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…

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,…

[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…

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…

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.