Earnings Call Transcript - ULTA Q3 2023

Operator, Operator

Good afternoon, and welcome to Ulta Beauty's Conference Call to discuss results for the third quarter of fiscal 2023. 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

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. 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?

David Kimbell, CEO

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. 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 leaning 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 Way, delivered 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 continued to outpace the growth of the mass market according to Circana data. In prestige beauty, our share gains in skincare 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, continued 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 on 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 a luxury brand, Pat McGrath Labs, expanded our presence with MAC to nearly all stores, and launched several exclusive and innovative brands, including Half Magic, Polite Society, and Rabanne. In skincare, 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 scents 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 confirm 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 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 refreshed the presentation with elevated aesthetics, improved navigation, and more storytelling graphics to inspire and educate our guests about 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 management, 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 spending, 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 Snackz assortment features a curated lineup of best-selling must-haves, minis, and unique sets. And just in time for the holidays, we launched a curated assortment of Dyson hair tools in select stores and exclusive holiday sampler 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 guests feel 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 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, spending, 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 roadmap 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 emission reduction goals approved by the Science Based Targets initiative. Details of our commitments are available in the ESG section of our investor website. Shifting now to our plans and expectations for the 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 an uncertain economic environment. With our diverse assortments and convenient omnichannel touchpoints, 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 gifts 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 BOPIS 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 Settersten, CFO

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. 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 that 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 2 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 a period in the year when our working capital needs peak as we build inventory for the holiday. I would note our recent activity does not reflect a change in our capital allocation philosophy, rather a lever to 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 remain 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, whom 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.

Operator, Operator

Our first question comes from Dana Telsey with Telsey Advisory Group.

Dana Telsey, Analyst

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 has such resiliency and 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?

David Kimbell, CEO

Thank you for your kind words about Scott and Paula. I’ll share some insights on the beauty category, particularly makeup, in response to your question. We are very optimistic about the long-term prospects of the beauty category for several reasons: a consistent introduction of exciting new products, a strong level of engagement, and a deep emotional connection. The link between wellness and beauty has intensified coming out of the pandemic, reinforcing our confidence in the broader beauty sector. Makeup, in particular, is a crucial aspect of our business. Although our makeup category was nearly flat this quarter, we believe in its future growth. We're observing positive trends and high engagement across all demographic segments. As we wrap up this fourth quarter and transition into next year, we are optimistic about the factors that will fuel our makeup business. Some specific initiatives to advance this sector include the launch of several new exclusive makeup brands, such as Half Magic, crafted by the Euphoria makeup artist, Polite Society, a prestige brand exclusive to Ulta, and Rabanne, a contemporary Spanish fashion brand debuting in cosmetics exclusively at Ulta. We are just beginning with these three exclusive brands. We also see strong performance with MAC, which is now available in nearly all locations. Notable growth is evident with key mass brands like e.l.f. and innovative new offerings in that segment. Regarding luxury, we feel we are just getting started; we launched and expanded CHANEL, introduced Dior and Natasha Denona this year, and added Pat McGrath in the third quarter. New products from existing brands are continuing to impact the category positively, and we are optimistic about the future. Recent examples include Tarte's Shape Tape Radiant Concealer, exclusive to Ulta, and blushes from Juvia's Place that are also exclusive to Ulta, along with new offerings from brands like Clinique, Benefit, Anastasia, NYX, and Maybelline. We are navigating past our biggest launch with Fenty in 2022, and as we look ahead, we see both the items we've introduced and additional new products coming as we approach 2024. We are confident and hopeful regarding consumer engagement in makeup and beauty overall, as well as our strategies to drive growth. Scott, would you like to discuss margins?

Scott Settersten, CFO

Sure. Thanks, Dana. So I'll give you a little 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 2024 and beyond. And again, this is directional, in no particular order, but I kind of start with the headwinds. Supply chain transformation will continue to be a tougher compare for us as we think about next year as we continue to build out 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 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, #1 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 deeper into 2024 and cycle through some of that. Shrink, we called out the third quarter. 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 absorbed, but over the long-term, we expect to be able to kind of leverage fixed store cost on a 3% to 5% comp.

Operator, Operator

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

Lorraine Hutchinson, Analyst

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

David Kimbell, CEO

Yes, thank you for your question, Lorraine. It is indeed our goal to gain market share across all areas of our business, and we remain optimistic about several segments, including our mass business, prestige skincare, prestige fragrance, and prestige e-commerce. However, we have experienced some pressure in brick-and-mortar sales, primarily due to the increased number of distribution points. There are significantly more brick-and-mortar locations in the market now compared to just a few years ago. We see this as a short-term effect from heightened competition. Historically, when new locations open near ours, there is a slight initial impact, but our stores tend to rebound quickly, allowing us to achieve growth and increase our market share over time. Overall, we are optimistic about the future. Our comprehensive strategies, including our product assortment, brand engagement, loyalty programs, and the unique customer experience we provide in-store, give us confidence. Despite some short-term pressures compared to last year, we are still stronger in market share than we were before the pandemic, and we are confident in our growth strategies moving forward.

Operator, Operator

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

Mark Altschwager, Analyst

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 3 months ago?

David Kimbell, CEO

Yes, I'll begin and then let Scott provide some additional insight. Looking at the promotional environment, I'll start there, Mark. As we noted in the third quarter, the promotional activity was higher this year than last, but still significantly lower than in 2019. While there has been some increase, it's not an irrational promotional market, and we have not returned to 2019 levels. We have been able to utilize our capabilities in CRM and overall personalization to manage our promotional intensity effectively. With that context, as we approach the fourth quarter, we don't expect significant changes from what we've observed—slightly more promotion, but not irrational compared to what we've seen so far, and still not at 2019 levels. Regarding our outlook, I’ll let Scott elaborate further, but we have not altered our fourth quarter comparable sales expectations. We've anticipated that in the second half of this year, our comps would moderate to low single digits. We performed slightly better than that in the third quarter, and we remain confident in our outlook for the fourth quarter. Our third quarter performance has given us the assurance to adjust the lower end of that range upward. Looking ahead, we do not expect major disruptions from promotions, but as Scott noted, the peak holiday weeks are still ahead, so we are monitoring that closely. We are optimistic about consumer engagement, which is reflected in our updated and refined outlook moving forward.

Scott Settersten, CFO

And I would just reiterate what Dave said, our fourth quarter comp sales expectations have not changed. 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 an 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.

Operator, Operator

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

Michael Binetti, Analyst

Scott, may I add my congrats. It's been great, the conversations over the years have 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 you have 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 a 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?

David Kimbell, CEO

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 at the fourth quarter, we're 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 2-, 3-year basis, but we're lapping some strong performance last year as we get through this fourth quarter.

Scott Settersten, CFO

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 bore a large brunt of the burden for 2023. So we would expect SG&A growth to moderate in '24 and beyond. And 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 costs, tool costs, 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.

Operator, Operator

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

Oliver Chen, Analyst

David, Paula, and Scott, it's been great working with you. Congratulations on all your achievements and what lies ahead. As you consider the full potential of your stores, you've seen impressive new store productivity along with significant e-commerce growth. What are your thoughts on smaller formats and how you plan to modernize the store experience and layout? Additionally, regarding UB Media, digital advertising is a key aspect of the future. What is your strategy moving forward? It seems that many brands value the data you provide and the unique insights you can deliver.

David Kimbell, CEO

Yes, thank you, Oliver. I'll begin with our stores. We maintain our forecast of 1,500 to 1,700 stores, and we believe we will be nearing the high end of that range. This expectation remains unchanged, and we are confident in it. It does not include our expansion alongside Target, for which we now have 510 locations. Our store profitability is strong, and we are optimistic about the performance of new store openings, with continued opportunities to grow our presence. One of the initiatives we have been exploring is a smaller format store, approximately 5,000 square feet, designed for smaller and more remote markets, where we are experiencing success. We have also updated our store layout, currently implemented in about 80 locations, including new stores and remodels, which enhances the shopping experience by making it more intuitive. We are bundling categories, highlighting services, and improving brand engagement. We are committed to enhancing the experience for our guests and remain very positive about our stores, their performance, and our future outlook. On UB Media, we are happy with our progress this year. We have invested significantly and had participation from hundreds of brands in thousands of campaigns throughout the year. Our team has grown, and we are leveraging the power of our data and unique insights from our 42 million members. Our diverse product offerings across various price points, categories, and demographics create a strong value proposition for our brands. We anticipate continued positive results, but we believe we are just beginning to tap into our potential, with much more to come as we look ahead. We are also intensifying our efforts in this area.

Oliver Chen, Analyst

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?

David Kimbell, CEO

Yes, Oliver, that's another question you're sneaking in on Scott's announcement day. AI is indeed a crucial element of our business. You mentioned QM Scientific, which we acquired a few years ago; it represents one of the many steps we are taking to enhance advanced analytics and personalize our guest experience. Overall, we are actively implementing this strategy, with plenty of room for further growth. Our ultimate goal is to better understand and anticipate our guests' needs, desires, and behaviors to improve service in-store, online, and across all our channels. We're also beginning to utilize generative AI, which holds promise for streamlining, accelerating, and enhancing various experiences, such as automating product descriptions in real-time. This will help speed up our innovation and augment our creative processes, as well as improve data management and our supply chain. We are excited about the contributions we've seen so far, and it remains a major focus for our organization to fully leverage and lead in this area.

Operator, Operator

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

Krisztina Katai, Analyst

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 goals?

David Kimbell, CEO

Yes. Great question, Krisztina, because our loyalty program is so key to our business and to our success. And I tell you, I couldn't be more pleased and proud of the team's efforts to evolve and advance this program. 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 through our guest services through our assortment, our advertising, our social media, every touchpoint we have. 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 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 primarily retention. We wouldn't be growing it if we weren't retaining at a very high, very healthy, and 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 members, those who have 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. 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. The third area is reactivation, where while we have very strong, healthy retention, we don't retain everybody. There is a pool of guests that most of the time it isn't because they had a bad experience; they just fell out of the habit of shopping at Ulta. 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

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

Operator, Operator

Sure. Our last question comes from the line of Michael Lasser with UBS.

Michael Lasser, Analyst

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?

David Kimbell, CEO

Yes, Michael, I want to begin by confirming that our goal and long-term strategy is to gain market share. Everything we do, including our assortment, marketing, loyalty program, stores, e-commerce, and digital tools is aimed at being a leader and driving our business forward. In many areas, we have been successful in gaining share, although our prestige makeup and hair segments have faced more challenges due to increased distribution points and competitive pressures. However, in mass makeup, skincare, hair care, prestige skincare, and fragrance, we are continuing to gain share. Our focus will remain on accelerating growth in the strong areas of our business while working to revive the challenged ones, and we have plans to accomplish that. Regarding makeup, we are confident in our recent launches and upcoming initiatives as we enter 2024, including in-store execution and online focus. In hair care, we see promotional activities as part of a balanced approach. We are pleased with our overall growth and are strategically leveraging our promotional efforts without resorting to extreme measures. Our aim is to maintain a thoughtful strategy that supports sustained share growth. Given our strong track record over many years, we are confident in our ability to continue this into the future. Thank you for your question, Michael. I also want to express my gratitude to our more than 53,000 Ulta Beauty associates for their contributions to a successful quarter and commend both Scott for his partnership and Paula, who I believe will excel as our new CFO. I wish everyone a happy and healthy holiday season, and I encourage you to shop at Ulta Beauty. We look forward to updating you on our fiscal 2023 results on March 14. Have a great evening.

Operator, Operator

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.