popular holiday kits. Looking ahead, we are excited to announce today a new partnership with the Estée Lauder company. We will be launching their MAC brand online in early May, and we'll begin roll out MAC to stores starting in June and continuing throughout the year. We plan to reach more than 100 stores in 2017, including the majority of new stores opening in the second half of the year. MAC is the #1 prestige makeup brand in the U.S. and one of the strongest brands in America. MAC has long been one of our guests most requested brands and its addition to our assortment helps us reach and better serve audiences that are important to us, including teens, millennials and diverse customers. To highlight the strong positioning as a makeup artistry brand, we plan to offer MAC makeup services at all stores in which we'll roll out the brand. The service component of the MAC offering is yet another example of how we're able to enhance and differentiate the shopping experience and drive traffic to our stores. Turning to the services business. Salon sales increased 15.2%, and comped 8.8% with strength in hair color and makeup services. Color services got a boost from the launch of Redken pH-Bonder, a color additive that better protects the integrity of the hair during color services. In skin, MicroZone services were a standout as the targeted promotion drove new guests acquisition. We continue to evolve our marketing strategy by utilizing our CRM and loyalty programs to simplify offers to attract new guests to the salon while still driving great value and a great experience. In addition to continuing their participation in New York Fashion Week, the Ulta Beauty artistic team recently styled the hair of the dancers performing for the Super Bowl halftime show with Lady Gaga, garnering significant exposure on social media and continuing to raise our profile as the hair authority. Our Benefit Brow boutiques continued their strong performance with brow services now available in about 850 stores. Benefit Brow Bars complemented their services business with product newness, including exciting product launches in the lip and the eyeshadow category. Now turning to store growth. Our growth and development team wrapped up a very busy year, opening 25 stores in the fourth quarter to end the year with 974 stores. New store productivity remains very strong. We have accrued all the real estate sites for our 2017 store program, including a handful of stores that are not in our typical suburban location and which will require more capital and higher rent. These include our new store at Michigan Avenue in Chicago opening this summer, our first store in Manhattan planned for the fall, and a store in the Mall of America in Minnesota. Moving to our e-commerce business. Ulta.com sales grew 63.4% on top of 44.2% growth last year, contributing 380 basis points to our total company comp. This revenue growth was driven almost entirely by increased transactions. While total traffic growth was up almost 63%, mobile traffic rose more than 90%, driven by growth in digital marketing pay channels, including search, affiliate, display and Facebook. Ulta.com's product mix continues to mirror that of our stores, with strong interest in newness and trials demonstrated by the ongoing success of our online-only beauty breaks and beauty bags that give our guests compelling sampling opportunities. Now this was the first year that our enhanced supply chain capabilities allowed us to confidently go through the holiday season without throttling demand on the site, enabling sales growth well above the plan. The profitability of our e-commerce business improved as a result of our more efficient fulfillment capabilities as well as a more effective promotional strategy. Finally, I'd like to update you on our supply chain operations and investments. Our supply chain team performed very well during the quarter, and the team did a great job keeping up with the higher-than-expected demand, both in stores and online to keep in-stock levels high throughout the quarter, in particular during the holiday selling. The Greenwood, Indiana distribution center ramped up to serve 230 stores to the holiday season and delivered 45,000 e-commerce orders per day during peak. Our newer Dallas building ramped to 130 stores and 25,000 e-commerce orders per day at peak. Shipping lead times continued to improve with 88% of orders shipping within 48 hours. So it was an 83% increase improvement compared to 2015 performance. We expect to ramp the Greenwood DC to serve close to 300 stores and the Dallas DC to serve a little over 200 stores by the end of 2017. We recently signed a lease for a West Coast distribution center in Fresno, California which is planned to open in the summer of 2018. This sixth DC will be a copy of the Dallas facility and is designed to substantially improve delivery times to the West Coast. From a systems perspective, our new forecasting replenishment system, SWIFT, performed as planned during the holiday period. As a result, we saw higher in-stock to increase productivity of our inventory in the fourth quarter. We also successfully implemented our new floor planning and assortment optimization tool, allowing for more analytical rigor around our assortment decisions. And finally, we continue to invest in foundational capabilities like our product information management system newly deployed to all of our suppliers. This capability streamlines to capture of more accurate product information directly from our brand partners. We're making good progress and we'll continue to leverage these investments to improve operational performance and the guest experience. This wraps up my review of the quarter. In sum, excellent fourth quarter results represented a strong finish to our best year yet. Our performance puts us in a unique position in the beauty industry and within the broader retail landscape to take advantage of the many opportunities before us to invest to drive the business for the long-term. And now, I'll turn it over to Scott, to discuss the drivers of our fourth quarter results and our outlook for the first quarter and all of 2017.

Thank you, Mary. Good afternoon, everyone. Starting with the income statement. Net sales for the quarter increased 24.6% to $1.58 billion, driven by 16.6% comparable sales and excellent new store productivity. The total company comp was composed of 10.9% transaction growth and 5.7% average ticket growth. The retail comp of 13% was driven by 8% traffic and 5% ticket. Ticket growth was driven primarily by average selling price. The units per transaction were also up, in line with the UPT performance for the year. The salon business comped 8.8% driven primarily by ticket growth but also included some encouraging signs of traffic growth. The retail and salon comp combined produced a total store comp of 12.8%. Operating margin increased 80 basis points, driven by strong SG&A leverage. Since components of the P&L are quite different this quarter compared to the rest of 2016, let me give you some color on the moving parts. Gross profit decreased by 10 basis points. But on a 2-year basis, gross profit increased 110 basis points. While we leverage fixed store cost on strong sales, product margins were down slightly for 2 primary reasons: First, and most importantly, we cycled over the elimination of a 20% off postcard promotion in Q4 of last year, resulting in similar year-over-year promotional levels versus the last several quarters when we were also able to opportunistically eliminate the similar 20% off postcard promotions. Second, channel and product mix put modest pressure on margin rates. While our e-commerce business continues to improve its overall profitability with more efficient fulfillment capabilities, Ulta.com's lower gross margin had a more significant impact on the total company margin rate during the quarter as our e-commerce channel represented a larger percentage of the business in Q4 at 10% of the mix versus 7% for the full year. On the product mix side, growth in prestige and mass cosmetics outpaced the higher-margin hair care category. And while many of the prestige brands we've added recently drive sales and margin dollars, they tend to dilute margin rate. Finally, we continued to see planned deleverage and distribution cost since supply chain investments are still weighing on gross profit as our new DCs and newly implemented systems continue to ramp up. Moving on to SG&A expense. We improved by 110 basis points, driven by leverage of advertising expense and corporate overhead on strong top line performance, offset slightly by investments in store labor related to prestige brand expansions and providing higher staffing levels in stores particularly during the holiday. In terms of the balance sheet, inventories increased 11.2% on a per store basis, well below the comp rate, driven by careful inventory management and better-than-expected sales. Capital expenditures were $93 million for the quarter, driven by our new store opening program, systems and fixtures for prestige brand expansions. CapEx for the full year was $374 million as some of the capital projects planned for the year slipped into 2017. We ended the quarter with $415 million in cash and short-term investments. In terms of share buybacks, we continue to repurchase shares in the open market as part of our 10b5-1 plan. During the fourth quarter, we repurchased approximately 190,000 shares of our stock at a cost of $47.3 million. For the full year, including the accelerated share repurchase program and activity under our 10b5-1 plan, we repurchased 1.6 million shares for $344 million at an average price of about $210 per share. Share repurchases contributed about 3 percentage points of EPS growth for the year. As of January 28, 2017, approximately $101 million remained available under the $425 million share repurchase program announced in March 2016. Turning now to guidance for fiscal 2017 and the first quarter. As Mary mentioned, we are in a unique situation among retailers with our current opportunity for growth and market share gains. From this position of strength, we plan fiscal 2017 to allow us to deliver on our long-range planned goal of delivering EPS growth in the low 20s percentage range while investing in new brands, store labor infrastructure and exciting new real estate opportunities while continuing to grow our brand awareness and invest more aggressively in digital. I'd like to share with you a few data points and assumptions that influenced our 2017 plan. First, sales for both the fourth quarter and the full year 2016 came in much stronger than we expected. So we are starting from a much larger base than we anticipated. We also delivered much more margin expansion in 2016 than expected, about 60 basis points versus our initial expectations of flat margins due to significant sales upside to our plan, which we are not counting on repeating to the same degree in 2017. Second, we plan to rollout more Clinique and Lancôme expansions than in our original plan as well as other brands across the portfolio, including launching MAC. This will put additional pressure on the P&L in terms of product margin rates and the startup cost of building out these brands. But these brand additions are expected to deliver incremental sales and margin dollars. Third, we will need to continue to invest in our supply chain and systems to be competitive from an omni-channel perspective. For example, we still need to play catch up with some basic omni capabilities like Buy Online and Pick Up In Store. And finally, as Mary described, we will open a handful of non-prototypical stores, like Manhattan, with much higher rent than average this next year. This is a prudent approach to testing some different types of real estate, but it will nonetheless pressure the P&L. All that said, our 2017 guidance is still in keeping with our long-range plan announced at our Analyst Day in October. Our plan allows us to invest in the business to improve the guest experience, drive market share gains and deliver healthy growth and sustainable long-term shareholder value. We plan to open approximately 100 stores to all 10,000 square-foot boxes. For your models, we expect to open 15 stores in Q1, 25 in Q2, 40 in Q3 and 20 stores in Q4. In terms of the mix of market sizes, roughly 60% will open in large and medium-size markets and 40% in small and single-store markets, mostly in power centers and community centers, with about 10 in malls, including the Mall of America. And 5 or so in urban street locations like Manhattan, Michigan Avenue in Chicago and Santa Monica, California. About 20% will be located in new Ulta Beauty markets, and 80% will be still in existing markets. Roughly 40% are planned in new shopping center developments versus 60% in existing centers. We plan to complete about 13 major remodels during the year. We expect of grow our e-commerce business approximately 40%. Total company comps are expected to be in the 8% to 10% range. We anticipate earnings per share growth in the low 20s percentage range, including the impact of the 53rd week and assuming approximately $300 million in share buybacks. Operating margin is expected to increase modestly in 2017 in the 20 to 30 basis point range, with margin expansion building in 2018 and 2019 to reach our goal of 15% by the end of 2019. I've highlighted some of the major margin headwinds but we also have many margin expansion opportunities ahead, including continued benefits from our CRM and loyalty program, supply chain efficiencies, procurement savings and new store productivity needs. As you model out the quarters, keep in mind the impact of the 53rd week in Q4. It's included in our low 20s EPS guidance. And while it's too early to forecast exact numbers, we anticipate that the extra week equates roughly to $100 million in sales or $14 million in pretax earnings, or approximately 2% of annual earnings growth. Turning to CapEx. In light of the additional opportunities we've evaluated, we expect capital spend to be higher than our previous guidance, in the range of $460 million, which is in line with 2016 CapEx as a percentage of sales. Compared to our initial plan, we expect to spend more capital for stores in the non-prototypical locations like Manhattan, and we are planning for a higher fixture CapEx with the continued rollout of prestige brands as our access to great brands accelerates. About $80 million has been allocated for prestige brand updates with about 700 expansions of Clinique, Lancôme, Benefit and now, MAC. Further significant investments include the Fresno distribution center and a series of customer-facing technology investments necessary to remain competitive. On the share repurchase front, our Board of Directors recently approved a new share repurchase authorization for $425 million to replace the prior authorization which will be canceled. Our guidance for 2017 assumes about $300 million in share repurchase, and our new authorization allows us flexibility to do more opportunistically. Our tax rate is expected to be in line with 2016. But keep in mind, the new accounting rules effective in 2017 will change how companies record the tax effects of employee stock option exercises. The tax benefit moves from the balance sheet to the P&L, resulting in a potential for increased quarter-to-quarter volatility in our EPS results. We don't expect the full year tax rate to be materially impacted. As a point of reference, if we had adopted this accounting update in 2016, our effective tax rate would have been about 1 point-or-so lower. Now moving on to specific guidance for the first quarter. We anticipate sales to be in the range of $1.244 billion to $1.265 billion versus $1.074 billion last year. We expect comparable sales to increase in the range of 9% to 11% versus 15.2% last year. E-commerce sales are expected to grow in the 40% range. We plan to open approximately 15 new stores in the first quarter versus 13 last year. So pre-opening is expected to be modestly higher. Earnings per share are expected to be in the range of $1.75 to $1.80 versus $1.45 last year, with modest leverage on both the gross profit and SG&A lines and with overall operating margin expected to increase slightly. The tax rate is expected to be 37%, and our fully diluted share count is estimated at 62.5 million. Now I'll turn it over to our conference call host to moderate the Q&A session.

[Operator Instructions] Our first question comes from Omar Saad with Evercore.

I know it's just the beginning of the year. I want to just kind of have you talk about how you think about the long-term comp guidance you gave at the Investor Day in the fall and the initial kind of comp guidance for the year and how we should think about the fact that you're expecting the 2017 comp rate to be in that 8% to 10% range versus the 7% to 9% longer-term guidance you gave. And what kind of what gives you confidence that this year will kind of be above that longer-term trend that you expect.

Great. Thank you, Omar. We try to be prudent, I guess, and really reasonable with the guidance that we give on every dimension. We see, obviously, the core of their brand. We've guided the 9% to 11% for the quarter. We feel confident about the strength of what's happening in the business, our ability to understand the dynamics and the levers that we have to continue to drive the results in a healthy long-term way. So I would just say that, really, there's no change to the long-term guidance. We always said that it would be stronger in the beginning and start to moderate a bit out in the outyears, so the 7% to 9% is the longer term. And as we guided 8% to 10% for this year, we feel it's just very much in our sight, line of sight, and feel very confident about being able to deliver that.

Our next question comes from Steph Wissink with Piper Jaffray.

Mary, could you talk a little bit about the brand boutiques? Just give us a sense of the current number across the 4 or 5 brands. And then of course, with the addition of MAC in that rollout how should we think about the staging and phasing of the rollout of those brand boutiques? And if you can just remind us what the productivity is of those prestige boutiques on a relative basis to your overall store average?

Yes, I'll talk about these in sort of just overall terms. First of all, let me reiterate, we're thrilled about the launch of MAC. We're thrilled about the progress we're making across the box in terms of brands and newness and innovation. There's hundreds of boutiques with brand expansions that will happen this year. We talked about that in the script. We're not going to break that out in specific detail or the productivity. What I would say, again, we've referenced this. So in the upfront, there's some investment in terms of getting a brand up and going, and these fixtures are a little bit more expensive but they drive incremental sales and profit. And also in the long-term, excellent for our brand in terms of really reinforcing ULTA Beauty as a great destination for All Things Beauty. So we feel very good about that current status.

Our next question comes from Kelly Halsor with Buckingham Research Group.

My first -- or my question is really around the margin expectations, and I appreciate, Scott, the color you gave. So if you can just dig in a little bit more on the puts and takes as you look at gross margin versus SG&A. Should we expect the same sort of dynamic to play out as we did in 4Q given that you have fully lapped the pulling of the coupons from last year? So not really expecting much product -- margin expansion from here? And then on the SG&A line, could you kind of quantify the dollar amount that you spent last year around the boutiques and how that plays out in '17? Is it going to be more? Or is it the same amount? Any color on that would be great.

Sure, thanks, Kelly. As far as the gross profit question is concerned, I'd say looking ahead, I think that's where your pivot point is. So as I look ahead to 2017, I'd say gross profit largely in line with what we saw in the fourth quarter. So to your point, we have -- we are now lapping what I would call, the low hanging fruit of the postcard elimination that we saw in the fourth quarter of '15 and then carrying through the first 3 quarters of 2016. I will, again, for investors, we opportunistically took advantage of that. There's still, we believe, plenty of opportunity to continue to tweak our promotional and discount tactics and strategies as we look out over the long term. And with benefits of that, we're still not counting on that being a major driver of our mid-teens operating margin target here over the next couple of years. Again, as a reminder, most of the benefits we see there will come from fixed store class leverage and capturing benefits from our supply chain investments. So still very confident in our long-range target there. As far as SG&A is concerned, we really don't get into the details of the boutiques, how much they cost and exactly the productivity, but rest assured, you see the results of that in our comp results, right? I mean, that's part and parcel of what we're doing, continuing to invest in the store environment which, again, is our most important investment. It's one of the reasons we're able to drive such healthy traffic gain to our stores, right, continue to invest in that to keep it fresh and exciting and fun for our guests. So we believe these are great investments for now and for long into the future.

Our next question comes from Jason Gere with KeyBanc Capital Markets.

Okay. I guess I got a question that I get from a lot of investors, and it's basically more of the male investors, so bear with me on this question. Can you just talk about the beauty enthusiasts? And I know that they're really the ones who are driving a lot of excitement on some of these new startup brands so -- as a means to drive sales. So can you talk about the sustainability of the beauty enthusiasts? So I guess the question I'm going to ask is really about the advertising that you're putting in-store, the support you get. But really, it feels like a lot of some of these brands that you're carrying are getting a lot of just word-of-mouth traction, YouTube support, et cetera. So can you maybe educate the male audience out there about beauty enthusiasts and your confidence that these enthusiasts can really continue to drive a lot of the excitement that's going on in some of your key categories?

We will be very enthusiastic to teach more about the beauty enthusiasm. But honestly, I'll ask David Kimbell to add. I just want to say that it's actually one of the core reasons and one of the core foundations as to why we feel very confident about our long-term prospects is our understanding of this segment, the size of this segment and the momentum. So I'll let Dave take it from there.

Yes, yes. We're -- we've spent a lot of time really trying to understand her behavior. And our beauty enthusiasts, I think, we shared at the Analyst Day, just some information about her. She makes up about 57% of total women in the marketplace that drives a disproportionate amount of the revenue in the category. So to your point, it's critical that we continue to find ways to connect with her. We're very optimistic about her long-term engagement in the category. In fact, every indicator we have is -- shows that she's just getting more engaged, and that's largely due to the relatively new tools that she has at her disposal through social media and YouTube and the ability to learn more, to share more, to be more engaged in makeup and hair trends and skin trends. So she is not demographically defined. We see that across all ages from teenagers, through millennials all the way up from an age, from an ethnicity standpoint. It's not demographically defined, but it is a mindset that keeps her positively engaged. And so many of the things that we've been doing over the last 2 years-or-so to pretty significantly change our marketing mix had been very purposeful in order to reach her in new and compelling ways. A lot of the tools we used in the past, we've found weren't as effective in meeting her today. So our advertising, even some of the broad scale advertising, like TV and radio, we think sets the stage, and then we're building much more communication through social media, our own applications on [ph] our own website to provide content and engagement tools, influencers in the marketplace that are driving much more change in how consumers behave. And then even tools like our GLAM LAB that we launched on our app, which is a way for her to engage in beauty, virtually engage in beauty in a way that she couldn't before. So we're focused on meeting her needs. We're, as I said, very optimistic about her continued engagement, and it's really center of everything that we're doing in building our business for the future.

Okay. I appreciate that. And then Scott, can you just -- did you say what the preopening expense was going to be for the year, just so we have that?

Yes. As a percentage of total sales, roughly flat with 2016.

Our next question comes from Dana Telsey with Telsey Advisory Group.

As you think about MAC, and it's so exciting that's coming in the stores, what could it contribute in sales? And how does the margin compare to the rest of the product categories? And then with online, the margin progression of online, where does it go and when does it balance out with stores? And just lastly, what kind of comps do you need to leverage expenses going forward?

Thank you, Dana. It's a 3-point question.

Exactly.

Yes, we share your enthusiasm about the launch of MAC, and we're not going to give specific value. We're just getting started, right? So we're starting online, and we're going to launch to a little over 100 stores this year. And it's a really important brand for us to have, and we're confident it's going to add to the mix very nicely and our guests will be very excited about it. Your second question was, remind me.

Online.

Online, you mean the margin, right? So I will say that we're very focused on improving the profitability of our online business. As we've talked about today. And the big part of our supply chain investment is around fulfilling the online orders in a way that's better for our guests in terms of speed and also more efficient in terms of cost. But we expect to see it to improve, but we expect that, that -- the four wall margins are always going to be higher than the online margin. On the flip side, so the margin is getting stronger, but the great thing is it's a very incremental business to us, right? So we study this closely. We look at it very closely at consumer and our guest trends. And the guests who are shopping online only, this is a small number of people, it's really about guests who are shopping in-store and online, and that guest is involved across both channels is really driving 2.5x more sales, really, than somebody who's just buying in store. So even if that margin is, I think, in some ways, inherently going to be somewhat lower than the bricks and mortar, it's a very incremental business to us, feeds very much into the dynamic that Dave was just describing about how the beauty enthusiast shops.

Our next question comes from Simeon Gutman with Morgan Stanley.

Back to the question -- well, let me phrase it this way. Thinking about 200 basis points of margin expansion over the next few years, is the cost component of these continued rollouts of new brands, is that factored in? And I guess as part of it, would you say it's fair that new brands rolling into your top line, benefit your top line as well. But maybe you haven't built the full ramp of a brand like a MAC into that longer-term outlook?

Yes, we certainly are doing the best job we can thinking about the cost of roll out of brands, and I say that's inherently assumed. We feel confident about the ability, we're maintaining the goal of reaching that '15 margin target by the end of 2019 and -- but being really, I think, very smart and prudent about how we get there, balancing short and long-term. And Scott talked about it well in his prepared notes, we adapt to the opportunity to invest long term in this business, and we're definitely going to do that because we know we've got -- we need to have the right brands, the right in-store experience and the capabilities to support that. So whether or not that top line could be stronger with some of these brand launches, I don't know. We try to be really as prudent as we can with our guidance. But we like to see how it goes before we call it higher than we think we need to. So...

And I would just add to that. Assuming things, again we're giving guidance here early in the year, there's a long way to go in 2017, but even if we only achieve to what we're guiding to today, by the end of 2017, we'll be halfway to our goal, right, of close to 15% by the end of 2019. So there's still plenty of room left for us in a long time. And again, we always weight these decisions carefully, right, versus dollars, and we think today that these investments and these choices are the best for our investors for the long-term.

Our next question comes from Oliver Chen with Cowen & Company.

This is Courtney Willson, in for Oliver tonight. We just had a question regarding expansion into urban locations. You mentioned more capital, higher rents. Will you be merchandising these stores much differently on the product side in terms of the balance of mass versus prestige? And do you have any plans to adjust your service offerings at all to cater towards the urban customer versus your traditional suburban customer?

Yes, Courtney. It's Dave, I'll take that. Overall, no. We're -- we think our model works in all types of locations, urban, suburban. So we're merchandising these locations pretty consistently with how we're doing in all of our stores. There may be some fine tuning changes that we'll make, and we're certainly looking at making sure that these stores are efficient and effective. But we don't see a big mix. I mean, a big part of what ULTA stands for is All Things Beauty, All in One Place, having the proper category and mix, being able to have mass and prestige and hair care. And so we're going to make sure that it's reflected in that location. As far services, we think that's a big part of our mix, too so we anticipate very strong service businesses in those high-traffic locations, and we're preparing for that, but we're not radically changing the store design and the amount of space allocated towards that.

Our next question comes from Ike Boruchow with Wells Fargo.

I guess, Mary, this might be for you. Just looking at the loyalty membership growth, the growth rate, I think, has accelerated the last couple of years. I think now it's like 29% at the end of this year. Can you just talk to some of the things that you've done the last 18 or 24 months that's helped you accelerate that growth? And then kind of what's baked into your plan for this year in terms of new membership adds? And I'm just kind of curious if there's a way to talk about how loyalty is maybe even benefiting the comp. And if that does start to normalize, how should we think about more sustainable comp growth rate? Just tying comp and loyalty together would be great.

Yes. So let me take some of that. Maybe I'll start. Dave, if you want to add. I will say, this is a bit of the secret sauce so I'm not going to get very specific about a lot of it because we're really proud about the loyalty program is working. And as you know, the loyalty members are driving the majority of our sales. So obviously, that's part and parcel to comp growth. I mean, that's the kind of the way to think about it. Comp is driven by a lot of components, but the sales are coming from our loyalty members. We've done a few things. One, is obviously, we just converted a couple of years ago to one loyalty program. We've simplified it. Our fleets make it very -- I think our communication about how the program works, how we communicate with that guest and how we convert new members, potential members in store, are all kind of components of what we've done that's making it work well. And I'll ask Dave to add some more color, but I will just say that also, what's exciting to me is we're not going to drive that rate of growth with new members forever, right, because we're kind of early in the program. But yes, we still really only have 20% of the beauty enthusiasts as we define them shopping at Ulta in the U.S. There's plenty more loyalty prospective members out there. And also even the folks that are on the program, we certainly don't have 100% of their share of beauty spend, and they're not even buying every category that we offer today. So we see these as all levers to continue to pull at the top line -- at the top level to help drive -- to continue to support the kind of comp growth that we're guiding. And maybe, Dave, just add a couple more points about what we've done with the program.

Yes, absolutely. As Mary said, the combination and the simplification into one program a couple of years ago really has allowed us to accelerate our growth in that space by a few things. The marketing has, by adding one program, has allowed us to just be sharper and clearer about marketing that on a national scale, which we couldn't do before. So we've been able to leverage that in all of our vehicles, reaching all of our guests. We have significantly increased our in-store execution, our store associates are -- better understand the program, they participate in the program, and they've done a great job educating our prospective members and converting prospective members into that program. And then we really made sure that just the value is there. It is fundamental to our overall business, and we want to make sure that we're continuing to meet her needs. There's 3 core things that we deliver to her. She finds value first in the points program, and we've got a number of levels and elements to that, but she finds that valuable, the ease of accumulating points and the simplicity of redeeming those points. She gets -- the second piece is she gets a lot of content from us. And this beauty enthusiast that I've described is open and interested in the content that we give her, whether it's our mag or e-mail or other activity that we have reaching out. And then we try to delight her throughout the year with special perks, birthday -- birthday gifts, anniversary gifts, sample programs. So those things keep her engaged, and the execution we've had through marketing and in-store and our merchandising partners have allowed us to drive that growth, and we're going to keep focused on doing that in the future.

Our next question comes from Rupesh Parikh with Oppenheimer.

So I also wanted to ask about your urban locations, and maybe even the Manhattan location. I just wanted to get a sense of whether you guys expect similar returns for the urban units? And then secondly, when you enter new markets such as, I guess, in this case, Manhattan, do you also typically see a meaningful lift on the e-commerce side of your business?

Yes, let me start with that one. So to Manhattan specifically, and I guess the other urban sites that we're going forward with this year. By and large, we expect the same kind of financial results. I would say Manhattan is a special case. I mean, so back to Dave's earlier point about we're putting our standard prototype store in there, right? It's 10,000 square feet, and that's an expensive proposition anywhere on the island. We went to a place where we felt most comfortable, kind of a neighborhood feel there with a lot of traffic. I know we've got a new subway station, right? It's just right near our front door. So we're trying to make smart decisions as far as the location is concerned. That would be a case where we would take something less than our internal hurdle rate, which is way north of 20%, right? And most of our stores that we open each year performed way in excess of our internal hurdle rates. In the case of Manhattan, we're still expecting to recruit investment returns well above our cost of capital. I think that would be another measure that would be significantly lower than the 20%. So we feel very comfortable that this is a wise decision, and it's going to produce great returns for us.

And in the question about e-commerce business when we open a new store, we do see that not only driving growth in that store but driving our e-commerce business. We see it in all types of markets, small markets and we anticipate that to be the case in Manhattan. We do have a strong awareness, and we surround Manhattan, so it's not like we're unknown in that area. But obviously, this will be the first time we're serving them directly and we anticipate our e-commerce business to benefit from that as well.

Next question, Chris Horvers with JPMorgan.

I'd like to peel apart the $80 million increase in CapEx. It seems like the number of Clinique and Lancôme upgrades were -- are in line with what you previously planned at the Analyst Day. Or I'm guessing that they were given that happened in October. So is the $80 million, is that MAC counters in the store, as in are you buying some of the real estate in markets like New York and Chicago? So perhaps you could lay out the size of the buckets of the incremental CapEx year-over-year?

Yes. This one is one that I could understand. It could get a little murky for people who would just looking at the numbers at the top level. So I would say that short but easy way to think about the $80 million is, it's just incremental store fleet investment, all right? So when we gave the guidance earlier in the year about CapEx maybe being kind of flat-ish in '17 compared to '16, we didn't have line of sight clear on MAC at that point in time or how many stores it might go into and things like that. Since that guidance, we've increased the number of Lancôme and Clinique and Benefit boutiques versus our prior thought process, you layer in MAC on top of that, you layer in a bit of inflation in the new store, cost to open the new store, so most of it is primarily boutiques in those new stores, which is again is a great -- it's great news for investors because it's a lot more cost efficient for us to put this boutiques in new stores versus going back and remodeling stores, right, kind of disrupting guest activity, and it's a lot more expensive to do that. So it's kind of a combination of those things. But by and large, the $80 million is going into the store fleet, which again, our most productive asset and the reason why ULTA is a standout as far as driving traffic.

Yes. And there's no purchasing of MAC real estate or anything like that. You asked that question at the end. Just to be clear, this is just investment in our stores.

Understood. So as a follow up, the CapEx should also drive extra depreciation expense which was not in what you previously guided in terms of margin expansion and getting to the mid-teens. So following up on a prior question that tried to address this, what's the offset in the margin line that allows you to stick to your existing long-term algorithm? Are you embedding more sales? Is there margin benefits that you are seeing now that you previously didn't expect when you laid that out?

No. I mean, again, we're giving guidance, there's a range of outcomes, right, that you're looking at, a continuum. And so we feel comfortable that between having flexibility on the upside to do better with promotion tactics, I mentioned earlier, other benefits coming out of supply chain investments may be quicker than we had originally thought and just other stronger retail trends that drive a lot of leverage on fixed store cost. So combination of those things. And as we look at the range, we feel very comfortable that we can stick to our target.

Our next question comes from Joe Altobello with Raymond James.

Krystyna on for Joe. I was wondering if you can talk about the promotional environment and who you're taking market share from?

The promotional environment, what that we're -- who are we taking market from.

Yes, I guess the best way to think about it is that we compete across a lot of dimensions, right? So I mean, we compete with the, I'd like to say, 70,000 places in any given day that you can buy beauty because we offer all the product categories and price points. So department stores are certainly one source. But we also compete with mass, with drug, online retailers. So it's really kind of across the board. Promotional environment, I guess, for us, what I feel good about is that we -- the quarter that we have with consistent levels of promotion a year ago, I think is a really good way to think about the underlying health of our business and that we have -- we're always going to make sure that we're providing a great value to our guests. And so there's always going to be some levels of coupons or promotions in store. But certainly, our loyalty programs allow us to get that much more focused and targeted and we've been doing that over the last few years. So I feel like we've got good control about our levers. We've got levers that we use as we need them. And more importantly, we're really just in an environment where beauty is certainly it's a growing category. It's very active. There's a lot of players. Nobody is doing exactly what we do, so we really try to just play our offense, and that's why we're talking about we're continuing to invest in the long term of our business because obviously, the beauty enthusiasts is voting with their dollars. We are not complacent. We're not perfect, right? So we know we just have to stay on top of our game.

Our next question comes from Mark Astrachan with Stifel.

I wanted to ask about the percent of stores with at least one prestige boutique if you could comment -- if you cannot answer directly, just give some direction sort of how that's increasing over time. And commentary about more expansions for Clinique and Lancôme that you mentioned on the call, that relative to the 100 more boutiques that you announced at the October investor meeting. And just sort of broadly, given growth and seeming increasing focus on prestige brands relative to mass, any thoughts about how you see the sales split over time between mass and prestige within the stores?

Yes. So I'd start by saying we don't give, as we've said before, we don't give specific numbers on that. But I'd say increasingly, many of -- most of our stores, certainly more than half have at least one boutique in them. And as we continue to grow, I think if you look at the history of what we've talked about, we said at the beginning of last year that we started the year -- started 2016 with approximately 200 of each of Clinique and Lancôme and 700 of Benefit, and then we added about 500 boutiques last year. And this year, as we said, another 700. So increasingly, we'll be reaching pretty much the whole fleet with at least one over time, and we think that's important to continue to elevate the experience and invest in our stores, as Scott has said. As far as the mix between prestige and mass, we really focused on making sure the entire store is growing. Certainly, prestige has been leading. But our mass business across cosmetics for sure, but also skincare and bath has also been contributing in a very strong way to our overall business. And that's really important because that's ultimately what our guest comes to us for is that mix. So as much as we talk about and we spend a lot of time today talking about prestige boutique investments, we've been equally as focused on building all parts of our store. We're investing in our haircare business, adding a lot of new brands there, we're, as I said, building our mass side. So the balance overall is important. We don't see a real dramatic shift. It might gradually continue to grow within prestige but we are focused on keeping that balanced for the long-term.

Next question, Simeon Siegel with Nomura.

Scott, just maybe to follow up on a few of the others. Just I guess, could we -- what do you expect depreciation to be this year? And then any update to what you'd expect CapEx to look like beyond '17? And then maybe for Mary or Dave, I don't know if I missed it, but where is the private label penetration at this point? Do you see any big difference between stores and online? And I don't know if you think about it like this, but is there a ceiling level that you wouldn't want to surpass?

Yes. So as far as D&A and CapEx is concerned, I think D&A we said $215 million.

$250 million.

$250 million, sorry, 2-5-0, for 2017, is the estimate. In CapEx, Simeon, it's hard for me to sit here today and think about how we could do anymore, right, how could we take on any more with the capacity that we have. So we expect that CapEx, I've learned now never say never, but it's hard to imagine that the number could get larger than what we're looking at for 2017. It's a large undertaking, but again, a lot of that is going into the store fleets, and we think there's great payback there and great prospects for our investors over the long term. One other thing I would say about CapEx, so again, getting back to that $80 million number year-over-year. There's a lot of other things going on behind the scenes, I guess, right, besides, just the MAC and the Clinique and Lancôme boutiques. There's things like Estée Lauder, right, we introduced it last year. Going much larger with it this year across the fleet, 250 comp stores, up an additional 100 new stores. There's things like that. Remember, when we go to the stores and we do these boutique drop-ins, we're also taking the opportunity to refresh the store, right, on a pretty large scale. So we're going in with new nail features, fragrance fixtures, updating the ULTA Beauty collection where it makes sense. So there's a lot of activity going on in the store just to keep it fresh, right? When she comes back, it's like a new shopping experience, right? And we just want to continue to do that. So that's the CapEx explanation.

Great. And then the ULTA Beauty Collection. I think we break it out. It's -- between 3% and 4% of the business similar online to in-store, which is true for most of our business. But actually, I'm really proud about our little Ulta Beauty Collection, the growth rate. I mean, Dave talked about this. The mass side of our business is very important to our guests. And our private label brand, we've really, really doubled down in making that a stronger brand than we had, and I'm proud of it. So part of the investments in store had to do with making sure that we're using fixtures and showcasing that brand and to its best possible light. We've invested in -- yes, we've redone the packaging. We're really bringing newness to that line, much more rapidly, and it is doing very, very well. So I don't know if there's a. cap. Certainly, like it. It's a great margin, and our guests -- the response of our guests is wonderful. The constraint would be, we're not going to be too big at anything, right? I mean, we want this to be a mosaic of brands that our guests want and love. Having said that, we know it can be bigger. It will be bigger, and we have a fair amount of space dedicated. We can make that space even more productive over time, and we will. So -- but we're proud about what's happening in Ulta Beauty Collection.

The next question comes from Matt Fassler with Goldman Sachs.

This is Katie Parson for Matt tonight. Just taking a little bit on the SG&A cadence that you guys have had over the last year. Obviously, the growth per store was elevated, reflecting the investments that you've made. In the fourth quarter, that growth rate came back down pretty sharply. But as we think about how the investments that you're going to continue doing over the next year will flow through, should we expect that growth rate to reaccelerate once again? Or kind of given the base of investments that were made last year that, that growth rate would remain below prior year levels?

Yes, I guess, I would say, again, in the quarter, when we look at individual quarter, every quarter has its special set of challenges and opportunities, right? And really, over the last couple of years, there's been a lot of investments, right? So I think we saw last year in the fourth quarter, we deleveraged on the SG&A line, right? I think for the year, we were kind of flattish. But the fourth quarter included some consulting expense. We were thinking about our Analyst Day and refreshing the 5-year plan. We were -- the business was strong. So we pulled forward some of our supply chain expense to try to get a head start on things. We also had some people decisions that we made to try to get more footsteps on the ground to make sure we could ramp up some of these investments even quicker. So again, we're lapping that in 2016. And you saw fourth quarter this year, right? We saw the fruits of our labor, so to speak, in a lot of different ways. We got a lot of leverage this year because we got an early start on a lot of those things. So I think we mentioned, as we look at 2017 now, SG&A, slight leverage, I would say, for the full year. So there's still a number of things that we need to work on, people-wise and tool-wise and we're just thinking what -- being pragmatic and doing what we think is good for the business for the long term.

I would like to turn the floor back over back to Mary Dillon for closing comments.

Thank you. I just want to reiterate, we're really proud about the year that we had in 2016, and I'd really like to thank our 32,000 associates for delivering that year and all their efforts to continue to drive our success in 2017 and beyond. I appreciate your interest in Ulta Beauty and look forward to speaking with everyone soon. Take care.

This concludes today's teleconference. You may disconnect your lines at this time.