Ulta Beauty, Inc. (ULTA) Q4 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Ulta Beauty Fourth Quarter 2017 Earnings Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to hand over -- to introduce your host, Ms. Laurel Lefebvre, Vice President, Investor Relations. Please proceed.

Thank you. Good afternoon, and thanks for joining us for Ulta Beauty's Fourth Quarter 2017 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. We make references during this call to non-GAAP sales and earnings growth in 2017, adjusted for the 53rd week, tax reform and one-time bonuses. [Operator Instructions] Also, we've gotten a few questions about our 2018 EPS guidance. And just to clarify, we expect to grow 2018 EPS approximately 20% off the 2017 GAAP EPS of $8.96. With that, I'll turn it over to Mary.

Great. Thank you, Laurel, and good afternoon, everyone. The Ulta Beauty team delivered excellent financial results in 2017 with an 11% comp on top of the 15.8% comp in 2016 and 37% GAAP earnings per share growth or 25% earnings per share adjusted for items primarily related to tax reform. However, the continued moderation in the growth rate of makeup, our largest category, made our fourth quarter a bit more challenging than expected. But nonetheless, we achieved strong sales and earnings growth in the fourth quarter while continuing to gain market share and make significant progress on our strategic imperatives. We grew the top line 22.6% or 15.7% adjusted for the 53rd week. Comp sales grew 8.8% on top of 16.6% comps in the fourth quarter of 2016, driven by positive traffic and ticket growth, a strong January and continued great momentum in e-commerce. Adjusted for tax reform benefits and onetime bonuses for hourly associates, earnings per share were up $2.75, up 23% compared to the fourth quarter of the prior year. I'll be briefer than usual with our highlights for the fourth quarter in view of the complexity of tax rate impacts and our desire to provide a full discussion of the planned appointment of the benefits of the lower tax rate as well as the various cost pressures informing our view of 2018. Starting with highlights on our loyalty program and brand awareness. The Ultamate Rewards loyalty program grew its membership 19% year-over-year to 27.8 million active members, driven by our store team's successful conversion efforts. We launched a new Diamond tier for our top guests who spend more than $1,200 per year with the goal of driving higher share of wallet with our best customers. The new program offers compelling benefits, including exclusive offers and even more points earned. The program launched 2 months ago and is off to a great start. Our credit card program continues to perform well with new accounts at conversion above plan and ongoing evidence that we garner a higher share of wallet from guests who sign up for the card. We also drove rapid growth in gift card sales, up about 30% in the fourth quarter, in part driven by strong performance of our expanded Blackhawk partnership in supermarkets and other national retailers. Our brand awareness metrics reached all-time high. We grew aided awareness to 91% compared to 86% a year ago, and unaided awareness rose 6 points to 55% from 49% last year. We are also proud to learn that Ulta was the most Googled beauty brand in 2017. Moving on to merchandising. We continued to strengthen our partnerships with our brands and launched new and coveted brands across all of our categories. While the Black Friday, Cyber Monday period was very strong, the overall holiday period was a bit softer than expected, with the best monthly growth of the quarter coming in January. The standout performance of prestige boutique brands, MAC, Clinique, Lancôme and Benefit drove the best growth rate in the portfolio. Reflecting the strong performance, we're ramping up the roll-out of these boutiques faster than we initially anticipated. We now plan to add 675 boutiques in 2018, compared to 700 in 2017, with the openings more weighted to new stores this year with about 380 in new stores and the remainder in existing stores. This includes plans for roll-out more than 200 new MAC boutiques. Our top line was also driven by strength in prestige skincare, prestige fragrance and mass cosmetics, all of which delivered double-digit comps. Skincare continues to perform very well, and we're adding several new skincare brands to take advantage of the growing trend in skin health, including The Better Skin Co., Crepe Erase, Mamonde, and House 99 by David Beckham, which is a men's grooming brand that is exclusive to Ulta Beauty. We are pleased to see a meaningful acceleration in mass cosmetics in the fourth quarter, driven by the success of popular new brands like Morphe. Ulta Beauty is this brand's exclusive brick-and-mortar partner. We've just completed a major mass cosmetics reflow, making significant enhancements to further differentiate our offering in this category. This entailed a major expansion of brands like Morphe, e.l.f., Makeup Revolution and the introduction of new brands like Milani, FLOWER and Wet n Wild. We also launched ColourPop Cosmetics color cosmetics, a cult favorite in select stores and online in late February. This is a true fast beauty brand featuring trend-right and affordable products and is exclusive to Ulta Beauty. Turning to prestige cosmetics. Similar to the third quarter, we saw this category slow from its stellar growth in 2015 and '16. While certain brands of makeup were very strong, others struggled to comp over significant multi-year increases. We're optimistic that we can accelerate growth in this category with encouraging newness in the pipeline. We're currently updating our prestige cosmetics assortment, including the launch of Beauty by POPSUGAR. And this is another Ulta Beauty exclusive inspired by POPSUGAR's network of 100 million beauty enthusiasts. We're adding high-growth brands, like Estée Lauder, NARS and COVER FX to dozen more stores, rolling out social media darling, Dose of Colors, to several hundred doors with an expanded assortment from its current small etagere. We're also excited about 2 recent Ulta exclusive foundation launches: Tarte's Shape Tape Foundation, which follows Tarte's best-selling concealers and IT Cosmetics' Bye Bye Foundation. And finally, we're thrilled to announce the prestigious addition for 2018, Chanel Beauté. Following our long-standing partnership with Chanel, offering their iconic fragrances in hundreds of our stores, we are honored to introduce Chanel Beauté in a small number of Ulta Beauty doors this year. This will be an added assortment featuring a Chanel-branded makeup station, with the first Chanel store opening in Westport, Connecticut in just a few weeks. With significant newness across all of our categories and particular focus in both mass and prestige cosmetics and amping up our efforts -- our offering of -- our efforts around exclusive products and brands, we are certainly planning for makeup to have a much better year in 2018. Let me turn now to our services business. Salon sales grew 17.2% or 8.7%, excluding the extra week and comped 3.2% in the fourth quarter. We're encouraged by the early results of the test of our improved salon business model in 2 districts. And we're in the process of rolling out the new model to additional markets, including the entire central region of the country, with more markets planned to convert in the summer. Guests and stylists alike are very pleased with this new approach, which simplifies the menu for hair and skin services, offers better transparency, and provides increased training for stylists. We're also investing in a new model for skin services in all new stores and a number of remodels in 2018, which will impact 180 stores. The new model, called the skin bar at Ulta Beauty, is designed to improve our skin services offering and will feature a full-time skin expert with responsibility for both prestige retail sales and skin service sales. This will also add retail space to the skin area compared to our previous model. We expect this model to also drive higher productivity of the space dedicated to skincare. Moving on to store expansion. We opened 16 stores in the fourth quarter, ending the year with 1,074 stores. The net cost to open a new store was about $1.6 million in 2017, up slightly from 2016, as expected in light of the increase in merchandise fixtures for boutiques. This cost is expected to be slightly lower in 2018 as we continue to gain efficiencies in new store construction. We're on track to open 100 stores in 2018, and we're very pleased with the quality of the stores that we've accrued so far. We continue to evolve our store format to respond to guests' rising expectations for an experiential environment. In addition to the new skin bar I just mentioned, the latest store model, our Level 10, features upgrades to the Ulta Beauty Collection ball, enhanced impulse fixtures and elevated prestige hair fixtures. We expect the average store rents for the class of 2018 stores to be slightly lower compared to the class of 2018 -- '17. Now let me turn to our e-commerce business. ulta.com grew 60.4%, including the extra week or 50.4% on a comp basis in the fourth quarter, maintaining its strong momentum and representing 12.8% of total company sales. E-commerce contributed 460 basis points of our total company comp, driven by transaction growth. Total site traffic growth rose 54%, while mobile traffic was up 66%. Our recently rolled out omnichannel capabilities door-to-door is ramping faster than expected and satisfying strong demand for online-only brands like Ofra, Lime Crime and new additions like Storybook Cosmetics as well as brands like Morphe and MAC that are not yet available in every store. And finally, to update you on our supply chain operations. Our supply chain performed very well during the quarter, operating at peak capacity for an extended period while maintaining high in-stock levels during the holiday selling period. In support of the higher e-commerce order volumes, our distribution teams continued to exceed their goals for processing time and in-home delivery speed during holidays. With e-commerce representing nearly 13% of total sales in the quarter, our supply chain was able to support this volume while reducing cost per order by about 10% compared to last year. Our investments in the new operating model allows the network to deliver record daily order throughput capacity at 10% above plan. From an inventory perspective, the team maintained high in-stock levels during the holiday season and through the end of the quarter, improving on last year's strong performance and exceeding our inventory turn goals for the year. Our post-holiday inventory plan was well executed, allowing us to recover from the holiday selling season quickly and capture strong post-holiday sales. So that wraps up my recap of the fourth quarter. And now I'd like to spend some time discussing how we're thinking about the future. As we began to plan 2018, we recognized several significant factors that will impact not just this year but the subsequent years as well and allow modifications to our original long-range planning assumptions. First, the impact of tax reform. This changes the game and provides us with a unique opportunity to deploy a portion of the benefits to invest in our associates and make us more competitive. It also enables us to accelerate certain investments to drive growth and innovation. These will deliver clear benefits to our business, but any reinvestment, obviously, impacts our operating margin rate. We also have to adopt the new accounting standard for revenue recognition that boosts the top line but is expected to negatively impact operating margin by roughly 20 basis points this year. Next, it's clear that our business will have a higher mix of e-commerce sales than previously anticipated. While it's good news that we reached our target of 10% e-com penetration 2 years ahead of plan, this does put modest pressure on the P&L from a rate perspective since gross margin for ulta.com is below that of our brick-and-mortar business. The great news is that e-commerce sales and margin dollars are largely incremental and represent additional share gains. The investments that we've made to enhance our digital and fulfillment capabilities position us to capture significant sales in e-commerce while providing exceptional experience for our growing number of omnichannel guests. We're also not immune to the various cost pressures that most retailers are facing today, including labor, freight and health care. Labor cost is the most significant of these for Ulta Beauty, and we face 2 challenges: rising hourly wages, wage rates in many markets across the country; and increased competition for workers in our distribution centers and, more importantly, the ongoing aggressive roll-out that we're doing of our prestige brand boutiques with dedicated and highly trained staffing. And finally, we're operating in a highly competitive marketplace coupled with the slowdown in the growth rate of cosmetics that has persisted longer than expected. While we remain optimistic that our differentiated model will continue to gain share in a very fragmented market, these category and competitive dynamics are likely to pressure margins in the near term. Now these headwinds will be in part offset by a formalized cost optimization program expected to unlock savings later in 2018 and beyond. As we mentioned on last quarter's call, we believe there's plenty of opportunities to leverage our scale to reduce inefficiencies, and we've identified 4 major work streams to drive benefits in the areas of indirect procurement, end-to-end operational efficiency, real estate cost and merchandise margin improvement. So taking all these factors into consideration, it's clear that for the long-term health of the business, it no longer makes sense to drive toward the 15% operating margin target on the timetable we set several years ago, and managing the business to obtain that target would require underinvestment in areas that we believe will drive robust, sustainable, long-term growth. We still expect to expand operating margin over the long-term. For 2018 however, we anticipate taking a small setback in the order of magnitude of 50 to 70 basis points. Going forward, rather than guiding to a precise operating margin target or time line, we will instead ask stakeholders to focus on how we create value through our very healthy earnings per share and margin dollar growth. We're planning to invest a portion of the roughly $100 million tax rate benefit expected in 2018 in a variety of projects designed to further enhance our differentiated positioning and elevate our overall guest experience. First, we are making critical investments in our people, including employee benefit enhancements that will improve our position in a competitive labor market and increase retention. In addition, we plan to invest in a series of new initiatives that will accelerate customer-facing innovation across multiple touch points to drive growth and strengthen our competitive position. One area of focus will be our store experience, where we'll be innovating on the human, physical and digital aspects of the journey to ensure we're delivering a compelling, exciting and easy experience for our guests in every trip. We'll also accelerate our investment in AI and data capabilities to drive more personalization and one-to-one offers for our loyalty program members. In addition, we'll increase investments in digital innovation to drive guest experience enhancement designed to drive engagement and education as well as increased sales through our e-commerce business. We'll also enhance our capabilities to both identify and incubate new brand opportunities that will further evolve our assortment and take full advantage of the changing landscape of brand creation. And we'll accelerate our services strategy with the continued roll-out of the new salon model and the addition of the new skin services model. Finally from an infrastructure standpoint, we'll accelerate activities around supply chain network optimization as well as investments in supply chain systems that enable buy anywhere, fill anywhere capabilities. We are confident these investments will allow us to continue to deliver industry-leading sales and earnings growth while making us a more competitive employer, improving the guest experience and allowing us to invest in growth platforms to drive sustainable differentiation, exceptional market share gains and long-term success. Before I turn it over to Scott, I'd like to address the topic of the recent lawsuits alleging that Ulta Beauty has resold used products. We are vigorously defending against these lawsuits and taking actions to ensure our guests continue to have the highest confidence in the integrity and quality of Ulta Beauty's products and packaging. Let me be clear: we do not sell used, damaged or expired products and have zero tolerance for any actions that would compromise the integrity of the products we sell. We are confident that our associates are following our policies regarding the handling of returned products. To fortify this policy, we're re-communicating and reinforcing with every associate across the country the proper procedures for processing returns. We have seen no indications that the publicity surrounding the allegations has negatively impacted our brand, our store traffic or our financial results in any discernible way. But we will remain vigilant and ready to take any necessary action to protect our brand and ensure we maintain the trust of our loyal guests. Now Scott will cover in more detail the drivers of our fourth quarter financials and our outlook for the first quarter and fiscal year 2018.

Thank you, Mary. Good afternoon, everyone. Starting with the income statement. Q4 sales of $1.94 billion were driven by 8.8% comparable sales growth, strong new store productivity and the benefit of the 53rd week. The total company comp of 8.8% was composed of 6.2% transaction growth and 2.6% average ticket growth. E-commerce sales growth remained strong and contributed 460 basis points to the total comp. The retail-only comp was 4.2%, with traffic up 2.7% and average ticket growing 1.5%. Ticket was driven by an increase in average selling price, while growth in units per transaction was slightly negative. The salon business comped 3.2%, driven primarily by ticket growth. Gross profit rate decreased 50 basis points, including about 20 basis points from the onetime bonuses for hourly associates. The 30 basis points of remaining deleverage are attributed to modest pressure on merchandise margins and investments in our salon business, in part offset by leverage in fixed store costs. Distribution expense was flat as a rate of sales year-over-year. Product margins continued to face some headwinds from channel, category and brand mix dynamics, with the mix of e-commerce sales the most significant driver. We were just slightly more promotional year-over-year largely due to the higher mix of e-commerce, which tends to be a more promotional channel. Preopening expenses leveraged about 10 basis points related to the timing and number of store openings in the quarter, with 16 openings in Q4 this year versus 25 in Q4 last year. SG&A expense deleveraged 60 basis points, including 40 basis points for the onetime hourly associate bonuses. Store labor was the most significant contributor to the remaining 20 basis point increase in SG&A by deleveraging about 50 basis points as we continue to invest in prestige boutiques as well as in more hours during the holiday season to deliver an optimal guest experience during peak shopping days. Corporate overhead leveraged about 30 basis points, benefiting from strong expense controls. Advertising expense deleveraged slightly. As a reminder, some of the upside we saw in the first quarter of 2017 came from shifts in the timing of some of the planned advertising expenses into the third and fourth quarters. Operating margin was 13.1% of sales, down 110 basis points on a GAAP basis. Excluding the impact of the onetime bonuses for hourly associates, adjusted operating margin decreased 40 basis points at 13.8% of sales. Turning to EPS. GAAP earnings per share grew 51.8% to $3.40, and adjusted EPS rose 22.8% to $2.75. The tax reform impact from both the onetime deferred tax remeasurement and the impact of the new lower effective tax rate starting January 1, benefited the quarter by $0.78. We made the decision to pay onetime bonuses to our hourly associates, totaling $12.3 million. About 1/3 of the expense impacted gross profit and about 2/3 impacted SG&A and, in total, reduced EPS by $0.13. The 53rd week was worth $109 million in sales and about $13 million in EBIT. Moving on to the balance sheet and cash flow. Inventories were up 5.3% on a per-store basis, well below comparable sales, driven primarily by inventory for new brands and boutiques. This performance demonstrates that our new merchandise planning systems are working to drive improvements in inventory management. This is particularly positive in light of the lower-than-expected sales and volatility of sales trends throughout the holiday season. Capital expenditures were $441 million for the year, driven by our new store opening program, investments in digital capabilities, prestige boutiques and merchandise fixtures. We ended the quarter with $397 million in cash and short-term investments. In terms of share buybacks through our 10b5-1 program, we repurchased approximately 266,000 shares of our stock at a cost of $58 million during the fourth quarter. The resulting lower share count added $0.07 to Q4 earnings per share. As of February 3, 2018, approximately $79 million remained available under the $425 million share repurchase program announced back in March 2017. Earlier this week, the Board of Directors approved a new share repurchase authorization in the amount of $625 million. Turning now to guidance for the full year 2018 and for the first quarter. Our initial 2018 outlook is in keeping with our plan to deliver high-single digit comparable sales and earnings per share growth in the 20% range. But some of the drivers have evolved, as Mary just described. We expect to open 100 net new stores in 2018 and execute on 17 remodel and relocation projects. Our e-commerce business is expected to grow in the 40% range. Total top line growth is planned in the low teens, including the impact of the 53rd week in fiscal 2017. Beginning in Q1 of this year, we'll be implementing a new accounting standard for revenue recognition. As a result, we expect to see a benefit to sales from credit card income and gift card breakage, which were previously classified in SG&A. This will be partially offset by the impact of the loyalty program reserves now being grossed up into sales. Since we have such a high customer engagement in our rapidly growing loyalty program, Ulta Beauty has a more significant impact from this accounting change than some other retailers. Adoption of the revenue recognition standard is expected to increase sales by about $50 million and reduce operating margin by about 20 basis points. Total company comps are expected to be in the range of 6% to 8%, with the retail comp in the mid-single digits. We are planning for comps to strengthen throughout the year as comparisons ease and newness in our merchandise offering improves. We expect to grow earnings per share approximately 20% on a GAAP basis, including the extra week in the 2017 and the base. Excluding the impact of the extra week, EPS growth is expected to be in the low 20s. Earnings growth adjusted for the lower tax rate would equate to low double-digit EPS growth. We anticipate capital expenditures of approximately $375 million. This breaks down to $175 million for new stores, remodeled and boutique expansions, $95 million for supply chain and IT, $80 million for merchandising, and $25 million for store maintenance and other. Depreciation is forecast at approximately $290 million. We expect to repurchase shares in the $500 million range for the year, and the annual tax rate is expected to be 24%. One note I'd like to add related to Mary's comments about the recent social media allegations. This guidance does not include any actions we may take to protect our brand and reputation to ensure that our guests continue to have the highest confidence in Ulta Beauty. As we look further out to 2019, the last year for which we gave long-term guidance at our Analyst Day in late 2016, we still expect to grow earnings per share in the 20% range and plan for modest margin expansion. We plan to host our next Analyst Day in the fall and expect to share our longer-term outlook at that time. Turning to more specific guidance for the first quarter of 2018. We expect sales to be in the range of $1.506 billion to $1.519 billion versus $1.315 billion last year. We expect comparable sales to increase in the range of 6% to 7% versus 14.3% last year. E-commerce sales are expected to grow in the 40% range. We plan to open 33 new stores in the first quarter compared to 18 in Q1 of 2017. Q1 preopening expense is expected to deleverage slightly as a rate of sales. Diluted earnings per share are expected to be in the range of $2.43 to $2.48 versus $2.05 last year, with operating margin planned to deleverage. Recall that in last year's first quarter, we had meaningful tax rate benefits resulting from a change in accounting for equity compensation as well as earnings upside from a timing shift of expenses into the back half of the year. The tax rate for Q1 is expected to be 24%, and our fully diluted share count is estimated at 61 million. We hope that our detailed press release and commentary today has been beneficial to investors in understanding the quarter and outlook that have a bit more complexity than usual. And with that, I'll turn it back over to Mary.

Thank you, Scott. And I'd just like to wrap up our prepared comments with some reflections on our overall 2017 performance. We made significant progress on our strategic imperatives throughout the year. We attracted millions of new customers, adding 4.4 million net new loyalty members, and we achieved all-time highs in brand awareness. We gained market share across all categories, added dozens of leading brands to the assortment, successfully rolled out 700 prestige brand boutiques and significantly revamped our services offering. We drove impressive new store productivity. We delivered stellar growth in e-commerce sales and increased the percentage of omnichannel shoppers. We improved our infrastructure and supply chain capabilities. And really perhaps most importantly, we continue to grow and develop a workforce of passionate, highly engaged associates who create and sustain our winning culture. All of these accomplishments give us tremendous confidence in executing our plans in driving sustainable, profitable growth in 2018 and beyond. Our business model remains strong and differentiated, and the investments we're making will continue to set us apart, support market share gains and make us relevant in the beauty industry for many years to come. So now I'll turn it over to our conference call host for Q&A.

[Operator Instructions] Our first question comes from the line of Christopher Horvers from JPMorgan.

So I wanted to ask about the promotional -- your promotional plan and your promotional posture. I think a big question in -- over the past few quarters is it looks like you added an incremental promotion to drive sales at the end. Which looked like you were trying to catch up to where you had guided The Street. So how do you think about those in retrospect? Do you think as a private company, would you have run those? And how are you thinking about 2018 differently, especially in light of some of the work you're doing around the Ultamate Rewards program?

Thank you, Chris. Let me start just by stepping back and providing some context, which is that we have many different demand drivers, and we always are really striving to deliver a great value equation to our guests and one that's going to drive share gains and profitable growth. So some of those demand drivers are easy to see and track, and others are maybe less so because they're very targeted, and a lot of folks are consumer target, right. So what I would say is the great thing is that we can and do flex those tactics as needed given the time of year, category, competitive dynamics. So we set out -- I guess some more context, really over 4 years ago to reduce our reliance on broad price discounting and, as you said, increased targeted offerings through our loyalty program. We also significantly shifted spending out of price promotion tactics into awareness and brand building tactics. And we've done that. The business, I would say, is much healthier because of that. So our brand partners, they appreciate what we're doing with the data and the insights in the loyalty program. And I'm confident that these are the right levers. So to your point, at the end of the fourth quarter, we did have an incremental 20% off postcard, end of the quarter, drove traffic and share gains, slight headwind in margin rate. But as I said, we actually have many levers and we take a very holistic approach. So in fact, we're less promotional on other tactics that we're probably less visible. So net-net, it's only a slight increase in overall promotions. And really, that was largely driven by the higher mix of e-commerce in the quarter, which tends to be more promotional. So to your question about looking forward, I'd say more of the same. It's just constant -- how do we -- over time, we know that getting more and more one-to-one and personalized is the goal for us. Our loyalty program allows us to do that. Some of the investments I talked about do as well. But we'll continue to use an array of tactics and levers to drive the long-term growth and share gains of the business.

And I would just like to add because I know this is a hot button for investors and we, of course, read all the weekly analyst reports that are tracking our every move on the promotional front. So one other fact I'd like to add is it's not -- this postcard in particular, it drove a lot of traffic to our stores, which helps us mitigate other potential gross margin risk to the business, right. So it helps us move through clearance products. In this case, it helps us move through some of the residual holiday products that's still in the stores. And so we were able to sell that at a profit with vendor support rather than sending it back to the vendor, right, where you have labor costs and potential shrink issues or, worst case, having to write it off at the end of the quarter. So those are both worst outcomes. So again, we try to be very thoughtful about the decisions we make and how we execute.

And I just want to throw in -- you mentioned potentially having to react to some of the -- these new stories about the used cosmetics potentially, seems to be foreshadowing -- maybe pulling one of those out to make sure you're defending the market share out there. And you also guided a more narrow range, 6% to 7% in the first quarter, so just trying to interpret that.

Is that a question?

Yes.

Our next question comes from the line...

Look, we just found out [indiscernible] I'm sorry. I wasn't tracking if that was a question or not, a follow-on question, Chris. So...

Chris, can you repeat your question?

Okay, he's gone. I'm happy to answer but I wasn't clear about it.

Okay, let's keep going.

I'm sorry. The next question comes from the line of Simeon Siegel from Nomura Instinet.

Congrats on a strong year, guys. So Mary, can you just talk about how your new store openings are going? You did mention these stronger new store productivity. I'm just wondering as the brand continues to gain awareness, are you seeing a faster sales ramp? And maybe, is there any change to the maturity profile?

Yes. I mean, I'm very encouraged as our new class of stores each year continues to ramp up stronger. Productivity continues to get better. The maturity ramp of the stores is a function of the overall comp rate. So that's going to flex based on the -- where we are in the overall comp. But what we are seeing in new store openings continues to be very strong and very encouraging and allows us to continue to drive more market share gains as we enter markets, even markets that we already have stores, right. As we're adding stores, we're continuing to build our market share and overall penetration. So it's quite strong.

Okay, great. And then just quickly, Scott, did you -- sorry if I missed it. Did you quantify or can you quantify what you expect mix shift to do to gross margins going forward?

We didn't quantify it. I would tell you that merch margins in general, as we said now for quite some time, we expect to manage to flattish, right. That's what's been inherent in our long-term thought process. So -- but we believe there's opportunities over the long term. So again, e-commerce, it's pretty obvious that that's going to be a headwind for us. It has been in recent quarters and will continue to be. And so we're planning and we're looking at things. We have ways to mitigate that. Both our private-label offering might be a way, just getting smarter about our assortment and numerous decisions by making use of our new merchandise tools that we put in place over the last couple of years, better analytical tools as well, inventory productivity gains we think we have in our future. And of course, the DCs play a big role in this as well so there are better capabilities, better optimized performance overall. And with Fresno, we're making thoughtful decisions on where we place these to make sure that we're closer to our end customers there, so again helping with transportation cost over the long term.

Our next question comes from the line of Simeon Gutman with Morgan Stanley.

A question for Mary. Ulta has been making a lot of investments while growth was robust. And now it sounds like we're still needing to make some investments at a time -- or I think some of us would think that you were relatively better off than your peers. So I know you'd mentioned some reasons why. Can we revisit that? And I don't know if I caught it, but within the margin guidance and, I think, the adjusted outside of the accounting change is down 30 to 50, how much of it is down to the extra investment outside of the e-commerce mix shift and some of the freight and the labor margin headwinds that you face?

Okay, great. Thank you, Simeon. Now I'll start with the question, I guess, about why we feel we need to make investments. I'd say first of all, I think we've got a really strong track record of making smart investments that earn a great return. And we've, in fact, made really significant progress against the 5-year plan that we communicated back in 2014. We're well ahead on, I guess, every dimension you might measure from sales and profit, the comp performance, share gains and whatnot. I would say though that retail is rapidly changing and really more so than maybe we would have thought 4 years ago. So while I feel very good about the investments we've made, this is simply an opportunity now frankly with the Tax Reform Act to size up the opportunities that affords us to invest at an accelerated pace on some of the dimensions that I talked about and really investing from a position of strength. We're very confident about our business model and our growth potential, but continuing to invest and maybe doing at an accelerated pace allows us to adapt to the increased pace of change, I think, that's happening in guest expectations and retail. So if we only solved for margin, I think we would not maximize the opportunity that's ahead of us. So when we think about those investments, it's both in people as well as guest-facing initiatives. And really, it's more about imagining a future of this intersection of the digital and physical world that's more focused on experiences, on discovery, personalization and less on what you might think of like the friction of commerce. So for us, it's just about how do you pace that and do it in a way that continues to allow us to really be the leader in beauty that we are and believe we continue to be. So it's as simple as that. Do you want to take the second question?

Sure. So the 50 to 70 basis points down for the year that we guided to -- I think you mentioned, Simeon. You caught the 20 basis points on the accounting change, which is kind of a onetime item, I guess, I would say, for the changing going from the cost method to the retail method for accounting for loyalty transactions. The remaining 30 to 50 primarily driven by labor, store labor, is a big driver of that, and that's connected to the boutique strategies. So we talked in the past a lot about cost implications there. So we're in a better position in '18 because more of the boutiques are going into new stores than they have historically. Historically, it's been going back into the comp base, which has been more of an expensive proposition for us through this accelerated depreciation notion that we've talked about in the past; so labor, the biggest piece with boutiques, which we say we're accelerating from what we had thought about earlier. And then the rest of it is really this tax benefit reinvestment, I would say, and most of that ends up in SG&A in the back half of the year largely, as does the store payroll as well is in the SG&A line.

Our next question comes from the line of Kelly Crago from Buckingham Research Group.

Mary, could you just talk about the prestige cosmetics category a little further? First, did you mention how that grew in 4Q? And then as we begin to lap some of the outsized growth in the category, what do you feel is an appropriate level of normalized growth? And what are some of your assumptions driving that outlook? And then just piggybacking on that, it'd be great to hear your thoughts on the recent successes of celebrity-brand introductions, which you haven't necessarily been able to participate in. So do you expect this to be a sustainable trend? And if so, are you seeing any opportunities to get involved in a bigger way?

Great. Thank you. I'm going to tag team this with Dave. So I'll start. And I guess I would say when I -- we think about our -- I'll really reiterate. We've continued to gain share in all the categories and all the channels that we're in, right. So we participate in a lot of different categories, All Things Beauty, All in One Place. So there's a lot of different irons in the fire that we have to drive our growth. And in prestige, for us, we comped around 10% last quarter. And a year ago, that was 20%. So that was still great growth, a little bit not as strong as it was the year before, but we had some brands that had great -- our prestige boutique beauty brands were really strong and continued to roll out. We had some other brands that had innovations that didn't work as well as the previous year. But we see our partners and new brand innovation very strong both in mass, which we can talk more about, and prestige. And I feel very confident that that's going to continue to be a strong segment of growth and really coming in a lot of different ways. So to your point about celebrity brands, that's just one of the many levers that are out there in terms of creation of brands, and we're participating across all of those. So I would not rule that out. I think there's a lot of ways for us to get innovation and we are -- so Dave, why don't you give a little more color on [indiscernible]

Yes, on our cosmetic -- on our makeup business. So yes, I'd just add to what Mary said by -- we really take a holistic approach at building our total makeup business. And while your question was about prestige, I want to talk about both mass and prestige because that's really unique for Ulta Beauty, obviously, and an important part of our strategy as we help introduce guests into opting into the mass business but then see them over time move into our prestige business. So they work very -- in a very integrated way. But I'd call out just a few core areas of how we're thinking about building our -- continuing to build our assortment and our growth and success in the makeup business. First and foremost, it is about strengthening the performance with our biggest brand partners, our established brands there. And we're seeing continued success with that. That drove some of the comps that Mary talked about in prestige and also in mass, so our Ulta Beauty Collection at the forefront of that going forward, as well as Maybelline and L'Oreal Paris on the mass side; brands like Tarte, Anastasia, IT Cosmetics, Too Faced driving growth on the prestige side. We're also rolling out, we've mentioned a couple of times, key brand partners that we've been establishing in more stores largely on the prestige side. We said 675 new boutiques across MAC, Lancôme, Clinique, adding benefit in new stores, but also NARS, Estée Lauder; on the mass side, e.l.f. rolling to all stores. So brands that have been successful in smaller subset of doors continue to expand out. Key exclusive brands are a big part of that. Tarte Double Duty Beauty has been a big success and a great partnership. IT Brushes for Ulta, Makeup Revolution on the mass side, an exclusive brand that is -- we're expanding and seeing a lot of success with. And then I'd say in the socially relevant, socially driven brands, we're seeing a lot of success and many of these brands are exclusive to Ulta. And we are seeing them already driving a lot of growth. On the mass side, Morphe launched late last year. We just launched ColourPop, Milani, Sleek, FLOWER; on the prestige side, Dose of Colors, Beauty by POPSUGAR, which is an exclusive line created by Ulta. Mary mentioned Storybook Cosmetics, which is an online brand. So we're seeing these influencer-led brands having a major impact in the marketplace. We've got many that we've brought in over the last 6 months and several that have just launched over the last few weeks. So we're very confident about the growth that we'll see there. And then the last thing I'd just reinforce is reflective of a holistic view that we see on the makeup business is the addition of Chanel Beauté, and we're very excited about that rolling into a small number of doors but another example of us driving growth in all aspects and all dimensions of the cosmetic business.

Our next question comes from the line of Mark Altschwager from Robert W. Baird.

So your prior long-range plan called for stronger comps in the early years, relatively lower comps in the out years. So I guess, the question is, would you expect your comp growth rate to reaccelerate as you accelerate some of these investments in personalization and store experience? Or would it allow you to at least sustain something in the 6% to 8% range for a longer period of time? Just I guess without previewing the Analyst Day this fall too much, it would be great to hear how you're thinking about the longer-term comp growth algorithm.

Okay. Thank you, Mark. A way to get a little preview, I like that, which we can't do and don't have, but no -- I would think about it as sustaining really the healthy comps that we're talking about right now and that we would -- I would expect that the need to evolve any retail business is going to be -- it's out there for all of us. So when we think about these investments, it's really to continue to be just as strong as we are and may -- and sustain the kind of comps that we're talking about. So more to come on that.

Our next question comes from the line of Erinn Murphy from Piper Jaffray.

I guess, Mary, my question was for you regarding the loyalty membership. The growth was pretty strong, so in 2017, as you said, 27.8 million at the end of the year. I guess, first, how do you anticipate the growth of that to continue in '18? And then how are you thinking about the customer acquisition cost if you get up into that next 5 million to 10 million customers?

Yes, I'll just start and then have Dave add some more to this. But I'm really thrilled with the kind of growth that we've had. We're at almost 28 million members, as we said, which is fantastic. And still, there's a lot of beauty enthusiasts out there that are not in our loyalty program. So we anticipate to be able to continue to drive growth albeit at a moderate pace over time. We've had really strong growth. We know we'll continue to grow it. So what would you like to add to that?

Yes. And I'd say as far as cost of acquisitions, we're not seeing a dramatic change. And then in fact, we're finding more efficient ways to drive our total marketing plan. And we really do take a comprehensive approach to drive new guests into our store. Mary mentioned in her prepared remarks the increased awareness, both unaided and aided, which we know contributes to our growth. We've got very strong marketing plans supporting both our total brand story as well as many of the new items that I've talked about. And then our stores have done a very good job improving their effectiveness at converting nonmembers into members, and we're anticipating that we'll continue to do that through 2018. So we're not expecting a real change in our efficiency of attracting new members into our program.

Okay, that's helpful. If I can sneak in one more just on the credit card. Is that still a drag on gross margin? Or is that neutralized now?

Yes -- no. I'm trying to put into context the drag. So the credit card has been a spectacular success and has been a real tailwind for the business overall. I mean...

The 20% offer that came with the launch [indiscernible]

Yes, yes. So that's moderated, the 20% off, in case that didn't come through loud and clear. So the initial sign-up margin rate headwind with that initial purchase really had subsided once we got the program off the ground back the second half of last year, really hasn't been an impact overall when we're talking about margin rates here in recent quarters.

The net impact is very positive.

Absolutely.

Our next question comes from the line of Dana Telsey from Telsey Advisory Group.

As you're thinking about this category performance, makeup and what you're seeing with prestige, how do you see the growth rates of that in the future? And do you see any changes going on with skincare versus makeup that we should be looking forward to? And then just on the store base, any changes to the store base potential given the stronger-than-expected e-commerce build?

Great. Thank you, Dana. I'll start with the store base. We obviously continue to look at that very closely and are thrilled with the productivity that we have, the real estate opportunity, the ability to take advantage of situations, I think, that are right for us in retail. So -- and we love the e-commerce growth because it's so incremental to the business, right. So it's not -- we don't have a shifting of purchases happening here. As you know, we look at that omnichannel guest closely and analytically. She continues to buy even more in-store and online and becomes the best guest. So -- but we look at it closely as we continue to build out the store base and make sure that we are picking the right spots and that we'll just keep watching that. But we feel very encouraged as I said we're going to open 100 stores this year. We're off to a very strong start already, and we think we're in the right place. On the -- oh, category stuff was the first question. Do you want to take that, Dave?

Sure, yes. I mean, on the category, on makeup specifically, the -- we're confident about both mass and prestige. They both slowed down in 2017 and -- but we're seeing through the -- some of the items that I talked about earlier, strong signs within our portfolio of growth. So we're optimistic at least within our business and our model that makeup trends will improve and we anticipate seeing that across the market. As far as skincare, I'm glad you asked because skincare has been accelerating. And we're very pleased with the results that we've seen on our skincare business again both on the mass and prestige side. Mary mentioned several of the new brands that we just recently launched actually last week that we're excited about but also continued strong performance with brands like Mario Badescu, Peter Thomas Roth, expansion of proactiv, Origins, Clarins. And then men's skin business, we think, will also drive some incremental growth, highlighted by House 99 with David Beckham. So we see a lot of growth in skin across the marketplace, and we're certainly, we think, leading the way and gaining share in that category as well.

Our next question comes from the line of Jason Gere from KeyBanc Capital Markets.

Mary, I might need you to go into that crystal ball again.

Got it.

Just on the cost optimization program, I guess I wanted to get a little bit of color on that. Did you use outside consultants on some of the projects? Because you guys haven't really gone through -- I wouldn't call it restructuring, but this level of some of this detail. And then Scott, when you think about the 50 to 70 basis points that margin will be down this year, how much of -- I mean, the cost optimization program, I guess, will help offset in the second half of the year. How much is that going to contribute this year? What would be the full year run rate? And then how -- and this is the crystal ball question. How much of that gets reinvested when you think about going forward into next year? So I was just wondering. A lot of details about -- well, hopefully, I can get some answers.

Thank you, Jason. I'll just start by saying a couple of things. One is I am thrilled that we're really in a formalized program that we're working on with dedicated internal leaders and a formal process in place, and we're doing it from a position of strength. So I think it's the right time for us to think about how do we take our growth and scale and identify opportunities to drive more efficiencies in the business, smarter ways to do business for many years to come. So we're fairly far down the path of identifying buckets of opportunities but way too early to start getting specific about what that's going to look like and when, but I feel really good about the progress we're making.

Yes. I guess, I would just add that the executive team is committed to seeing this through. I mean, I think we're in a good spot in our maturity curve here to be working on this ahead of what you might have seen historically in other operations. So we're not going to share a lot of specifics, but there's hard targets in the 2018 plan and this is going to be a multi-year program and feeling really good about it at this stage.

Is it fair to say -- and maybe just to follow up, when you look at some of the other competitors out there, whether department stores who've kind of gone through this type of, I guess, cost-cutting efforts in the past that they're kind of near the tail end of those programs, you're at the beginning, it puts you in a competitive advantage as we think about the next couple of years?

Well, I would hope so. I mean, the idea is that it really is the right time for us to think about short term and long term, the ability to continue to drive the kind of returns that our shareholders expect and want while continuing to invest in the business that has many, many years of growth ahead of it and the need for investment in a changing retail environment. So firstly, I think about it a little bit less of cost-cutting. I think about it more as driving efficiencies to invest in growth, and now is the right time for us to do that.

Our next question comes from the line of Brian Tunick from RBC Capital Markets.

This is Bilun on for Brian. I just wanted to ask about the ticket growth. I believe it's been around mid-single digits over the last 2 years and starting to slow a little here. So as you think about the comp sales from here, is it reasonable to assume a lower contribution from ticket growth? Or do you think there is still opportunities to grow the average ticket from maybe channel mix, product mix or anything that we should be aware of? And then secondly, I might have missed this but -- so the vendor participation for the different kinds of promotions, say the 20% off coupon, is that different than planned events, like the 21 Days of Beauty that you run almost every year?

Yes. So maybe I can start with the comp deconsolidation. So when we think about the business, it's always with a healthy balance of traffic versus ticket kind of contribution. That's the way we plan our business. I mean, over the last couple of years, you've seen us outperform that especially on the traffic side of things. So again, it's a balance. The way we think about -- we wouldn't -- there's nothing out ahead of us that we would say we would expect anything materially different than that at this stage of the game.

And as far as brand partner support of our key promotional activity, I guess I won't get into specific details about each individual item other than to say we are very close -- work very closely with our brands to deliver the best experience to our guests, and they are active supporters of our efforts in the marketplace. And we anticipate that they'll continue to be that.

Our next question comes from the line of Adrienne Yih from Wolfe Research.

Mary, first of all, congrats on the Chanel Beauté, very, very impressive to land them. I was wondering if you could talk a little bit about how many stores, how many SKUs and the timing of that. And then along with that, the skincare size of -- prestige skincare size of market relative to prestige cosmetics and then your penetration within Ulta in those 2 categories.

Yes, I'm not sure we'd break out all that in so much detail, but I'll tag team this with Dave. Thank you. We're thrilled about Chanel Beauté as well. It will be a pretty -- a small number of stores to start. We're starting Westport, Connecticut, in the next couple of weeks, [ additive ] assortment, beautiful brand. So we're thrilled to continue and deepen that partnership.

Yes. And the assortment will be highlighting the most iconic items. As Mary said a real [ additive ] assortment, we're really excited about the presentation in-store. But it will feature their iconic lipstick, Rouge Coco lip gloss and blush, cream foundation, skincare items. And so we think it will be a really nice presentation of their brand and a nice addition into our portfolio.

Fantastic. And then Scott, just a clarification. On the year-over-year operating margin pressure, is that against the GAAP 13.1% or the 13.8%? And then for Q1, can you help us out a little bit with the gross margin? Because you're opening, I think, more stores in Q1 year-over-year, should we think about more pressure and then having that relieve itself or reverse itself in Q2?

Yes. So it is -- so the guide -- the operating margin guidance is versus the GAAP information. We'll clarify that. And then Q1, yes, interesting -- I'm glad you asked this question because it is important for people. We did state it a few times. Q1 is probably our toughest compare of the year, right. So we had a 14% comp last year. We had some -- we pushed some expenses out of first quarter into the back half of '17. So that helped us as well. So the other things to keep in mind there, I would say, is supply chain deleverage. So we got a new DC in Fresno, California that's going to open up mid-year next year, so some slight deleverage there in the early part of the year and then improving in the back half of the year. And then you're right-on with the store program, so a lot more stores opening up in first quarter '18 than a year ago, plus we're carrying forward somewhat, I would call, higher cost kinds of real estate, right, that we put online second half of last year, Manhattan being the most notable of those that we're still up against here in the early part of the year; so again, fixed door cost leverage, tougher the first half of the year but improving as the year goes out.

Our last question comes from the line of Oliver Chen from Cowen and Company.

Our question is just the evolution of the space and how you're thinking about driving value and experience in the context of Amazon and other pure-play competitors. Just what's on your mind in terms of the shifting needs of the consumer? And how are you prioritizing and what can -- you can do just to make sure you have a competitive advantage along the [ attributes ] of value, of store experience, personalization and customer engagement?

I would say all of the above, Oliver. It's a great question. And I believe we are really well positioned to really be a leader in this category for many years to come, both in the physical space as well as digital, full stop. I mean, to us, this is a category and a consumer that we focus on, the beauty enthusiasts who really loves both the in-store experience to try and discover and get services as well as the convenience and fun of buying online. And so we offer really what nobody else does, and we will continue to do that, so the broadest assortment across all categories and price points, a great in-store experience and online experience that means we just keep getting better, right, services, our loyalty program. And I'd say as we think about our e-commerce platform, we just continue to build out our e-commerce platform in a way that is great. It gives us great control over content, the guest experience, the pricing, the data. So we like the model. We think we're well positioned. And as we think about the future, imagining what that guest wants 5 and 10 years from now in that intersection of the physical and digital world, it's -- that's our job to do. But we believe she'll continue to want to have a physical experience as well. So that's how we think about it. It's a competitive space, but we think we're playing to win. So we will.

And lastly, just as a quick follow-up. On the inventory journey, you've done a really good job managing capital and also the SWIFT system and thinking about accuracy. What are the next steps for inventory in terms of what you want to do and ensuring the omnichannel as well as the supply chain and speed and turns and stocks and service levels are where you want them to be regarding both the customer-facing as well as the planograms in the stores? Just curious about inventory.

Yes. I'd say we're still in the early innings with respect to inventory optimization. So I mean, as you well know, it's a never-ending quest, right, to have the right product at the right place at the right time, which she's interested in purchasing, whether it's on the store shelf or it's in our distribution centers ready to be shipped out to her front door. So we've been making a significant number of investments over the course over the last couple of years with tools. You mentioned SWIFT is one and better space planning kinds of tools in the stores. I mean, our analytical capabilities have improved a lot over the last 3 to 4 years. That will continue. That's the quest again that will be evergreen for us to try to get better and better insights into our purchasing behavior and how we ship things quicker and more efficiently to folks. So there's still a lot of -- I guess, I would say a lot of progress for us to be made there when we think about inventory productivity and inventory turns kinds of things as we look to 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.

I want to close by thanking our 35,000 associates for their commitment to providing a great guest experience and for delivering exceptional financial results in 2017. I look forward to speaking with all of you soon. Thank you.

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