Ulta Beauty Q3 2023 Earnings Call Transcript

Presentation

[Operator]

Good afternoon, and welcome to Ulta Beauty's Conference Call to discuss results for the third quarter of fiscal 2023. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce Ms. Kiley Rawlins, Vice President of Investor Relations. Ms. Rawlins, please proceed.

[Kiley Rawlins, Vice President of Investor Relations at Ulta Beauty]

Thank you. Good afternoon, everyone, and thank you for joining us for a discussion of Ulta Beauty's results for the third quarter of fiscal 2023.

Hosting our call today are Dave Kimbell, Chief Executive Officer; and Scott Settersten, Chief Financial Officer. Kecia Steelman, President and Chief Operating Officer, will join us for the Q&A session. Paula Oyibo, Senior Vice President of Finance, is also on the call with us today.

Before we begin, I'd like to remind you of the company's safe harbor language. The statements contained in our 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 caution you not to place undue reliance on these forward-looking statements, which speak only as of today, November 30, 2023. We have no obligation to update or revise our forward-looking statements, except as required by law, and you should not expect us to do so.

We'll begin this afternoon with prepared remarks from Dave and Scott, and then open up the call for questions. To allow us to accommodate as many questions as possible during the hour scheduled for this call, we respectfully ask that you limit your time to one question and one follow-up question. If you have additional questions please requeue. As always, the IR team will be available for any follow-up questions after the call.

Now I'll turn the call over to Dave. Dave?

[Dave Kimbell, Chief Executive Officer at Ulta Beauty]

Thank you, Kiley, and good afternoon, everyone. We appreciate your interest in Ulta Beauty. I'll start today with comments about our CFO transition plans and then discuss our third quarter performance. Then Scott will review the financial results and our outlook.

Starting with the succession plans we announced this afternoon. After nearly 20 years with Ulta Beauty and more than a decade as CFO, Scott Settersten, has shared with us his decision to retire, effective April 1, 2024. From his early days helping take Ulta Beauty public, and throughout the last 10 years as CFO, Scott's impact on Ulta Beauty has been tremendous. He's been a passionate steward of our business and the strong and constant shareholder returns achieved during his tenure are a testament to his leadership and disciplined approach to driving profitable growth. I want to express my sincere gratitude to Scott for his partnership and his remarkable contributions to our business. He has been an exceptional partner to me and an inspirational leader for our team across the company.

With Scott's retirement, I'm very pleased to announce that Paula Oyibo will be our next Chief Financial Officer. Paula is a dynamic finance executive with broad industry experience, and I am confident she is the right leader for this next chapter of Ulta Beauty's growth. Since joining the company in 2019, she has established herself as a trusted partner and visionary leader. Her deep understanding of our business, experience leading large finance organizations and strong commitment to nurturing talent with an inclusive culture make her the ideal person to serve as Ulta Beauty's next CFO. Paula will be a great addition to our dynamic executive team, and I look forward to partnering with her as we continue our growth journey.

This announcement represents another great succession story for Ulta Beauty. I am grateful to Scott for being intentional and thoughtful in ensuring we have a seamless plan for this critical leadership role. And I am excited that Paula will bring her business-first mindset, influence and energy to the executive team.

Okay. Now let's talk about our third quarter performance. The Ulta Beauty team delivered strong performance again this quarter, with sales, gross profit and EPS all exceeding our internal expectations. Our traffic trends remain healthy, our brand awareness and loyalty program reached all-time highs, and our transformational initiatives are on track. I want to thank all Ulta Beauty associates for maintaining their focus on creating great guest experiences and delivering these results while executing against our transformational agenda.

For the quarter, net sales increased 6.4% to $2.5 billion. Operating profit was 13.1% of sales and diluted EPS was $5.07 per share. Comparable sales increased 4.5%. As discussed on prior calls, we expected the sales growth to moderate from the first half as we lapped two years of strong double-digit comp growth. Comp sales growth for the quarter was driven by approximately 10% growth from our digital channels. Stores delivered low-single-digit comps as we lapped high-teen growth last year. Store traffic remained healthy, increasing in the high-single-digit range.

Turning to performance by category. Skincare was again our fastest-growing category, driven by double-digit growth in mass and prestige segments. Beauty enthusiasts have maintained their skincare routines while also experimenting with new regimens. Consumer interest in moisturizers, serums and cleansers is driving growth, and brands leading into these trends like Drunk Elephant, Good Molecules and COSRX contributed to our strong results. Dermatologist-recommended brands also continued to resonate, driving growth for brands like La Roche-Posay, Cetaphil and Dermalogica.

The fragrance and bath category delivered low-double-digit growth. Newness from Ariana Grande, Burberry and YSL contributed to the category's performance. Prestige brands, Valentino and Carolina Herrera, and luxury brands, CHANEL and Dior also drove meaningful growth.

Sales in the makeup category were flat, with mid-single-digit growth in mass makeup offsetting a modest decline in prestige makeup. New brands like Dior and NATASHA DENONA and Beautycounter and existing brands with compelling newness and innovation, including e.l.f., Juvia's Place, MAC and OPI, all delivered growth during the quarter. While many mass brands continue to benefit from engaging newness and social engagement, our prestige makeup business was more challenged as we continue to lap the strong impact of last year's Fenty launch.

Finally, comp sales for the hair care category decreased in the low-single-digit range, primarily driven by a decline in hair tools. Newer brands, including exclusive brand LolaVie and Shark Beauty and Donna's Recipe as well as newness from Not Your Mother's and OUAI deliver growth for the category. Trend-relevant products from Redken and Biolage resonated strongly with guests while social virality drove growth for IGK and Mielle.

Comparing to mass beauty dollar sales for the 13 weeks ended October 28, 2023, we continue to outpace the growth of the mass market according to Circana data. In prestige beauty, our share gains in skin care and fragrance were offset by softness in makeup and hair according to Circana. From a channel perspective, we gained prestige beauty share across digital channels, but were more challenged in brick-and-mortar channels, reflecting the impact of increased distribution for prestige beauty. While these dynamics increased competitive intensity in the short term, we are confident our sales-driving strategies will support our ability to capture more market share over the long term.

Our services business delivered high-single-digit comp growth, primarily driven by engagement in core services, including haircuts, blowouts and makeup services. Ear piercing, one of our newer services also performed well, and salon backbar takeovers, which give our stylists an opportunity to introduce brands to guests continue to drive product attachment and new guest acquisition for participating brands.

Unlike other discretionary retail categories, the U.S. beauty category has consistently driven growth over time. Based on data from Euromonitor, in the 15 years prior to the pandemic, the U.S. beauty category grew in the low- to mid-single digit range every year except during the Great Recession when the category experienced low-single-digit declines and in 2020 when the category declined 6%. In 2021 and 2022, the category experienced unprecedented double-digit growth as consumers recovered from the pandemic. And as we lap the strong growth this year, consumer spend has remained healthy. While we expect growth will continue to normalize to historic ranges, we remain confident the category will continue to grow, barring a macroeconomic event.

In addition to factors that have driven the category historically, including a strong emotional connection with consumers, newness and innovation, and societal changes, today, consumers are thinking differently about the role beauty can play in their wellness routine, which we believe will drive increased usage for the category.

As we think about the opportunity to expand our market leadership and drive long-term profitable growth, our strategic framework guides our priorities and focus. Let me share some highlights and the progress made this quarter.

Starting with our efforts to drive growth with an expanded definition of All Things Beauty. During the quarter, we enhanced our assortment with trend relevant brands in every category. In makeup, we introduced luxury brand, PAT McGRATH LABS, expanded our presence with MAC to nearly all stores, launched several exclusive and innovative brands, including HALF MAGIC, Polite Society and Rabanne. In skin care, we launched PanOxyl, a dermatologist-recommended brand popular with Gen Z. In haircare, we launched Shark Beauty, an innovative brand of hair styling tools at accessible price points. And in fragrance, we launched Snif, an emerging brand offering gender-neutral sense available only at Ulta Beauty.

Building on our long-term partnership with CHANEL and other luxury fragrance brands, we see an opportunity to expand our luxury offering into makeup and skincare. In Q1, we launched Luxury at Ulta Beauty and our member analytics confirms that our new luxury assortment is driving incrementality and increased spend per member.

In addition to strengthening our core assortment, we are leaning into broader trends in beauty through our cross-category platforms. We continue to expand our Conscious Beauty platform. At the end of the quarter, more than half of our brand portfolio was certified in at least one pillar, with 260 brands certified in more than one pillar. Newly-certified brands include COSRX, Loving Tan and Polite Society. We also increased our portfolio of BIPOC brands, welcoming PAT McGRATH LABS, CurlMix, BETTER WORLD FRAGRANCE HOUSE by Drake and POUND CAKE to the portfolio. And we expanded our wellness assortment with the launch at -- of at-home spa tools from LUV SCRUB, Solawave and Skin Gym.

In addition, we expanded the wellness shop to an additional 500 stores and refresh the presentation with elevated aesthetics, improved navigation and more storytelling graphics to inspire and educate our guests how to connect to wellness in their everyday lives.

Guests are moving effortlessly between physical and digital channels, and we are investing to enhance the guest experience across all touch points. We have been on a multiyear digital transformation journey to upgrade our infrastructure and deliver a more engaging and seamless digital guest experience while also positioning future growth. In August, we completed a significant step in this process with the transition of our digital commerce experience, including cart, emotions, checkout and member account data to our new architecture. Overall, our team successfully executed these changes, and I am pleased to report our new digital experience performed very well over the high demand Thanksgiving weekend, including Cyber Monday.

The modernization of our digital technology ecosystem is nearly complete, enabling us to elevate and optimize our existing guest experience while driving digital innovation, utilizing a modern, agile approach.

In addition to our digital platforms, we are also enhancing our in-store experiences. Our member data demonstrates that an excellent guest experience drives spend, increased frequency and creates lasting loyalty. This quarter, we launched a refreshed guest engagement model, which elevates the guest experience through authentic engagement, helpful experiences and friendly interactions to create a genuine human connection. While still early, we are encouraged by the improving trends in guest satisfaction scores.

We continue to expand and enhance the Ulta Beauty at Target experience. We opened 89 Ulta Beauty at Target shops during the quarter, ending the quarter with 510 shops. This quarter, we were excited to launch FENTY BEAUTY, delighting our guests with a new way to shop this fan favorite brand. Created exclusively for Ulta Beauty at Target, the Fenty snacks assortment features a curated lineup of best-selling must-haves, minis, and unique sets. And just in time for holiday, we launched a curated assortment of Dyson hair tools in select stores and exclusive holiday sample kits in all Ulta Beauty at Target shops.

Beauty is an emotionally-driven category, and we are investing to drive greater love, loyalty and connection with Ulta Beauty. We continue to strengthen the Ulta Beauty brand, unaided brand awareness increased to a record level this quarter with meaningful gains among Gen Z and millennial beauty consumers. We also expanded the connection guest field for Ulta Beauty as measured by significant growth in brand love. These gains reflect the impact of our strategic brand building efforts as well as our marketing actions to support key promotional events and brand launches.

At Ulta Beauty, our mission is to use the power of beauty to bring to light the possibilities that lie within each of us. Building on our commitment to make beauty as a force for good, we've created The Joy Project, a multiyear initiative to make beauty and the world a more joyful place. We launched The Joy Project in September with an integrated campaign across national TV, PR, social media and our owned channels. In addition, we created a training curriculum for transforming the way our associates think about self-confidence, and to give them tools to empower our guests to do the same. In October, we expanded The Joy Project while reinforcing our role at the intersection of beauty and culture as the exclusive beauty partner for TikTok's first ever beauty month. Grounded in TikTok's theme of reclaimed joy, this month-long activation leveraged creator content and events, premium platform advertising placements and custom filters that allowed users to see their inner joy.

We continue to adjust our promotional strategies as the category normalizes and consumers navigate rising cost pressures. Responding to consumer needs and competitive shifts, we continue to evolve our key tentpole events like 21 Days of Beauty, while also deploying new offers with more relevant storytelling to drive sales and traffic. While our promotional activity increased this quarter, our targeting capabilities and promo optimization efforts enabled us to manage the financial impact. Notably, overall promotional levels remained meaningfully below 2019 levels.

Turning to our loyalty program. We ended the quarter with 42.2 million active members, 8% higher than last year, driven primarily by improving member retention and new member acquisition. Spend per member remains healthy, driven by greater shopper frequency. As we engage members with exclusive promotions, point accelerators and personalized content and recommendations, we are driving engagement spend and frequency. These targeted efforts are also enabling us to elevate more members to our platinum and diamond tiers. Compared to last year, the number of platinum and diamond members has increased more than 20%.

Turning now to our efforts to drive operational excellence and optimization. We are executing a multiyear transformation agenda intended to unlock new capabilities and efficiencies to fuel our growth. In addition to the digital store progress achieved this quarter, we continued to advance our road map in other key areas. We completed the retrofit of our Greenwood distribution center, began shipping to stores and fulfilling e-commerce orders from our new Greer market fulfillment center and transitioned our Chambersburg distribution center to our new ERP platform.

Our teams have delivered several major milestones this year, and we are on track to complete many of our transformational projects next year. We plan to complete the transition of our digital store in the first half of 2024, and we expect to complete the upgrade of our ERP platform and the expansion of our data management systems in the second half of 2024. We will advance our supply chain optimization efforts next year with the continuation of our Dallas DC retrofit, as well as the conversion of our Romeoville, Illinois fast fulfillment center to a new market fulfillment center.

Finally, as the nation's leading specialty beauty retailer, we strive to be good stewards of our environment. Reflecting our commitment to leave a positive legacy, I am excited to share we have established a mission reduction goals approved by the science-based target initiative. Details of our commitments are available in the ESG section of our investor website.

Shifting now to our plans and expectations for holiday. The holiday is off to a good start. But we know the biggest selling weeks are still ahead of us. Our insights suggest that consumers are ready to celebrate even as they navigate in an uncertain economic environment. With our diverse assortments and convenient omnichannel touch points, we are well positioned to help our guests celebrate this season.

Our holiday campaign this year is the gift is just the beginning, which underscores our belief in the power of beauty and Ulta Beauty. While a gift can be a signature fragrance or an innovative hair tool, beauty can also be the gift of self-care, fun and joy. Through this campaign, we're celebrating the moments that make the holiday special, family, friends, connections, joy and pairing them with the perfect gifts. Our merchants have thoughtfully created a holiday assortment of exclusive first-to-market items along with iconic classics. With products across mass, prestige and luxury, we offer guests both value-first and splurge-worthy items to help them find perfect budget-friendly guests for others or themselves.

Our store teams are ready to bring the holiday to life for our guests. Our new POS system enables associates to easily order items not currently available in their store and our new mobile POS tools provide guests with an elevated and faster checkout process. And with BOPUS and same-day delivery options in every store, it's never been easier or more convenient to shop at Ulta Beauty. Our teams have been working hard all year to ensure Ulta Beauty is ready to bring joy to our guests this holiday season, and I am proud of how well they are executing for our guests.

While the beauty category will likely be a bit more promotional this holiday season, I'm confident our marketing and assortment strategies combined with new capabilities will position us to deliver another successful holiday.

In closing, the beauty category remains healthy, and consumer engagement remains high. We remain confident in the resilience and power of beauty and in our ability to drive market share and profitable growth.

And now I will turn the call over to Scott for a discussion of the financial results. Scott?

[Scott Settersten, Chief Financial Officer, Treasurer and Assistant Secretary at Ulta Beauty]

Thanks, Dave. Good afternoon, everyone.

I want to echo Dave's sentiments and thank the Ulta Beauty team for delivering third quarter financial results that were ahead of our internal expectations. Solid sales growth supported by strong guest traffic and new store sales performance helped to mitigate some of the unique margin pressures we faced in the third quarter and enabled us to deliver gross margin modestly ahead of plan. SG&A spend was in line with expectations, resulting in operating margin of 13.1%.

Turning to the P&L. Net sales for the quarter increased 6.4%, driven by 4.5% growth in comp sales, strong new store performance and solid growth in other revenue. Transactions for the quarter increased 5.9%, driven by healthy traffic across both channels. Average ticket decreased 1.4% as the decline in average units per transaction more than offset the impact of a higher average selling price.

While retail price increases remain a benefit to our comp performance, the overall environment continues to normalize, and we are seeing the extraordinary pricing benefits from last year continue to roll off. We estimate price increases contributed less than 200 basis points to the overall comp in the third quarter.

During the quarter, we opened 12 new stores and relocated two stores. In addition, we remodeled 11 stores.

Q3 gross margin decreased 130 basis points to 39.9%, compared to 41.2% last year. The decrease was primarily driven by lower merchandise margin, higher inventory shrink and higher supply chain costs, which were partially offset by strong growth in other revenue. Overall merchandise margin was lower primarily due to lapping the timing benefit of retail price changes last year, as well as increased promotional activity this year. While promotional activity continues to normalize, the overall financial impact remains meaningfully below 2019 levels.

Inventory shrink continued to be a headwind. Our efforts to address shrink appear to be stabilizing the impact, but the overall environment remains challenging. In addition to new fragrance fixtures, which have been installed in nearly three quarters of the store fleet, we continue to invest in associate training, staffing and operational improvements to mitigate the impact of shrink. And we continue to work with our retail industry partners to influence macro changes aimed at improving the overall environment.

Supply chain costs were higher during the quarter, reflecting depreciation related to investments in our supply chain transformation, as well as the recent opening of our new market fulfillment center in South Carolina. These gross margin pressures were partially offset by strong growth in other revenue, primarily due to growth in both credit card income and royalty income from our Target partnership.

SG&A increased 10.8% to $661.4 million. As a percentage of sales, SG&A increased 110 basis points to 26.6%, compared to 25.5% last year, primarily due to higher corporate overhead, greater store expenses, investments in store payroll and benefits, as well as higher marketing expense which more than offset lower incentive compensation.

Corporate overhead expenses were higher in the quarter primarily due to investments related to our strategic priorities, including Project SOAR, Digital Store, other IT capabilities and UB Media. Year-to-date through the third quarter, we have invested about 75% of our planned $60 million to $70 million of incremental spend to support our strategic initiatives.

Store expenses were higher in the quarter, reflecting ongoing inflationary pressures across the business. The increase in store payroll and benefits was primarily due to the impact of planned investments in average wage rates.

Higher marketing expenses in the quarter were largely driven by increased investments to drive member acquisition, loyalty and brand awareness across key channels, including social, video and streaming.

Lower incentive compensation was a benefit in the quarter, reflecting operational performance that is more in line with our internal targets compared to last year's significant outperformance.

Operating income for the quarter declined 9.6% to $327.2 million. As a percentage of sales, operating margin decreased 240 basis points to 13.1% compared to 15.5% last year.

Diluted earnings per share decreased 5.1% to $5.07 per share compared to $5.34 per share last year.

Turning to the balance sheet and cash flow statements. Total inventory increased 9.8% to $2.3 billion, compared to $2.1 billion last year. In addition to the impact of 31 additional stores, the increase reflects inventory to support higher demand and the stocking of our new market fulfillment center in South Carolina, as well as new brand launches and product cost increases.

Capital expenditures were $106 million for the quarter, reflecting investments in new and existing stores as well as supply chain and IT investments to support our transformational agenda.

Depreciation was $61.4 million in the quarter compared to $58.5 million last year.

We repurchased approximately 687,000 shares at a cost of $281.5 million. Year-to-date, we have repurchased 1.8 million shares at a cost of $840.5 million.

During the quarter, we drew on our revolving credit facility to support our ongoing capital allocation priorities, including share repurchases and capital expenditures during the period in the year when our working capital needs peak as we build inventory for holiday. I would note our recent activity does not reflect a change in our capital allocation philosophy rather a lever to short support short-term cash needs.

We ended the quarter with $195.4 million in short-term debt and $121.8 million in cash and cash equivalents.

Moving to our outlook. We are narrowing our sales and EPS guidance for fiscal 2023 to reflect our actual performance through the first three quarters of the year and our expectations for Q4. We expect net sales for the year will be between $11.1 billion and $11.15 billion, with comp sales growth between 5% and 5.5%. For the year, we continue to plan to open approximately 25 to 30 net new stores and remodel or relocate 20 to 30 stores. Our expectations for operating margin for the year remains unchanged, at between 14.6% and 14.8% of sales, with deleverage to come from both gross margin and SG&A, with slightly more deleverage coming from SG&A. Reflecting these assumptions, we now expect diluted EPS for the year will be between $25.20 and $25.60.

We have refined our expectations for Q4 to reflect the expected resilience of the beauty category as well as potential risks from cautious consumer spending, increased points of distribution for prestige beauty and higher promotional activity. We continue to expect comp sales will be flat to up modestly for the fourth quarter. We still have several important weeks left in the holiday season and the operating environment continues to be dynamic. In addition, we are lapping the exceptional results last year, including an incredibly strong January, which was our strongest monthly comp sales performance of fiscal 2022. For modeling purposes, we now expect gross margin to deleverage modestly and operating margin to be flat to down compared to last year.

One final update. We now expect to spend between $400 million and $425 million in CapEx in fiscal 2023, including approximately $180 million for supply chain and IT, $170 million for new stores, remodels and merchandise fixtures, and about $60 million for store maintenance and other. We expect depreciation for the year will be around $245 million. We now expect share repurchases to be approximately $950 million.

Our teams delivered another solid quarter amidst a dynamic operating environment. As we look ahead, we are focused on delivering our plans for the holiday season and finalizing our plans for next year. We will share more about our expectations for fiscal 2024 when we report our year-end results. But we remain confident. We are well positioned to deliver performance in line with our financial targets of 3% to 5% comp sales growth and 14% to 15% operating margin, with EPS growth next year, reflecting the lapping of an extra week in fiscal 2023.

Before I turn it over to our operator to moderate the Q&A, I want to take a moment to say thank you. It has been an honor and a privilege to serve as CFO for this special company for more than a decade. I look forward to passing the baton to Paula Oyibo, who I've worked with closely over the last several years. We will continue to work together over the coming months to ensure a smooth transition. Thank you again.

And now I'll turn the call back over to our operator to moderate the Q&A session.

Questions and Answers

[Operator]

Thank you. [Operator Instructions] Our first question comes from the line of Dana Telsey with Telsey Advisory Group. Please proceed with your question.

[Dana Telsey, Analyst at Telsey Advisory Group]

Hello, everyone, and congratulations on the nice results. And Scott, congratulations on such a wonderful tenure at Ulta, and looking forward to your next chapter. And Paula, congratulations on the new role.

As all of you think about the beauty category, which obviously is such resiliency in your sales up around 6%, how do you feel on the category trends with makeup and what we see there as that evolves going into next year, product newness, pricing? How do you parse it together? And looking at the gross margin and SG&A levers, the lower merchandise margin that you had and the higher shrink, how do you see that evolving going forward? And what's changing in the promotional and pricing area? Thank you.

[Dave Kimbell, Chief Executive Officer at Ulta Beauty]

Great. Well, thanks for those nice comments about Scott and Paula, and I appreciate that. And I'll start with some thoughts about the beauty category and makeup specifically, to answer your question there, and then maybe Scott can pick up on the gross margin.

As I mentioned in my comments, we remain very confident about the long-term future of the beauty category for all the reasons I highlighted, a steady stream of compelling newness, high level of engagement, emotional connection. The connection between wellness and beauty that's stronger than ever coming out of the pandemic give us confidence more broadly in beauty. And then makeup specifically, is an important part of that. And while the makeup category for us was essentially flat for the quarter, we are confident in the future of that important part of our business. We see strong positive trends, a high level of engagement across all demographic groups. And as we get into both completing this fourth quarter and moving into next year, we're confident in what will drive -- driving our makeup business.

Some of the actions that we've taken specifically and make up to drive this business forward, continuing to launch several new exclusive makeup brands, brands like HALF MAGIC, which was created by the Euphoria makeup artist. Polite Society, a prestige brand, exclusive again to Ulta, from the creators of Too Faced. Rabanne, which is a contemporary Spanish fashion brand, launching into cosmetics exclusively at Ulta. We're just getting started with those three exclusive brands at Ulta Beauty. We continue to see strength with MAC, and we've expanded that into nearly all doors. Strong growth on key mass brands like e.l.f. and with great compelling innovation within that segment of the makeup business.

I talked in my remarks about luxury and we're -- while we've expanded that throughout the year, we feel like we're just getting started there. We launched -- expanded CHANEL, launched Dior and NATASHA DENONA this year, and then added PAT McGRATH in the third quarter.

In new items with existing brands continue to make a difference in the category and we're confident in what's ahead. A couple of recent examples. Tarte's Shape Tape, Radiant Concealer, exclusive at Ulta Beauty. Juvia's Place, blush liquid -- blushes, exclusive at Ulta. And newness from other existing brands like Clinique, Benefit, Anastasia, NYX, Maybelline, go down the list.

So we're confident. We're lapping the biggest launch we had with Fenty from 2022. But as we look forward, we see both the items that we've launched and more newness coming as we enter into 2024. We're confident and optimistic both in the consumer engagement and makeup and beauty in general and our specific strategies to drive growth.

Scott, do you want to talk about margins?

[Scott Settersten, Chief Financial Officer, Treasurer and Assistant Secretary at Ulta Beauty]

Sure. Thanks, Dana. So I give you a little bit more maybe than you were thinking about when you initially put this question together because I'm sure it's on other investors' minds as well.

So thinking about '24 and beyond, and again, this is directional in no particular order, but I kind of start with the headwinds. So supply chain transformation will continue to be a tougher compare for us as we think about next year as we continue to build out in and work through our distribution centers across the country. E-commerce mix, we've talked about, again, it's been a bit of a benefit for us the last couple of years. We expect e-commerce to grow at a higher rate than brick-and-mortar, next year and the years to come, and so that will be a headwind for us in gross margin. Again, we've got ways to mitigate that now, that we didn't have back in 2019, namely BOPIS, ship from store and same-day delivery.

So those would be the headwinds. I'd say promotionality is something I call kind of a TBD. So again, 2023 has been a bit of a deleverage point for us because we're getting back into a more normal environment. It's yet to be seen on how 2024 will shake out. So that's something we'll have to navigate.

On the plus side, you mentioned a couple. Well, other revenue, number one, again, 2023, it's been a big tailwind for us. We would expect that to continue, although moderating a bit in '24. Cycling over price increases this year has been a major headwind to the business in the gross margin line. That will moderate as we get into -- deeper into 2024 and cycle through some of that. Shrink, we called out third quarter. We we're gaining on it a little bit. Again, it's not mission accomplished by any stretch of the imagination, but we do feel like we've got tactics in place now that will help us get that better managed. UB Media as that business continues to scale up, we expect that to be a margin benefit for us and then, of course, fixed cost.

Again, in the third quarter, a bit of an anomaly with some of the repair and maintenance expenses that we absorb, but over the long term, we expect to be able to kind of leverage fixed store cost on a 3 to 5 times [Phonetic].

[Dana Telsey, Analyst at Telsey Advisory Group]

Thank you.

[Operator]

And our next question comes from the line of Lorraine Hutchinson with Bank of America. Please proceed with your question.

[Lorraine Hutchinson, Analyst at Bank of America Securities]

Thank you. Good afternoon. You mentioned some brick-and-mortar share loss in prestige in the quarter. Can you talk about strategies, brand launches, marketing that you're working on to defend the sharing and return to growth?

[Dave Kimbell, Chief Executive Officer at Ulta Beauty]

Yes. Thanks for the question, Lorraine. Yes, yes, we -- it is our objective to gain share across all parts of our business, and we did -- we feel positive about that in many parts, including our mass business, our prestige skin care, our prestige fragrance business, our prestige e-commerce business. But brick-and-mortar was pressured. And we think that's largely due to a expanded points of distribution. There are hundreds more brick-and-mortar locations in the market now than there were even just a couple of years ago.

But what we see is more of a short-term impact from this competitive -- kind of the competitive pressure. Historically, as we've seen new locations open near our existing locations, there's a short-term modest impact. But relatively quickly, our stores are able to rebound and recover and to drive growth -- share growth over time. So largely, what we're seeing, and we're confident in the path ahead that our strategies -- our holistic strategies and everything that we're doing across our assortment, across our brand engagement, our loyalty program, and then certainly, the human experience that we uniquely deliver in our stores, give us a lot of confidence that while there's some short-term pressure year-over-year, we're still stronger in share than we were pre-pandemic, and we're confident in growth behind our strategies going forward.

[Lorraine Hutchinson, Analyst at Bank of America Securities]

Thank you.

[Operator]

Our next question comes from the line of Mark Altschwager with Baird. Please proceed with your question.

[Mark Altschwager, Analyst at Robert W. Baird & Co.]

Good afternoon. Thanks for taking the question. And Scott and Paula, congratulations to each of you. So for the Q4, you mentioned that you refined your outlook given some of the risk to consumer spending and endpoints of distribution. I guess, but overall, you are raising the low end of your guide, Q3 a bit better than your internal expectations. So maybe just give us a little bit more detail on how your views on category spending and the promotional backdrop have changed versus three months ago?

[Dave Kimbell, Chief Executive Officer at Ulta Beauty]

Yes. I would -- yes, so I'll start, and let Scott give a little insight here.

When we look at the promotional environment, maybe I'll start there, Mark. As we highlighted in the third quarter, the promotional environment was higher in Q3 than a year ago, but still meaningfully below 2019 levels. So while we're seeing some increase, it's -- we don't see an irrational promotional market. We're definitely not back to 2019 levels. And we've been able to leverage our capabilities behind CRM and overall personalization to manage more effectively within our promotional intensity.

So with that backdrop, as we look into the fourth quarter, again, we're not expecting anything radically different than what we saw, a bit more promotional, not irrational to what we've essentially seen so far, not back to 2019 levels. And when we look at our outlook, and I'll let Scott give a little bit more color, we really haven't changed our fourth quarter comp sales. As we've been talking for a while, we've seen -- we expected in the second half of this year for comp to moderate to low-single-digits. We were a bit ahead of that in the third quarter, and we're still confident in our outlook for the fourth quarter, and that gave us -- really our third quarter performance gave us the confidence to move up the bottom end of that range.

So as we look out, we're not anticipating any major disruptions from promotion. But Scott mentioned the biggest weeks of holiday are still ahead, so we're staying close to that. The consumer engagement, we're positive about, and that's reflected in our updated refined outlook going forward.

[Scott Settersten, Chief Financial Officer, Treasurer and Assistant Secretary at Ulta Beauty]

And I would just reiterate what Dave said, our fourth quarter comp sales expectations have not changed, all right? We are giving ourselves a little bit wider range, I would say, on operating margin than you would probably expect to see at this stage of the year. But it is $1 billion above the last couple of quarters. So small changes in consumer reaction could have a bigger impact on our business. So we're just being prudent, giving ourselves room to maneuver, I guess, I would say, thinking about how we deliver overall great experience for the guests, both in the store and online. And again, we feel like we're really well positioned. We're off to a good start, but there's still a long way to go.

[Mark Altschwager, Analyst at Robert W. Baird & Co.]

Very helpful. Thank you.

[Operator]

And our next question comes from the line of Michael Binetti with Evercore ISI. Please proceed with your question.

[Michael Binetti, Analyst at Evercore ISI]

Hey, thanks a lot for taking my question here. Scott, you may have my congrats. It's been great, the conversations over the years has been wonderful, and Paula cannot wait to work with you.

Dave, you reminded us how resilient the category is in the low- to mid-single digit growth over time. The comp guide [Phonetic] for the fourth quarter allows comps to go as low as flat, so below the algo, below the industry rate. I know there's some unique hurdles that you pointed to. Is that really the only impediment to a normal -- return to normal comp is the hurdles in January effect that you pointed to?

And then I'm also curious with SG&A growing double-digits this quarter. Scott, you mentioned algo comp next year. Can you just kind of walk us through how to get to leverage on SG&A given the recent growth rate in the SG&A line?

[Dave Kimbell, Chief Executive Officer at Ulta Beauty]

Yes, I'll start with comp. But yes, I think you've said it well, we're -- again, when we look long term, very confident in the total growth of the category and our ability to gain share. That's certainly our objective all the time as we look in the fourth quarter. It's a -- we are lapping a very strong fourth quarter last year. We anticipated this. We've been talking about a moderation in our comp trends all year long. And so far, it's played out essentially, as we thought with some modest improvement, a little bit ahead of that, but that's how we anticipated.

So when we look into the fourth quarter, what's reflected in our outlook is continued strong engagement, a successful holiday and healthy comps certainly on a two, three year basis, but we're lapping some strong performance last year as we get through this fourth quarter.

[Scott Settersten, Chief Financial Officer, Treasurer and Assistant Secretary at Ulta Beauty]

And Michael, we're in the midst of a multiyear transformation on many fronts across the business that, again, we expect to deliver significant efficiencies and optimization opportunities for our business for many years to come. And so 2023 is an extraordinary investment year. A lot of it is coming through the SG&A line, again, the $60 million to $70 million, on top of $50 million last year. Again, we believe we're at or near the peak of that third quarter for a large brunt of the burden for 2023. So we would expect SG&A growth to moderate in '24 and beyond.

But I would remind folks, again, when you're just calling out the SG&A line, we have said consistently, we're willing to invest in SG&A as long as we can deliver operating margin leverage. So again, UB Media is a good example of that. It costs money, people cost, tool cost and things to ramp up there over time, but we get back in the gross margin line over the long term. So we're well positioned for the future and believe we're on the right track.

[Michael Binetti, Analyst at Evercore ISI]

Thanks a lot guys. Best of luck on holidays.

[Operator]

Our next question comes from the line of Oliver Chen with TD Cowen. Please proceed with your question.

[Oliver Chen, Analyst at TD Cowen]

Hi David, Paula and Scott. It's been awesome to work with you. Congrats on everything you've done in the years ahead.

As you think about stores and the store maximum potential you've had really nice new store productivity and also pretty extraordinary e-commerce growth. What are you thinking about for smaller format and also as you continue to modernize the experience, how the stores should be laid out?

And then second, on UB Media, a big part of the future is digital advertising. What's the path there in terms of what you're doing? It feels -- we believe that a lot of the brands do appreciate the data that you have and the cross-section you can offer them as well. Thank you very much.

[Dave Kimbell, Chief Executive Officer at Ulta Beauty]

Yes. Thanks, Oliver. I'll start with stores. We continue to reiterate our outlook of 1,500 to 1,700 stores, and towards -- and we've said that we believe we'll be towards the high-end of that range, and that hasn't changed, and we're confident in that. And that does not include our expansion in partnership with Target. And as I mentioned in the call, we're up to 510 of those locations. Our store-level earnings, our store profitability remains very healthy. We're very positive about the new store opening performance, and we're confident in the opportunity to continue to expand our presence.

We have a couple of things that you highlighted. We've been testing and I'd say, expanding really a smaller format, which is a 5,000 square foot store that's really targeted towards smaller markets, more remote markets, and we're having good success there. We've updated our full store layout that we've expanded into -- I think it's maybe 80 stores now or so that all new stores and some remodels that have a new format that makes it more intuitive to shop the whole store. The categories are bundled together. The services are highlighted more. The brands are easy to engage in. And so we continue to invest in the experience and elevate how we're engaging with our guests. And we're very bullish on the stores, the performance and the outlook.

On UB Media, we're pleased with our advancements. We've invested in that this year. We've had hundreds of brands participate, thousands of campaigns over the course of the year. We've expanded our team. And it's exactly what you said, the power of our data, the unique insights that we can bring, because we have 42 million members, and we have an assortment that spans all price points in all categories and all geographies and demographics, we've got a really powerful tool with our brands, we can bring value to our brands through that. And so I'd say we continue to see good results from that. But I'd also say we're just getting started with a lot of opportunity, more to come as we look into the future. So we're putting -- we're accelerating that effort as well.

[Oliver Chen, Analyst at TD Cowen]

Okay, David. Last on AI. You have QM Scientific and creative deals you've done, and you've also been active in augmented reality. Are there any highlights about how you see AI impacting the pre- and post-shopping experience and/or how you're utilizing it across the organization?

[Dave Kimbell, Chief Executive Officer at Ulta Beauty]

Yes. You're sneaking another question in, Oliver. On Scott's announcement day, too, right? But yes, AI is an important part of our business. You mentioned QM Scientific, which we bought a few years ago, really is one step among many to increase the power of advanced analytics to more personalize our guest experience. And I'd say across the board, we're bringing that to life, more opportunity to go for sure, but with an ultimate objective of being able to better anticipate and understand our guest needs and desires and behaviors so we can better service them in store, online and through all of our touch points.

And then we're using generative AI, we're really just getting started, but we see opportunities within Gen AI to streamline, accelerate and advance some of the experiences, things like our product descriptions, to automate some of that to make it more real time to speed up our innovation to leverage some of our creative processes, and behind the scenes with some data management and supply chain and other places.

So we're excited about both what it's contributed so far, and it's a big focus for our organization to take full advantage and be a leader in that space as well.

[Oliver Chen, Analyst at TD Cowen]

Thank you very much.

[Operator]

Our next question comes from the line of Krisztina Katai with Deutsche Bank. Please proceed with your question.

[Krisztina Katai, Analyst at Deutsche Bank Aktiengesellschaft]

Hi, good afternoon. I'll add my congratulations to both Scott and Paula. But my question is to you, Dave. I was wondering if you could talk about member engagement. You said that diamond and platinum members increased 20%. So what are you seeing with some of these newer members versus your more mature cohorts? And what are some of the early reads that you can share from a personalization effort perspective, how those are helping the maturation of wallet share or member spending that essentially gives you confidence that you can continue to deliver on your compound goal? Thank you.

[Dave Kimbell, Chief Executive Officer at Ulta Beauty]

Yes. Great question, Krisztina, because our loyalty program is so key to our business and to our success. And I tell you, I can't -- couldn't be more pleased and proud of the team's efforts to evolve and advance this program. And what I say internally to our 53,000 associates is, every single one of us own and contribute to loyalty, both the acquisition of new members, but importantly, the engagement and delighting our members every single day, in-store, online and our guest services through our assortment, our advertising, our social media, every touch point we have. And so it is an always-on activity for us, it's top of mind every day for us to make sure that we are delighting our guests because we know that's the secret to our success and our long-term future.

The debt -- big picture result of 8% growth of our loyalty program is evidence that that's working because the things that come together to drive that type of growth on a big number, a big number to start with is, first and foremost, retention we wouldn't be growing it if we weren't retaining at a very high, very healthy, we believe, industry-leading level, and we continue to work to improve that every day with every member through our personalization. So the personalization efforts, I'd say, first and foremost, are ultimately about retention because if I can use personalization to provide more value to our guests, then they will be more likely to stay with us, to buy more with us and to be a long-term guest and move up into the platinum and diamond levels and all of that.

We also saw nice results in new member, who never been a member of Ulta Beauty, and we continue to expand that, and that's through our new stores, our advertising, our partnership with Target, our digital presence, our social media. And we feel like, while we've had a lot of scale, there are tens of millions of beauty enthusiasts that are not currently part of our program.

And the third area is reactivation, where while we have very strong healthy retention, we don't retain everybody. So there is a pool of guests that -- most of the time, it isn't because they had a bad experience. It just fell out of the habit of shopping at Ulta. And so we have a very personalized direct program to reengage and reactivate those lost guests, and that's been contributing to our growth.

So across the board, we're pleased with the engagement. We're pleased with the spend per member, all metrics in that program continue to be encouraging to us, and we see a long runway, and we're focused on it every day through innovation, hard work and just a commitment to guest experience to drive that for the long term.

[Kiley Rawlins, Vice President of Investor Relations at Ulta Beauty]

Operator, I think we have time for one more question.

[Operator]

Sure. No problem. Our last question comes from the line of Michael Lasser with UBS. Please proceed with your question.

[Michael Lasser, Analyst at UBS Group]

Good evening. Thank you so much for taking my questions and best wishes to Scott and Paula. My question is, how long are you willing to absorb market share losses in the prestige beauty category before responding with an increase in promotional activity? And if we assume that those market share losses extend into 2024, how is that going to impact Ulta Beauty's ability to achieve its earnings algorithm next year? Thank you so much.

[Dave Kimbell, Chief Executive Officer at Ulta Beauty]

Yes, Michael, I'd say that, first, I'd start by answering that question is, yes, our goal and our long-term history is to gain share and our entire strategy across our assortment, our marketing, the loyalty program, our stores, our e-com, our digital tools, everything we do is designed to be a leader and to gain share and to drive our business forward. And in many parts of our business, we have been and continue to be doing that.

Our prestige makeup and hair business have been more challenged. And that's really a reflection of expanded points of distribution, which I talked about hundreds points of distribution in largely in those that are impacting disproportionately those categories and some other competitive pressures. In mass, makeup, in mass skincare, in mass haircare, in prestige skincare, prestige fragrance, we are gaining share and have continued to do so. So our focus is to continue to do that, to take the healthy, strong share growing parts of our business and accelerate that, and to return the ones that have been a bit more challenged to growth, and we have got plans to do that.

I talked about makeup on an earlier question. And we go through the newness that we've launched and more to come as we turn the calendar to 2024, the execution that we have in store, our focus online, we're confident that we will be able to drive that back. Same holds true in haircare.

Specifically around promo, honestly, we see it trickle as a balance. Where we feel good about our overall position, our overall growth. As I said, we're gaining share in many parts of our business. And so we're pinpointed in how we want to leverage our promotional intensity. We don't want to wildly swing back when we have confidence that it's not just promo that will return to share growth, it's the collective strategies and actions, the long-term efforts around assortment and execution that will drive share growth over time.

And so we'll leverage promo in the short term. We have been, but as we've said earlier, we in no way have turned back to 2019, which is one indicator. We're not just going to swing wildly. We'll be thoughtful, strategic, and have clear actions and long-term actions that get us to sustain share growth. And I say that from a position of confidence given our track record of gaining share consistently for many years, and we're confident we'll be able to do that well into the future.

All right. So thank you for that question, Michael, and thanks for all of you for your engagement. I want to close by thanking our more than 53,000 Ulta Beauty associates for delivering another strong quarter for our shareholders while also successfully executing against our strategic priority.

And once again, I want to thank Scott for his partnership and tremendous impact on Ulta Beauty, and I want to congratulate Paula as I know she is going to be an outstanding CFO for our company.

We wish you all a happy and healthy holiday season. I hope you get out and shop at Ulta Beauty often. And we look forward to speaking to you again when we report results for fiscal 2023 on March 14. Hope you have a good evening.

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

• Kiley Rawlins, Vice President of Investor Relations
• Dave Kimbell, Chief Executive Officer
• Scott Settersten, Chief Financial Officer, Treasurer and Assistant Secretary

Analysts

• Dana Telsey, Telsey Advisory Group
• Lorraine Hutchinson, Bank of America Securities
• Mark Altschwager, Robert W. Baird & Co.
• Michael Binetti, Evercore ISI
• Oliver Chen, TD Cowen
• Krisztina Katai, Deutsche Bank Aktiengesellschaft
• Michael Lasser, UBS Group AG