Ulta Beauty, Inc. (ULTA) Q3 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Ulta Beauty Third Quarter 2017 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, Vice President, Investor Relations. Please proceed.

Thank you. Good afternoon, and thank you for joining us for Ulta Beauty Third Quarter 2017 Conference Call. Hosting our call is 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. 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. Our third quarter results clearly demonstrate the strength and distinct advantages of the Ulta Beauty business model. We delivered a double-digit comp in spite of a moderation in the growth rate of our largest category, makeup, and meaningful disruption from hurricanes. We flexed our merchandising and marketing plans, leveraged our consumer insights and CRM platform and worked with our brand partners to create compelling offers for our guests. We also benefited from the unmatched breadth of beauty categories and products that we offer. These levers allowed us to drive significant share gains, continue to rapidly grow our base of loyalty members and thrive in spite of shifting category trends within the beauty industry and disruption in some of our largest markets. Before I share our results, including the financial impact of the hurricanes, I'd like to take a moment to mention the fantastic job our teams did to prepare for the storms, support our field associates who were personally impacted and get our stores back up and running following an incredibly challenging time for these regions. It was truly inspiring to see the collaboration and caring from all corners of our organization to manage through this period. To recap our third quarter financial performance. We grew the top line 18.6% and delivered healthy 10.3% comps on top of 16.7% comps in the third quarter of 2016, an acceleration on a 2-year stack compared to the second quarter. The disruption from the hurricanes in Florida and Texas negatively impacted our results by a little more than 1 point of comp. Comp sales were driven by balanced traffic and ticket growth and continued strength in e-commerce. In terms of category trends, our highest sales growth was in skincare and fragrance, while haircare also strengthened. Makeup, while still producing very healthy growth by any standard, was softer compared to last year when it drove a disproportionate amount of our comp growth. GAAP diluted earnings per share of $1.70 grew 21.4%. We delivered better-than-expected EPS growth despite gross margins contracting a bit more than initially planned. Some of this margin pressure was expected, driven by new store and boutique activity in the quarter and marketing and test-and-learn activities pushed back from the first quarter into the back half. In light of the hurricane disruption and the moderation in color cosmetics growth, we decided to boost our CRM and promotional activity. This allowed us to continue to drive strong market share gains and rapid membership growth in our Ultamate Rewards loyalty program. I'll turn now to a more detailed discussion of the strategies that drove our results in the third quarter, beginning with our strategic imperative to acquire new guests and deepen loyalty of existing guests. Our loyalty program continues to deliver significant benefits, and well over 90% of our sales are captured through the program. At the end of October, our Ultamate Rewards program grew to 26.4 million active members, up 21% year-over-year. Retention rates, sales per member, frequency of purchase and average member ticket are healthy and stable. To update you on our efforts to increase adoption of our credit card which we launched last year, we've rolled out in-store initiatives to drive awareness and are offering new incentives like free gift with sign-up in addition to savings on guest's first purchase with the card. We also launched the capability to apply online and buy which drove significantly higher online applications. Credit card sign-ups continue to grow with new accounts and conversion above plan, and we're continuing to garner a much higher share of wallet of our customers who signed up for the credit card. We're also very pleased with the growth in third-party distribution of gift cards through our Blackhawk relationship. We rolled out our gift cards to 10 additional retail partners in the third quarter, bringing our reach to 13,000 stores. We plan to add another 500 stores with 3 additional grocery chains in the fourth quarter, with more retail partners in the pipeline. Aided by this expansion, gift card sales grew nearly 50% in the third quarter with expectations for a strong fourth quarter performance. Now turning to our marketing programs. We executed another successful 21 Days Of Beauty event in September. Historically, this has been a promotion focused on color cosmetics with the strategic intent of migrating customers from our primarily mass basket to a richer basket, blending mass and prestige items. This year, we incorporated skincare items to take advantage of the current strong trends in skincare. We improved our overall offering, featuring highly sought-after brands and products like MAC lipsticks, and increased influencer content across Ulta Beauty channels, digital partner platforms and influencers' own channels, which all drove excitement for the event. In October, we had strong results with our signature Gorgeous Hair event and focused on our partnership with the Breast Cancer Research Foundation. We built on the success of our Gorgeous Way to Give campaign, performing 42,000 services during our salon Cut for a Cause event, partnered once again with The Ellen DeGeneres Show, garnered more than 5 million views of our new social media campaign featuring breast cancer survivors with an empowering and inspiring message and executed a series of activities all month long in stores, distribution centers and in corporate. We raised $4 million this year alone to fund research projects to support BCRF's quest for a cure. We continue to partner with Refinery29 in the iHeart Music Festival to drive brand awareness, and we launched a new partnership with Allure Magazine to enhance our position as a beauty destination. This partnership included an Allure Magazine curated mini book called Shop Like a Beauty Editor. This book features the favorite picks of Allure beauty editors available at Ulta Beauty. The program also highlighted digital content from Allure editors in their e-mails and the mix section on ulta.com. We also became the exclusive and presenting sponsor of Demi Lovato's Simply Complicated, which is a full-length documentary on YouTube that gives an intimate look into the life of the popular star. The video has already been viewed more than 10 million times. The partnership includes 3 get-the-look videos featuring products sold at Ulta Beauty. These efforts are part of our multiyear strategy to increase awareness of the Ulta Beauty brand, which has led to all-time high results for this metric. Aided brand awareness now stands at 87%, up from 84% last year, while unaided brand awareness grew to 50% compared to 41% last year. Next, I'd like to provide an update on our merchandising initiatives. The Ulta Beauty team did a fantastic job maximizing our brand partnerships, ensuring that must-have and often-exclusive product is on our shelves. We continue to drive rapid market share gains across the board with particular strength in prestige beauty. According to third quarter data tracked by the NPD group, Ulta Beauty continued to rapidly grow our share of prestige makeup, accelerated our gains in prestige skincare and fragrance and added 320 basis points of market share in prestige beauty overall. Year-to-date, Ulta Beauty grew the prestige segment by 28% while all other retail tracked by NPD only grew in the low single digits, netting to a total prestige beauty industry growth rate of 5%. Our broad and balanced portfolio of product categories and brands continues to be a lever in our ability to deliver healthy comps. Skincare in both mass and prestige, fragrance, professional haircare, sun care, accessories and personal care appliances all delivered well above average growth. Similar to what we discussed last quarter, the industry overall seems to be experiencing a bit of a lull in innovation in color cosmetics, although not across all brands. Our prestige boutiques featuring Clinique, Lancôme, MAC and Benefit brands were very strong as we continue to roll out 700 boutiques this year. These 4 high-growth brands contributed almost 1/3 of our total comp growth during the quarter. We are delighted with our new partnership with MAC. At the end of the quarter, we had 107 stores rolled out, and we'll have approximately 120 boutiques by year-end. We also rolled out 5 of MAC's hero SKUs in our impulse fixtures across the chain. Our assortment features several exclusive instant artistry kits available only at Ulta Beauty. MAC has quickly become the #1 brand at 80% of the stores where it's launched, and is a close second in the rest. Our consumer insights team has surveyed our MAC guests with their findings demonstrating that we're helping to recruit a new consumer to the brand, with roughly 50% of the MAC buyers at Ulta either new to MAC or lapsed MAC users who haven't purchased the brand in over a year. Beyond the prestige boutiques, we've seen the rest of our prestige color cosmetics category slowing compared to last year's exceptional pace of growth, but prestige makeup is still very healthy and comping in the high single digits. Many of our brands like Tarte and Too Faced are delivering strong innovation and double-digit comps. Encouragingly, color cosmetics, both mass and prestige were very strong during Black Friday weekend, which we believe bodes well for this category during the holiday season. We're also excited about developments on the mass side of the assortment in makeup, with e.l.f. rolling out chain-wide next year and cult favorite, Morphe, a social media influencer brand focused on eyeshadow palettes and brushes, added to 300 doors in ulta.com. Another brand born on social media is Dose of Colors, which was available online-only for the past several months. Following its success in ulta.com, we recently introduced 2 popular palettes to 400 stores and will be adding 21 lip and eyeshadow Dose of Colors SKUs in time for holiday. So fragrance was another highlight during the quarter comping in the high teens, with success in the base business and several strong new launches, including Chanel Gabrielle, Gucci Bloom and Carolina Herrera Good Girl. We continue to launch exclusive fragrances like Ballet Rose from Philosophy and an exclusive line of 4 fragrances from Kate Spade. Both prestige and mass skincare comped well above the house, with newness from No7, Yes To, Skinfood and MEMEBOX driving strength in mass skincare; and Mario Badescu, Dermalogica, Peter Thomas Roth and Juice Beauty driving exceptional growth on the prestige side of skincare. Our professional haircare category was bolstered by the rollout of Bumble and bumble in more than 500 stores, new brands like Aquage, the chain-wide rollout of Drybar and newness driving double -- strong double-digit comps in DevaCurl, Kenra, Matrix and Pureology. So as you can see, there's a lot going on in our assortment as we have access to more and more brands that continue to elevate our product offering. Now looking ahead to next year, we're excited about the new brand pipeline with additions in every major category, including makeup, skincare and haircare as well as a significant reflow in our mass cosmetics area planned for the beginning of 2018 to make room for brand additions and expansions. Our positioning of All Things Beauty, All in One Place gives us multiple levers to drive growth and quickly adapt to trends and changing industry dynamics. Let me turn now to our services business. Salon sales grew 10.8% and comped 3.8% in the third quarter. While a moderation from our rapid growth earlier in the year, these increases show that we continue to gain share and far exceed growth rates for the services industry. We saw some regional variation in our growth rates with slower growth in Florida and Texas, 2 of our biggest markets for services, reflecting disruption from the hurricane. The team managed labor and operating costs well and increased the profit rate of the services business while investing in growth initiatives. We're in the early stages of testing our improved salon business model in 2 markets, and we're encouraged by the early indicators. Initial surveys of our guests revealed significantly higher engagement and satisfaction with this new approach. As a reminder, the new guest-centric model features a simplified menu for hair and skin services, a more transparent pricing model to clearly and consistently communicate pricing to our guests and increase training for stylists. We believe this innovative approach is the foundation for long-term growth and share gains. Earlier this year, we launched our Pro Team, a group of salon stylists from Redken, Matrix, L'ANZA and Wella who are in charge of elevating the profile of the salon at Ulta Beauty, building trend collection and leading education programs for our 7,000 stylists. The Pro team is already making a big impact and getting a lot of attention in the salon world with extensive coverage in industry publications like Modern Salon and Behind The Chair. This publicity is positioning us as a trendsetter and helping us to track the best talent to our salon team. Now to update you on our new store program. We opened 48 stores in the third quarter, ending the quarter with 1,058 stores. We were able to open almost all of our 100 net new stores in our 2017 program before Black Friday weekend to take advantage of holiday traffic and sales. New stores continued to open up very strong, with the class of 2017 stores exceeding its budget and IRR hurdles. Earlier this month, we opened our first Manhattan store in a great neighborhood location in 86th and Third. This store is off to an excellent start in its first few weeks. Similar to the Michigan Avenue store in Chicago, we're seeing great results in the salon after hiring a seasoned team of salon professionals. At the Manhattan store, it offers extended hours to accommodate early morning blowouts in the salon before work or school. We're pleased to report that our newly opened high-profile stores in Chicago, the Mall of America and Manhattan are all performing very well. Looking ahead to 2018, the majority of our 2018 real estate program has been approved, and we're on track to open up another 100 stores next year. Now turning to our e-commerce business. Ulta.com sales grew 62.9%, representing nearly 9% of total company revenue and continuing the rapid growth we've seen from the past several quarters as we enhanced our assortment, site experience and delivery capabilities. E-commerce sales were driven by transaction growth. Total traffic growth was up 57% and mobile traffic grew 92%, driven by investments in digital marketing. We relaunched our mobile site during the quarter, improving the guest experience with the redesign of the shopping cart and checkout experiences. We also improved the credit card application experience, implementing the ability to apply and buy in one transaction, which has more than doubled the number of credit card account sign-ups online. We also gave the Ulta Beauty app a mini makeover, adding features like the ability to buy and e-mail gift cards from your phone; easier use of features like checking Ultamate Rewards account and point balance; an improved version of our try on app, GLAM LAB, a feature to enable push notifications to get alerts about the latest promotions and exclusive product launches, and the capability for guests to use voice search to find products. Mobile app traffic increased more than 300% during the quarter. We continue to build our ulta.com assortment with the addition of more online-only brands like Lime Crime, one of the first digitally native beauty brands, offering edgy makeup and hair color; Little Barn Apothecary bath products; the Pérsona Identity Palette created by YouTube influencer, Simply Sona, and exclusive to Ulta Beauty; and Milani makeup and primers. Online-only brands accounted for a significant portion of our e-commerce growth during the quarter. Ulta.com also delivered excellent results with our signature promotions like 21 Days Of Beauty, the Gorgeous Hair event, as well as online-only promotions including platinum perks, beauty sample bags with purchase and limited-time beauty breaks. We launched Shoppable Instagram in August, and we're seeing growing interest and engagement in this platform. Now turning to the development of our omni-channel capabilities. Last quarter, we've mentioned our store-to-door test in 40 stores which enable guests to place ulta.com orders in-store and have the products delivered to their homes. We rolled out this capability chain-wide at the end of the third quarter. And while this initiative is still fairly small in terms of demand, it's proving quite useful in satisfying guests looking for hot brands that are not available in every store, such as MAC or Morphe. The number of omni-channel shoppers continues to steadily increase. Guests purchasing both in-store and online now represent 9.1% of our loyalty members compared to 7.5% a year ago. And she's spending 2.7x more than a retail-only guest when she shops in both channels, including doubling her spend in our stores. And finally to update you on our supply chain operations. We continue to develop capabilities and leverage economies of scale in our distribution network to deliver exceptional guest experiences while focusing on cost optimization. Our DC network is forecast to ship nearly 20% more units this year compared to 2016, with almost 10% of units supporting our e-commerce business. Our improved operational capabilities are supporting this growth while capturing significant savings. E-commerce costs per order are down 10% year-over-year with a 4.4% reduction in retail replenishment costs over the same period. From the speed-to-guest perspective, the supply chain team has achieved a 20% reduction in retail replenishment lead times, with most of our e-commerce orders processed within 24 hours of an order being placed. We also -- we've also continued to implement technologies to provide greater control and visibility, supporting ongoing efforts to improve service and reduce costs. Our DC network has continued to mature with the ramp of our new DC operating model in Greenwood and Dallas. These 2 facilities are expected to process nearly 85% of our e-commerce volume during the peak 2017 holiday season. As we prepare to go live with the Fresno DC next summer, we'll continue to see more e-com demand fulfilled out of our new DC operating model. And speaking of Fresno, construction of our new West Coast distribution center is nearly complete, and hiring of the management team is well underway, and we're on track to open next summer. The Fresno DC will add another 670,000 square feet of capacity that can service up to 400 stores and 45,000 e-commerce orders per day. Fresno will also provide a platform to implement new technologies to increase productivity and significantly reduce transit time for our West Coast customers. From an inventory perspective, we've been building our DC and store inventory levels to prepare for the significant volume spike that we anticipate during the holiday season. The team has done a great job maintaining high in-stock levels. And while they remain above goal, we've also focused on achieving our inventory turn goals. Inventory per door grew by 6.5%, well below our total sales comp of 10.3% in the third quarter, a solid achievement in light of the additional safety stock we built in support of our fourth quarter sales projections. I'm also really proud of the partnership among the supply chain teams, store operations and merchandising teams to ensure the seamless execution of our many new brand launches and category reflows. That completes my progress report on our strategic imperatives. Looking ahead to the rest of the year, we're looking forward to an exciting fourth quarter as our teams work together to inspire our 26 million loyal guests to treat themselves and their friends and families this holiday season. Our merchants have planned a great assortment with lots of newness and exclusives. Our marketing team is executing a compelling 360-degree plan around our Bring the Beauty theme, including new creative for television and radio. Our store teams are ensuring strong execution of the planograms and events, and we're investing in labor hours to give great guest service. And our supply chain and system teams are supporting the stores and ulta.com with improved inventory planning, leading to higher in-stock levels. We are ready. And with that, I'll turn it over to Scott to discuss in more detail our third quarter financial results and our outlook for the current quarter.

Thanks, Mary. Good afternoon, everyone. Starting with the income statement. Sales for the third quarter rose 18.6% to $1.34 billion, driven by 10.3% comparable sales growth and strong new store productivity. Adjusting for roughly $14 million in lost sales during to the hurricanes in Texas and Florida, total sales would have been above the high end of our guidance. The total company comp of 10.3% was composed of 6% transaction growth and 4.3% average ticket growth. E-commerce sales growth remained very healthy, contributing 370 basis points to the total comp. We estimate that the hurricanes in September impacted our overall comp rate by about 100 basis points, so the adjusted comparable sales growth of 11.3% was above the high end of our guidance range of 9% to 11%. Our retail comp was 6.8%, split evenly between traffic and average ticket growth. Ticket was driven primarily by an increase in average selling price, while growth in units per transaction was up slightly. The salon business comped 3.8%, driven primarily by ticket growth. The retail and salon comp combined were 6.6%. Gross profit rate decreased 110 basis points, primarily due to deleverage in merchandise margins. Rent and occupancy leveraged slightly despite more new stores opening versus last year and more high-rent locations in the portfolio year-over-year. Supply chain expense was flat as a rate of sales year-over-year as we balanced investments in our DC network and systems with cost efficiencies resulting from the maturation of our Dallas and Greenwood DCs. Product margins declined as expected, reflecting the dynamics we've discussed for the past several quarters relating to channel, category and brand mix headwinds. A higher mix of e-commerce sales and prestige brand boutique sales were the most significant drivers. Increased engagement on our loyalty program also pressured gross margins slightly. In addition, in light of the relative softness in our makeup category, exacerbated by the hurricanes coinciding with our signature event, 21 Days Of Beauty, we elected to drive market share gains through a variety of compelling offers. These actions yielded the desired outcome of significant share gains during the quarter but weighed on gross margin rate more than we anticipated going into the third quarter. We also delivered 90 basis points of SG&A improvement, a strong performance in light of additional expenses related to the hurricanes. The improvement was driven by corporate overhead leverage and excellent control of variable store costs, offset by investments in store labor related to our prestige boutique strategy and investments in store hours to execute brand rollouts and reflows as well as to strengthen guest service overall. Advertising expense was flat as a percentage of sales. As you may recall, in the first quarter, we benefited from shifting the timing of some of the planned advertising expenses into the third and fourth quarters. Turning to EPS. Earnings per share grew 21.4% to $1.70. A few puts and takes to cover here. We had a $0.04 benefit in the third quarter related to a lower tax rate compared to the third quarter of last year, in part due to the new accounting standard that changes how companies report the tax effects of employee stock option exercises and vesting of equity awards. Earnings per share were negatively impacted by about $0.08 from lost sales and one-time costs associated with the hurricanes in September. In terms of more permanent and strategic impacts, we continue to return excess cash to shareholders through our share repurchase program. Earnings per share in the third quarter benefited by about $0.03 due to the lower share count year-over-year. Moving on to the balance sheet. Inventories increased 6.5% on a per-store basis, well below the comp rate, a solid performance given the significant investments in new brands and boutiques, the ramping of the Dallas DC and inventory to support high in-stock levels for the robust comp growth anticipated this holiday season. Capital expenditures were $144 million for the quarter, driven by new stores, systems and fixtures for brand expansions. We ended the quarter with $107 million in cash and short-term investments. In terms of share buybacks, we continue to be more active with repurchase activity within our 10b5-1 plan in view of the pullback in our share price. During the third quarter, we repurchased approximately 591,000 shares of our stock at a cost of $131.7 million. As of October 28, 2017, approximately 136 million remain available under the 425 million share repurchase program announced in March 2017. Turning now to guidance for the fourth quarter and full year 2017. For the fourth quarter, we expect sales to be in the range of $1.926 billion to $1.959 billion versus $1.581 billion last year. We expect comparable sales to increase in the range of 8% to 10% versus 16.6% last year. E-commerce sales are expected to grow in the 40% range. We plan to open approximately 16 new stores in the fourth quarter compared to 25 last year. We're planning to open more stores in Q1 2018 compared to Q1 2017. And combining the timing impacts, Q4 preopen expense is expected to be flattish as a rate of sales. Diluted earnings per share are expected to be in the range of $2.73 to $2.78 versus $2.24 last year, with modest operating margin deleverage expected. We expect gross profit to be flattish as we are now forecasting less leverage on rent and occupancy costs on a more moderate retail comp expectation compared to earlier in the year. Our current forecast also includes prudent assumptions for merchandise margin in light of current category dynamics. We anticipate that SG&A expense will deleverage as we are planning higher labor costs driven by the full rollout of the prestige boutiques for the year that puts additional pressure on the payroll line in the short term as well as a slight deleverage of marketing expense related to the timing of advertising costs that were moved from Q1. These factors will be partly offset by leverage of corporate overhead expenses. The tax rate for Q4, excluding any impact of the new accounting standards for share-based payments, is expected to be 37.4%. And our fully diluted share count is estimated at 61.4 million. Rolling that up for the full year guidance. We expect to end the year with 1,074 stores, and we'll complete 11 major remodels and 7 relocations. We expect to grow our e-commerce business approximately 50% to 60%. We are maintaining our expectations for total company comps to be in the 10% to 11% range. FX is now expected to be approximately $450 million compared to our previous view of $460 million, which includes new stores, remodels, relocations, approximately 700 prestige brand expansions and investments in systems. We are maintaining our guidance for earnings per share growth to be in the high 20s percentage range. This includes the impact of the 53rd week which is estimated to represent about $100 million in sales and $14 million in pretax earnings. It also includes the impact of the third quarter hurricanes, assumes share buybacks in the 370 million range and assumes a full year tax rate of 35.6%. Operating margin is still expected to increase modestly for the year, albeit a bit less than initially planned, due to the actions we took in the third quarter to capture market share and the elements of the Q4 P&L I just described. Updating our initial view of the 20 to 30 basis points of operating margin improvement, we now anticipate margin rate to be in the range of flat to up about 10 basis points. We remain confident in our long-term range plan to deliver earnings per share growth in the low 20 percentage range and we continue to plan for margin rate improvement to build in 2018 and '19 to reach our goal of 15% by the end of 2019. This margin expansion is expected to come primarily from rent and occupancy leverage, benefits of our supply chain investments and more efficient distribution centers and systems and corporate overhead savings as we gain efficiencies and lap over significant investments in the last several years that have enabled us to execute our growth strategies and infrastructure initiatives. Now I'll turn it over to the conference call host to moderate the Q&A session.

[Operator Instructions] Our first question comes from Ike Boruchow of Wells Fargo.

Scott, I guess my question is for you on the gross margin line. I apologize if I missed this. But for the gross margin decline in Q3, can you parse out how much of that was fixed cost deleverage versus merchandise margin? And then I -- if you guided gross margin for Q4 flattish, could you also walk us through the puts and takes on merch margin versus fixed cost?

Sure, Ike. Well, I'm not going to parse out the basis points, but I'd give you a little bit more color on what we described in our prepared remarks. So as far as 3Q is concerned, again we are down 110 basis points actual for the quarter. After going-in assumption, it was kind of flattish, I would say, on the gross profit line. So again, part of it was expected and part of it was unexpected. So the expected part, I guess I would say prestige boutiques, those brands, put a little bit more pressure on gross profit. We've talked about that now for quite some time. Again, those brands performed extremely well during the quarter, were a bigger percentage of the pie overall, so created some downward pressure on rate. Similar story with e-commerce. Again, the going-in assumption was about a 50% growth rate, ended up in just over 60% year-over-year for the quarter. E-commerce, with some of the promotional activity that we do usually typically over indexes there, right, with the digital connectivity that we see there. Again, e-commerce creates a little headwind on the gross profit line. But on the EBIT line, we're almost agnostic on where that sale goes, whether it's through the retail fleet or through our e-commerce network. So very happy there overall with the results. As far as the unexpected piece was concerned, again, color cosmetics continue to be a little softer than we were thinking back in late August when we put our forecast together. And then, of course, we had the hurricanes, right, spring on us in a much more significant way than maybe you've seen with some other retailers. So a lot of stores impacted, a lot of them very high volume stores in key markets for us. At the peak of one of our signature events for the year, I think we had more than 1,000 store days impacted either full closures or partial closures. Again, tough to determine what the CNN effect on some of that stuff was, right? It was raining hard in a lot of parts across the U.S., not in just those 2 markets. So that, we reacted to during the quarter. We saw some softness in the sales trends and we reacted appropriately. Ulta, luckily, we've got a lot of levers we can pull. And so we immobilized the internal forces here, and we're able to recapture a lot of those sales, albeit at a somewhat lower margin rate. So fixed store cost, there was leverage there although not as much as we thought, right, kind of going into the quarter because the retail comps were a little bit softer. And of course, thinking back to last year on the very healthy retail comps that we generated, not consistent with the rates of leverage we saw last year. Supply chain did a little better overall. Again, we were thinking it'd be kind of flattish but they did a little better than we were expecting going in, so things are working well in the back of the house. Pivoting then, so 3Q and looking ahead at 4Q, gross profit, we're thinking kind of flattish for the quarter overall. Again, merchandise margins, we're thinking flattish to down modestly for the quarter. So again, not the same kind of circumstances apparent in the fourth quarter. So it's already a promotional period, right? So margin rates are already under pressure from just the nature of the overall environment there. We've got things we talked -- we referred to the credit card which gives us a lot of tailwinds with basket build and things like that. So we're doing a great job signing up people there. Gift card is another thing that we've got implemented with really healthy growth rates there year-over-year. Of course, those are post holiday kind of redemptions by and large, right, where the margin rate environment I'd say is a little bit healthier, right, and maybe preholiday. So we're optimistic that we can hold margin rates flattish in the fourth quarter. Fixed store cost leverage, we expect to get some in the fourth quarter, again, probably not as much as we saw last year on a healthier retail comp overall. Supply chain, we're going to get leverage there this year in the fourth quarter, which is quite a bit of different story than what we've seen the last few years in the fourth quarter when we've been ramping up these new distribution centers, right? So again, a great story. Those buildings are online. We're optimizing them, and they are driving efficiencies and leverage for us overall on the gross profit line.

Our next question comes from Omar Saad of Evercore ISI.

I was wondering if you could expand upon the category shifts you're seeing a little bit in the marketplace. It sounds like skincare continues to strengthen as the makeup color business softens. How should we think about that dynamic? Is -- and the skincare dynamic relative to makeup, is it an online purchase? Is it a replenishment? Do you see a lot of innovation coming down on that side of the business as well? Just help us think about that transition and what it might look like from our side.

Yes, well, first of all, I would say that one of the great things about the Ulta Beauty business model is that we participate -- the All Things Beauty, All in One Place line is real, so we participate across all the major beauty categories which gives us a lot of ability to drive growth and share gains and flex with category cycles. So I would say, first of all, we take a really macro kind of long-term view in the sense there's many categories within the big beauty category and there are cycles that happen. One thing I'll just say is that -- I'll come back to skincare in a minute, but guests are just as engaged as ever in makeup. And so if you just look at what's happening on YouTube or Instagram, or our own followers across channels, if you look at the trends that we see in demographics, the beauty enthusiasts segment of the future, millennials, Latinas, teens, all over index particularly in makeup. So we feel confident that the involvement and engagement in makeup, the somewhat softer current performance is fairly -- it's not a long-term trend. It's about innovation, lapping over some really big kinds of innovation platforms in the last couple of years. So makeup is great. We also saw not only strong growth but really strong share gains continue for us in makeup. So that's good. Now as you said, what's kind of cool is that we've seen some acceleration in some other categories. So in particular, fragrance and skincare both accelerated in terms of growth and our share gain, and we think that has a long-term life to it as well. Skincare has really been driven by a lot of innovation, and Dave can add more color to this. But some interesting innovation, what I'd call faster, funner ways to do skincare like masks or more interesting efficacious ingredients from Korea. And so that's interesting. And we think that's going to -- it has no reason to continue to not be strong across both prestige and mass. And we see a lot of innovation coming down the pike, I'd say across all categories for us as we look out into fourth quarter and 2018.

Our next question comes from Joe Altobello of Raymond James.

Want to talk about your store target of 1,400 to 1,700 doors over the next few years. And I know in the past, you've mentioned that some of that will be determined by how quickly your e-commerce business grows. And obviously, that's been outpacing, I think, both your and our expectations. So how should we think about that ultimate number given the rapid pace of e-commerce growth? Will we expect to be toward the low end of that range in, call it, 5 years or so?

Well, I would say, first of all, we love the fact that our e-commerce growth is picking up. And as Scott said I think very well, we're agnostic about it from a bottom-line profit perspective, but we're actually really positive about it as it relates to customer engagement. So the folks that are like 9% of our loyalty members that are omni-channel, multichannel right now, by far our best guests in terms of spending, almost 3x the amount of somebody who's only shopping in-store but she's also shopping even more in-store than before. So we talked about this a lot. It's not a shift, it's not a channel shift, it's actually an expansion of us getting more per share of wallet. So that's all great. Now of course, we're always thinking about our physical footprint and buildout, and that's something that we're very rigorous and disciplined about. We have no reason to change that target right now. There's a range for a reason because it's a range. I don't think there's any one point in time. But to me, the best thing is that, every year, our store fleet continues to perform better than the year before. So 2017 store fleet is ahead of budget and our IRR target, and we continue to see it strengthen. So I guess the best way to think about it is we actually know that when we build stores, the e-commerce business also grows with it so they actually are complementary, not stealing from each other. And so we have no reason to think that dynamic will change. And we, of course, are very disciplined about our real estate decisions. But we would keep that targeted range that it's in right now.

And I would just remind folks, again, Ulta is a little bit different than a lot of typical retailers that are struggling these days, right? I mean, these stores are built to generate significant SLE, 20% plus at low to mid-single-digit comp kind of numbers on the top line. So again, while we monitor store productivity very closely, there's nothing today that would suggest to us that there needs to be any kind of radical adjustment to our long-range targets at this point.

That's helpful. Just one last one, is there any lingering impacts from the hurricanes in the fourth quarter?

No. I mean, there -- it's a pretty sizable charge we had to absorb. So there's insurance claims being prepared, and we're working on trying to get as much of that back as we can in the fiscal year.

Our next question comes from Steph Wissink of Jefferies.

Mary, just a question on your comments around the pipeline into 2018, innovation, newness and then some of your initiatives around recasting your mass makeup business. Could you just talk a little bit more about some of that enthusiasm?

Yes. Actually, you know what, I'll let Dave take this since he's the closest to it. Dave?

Yes. No, we were -- yes, we're excited about it. I mean, we're, of course, always looking to continue to innovate in every category that we have. And makeup is no exception, particularly given the importance in some of the things that we've seen this year. So on both sides of the house, in prestige and in mass, we've got quite a wide variety of newness coming in. And I'd classify that in kind of 3 ways that does apply to both mass and prestige. One is continued innovation from some of our biggest brands, brands that have been successful this year, like Tarte and Too Faced brands, that have been important drivers for us in the past, like NYX and Urban and IT Cosmetics will continue to have strong pipelines that we're excited about, and we're partnering with them to leverage our loyalty program and all the other assets we have to make them as big as possible. So we feel very positive by what we're seeing as we look out through 2018. We'll also see expansion into more stores of existing brands, brands like MAC. Mary mentioned e.l.f. A number of brands that are in limited doors today will continue to roll out through 2018. And there are a number of new brands that we'll be launching in 2018 as well. Mary talked about a reset in mass. And while we're not announcing all of the specifics yet, we see that as a growth driver of our business, an important element of our business to bring new guests in and allow them to ultimately shop the entire store. So we've got some exciting new brands coming in, in both sides of the store as well. So it will be a well-rounded set of innovation in makeup and the same applies in haircare, skincare and across the whole store. So we're optimistic and positive about what we're seeing.

And I'll just add, too, that we're also actively participating with -- there's a lot of social media influencer brands that are hot. And so we talked about this a little bit but Morphe, Dose of Colors, Lime Crime, these are bands that were born more through social media. But also many of these brands also understand that the benefit of sort of merging the digital and physical is important for their guests and for our guests as well. And so we're seeing some nice growth with those brands, too.

Our next question comes from Adrienne Yih of Wolfe Research.

So Mary, I guess my first question is for you. Can you discuss how you choose your strategic response to an increasingly promotional environment, either maximizing profit or market share dollars? And what are the competitive factors that sway your decision? And then for Scott, op margins had been down the past 2 consecutive quarters. When we look to 2018, should we think that Q1 and Q2 still have that pressure and then we expand again in the back half the year?

Thank you, Adrienne. So I'll start with your first question. I guess stepping back, this is really -- I mean, we really are playing the long game here and believe that Ulta Beauty has the most relevant proposition for the beauty enthusiasts now and into the future. And for us, it's really about long term, driving more guests, gaining more beauty enthusiasts into our loyalty program and also capturing more per share of wallet. So each quarter is a little bit different. But we're looking to drive not just long-term share gains but really long-term engagement with our loyalty platform. And so this quarter was an example of -- we did not want to miss the opportunity to continue to -- on the momentum. We gained 1.8 million new loyalty members this quarter. So I consider that a long-term play not just a short-term price promotion play. Now we need it to drive some traffic because there was some disruption with the hurricanes and some softness in the category. But for us, that's kind of how we think about it strategically, long term, it's how do we continue on the momentum that we have to drive and get an even bigger loyalty program, which really is the -- I guess the flywheel to drive our business for the long term.

Yes, so looking ahead on operating margin, again, we know that's the hot button with our investor group, right? And so there were some unforeseen circumstances that happen. So softness in the color cosmetics area, we're kind of navigating our way through there as best we can. The hurricanes, we had to react to that. We thought that was the best course of action for us. So the last couple of quarters, we're not what we expected going into 2017, right? But the good news is we were able to respond, and we delivered on our financial commitments to our investors, right, so that's the good news. So as far as the quarter sequencing goes next year, I mean, I'm not going to be able to give you really probably the detail that you want on that, but we're prepared today just to give people a sense, like as we're thinking of 2018, here's a couple of data points, right, that we can process on. So again, Dave talked to newness for next year, right? So Ulta Beauty, great innovator, we'll continue to be next year. And we're -- our merchant teams have been working hard with the marketing folks figuring out what can we do next year, right, to reenergize the color cosmetics space both with our existing vendor partners and new folks, right, that we can bring in to the assortment overall, with the thought being how do we mitigate some of the merchandise margin pressure, right, that we've been facing here recently. So that's number one. When we think about other drivers for operating margin for the long term, so one thing is CapEx for next year. Right now our preliminary view again -- and we're not guiding for next year, but the preliminary view looks like CapEx will take a significant step down next year, right, below $400 million, significantly below $400 million versus the $450 million, let's call it, that we had in 2017. So some of you have heard us talk about what's driving some of that. So we've kind of cycled through the peak on the boutique rollouts, right? So there's been a lot of accelerated depreciation flowing through the P&Ls the last couple of years related to these remodel activities that we've taken across the large part of the fleet, right, to keep our store fleet looking fresh. So we're kind of past that now. I'd say we're taking a more moderate view with some of the back-of-the-house investments. So we've made significant investments the last couple of years, and now we're shifting to more of an optimization kind of mode, right, making sure we're getting the value out of those investments we've made the last few years. And you've heard us talk about forecasting and replenishment and master data and space planning and all those kinds of things. So that's kind of what I'm referring to there. Fixed store cost leverage. So again, we're not -- it's not a straight line, right? This year, we've had some higher rent, kind of higher profile locations go online. They were the right real estate decisions for us at this point in time. But they put pressure on margin rate. There's no avoiding that, right? So next year, as we look in at our store rollout plan, it's going to be what I would call a more normalized kind of rent structure, so more of our -- the historical vanilla power center kind of location. So again, we'll get the benefit of cycling some headwinds in fixed store cost this year. And then finally, cost optimization. Again, you've heard Mary and I talk about this over the last year or so. There's a more formal plan being put in place for 2018. That's going to go live with boots on the ground. We believe there's plenty of opportunity to leverage our scale and to reduce inefficiencies that built up over the years naturally as we've been primarily focused on growth. So we think there's a great opportunity there as well. So we just want our investor base to understand that there are specific actions being taken to help us drive operating margin leverage in 2018 and beyond, and we'll share more details on all that when we talk with you on our fourth quarter call.

Our next question comes from Rupesh Parikh of Oppenheimer & Co.

This is actually Erica Eiler on for Rupesh. So first, I just wanted to also touch on the promotional environment. Just curious how the holiday promotional environment has progressed this year versus perhaps recent years? And then as we move past the holiday, any thoughts you can share about how you're thinking about the promotional environment? Are you expecting that as some of that innovation starts to roll through that the potential need to be promotional should abate?

Yes, I'll start with the second part of your question and then maybe, Dave, you can add on the holiday piece, too. But I would say, not to be redundant, but I'm really proud about the fact that we've got a business model that has a lot of levers and, frankly, flexibility. And so we've worked really hard over the past few years to really reduce our reliance on more broad-based, broad scale, just blunt instrument I'd call it, to a much more sophisticated lever, marketing mix. That's allowed us to do a couple of things. One, allowed us to participate in things that are driving the kind of brand awareness that we have today. I mean, to have 50% unaided brand awareness right now is actually a really big deal. And so we've been able to kind of pull back on broad-based discounting and still maintain a reasonable overall marketing spend by shifting into things that are driving awareness, allowing us to participate in the social channels where the journey is happening, from people learning about beauty, and then do more demand creation in a more targeted fashion, right? So the whole point of the loyalty program is to be as targeted as we can. That, in conjunction with exciting brands and assortment and events and all that, right, that all comes together in a great mix that allows us, I think, to be really smart and efficient. So there's times that we had to flex levers more aggressively than others, and it would be our intention to be less about price discounting and more about targeted promotions. And part of what we invest in -- or investing in over time is the ability to get even more personalized in everything we do. So that's the notion of -- at a time where we're using tools to get people into loyalty program, that provides long-term benefits because we know that our ability to target them with really exciting relevant offers that are not really relying on discounting but just exciting offers will only increase over time. So that's kind of a long answer to your question, but that's the goal, to have leverage, have flexibility but also continue to bias towards more targeted personalization. Holiday, Dave?

Yes, as far as holiday, I mean I think Scott said earlier, of course, the holiday is always a very promotional period, it has been in the past, and we don't expect that to change this year. It's -- we're only about a week into the heaviest part of the holiday period, so it's hard to say exactly what -- how it will shake out for the rest of the period. But so far, we've only seen perhaps maybe modest changes to promotional strategy or intensity, and we'll be watching carefully. Our plan is to continue to do all the things Mary had said, continue to drive promotion where it's necessary as we have planned through the rest of the holiday period, but deal with great products, our loyalty program, advertising, marketing, in-store experience, all those things to drive through the rest of this holiday period.

Okay, that's helpful. And then just quickly, can you share with us any potential plans that -- what you plan to do with the excess tax benefit if the proposed tax reform is passed? Just curious, should we expect that to flow through to the bottom line? Are you planning to reinvest it? Just any thoughts you can share on that potential tax benefit would be helpful.

Yes, another question on everyone's minds, right? It seems -- it may be a little premature to speculate on what we would do with that. But I would tell you that it'd be subject to very comprehensive discussion with our board about how to best deploy any potential cash tax savings here in the future. I mean, there's lots of things that we have on our road map that potentially we'd like to accelerate to drive the core business. There's things, other growth levers like international, things that we've been thinking about that perhaps we could get a little quicker start on and then, of course, capital structure overall, just making sure we optimize that for the long term.

Our next question comes from Dana Telsey of Telsey Advisory. Our next question comes from Steven Forbes of Guggenheim Securities.

So I wanted to focus on the product brand offering. So maybe you can kind of just discuss how you expect the ULTA Beauty Collection to evolve over time as it relates to maybe number of SKUs, the category exposure and really what you want that collection of SKUs to stand for as you think about how it fits into your overall customer value proposition. And then just lastly, still on the same topic, can you touch on how that part of the assortment performed during the most recent quarter, maybe year-to-date?

Yes, yes. So our ULTA Beauty Collection is a key part of our overall strategy. It's a part of our business that we're very proud of and have invested in pretty, pretty aggressively over the last year or so. We've revamped our packaging, the formulations, how we market it, how we communicate it, we're actually gearing up for even a larger presence of that in early 2018. So we're very overall pleased with its result. It has a strong presence in makeup, of course, but also in skin, bath and then holiday -- the holiday season is a big time for our ULTA Beauty Collection with an expanded assortment that is designed just for the holidays. So we're continuing to invest in all those things and drive that business and, as I said, have positive and optimistic plans in 2018 to make that an even bigger part of our business. Having said that, it's still relatively small in the total store. So it's not going to be the major part of our assortment, but it's one that can add a nice, obviously exclusive, higher margin business and one that we're going to continue to invest in and drive into the future.

And just on that, any commentary on the performance of that selection of SKUs either year-to-date or in the quarter?

Yes. We, I guess, hadn't -- we don't historically talk about any individual brand performance. So -- but I'd say overall, again, we're proud and pleased with the history of that brand and optimistic about where it's going into the future.

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would now like to turn the call back over to Mary Dillon for closing remarks.

Thank you. I just like to think our 36,000 associates for their incredible commitment to serving our guests and delivering operational excellence. It's a very busy time of the year. And we thank you all for your interest in Ulta Beauty and look forward to speaking with all of you soon.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.