Ulta Beauty, Inc. (ULTA) Q4 2018 Earnings Report, Transcript and Summary

Greetings. Welcome to the Ulta Beauty Fourth Quarter 2018 Earnings Results Conference Call. [Operator Instructions] Please note, this conference is being recorded. I would now turn the conference over to your host, Laurel Lefebvre, Vice President, Investor Relations. Miss Lefebvre, you may begin.

Thank you. Good afternoon, and thank you for joining us for Ulta Beauty's Fourth Quarter 2018 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 reference during this call to non-GAAP sales and earnings growth, adjusted for the impact of the 53rd week and one-time tax-related items in Q4 of 2017. During the Q&A session, we remind you to ask one question only to allow us to have time to respond to as many of you as possible during the hour scheduled for this call. I'll now turn the call over to Mary.

Thank you, Laurel, and good afternoon, everyone. The Ulta Beauty team delivered excellent results for the fourth quarter. This performance reflects an acceleration in the retail comp, primarily driven by traffic, continued strength in mass cosmetics, boutique brands, skincare and fragrance, and stable performance in prestige cosmetics. We're gaining significant share across all major categories, particularly with digitally native brands that our guests are highly engaged with and where Ulta Beauty is often the only point of distribution in brick-and-mortar. Solid execution of our holiday plans by our merchandising, store operations, e-commerce, marketing, supply chain and systems teams drove a successful holiday period across multiple metrics: sales, in-stocks and guest experience. To recap our fourth quarter financial performance. Total sales increased 9.7%, or 16.2% adjusting for last year's 53rd week. We achieved our best comp sales performance of the year with a 9.4% comp on top of an 8.8% comp in the fourth quarter of 2017. The strong performance was driven primarily by transaction growth, with meaningful improvement in the retail traffic trend. Diluted GAAP earnings per share of $3.61 grew 6.2% compared to $3.40 achieved in last year's 14-week fourth quarter, or 31.3% excluding the benefit from tax reform-related items in the fourth quarter of 2017. We delivered these results by executing on our strategic imperatives. And I'll provide an update on each, starting with our strategies to increase loyalty and evolve our brand. Our Ultamate Rewards loyalty program remains one of our most valuable assets. Membership at the end of the year reached 31.8 million active members, representing active member growth of 14.4% compared to 2017. Our store team's sustained focus on conversion benefited from robust store traffic during the quarter. As we anniversaried the launch of our Elite Diamond tier, we are pleased to see the number of guests that attained Diamond level was ahead of plan, with very high guest engagement. The latest loyalty program benefit was launched at the beginning of the new fiscal year with the new perk offering our guests the ability to use points on all skin, brow, makeup and hair services, and guests are loving it. We've been talking about personalization as the next frontier in loyalty. We're currently focusing our efforts around personalization by incorporating relevant product recommendations and replenishment reminders across digital channels, with much more in the works in concert with our acquisitions of QM Scientific and GlamST last fall. I'll cover more on this topic in a moment when I discuss digital innovation. Our credit card program exceeded expectations in 2018, with penetration of credit card sales reaching double digits. Success here was driven by outstanding store associate engagement, effective acquisition campaigns such as gifts with applications, seamless integration into the loyalty calendar and strong support from internal and external partners. Gift card sales grew 24% in the fourth quarter, and this healthy growth helped fuel strong post-holiday sales. Increases in our third-party distribution network drove much of this growth, with the total third-party door count now surpassing 50,000 distribution points. Benefiting from our holiday marketing campaigns, Q4 brand awareness maintained all-time high levels reached throughout 2018 at 55% for unaided and 90% for aided awareness. Brand awareness showed momentum across all generations, with particular strength among Gen X and Gen Z shoppers as well as progress with our Latinas and African-American beauty enthusiasts. We also continue to drive a stronger emotional connection to our brand as a result of our marketing and public relations efforts to advance our new brand purpose, The Possibilities Are Beautiful. Next, I'd like to share an update on our strategy to delight our guests with our merchandise assortment, focused on innovation, differentiation, exclusivity and speed to market. Newness continued to drive traffic and share gains across all categories. Products that weren't in the assortment a year ago drove about 4 points of our total company comp. Top-performing categories were mass cosmetics, prestige boutique brands, fragrance and prestige skincare. Smaller departments like accessories and sun care also delivered double-digit comps. The makeup category overall, through the lens of mass and prestige cosmetics combined, comped exactly in line with the [ house ]. Our strategy to be the partner of choice for digitally native brands like Morphe and Kylie Cosmetics are paying off. Both brands drove very strong traffic in stores, suggesting our guests are motivated to make more trips to the store to try these products in person. Despite a tough comparison to double-digit comps in the fourth quarter of last year, mass cosmetics accelerated to be our best-performing category in the quarter, with Morphe, Revolution Beauty and e.l.f. leading the way. Building on the success of changes to the assortment we made a year ago, we just reset the mass cosmetics area again with more space dedicated to the fastest-growing brands. Morphe expanded to a larger footprint in most stores and is having great success with collaborations with mega influencers, Jaclyn Hill and James Charles. Morphe recently launched its Fluidity Foundation in 600 doors featuring 60 shades, and we also just launched a Morphe makeup fresh collaboration with Jeffree Star, another high-profile social media influencer with 11.5 million Instagram followers. We also expanded ColourPop to 250 more stores, now available in nearly 800 stores. Other brands that earned expansions to either more doors or more shelf space include e.l.f., L.A. Girl, Milani, Wet n Wild and BH Cosmetics. [ Counts ] remained very healthy across Benefit, Clinique, Lancôme and MAC. We rolled out 692 prestige boutiques in total for 2018, and plan to expand the presence of these 4 brands in many additional doors in 2019 in various expressions in our stores, including presence in line, on wall presentations, on endcaps and in impulse fixtures. In the rest of the prestige cosmetics portfolio, top performers included Estée Lauder, Kylie Cosmetics, NARS and Tarte. We have a lot of exciting newness across the portfolio that's encouraging for this category's performance in 2019. Key launches include Tarte face tape foundation, inspired by the iconic best-selling shape tape concealer; Sugar Rush, an exclusive sub-brand from Tarte, specifically created to target the Gen Z beauty enthusiast; a new brow program and makeup pallet from Urban Decay; and the launch of new brands, Smith & Cult and Grande lash. We're also highlighting trends more visibly in our store with a focus on clean beauty, with a vegan beauty endcap, and the expansion of our hottest-in-beauty section in-store. This was launched last fall as an endcap, showcasing new, hot digital brands like Lime Crime, Ofra and Sugarpill, and is moving in line this quarter. To update you on Kylie Cosmetics, which launched in mid-November, we experienced very strong sell-through on the 28 lip products we offer and were essentially out-of-stock for a few weeks at the end of the quarter. This popular brand clearly drove store traffic and new customer acquisition, with an uptick in younger, more diverse guests. Product began flowing back into the stores in late January and we're currently in a much better in-stock position. This week, several new items are setting to add to the original assortment, including eyeshadow palettes and some additional lip products. Fragrance had a banner year, capped with a strong fourth quarter performance that drove double-digit comps. These results were underpinned by our holiday marketing and gift-with-purchase programs as well as the success of our Fragrance Crush program, which highlights a fragrance each month. KKW FRAGRANCE, launched exclusively in brick-and-mortar at Ulta before holiday, was a standout in the portfolio. YSL, Versace and Ulta Beauty exclusive Ariana Grande fragrances were also among the leading brands driving our growth in fragrance. The prestige skin category delivered solid growth, led by strength from Mario Badescu, First Aid Beauty and proactiv. We're broadening our brand portfolio with the addition of new brands like Urban Skin Rx, a line of clinical skincare products designed for women of color; Fountain of Truth, a clean, cruelty-free line developed by Giuliana Rancic; My Clarins, an exclusive line of vegan skincare products from Clarins; and Cannuka, a skincare line infused with CBD and honey. We've also added a curated assortment of Kiehl's products in all doors in our impulse fixtures, and all new stores we open this year will offer the full Kiehl's product line. The overall haircare category also delivered solid growth, with broad-based strength across core professional haircare brands and a successful promotion featuring jumbo sizes of Pro Hair products. Consumer interest in Sugarbearhair vitamins was a highlight in the mass hair category. In summary, the team has done a fantastic job evolving our offerings across the entire box and making sure we have the right brands and products to delight our guests [ to ] create constant newness. Now let me update you on our services business. Salon comp sales rose 6.2%, driven by average ticket increases. Total salon revenue increased 4.7% compared to last year's fourth quarter with an extra week of sales. The salon teams benefited from the healthy traffic in our stores and drove strength across all the major service categories, including color, cut and style, blowouts, hair treatments and makeup. We're seeing encouraging results from the regions that have rolled out our services optimization platform and plan to implement this program for the entire chain in the second quarter. The hallmarks of the services optimization program are our compensation designed to attract and retain top talent, industry-leading internal training and education, simplified menus, transparent pricing and an enhanced field team focused on business and technical training in each district. We continue to test our new salon appointment booking tool in partnership with technology startup Spruce, which has developed an enhanced tool for booking appointments for all services, including hair, skin, brows with the Benefit Brow Bars and makeup with MAC artists. We expect to roll out the booking tool with further enhancements in 2019. Our Ulta Beauty Pro team won the prestigious NAHA, or North American Hair Award, for the Salon Team of The Year for the first time this year. Both the Ulta Beauty Pro team and the Ulta Beauty design team were nominated in this category. This type of recognition highlights Ulta Beauty as an industry leader and authority in salon hair care, raising our profile and helping us attract high-quality stylists. Now I'll turn to store growth. We opened 11 net new stores in the fourth quarter compared to 16 last year and ended the year with 1,174 stores. New store productivity remains very strong. We plan to open approximately 80 stores this year, the majority in suburban strip centers and power centers. The 2019 plan anticipates about 3/4 of the new store portfolio in existing shopping centers and 1/4 in new centers, with almost all stores filling in the existing markets compared to just a couple stores in new markets. Our real estate strategy is evolving to focus on portfolio management with heightened attention on lease renegotiation; evaluating repositioning, relocating or closing stores at the end of leases; and continuing to remodel and upgrade storefronts and pylon signs to ensure consistent branding and shopping experiences across the portfolio. Moving to our e-commerce business. Ulta.com grew comp sales 25.1% on top of 50.4% in the fourth quarter of 2017, and contributed 240 basis points to our total company comp, driven by transaction growth. Total site traffic rose 33%, with mobile site traffic growth up 31% and mobile app traffic up 49%. We're driving healthy growth of our omni-channel members with loyalty members shopping both retail stores and Ulta.com increasing to 12.1% of guests for 2018 compared to 10.4% in 2017. Our e-commerce growth rate was a bit softer than our guidance of mid-30s, which we attribute primarily to a reverse channel shift in light of our guests' avid interest in coming to the store to see and try makeup from digitally native brands like Morphe and Kylie Cosmetics. All of the moderation in our e-commerce growth rate came from the cosmetic category across both prestige and mass. We made the strategic decision to emphasize our in-store offerings with these newer brands with a broader assortment and more inventory allocated for highly anticipated launches like the James Charles palette. As a result, the strength of these digitally native brands was even more concentrated in-store than we planned. Another factor in the top line moderation for Ulta.com relates to e-commerce's higher sensitivity to promotional offers. We saw the bigger impact to our online sales as a result of being less promotional year-over-year. We continue to see strong guest adoption of our buy online, pick up in store initiative. We're expanding focus from the 47 stores that launched in late 2018 and plan to deploy to the full chain this summer. Turning to digital innovation highlights. Following the acquisitions of GlamST and QM Scientific last fall, we're pleased to report that both teams are integrating very well into the Ulta Beauty team. We've migrated our personalization platform to Google Cloud and are bringing to life product recommendations and adding more data such as reviews and clickstream data to amplify our understanding of our guest behaviors. We're also working on conversational commerce and AI-driven communications to automate common guest service inquiries on topics such as birthday gifts and loyalty points. GLAM LAB, our virtual try-on app, recently launched live video on iOS, which will soon be available on Android devices as well. Previously, the app offered only static images. With advances in virtual try-on capabilities, we're mapping out linkages between AI and try-on apps that will have applications in areas such as skin diagnostics or finding the perfect foundation. As a reminder, we won't be breaking out detailed quarterly e-commerce metrics starting in 2019, but we'll continue to provide color on e-commerce trends and its contribution to our growth. Lastly, I'll provide an update on our supply chain strategy. Our supply chain team and operations performed very smoothly during the busy holiday season and delivered excellent in-stock levels while controlling overall inventory levels. Inventory per door grew 1.3%, well below the comp growth rate, as we leveraged core systems such as SWIFT to improve inventory productivity. Our Fresno DC is ramping up more quickly than our previous DCs, now serving 235 stores and 21% of e-commerce orders. We're winding down our Phoenix distribution center, which will officially close later this month. The teams there have done an excellent job transferring inventories to our remaining network and wrapping up the facility closure with minimal disruption ahead of the lease expiration at the end of the month as well as assisting the smooth transitions of our associates into the local job market. We're excited to announce that we're in the process of converting our Romeoville, Illinois, distribution center into Ulta Beauty's first fast fulfillment center planned to open this summer. A second FFC is in the works and expected to open in the summer of 2020 in Jacksonville, Florida. Fast fulfillment centers serve only e-commerce orders and will be able to fulfill up to 30,000 orders per day during peak times, increasing our network capacity and progressing toward our goal of 2-day e-commerce shipping by 2021. Another initiative to speed delivery to our e-commerce guests is our ship-from-store project. We plan to launch a test of ship from store in 5 locations around the country in the second half of the year. So with that, I'll turn it over to Scott to discuss in more detail the drivers of our fourth quarter financials and outlook for 2019.

Thank you, Mary, and good afternoon, everyone. Starting with the income statement. Our 9.4% comp, along with strong new store productivity and e-com growth, drove revenue growth of 16.2% adjusted for the 53rd week of the fourth quarter of 2017. The revenue recognition standard adopted at the beginning of 2018 contributed about $15 million of revenue. As a reminder, this represents the combined impact of income from our credit card program, gift card breakage and the timing of recognition of e-commerce sales, offset by the value of points earned in our loyalty program. We enjoyed the strongest traffic in several quarters with transactions up 7.1% and ticket up 2.3% for the total company. The retail-only comp of 7% was driven by 4.9% transaction growth and 2.1% ticket growth. Ticket was driven 2/3 by average selling price and 1/3 by increases in units per transaction. On the gross profit line, margin improved 90 basis points year-over-year. The new revenue recognition accounting standard added about 60 basis points to the gross profit line and a comparison to last year's special bonuses for hourly associates helped by about 20 basis points. The factors driving the modest underlying gross profit improvement were fewer promotions overall, a lower-than-expected mix of e-commerce sales and strong leverage of rent and occupancy expenses on better-than-expected sales, offset by investments in our salon business and supply chain operations. Turning to SG&A. We deleveraged by 90 basis points, including 90 basis points of impact from the revenue recognition accounting standard. Underlying SG&A expense was flat on a rate basis due to planned deleverage in corporate overhead related to investments in growth initiatives, offset by leverage in marketing and variable store expenses. Operating margin rose 10 basis points year-over-year to 13.3% of sales, including a negative impact of 30 basis points attributable to the revenue recognition accounting change. This was above the 20 basis points impact reported earlier in the year as our guests adopted to open their rewards credit card at a higher-than-expected rate. This, in concert with stronger-than-expected Q4 sales, resulted in guests earning more loyalty points, requiring us to defer more revenue. Moving on to the balance sheet and cash flow. Total inventory grew 10.9% and was up 1.3% on a per-store basis, well below comparable sales as we continue to realize efficiencies from improved systems and processes. Capital expenditures were $319 million for the year, driven by new store opening program, supply chain, systems and merchandise fixtures. CapEx came in a bit below expectations due to some early savings on store fixtures resulting from the Efficiencies for Growth program as well as the timing of some planned IT and supply chain spending that will now fall into 2019. We ended the year with $409.3 million in cash. We repurchased 2.464 million shares at a cost of $616.2 million, or an average share price of $250 for the full year, through our 10b5-1 program. We stepped up our repurchases opportunistically in the fourth quarter to take advantage of our better-than-expected cash flow generation as well as market volatility late in the year. $46.1 million remain available under our $625 million authorization as of the end of the year. Today, we announced a new share repurchase authorization for $875 million, with plans to repurchase approximately $700 million in fiscal 2019. Turning now to guidance for 2019. Our outlook for this year is consistent with the long-term outlook we provided at our November Analyst Day. We plan to open approximately 80 new stores, all our traditional 10,000 square-foot prototype. We plan to remodel 12 stores and relocate 8 stores as well as execute 270 store refreshes or mini remodels, generally entailing the addition of new brands and improvement in overall fixturing. We anticipate driving top line growth in the low double digits with total company comparable sales planned in the 6% to 7% range. We expect e-commerce to grow in the 20% to 30% range, contributing approximately 20 basis points to comparable sales. We expect to deliver earnings per share in the range of $12.65 to $12.85, with approximately 10 to 20 basis points of operating margin expansion. The underlying assumptions are to deliver gross profit improvement driven by merchandise margin expansion, rent and occupancy expense cost leverage and the benefits of our credit card program. These benefits will be offset by deleveraging SG&A due to store labor and investments in growth initiatives and innovation. Areas such as digital innovation, our salon services strategy, expanding our omnichannel capabilities, IT security and infrastructure, personalization efforts, our strategy to pursue emerging brands and initiatives to enhance the guest experience will, as a whole, contribute to corporate overhead deleverage. In terms of the cadence of investments and benefits of these initiatives throughout the year, while we're no longer providing specific quarterly guidance, you can expect EPS growth this year to be slightly weighted to the back half, with more of the benefits of the Efficiencies for Growth cost optimization program occurring later in the year. You can expect low-teens EPS growth and modest operating margin deleverage in the first half, and high-teens EPS growth and modest operating margin leverage in the second half of the year. In terms of capital, we plan to spend between $380 million and $400 million. This includes CapEx of approximately $190 million for new stores, remodels and merchandise fixtures; $140 million for supply chain and IT, including new fast fulfillment centers; and about $60 million for store maintenance and other. Depreciation and amortization expense is expected to be approximately $315 million. We expect our tax rate to be 24%, which does not include any estimates of the impact of share-based compensation. The fully diluted share count for the year is expected to be approximately 58 million. Our plan assumes share repurchases in the $700 million range, contributing about 4 points of earnings per share growth. And with that, I'll turn it over to our conference call host for Q&A.

[Operator Instructions] Our first question comes from Erinn Murphy, Piper Jaffray.

I guess, my question, Mary, is for you. If you could talk a little bit more about how you anticipate some of the personalization efforts you have going on to really be that unlock to driving wallet share higher. Any examples you have there? And then, Scott, just a clarification on the guidance. You talked about the deleverage first half versus leverage in the second half. Is your same-store sales guidance of 6% to 7%, is that fairly similar throughout the year? Or is there a difference in first half versus second half?

Sure I'll start with the loyalty program and I'll ask David to add a couple bits at the end, if he wants. But to give you a full answer, the -- I'd say, overall, the spend-per-member growth is going to be driven by a lot of things, personalization being one of them, for sure. But we're pleased with how it's been progressing. So really, things that we do today, like newness and the perks that we continue to innovate, the credit card program, the tiers like the newest Diamond tier, all are contributing to engagement and driving that spend per member. And as guests mature in the program, their spend just naturally grows over time as well. Personalization is -- I think, we're very much in the early innings on it, very excited about it, and it's really about driving more customized experiences. I guess, one simple example would be recommendations. So the smarter that we can get about a guest's past purchase patterns and infer her preferences or his preferences based on that, it gives us the ability to serve up recommendations that are even more relevant, for example. And if there's any other examples you want to add?

Yes, the other areas we're focused on, certainly, yes, product recommendation, replenishment reminders. We're adding into that additional customized co-purchase recommendations, site personalization. So customizing your site experience based on your previous behavior. For example, if we see that you're a first-time visitor, you'll get a different experience than if you're a frequent visitor. Your homepage might change, we'll do product finders in unique ways. Really, the purchase -- the acquisition of both QM Scientific and GlamST was to accelerate our personalization efforts, and we're really excited about the progress and results to date and feel like we're going to take a big step towards that goal in 2019.

As far as the comp cadence for the year, I would say, generally speaking, it's a pretty consistent 6% to 7% throughout the whole year. Although I would say, maybe the fourth quarter, you might take a little bit more conservative approach on as we'll be comping over some great kickoffs here with Kylie and James Charles here this last fourth quarter.

Our next question comes from Christopher Horvers, JPMorgan.

So I'll slide my 2 questions into 1 as well. So first on the digitally native brands, really impressive in terms of how it drove that traffic and retail comp acceleration. So maybe diagnose, was that more Morphe? I mean, it's in more stores. Kylie had a smaller assortment. There's 18 SKUs or something like that, and it's sold out. So sort of how would you assess that? And would you expect the Kylie piece to accelerate now that the assortment is starting to expand and presumably will expand further over the year? And my second question is for Scott also, which is you gave a lot of color on cadence. Curious on the first half versus back half, how much of that is gross margin versus SG&A? Is gross margin -- as we continue to scale over salon investments, is that the sort of pressure point in gross margin and would you expect that down in the first half?

Possibly 3 questions in 1. Listen, we're excited about the momentum on the business, digitally native brands being a part of it, but frankly, really not the only and most major part. I mean, we had, as I discussed in the script, really strong growth across a lot of -- most of our categories and share gains across almost every single category. And strong double-digit growth across many places. So really, I would say that think about those as definitely big launches. Morphe, we had already launched. The James Charles palette was a nice, good addition because he has a strong following. And of course, Kylie was new and a pretty small assortment. So you can expect that -- I've already said, we're expanding that assortment. That's happening right now. And I'd like to think about it as a plethora of ways that we're going to continue to be the source, I think, leader for growth in the category by participating across categories with the many brand partners that are both existing and new. So I think about it as, I guess, sort of we're all really focused on what are our guests looking for at the end of the day. And if we can make sure to offer that to them, I think we're going to continue to be in a good place.

Yes, so as far as color on the year goes, so we're transitioning into this new sphere, right, this new zone of guidance and annual guidance and whatnot and updating on the quarters. But I know everyone has this question, Chris, so you got to the buzzer first. So when we look at the year...

That was my goal.

The modest operating expansion for the full year, it's going to come on the gross margin line, it's what we expect, and it's going to come through better merchandise margin overall. I think I could point to the clearance event in that second, third quarter time period this last year. We wouldn't expect to have to do that again in 2019. That's not in our plan. You mentioned salon. Yes, that will be a headwind but it's not the biggest driver in there. So that will be some deleverage on the gross margin line. DC leverage in the first half of the year is heavier because of Fresno, right? We won't lap that until the middle of the year. And so supply chain will kind of moderate in the second half. And then, we've got some good occupancy leverage in there throughout the year, but there's a slight shift quarter-to-quarter just because the new store program sequences a little bit different in 2019. SG&A then, it's a net deleverage for 2019 and it's primarily coming out of the investments we're making, right, to drive long-term healthy sales and earnings for the business. So the M&A things we did, right, turning to OpEx now, there's a lot of other innovation. Mary went through a long list of things that we're doing to drive the business, and primarily, those things fall in the SG&A. Corporate overhead is really the primary culprit there, so to speak, on the deleverage.

Our next question comes from Stephanie Wissink, Jefferies.

This is Ashley Helgans on for Step Wissink. We wanted to know, are you seeing a shift in purchasing from prestige to masstige as you continue to add more masstige brands?

Hi, Ashley. We are -- frankly, we're seeing strength across the whole makeup category. Certainly, there's brands across all price points that are doing very well, and there's others that are struggling. So I wouldn't say it's a strength. And one of the -- it's a shift. I will say, one of the strengths that we have at Ulta Beauty is what we call mass migration and bringing a guest in -- a segment of guests in through mass brands and introducing them into prestige brands. That is still continuing. That's quite healthy. It's a unique aspect of the Ulta Beauty experience since we're the only ones that carry brands across all price points. That behavior is still quite strong. And so brands at all price points, from entry-level price points such as e.l.f., all the way up through our most prestige brands, whether it's Lancôme or Chanel, are performing quite well. We are seeing strength. This masstige area of brands with price points kind of in between is a growth area, but it's not really at the expense of any specific part of the business. It's just attractive right now as some of those brands are stronger at this moment.

Our next question comes from Simeon Siegel, Nomura Instinet.

Scott, just recognizing that you lapped that one-time bonus. Just any help in terms of thinking through the SG&A dollar growth? I think you called, or I think you mentioned wage, so just any thoughts there? And then, are you guys seeing -- I don't know if you had mentioned it. As you think about the digital natives and as those grow, is there any difference in terms of the in-store versus e-com performance relative to the rest of your portfolio?

Yes, so we don't really characterize or describe SG&A in dollars growth year-over-year. I know others in the department store and other spaces do that. But just color on SG&A overall, again, it's going to be a net deleverage point for the full year. Heavier maybe the first part of the year as we still got some of the investments that were late starting in 2018, right? We had heavier deleverage in corporate overhead in the second half of 2018, and some of the investment and growth initiatives kind of we got out of the gate a little bit slower in 2018 than we had planned to do. So that will continue into the first half of 2019. Store labor, we'll continue to make investments there to drive growth strategies there. But I think that gets neutralized a lot by some marketing leverage we expect to close on in 2019. So yes, so we're in a good spot overall, we believe, well managed and doing the right things for the business for the long-term.

And then, to your other question, Simeon, I would say, it sort of -- it depends. Overall, digitally native brands are performing well, both online and we're bringing them into the store. So maybe what we just saw on the last quarter, it's a little bit about how we choose to play it, frankly. As we went into this quarter, we emphasized those 2, Kylie and James Charles, launches more in-store, frankly, and it really drove a lot of in-store traffic. They're also doing really, really well online. But we had a bigger assortment in-store. And so I would say that we also have brands that we sell only online that did quite well. So for us, it's about -- I think it actually is a good proof point about the basic thesis of our business, which is that the physical experience of trying on -- trying products in person really appeals to a lot of our guests, and then she also wants to be able to buy it online and be convenient as well. So it's an interesting time for us to say how do we kind of meet the guest where she is, think about how -- what's best for our business, but I don't see any reason why we can't be successful in both channels.

Our next question comes from Steve Forbes, Guggenheim Securities.

So I wanted to focus on the refresh program, right, because I believe 270 is a slight step up versus the trend line over the past couple of years here. So maybe just touch on what the store-level needs are? I know you mentioned, right, new merchandise and fixtures and et cetera, but maybe just focus on what the store-level needs are that are driving this ramp and what the typical refresh will include as it relates to that merchandise focus?

Yes, the primary purpose of this year's refresh program is really to continue to expand some key brand partners that we have. As we go into these stores, we'll, in some cases, address opportunities to enhance or improve or repair certain parts of the store. But we see a big opportunity for us to continue to expand with key brands. And what's going to be a bit different maybe this year versus years in the past when we think specifically around some of our brands like Clinique and Lancôme is we'll be expanding them into a variety of different expressions. In some cases, in a boutique, as you've seen and come to know at Ulta Beauty, but in many cases, in different expressions, whether that's in gondolas, on walls, on endcaps, in other parts of the store. So that's the primary focus of that -- of this year's rollout and improvement with our stores.

And Steve, just from a quantitative standpoint, if we think about it in terms of the total fleet investment, so if you compare new store, 100-plus last year, the 80 next year, the remodel boutique kinds of activities that we have and the merchandising fixtures in general that we're always refreshing our stores, right, in one fashion or another. I think it's actually a step down in net CapEx year-over-year, if you look at it that way. So again, it's a key focus for us. Keep that store fleet looking fresh all the time, keep it inviting and making sure we're delivering the best guest experience that we can.

Our next question comes from Simeon Gutman, Morgan Stanley.

My question is on traffic and ticket. It looks like during the year, ticket actually decelerated and traffic increased. You mentioned in the fourth quarter this reverse channel shift. Can you talk about it for the rest of the year in '18? Should we expect the reversal of that? And then, just as a second part, what's embedded in the 6% to 7% as far as AUR growth for 2019?

Yes, so as far as the traffic trends go, I mean, we know we struggled a little bit and we had some headwinds early in the year, and we picked up momentum. We saw that. We're on it. We're -- the merchant team and all their support partners are working hard to make sure we bring the best that we can, that our guests expect from us and that's going to generate excitement, whether it's in-store or online. So again, going into every quarter, going into every year, our expectation is to drive a healthy balance between traffic, transactions and ticket growth overall with no, I wouldn't say, any one specific expectation for any one of those elements, right? So again, earlier in the year, some of the newness didn't deliver, right? Didn't drive as much excitement in either of the channels as we'd hoped for. We found more winners in the back half of the year, right? And that drives traffic, whether it's online or in-store.

And the AUR part, can you -- because I think, in the fourth quarter, you mentioned that AUR was about 2/3 of the ticket growth, and I don't know if there's a number you can share with us that you expect in 2019, sort of I think of it almost as a head start as part of that 6% to 7% comp outlook.

Yes, I think, sometimes, we try to overengineer our financial models. Again, it's always a healthy balance, whether it's ticket versus traffic or it's units versus average selling price. Again, at the end of the day, these products get hot and things happen that you can't control, right? The guest is going to determine how they want to spend their money.

Our next question comes from Adrienne Yih, Wolfe Research.

Mary, my question is on the loyalty program. I was wondering if you can share with us the percent of Platinum clients that are actually converting to Diamond? And then, are you seeing a replenishment of the Platinum membership? And then, really quickly, for Scott, inventory has been growing slower than sales for the past 4 consecutive quarters. I'm wondering if that's a sustainable spread go forward?

Thank you, Adrienne. We don't really break that out specifically. I'll tell you, we feel really good about the Diamond tier launch. It's ahead of -- I guess, I would say, it's ahead of what we expected so far, which is fantastic because these folks are our best guests in terms of being omnichannel guests, services guests, high share of wallet, et cetera. And we're seeing overall, throughout the loyalty set of folks, as they mature, they spend more, and so we're going to have more of them moving from Platinum into Diamond. And our job is to continue to entice them to spend more through everything that we do every day. And I think all that is working really well. So as I mentioned, whether it's newness; new perks, we just started with being able to use loyalty points on services and that seems to be very appealing; credit card growth; and then the additional ability to use personalization tools. I think we feel good about where we are.

As far as inventory goes, I think we addressed some of that at Analyst Day here back in November. So yes, we expect that we're still in the early stages. I mean, I think it's evidenced, the metrics you referred to. And now, again, I don't know that I'd be able to draw a line, right, and continue in perpetuity some of the performance we've seen here most recently, but we believe we've got the tools and the capabilities in place now to definitely do a lot more by way of optimizing our inventory over the long-term and margin results, right, that are coming from being able better to control the flow, far more automated kind of markdowns, doing better with our transitions and our assortment decisions. So we still think there's a long way to go there.

Our next question comes from Michael Goldsmith, UBS.

So you mentioned that newness drove about 4 points of the comp. Can you help quantify how much of an acceleration that was in past periods? Is this level sustainable? And then, on the channel shift to the real stores this quarter, does that change the way you think about product and brand launches in the future?

Yes, on the -- I don't know if we would break out in the past, Laurel. You can help me with that.

We have broken it out in the past. It was maybe 1/3 or maybe a little bit higher than that, so not a dramatic increase, but it's definitely accelerated, some of the new James Charles and some of the Kylie products.

And the goal is to always drive as much comp as we can. So I mean, I can't -- we can't predict that would be a continued trend. I mean, that was a bit of a -- it worked great, but I wouldn't say that we'd expect it to be ongoing at that level. But our merchant team is constantly out there. There's all sorts of newness all the time and that's what our guests really want, and I think we're doing a good job of delivering that. And as for the channel shift, I guess, in some ways, we're kind of learning as we go. As I said, we're being very direct about the fact that the e-commerce growth was somewhat different than we expected this quarter because it's sort of a high-class problem to have, we have more people shopping in the stores. And I think it's interesting, again, proving the thesis that the in-store experience is extremely important sometimes as well. So I think we'll just continue to be strategic and tactical about how we think about launches. And it's going to vary. There won't be any one formula, I think I'd say, but I think it's good that we have options.

Our next question comes from Michael Binetti, Crédit Suisse.

So you guys came out of the quarter with good momentum in the comp and it looks appropriately conservative to us. But I guess -- the outlook looks appropriately conservative. But I guess the margin break in fourth quarter was a little different than we thought, SG&A flow-through was a little lower on a lot more revenue. I guess I'm just trying to think forward a little bit related to leverage rates given that the guidance you just gave us sounds like it has some investments in the base right now that are leading to a little bit more margin expansion later in the year. But if you do -- with the momentum today, means you're going to have better sales than what you have in the same-store sales guidance this year. How should we think about you guys approach how much flows through to the bottom line this year versus dialing up the investments even more?

Yes, I'd say what we've been through, we've been investing for a long time, right, Mary? I mean, for multiple years now and it's a moving target, Michael. You know that. Retail is a very dynamic environment. So we talked -- I think I referenced supply chain and maybe a little bit less deleverage in the back half of the year, but we're still making big investments through fast fulfillment centers and other tools and things we're putting in place to help our teams perform better day-to-day. So the investment never ends, right? In air quotes, I guess I would say. So -- and we're pragmatic. Whenever we're looking at the quarter and we see sales strength, there's an opportunity to pull back on promotional cadence and things like that. So we're just -- every quarter and every year presents its own unique set of elements that we try to navigate through and just deliver the best overall result.

If I could ask a quick follow-up, Scott. So I think you guys -- I think one of the most interesting parts of the quarter was the changing language on the merch margin. And today, it sounds like the plan is for that to be positive. I think, more recently, the plan was to manage towards a flat merch margin, and frankly, at times, it sounded like that was going to be an aspirational goal. Would you mind telling us what's changed and what you've seen that's giving you the confidence saying, hey, we can actually guide to and manage to a little bit better merch margin than we've spoken to more recently?

Yes, I'd say the primary driver is around Efficiencies for Growth or EFG. So again, we haven't spoken to that directly today. But that's an umbrella over the whole enterprise, right? And so there's a lot of benefits to that, that are going to flow through both the gross margin line and the SG&A line. It's going to help us offset cost pressures that you see all retailers talking about, whether it's innovation things or digital things or wage rate pressures or freight pressures. I mean, there's a whole list of things that we are navigating our way through here. So EFG, I think Adrienne asked a question here earlier about inventory. So that's a key piece of what's going to help merchandise margin. It's not just the out-the-door selling margin, it's how we work with our vendors more efficiently and optimize a lot of the, what I call, the core processes internally around the merchandise assortment and how we transition our stores and how much store labor gets incurred to execute some of those things and the partners we work with and all the economics that go along with that. So that's really it that's driving our assumptions around better merchandise margins here in the foreseeable future.

Our next question comes from Mark Altschwager, Robert W. Baird & Company.

You highlighted how Kylie essentially sold out later in the quarter and it took some time to replenish. And I'm wondering, is that sellout or scarcity going to become a bigger component of the model as you lean in to these -- to the digitally native brand strategy? And if so, how should we think about the implications for merchandise margins longer-term? And then, separately, I'm just -- I'm wondering what percent of your assortment today you would say is unique to Ulta and where you see that metric headed over the next 1 to 2 years?

Yes, Mark, on Kylie, I guess I wouldn't say that there is a one-size-fits-all solution to that. I think, with Kylie, we anticipated potentially having out-of-stocks late in the quarter. It actually happened a little bit earlier as reaction -- consumer reaction was a bit more positive than we anticipated. And it's not our ideal scenario, but it was one that we had planned on for this specific launch. As we look forward with other brands that are in our portfolio, that's not -- we're not experiencing out-of-stocks on a consistent basis and that's not something that we would certainly want to make a practice or a habit. But there will be instances on brands, as they're either building their capacity or the timing makes sense, that we may experience that. But I wouldn't think of that as, now, that's the new normal or a new way for us to approach it. So that in and of itself shouldn't have an impact going forward. As far as the percent exclusive, we talked in the past in the 6% to 7% range. We'll continue to try to grow that over time. I think as we bring in new brands like Kylie and that becomes a bigger part, a big focus for us as we look at new brands, whether they're larger existing brands or new emerging brands, is to drive as much exclusivity as we can. Our guests respond favorably to that. So whether we're the absolute only place or it's in very limited distribution, that's a focus for our merchant team and one we're having a lot of success on, so we plan to continue to grow that number going forward.

Our next question comes from Omar Saad, Evercore ISI.

Stepping back at a high level, most of my detailed questions are answered already, but going back at the high level here, you've got such kind of broad-based strength in your business. You seem to be hitting on a lot of cylinders. You've got a lot of great things in the pipeline. You seem to be really managing that balance between online and off-line. Is it -- as you gain more -- I imagine this is giving you a lot more confidence in the business. As you gain more confidence in the business, does it help you think maybe a little bit earlier, looking ahead towards longer-term opportunities such as international as you just get better and better at what you've been doing? Or is it really still there's so much to do here in the North American market and the U.S. particularly, that remains your focus?

Omar, thank you. That's a great question and certainly something that we work on all the time, thinking about both the short-term, literally the next day, the next quarter, and 10 years from now. So I'd say, first and foremost, I think there's a lot of things for us to do to continue to drive growth in our core business model and that's what we're really, really focused on. So we've got a lot of stores to build, a lot of stores to remodel. We're focused on, frankly, what should the experience of the future be like online and in-store. And in some ways, we've gotten started but there's a lot more that we can and will do there because we don't rest on our laurels, no pun intended. But we fully would expect that what guests would expect in the future in terms of a retail experience is just going to continue to change. So I'd say a lot of what we're focused on is continuing to do what we do well today and then think about how to invent the future of our core model with confidence. I mean, I do feel that we feel that if we play our offense, which is really deep understanding about our guests, really treating our associates well with a culture that seems to be working, and positioning Ulta Beauty as a really inclusive beauty retailer and everything that goes with that, we think we're on the right path. So at the same token, we're absolutely thinking about what does the longer-term future look like to continue to drive shareholder returns, and there's many ways to think about that. So that hasn't changed. We're not announcing doing anything differently today, but that's a fair question and one that we work on.

Our next question comes from Michael Baker, Deutsche Bank.

I guess I'll ask this one. Gross margins, you went through a number of drivers. I don't remember -- forgive me if I missed it. Did you talk about mix towards e-commerce as a potential drag? I don't think you did. In the past, you have. And so is it that that's no longer going to be a drag because the margins there are catching up? Or it's just offset by other things or too small to matter?

Yes -- no, that's built in there. When we're talking about merchandise margin expansion, 2019 specifically, I mean, we're -- nothing's really changed there, the underlying economics of that channel of the business. So again, pressure on the gross margin line. But on the EBIT line, you're right, stores in e-commerce are much -- it's a much closer horse race overall. So again, what we saw in the fourth quarter, right, a little bit more moderate e-commerce growth is good news on the EBIT line, right? So stores still drive a better variable contribution overall. But again, back to the big picture, we have to do both well. We're going to -- we'll take whatever margin characteristics come from either and try to drive the best result we can.

Okay. Understood. And since I waited this long, I'll try to slide in a second one, if I could. Just on the competitive environment, a couple -- at least one of your big suppliers and even a competitor talked about slowdowns in the fourth quarter. You clearly didn't see it, so you're taking share. Can you just describe the different channels within the competitive environment, department stores, drugstores, online, et cetera, what are you seeing?

Yes, we're -- we feel really positive overall. And obviously, in the fourth quarter, we're very pleased with our results. As we look across the competitive landscape, again, we talked about this in the past, beauty is a very attractive category. We are very respectful of our competitors and they're all doing some really interesting things. So we watch across all of them and they're all, whether it's in the mass segment or prestige or online competitors, are certainly formidable and driving changes. We've -- as we look across the marketplace, there have been some shifts in reported metrics around the category. Fortunately, at Ulta, we feel like our collection of products, the balanced assortment that we have across categories and price points, the guest experience that we deliver was able to kind of navigate our business through any changes in the broader marketplace and frankly, be a leader in that. And that's what we're focused on continuing to do and play offense as we deliver a great experience to our guests going forward.

Our next question comes from Daniel Hofkin, William Blair & Company.

Just a couple of quick questions, quickly on the gross margin. If we kind of correct for the channel shift, exclude that factor, it kind of seemed like the promotional backdrop was fairly steady and maybe your merchandise margin also was pretty steady, again, correcting for the channel shift. Is that a reasonable interpretation and kind of your view on that in the near term? And then, secondly, if you could just update us on your thoughts on kind of the urban store opportunity over time, it'd be great to hear any thoughts you might have on that.

All right. So as far as margin characteristics, I think that's a fair way to look at it. I mean, we didn't get into much in the details here, I guess, in the Q&A on margin. But I mean, mix always plays a significant role in what the financial outcomes are. So product mix, fragrance and mass color, we pointed out was stronger. We're taking share there. Those are slight rate headwinds for us overall. But again, we'll take that any day of the week, right, with the sales increases that we saw. And then, we just mentioned the channel shifts. So e-com was a little bit more moderate than what we expected. And actually, that's good news in the short term. So we get a little bit of a tailwind on that on the EBIT line. Merchandise margin target. So we pulled back on promotion, right? We talked about that. Again, people get a little bit overly focused on that 20% off coupon, but there was add back. There's the loyalty points. Don't forget, we called that out in our remarks, right, that, that hurt us a little bit more than we were expecting. But again, that's fantastic news, great for long-term investors. People are engaged in our credit card and our loyalty program and they earned more points than we expected, which hurt rate a little bit in the short-term, but all those guests are coming back in the next few months, right, to use those points in our stores or online. So we think that -- again, we think that's a fair trade.

Yes, and I'll just jump in, Dan, on the question on urban stores. It kind of depends on how you define urban, there's a lot of different ways to describe it. So the vast majority of the stores that we have planned to build, I guess, you'd consider sort of non-urban, more in our traditional kind of power centers. But we have plenty of urban stores or city stores that we like and that do well. I'd say, the addition of more -- I wouldn't call them flagship, more high-profile stores, like the Manhattan Upper East Side and Michigan Avenue, has also been great in terms of just expanding awareness and presence of Ulta Beauty as a retailer. But those kind of things have a different cost scenario in terms of how to run them. And so we're just going to continue to be really selective. And there's going to be spots where we like the footprint, we like the parking, we like the -- what's around us, and they'll be few and far between, I think, because really, our model tends to not be super urban and does fine.

Our next question comes from Ike Boruchow, Wells Fargo.

Just a quick question for Mary or Scott. Just I think, 2, 3 years ago, you guys targeted 10% of sales for your e-com business. You're above that now but it looks like the growth rate is also starting to change. The quick 2 questions is, can you give us an update of where you think that penetration ultimately should go over the next couple of years? And then, more specifically, if you are in a situation where the e-com growth rate is decelerating a bit while the store comps are actually accelerating, Mary, to your point earlier in the call, does that change your view of the ultimate margin of the business, meaning getting more sales out of a higher-margin channel for Ulta versus the e-commerce channel? I guess those are my 2 questions on e-com.

Well, I would say, first of all, the e-commerce, the way we guided for this year is consistent with roughly where we're feeling as we looked at our longer-term plan, that we're off a very big base and that we'll be pushing $1 billion in sales. And so we naturally expected that to moderate. And so I don't -- I think the fourth quarter may have been a bit of an anomaly. We'll see in terms of that dynamic. But again, I think, our job is to just stay smart and flexible with the levers that we have and understand the dynamics that's happening from a consumer behavior perspective. There's no way, shape or form that the importance of e-commerce as a channel is going to diminish, it's only going to grow. And so we need to continue to make sure that we're a great omnichannel retailer as well as a great brick-and-mortar retailer. I think it's kind of the best way to answer it. And then, the...

Yes, I don't really think there's anything, my crystal ball out here on the table, as far as margin characteristics over the long-term. Again, I'm a conservative person by nature. I'd say there's inherent headwind built into that piece of the business, right, regardless of the scale, at least the scale that we're talking about here as a specialty retailer. And so, again, we're working hard every day with tools, with our supply chain, road map, build-out of facilities, to get closer to customers, maintain maximum flexibility as things continue to evolve there and just hoping that we make smart decisions along the way.

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

Great. I'd like to wrap up by thanking our 45,000 associates for delivering an excellent 2018 and teeing up 2019 to be another year of strong top and bottom line growth. I think our team is really well positioned to execute on a host of growth and efficiency initiatives to drive the long term success of our business and create significant shareholder value. So I look forward to speaking with all of you again soon. Thank you.

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