Greetings, and welcome to the Ulta Beauty Second Quarter 2020 Earnings Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Kiley Rawlins, Vice President, Investor Relations. Please proceed.

Thank you, Diego. Good afternoon, and thank you for joining us today for our discussion of Ulta Beauty's results for the second quarter of fiscal 2020. Hosting today's call are Mary Dillon, Chief Executive Officer; and Scott Settersten, Chief Financial Officer. Dave Kimbell, President, will join us for the Q&A session. Before we begin, I'd like to remind you of the company's safe harbor language. The statements contained in this conference call, which are not historical facts, may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. We caution you not to place undue reliance on these forward-looking statements, which speak only as of today, August 27, 2020. 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. In today's comments, we will discuss certain non-GAAP financial measures, including adjusted diluted EPS, which has been presented to reflect our view of our ongoing operations by adjusting for store impairment charges and costs associated with the permanent closure of 19 stores. A reconciliation of these measures to the corresponding GAAP measures can be found in our earnings release, which is available on the Investor Relations section of our website at www.ulta.com. We'll begin this afternoon with prepared remarks from Mary and Scott. Following our prepared comments, we'll open the call up for questions. [Operator Instructions] As always, the IR team will be available for any follow-up questions after the call. Now I'd like to turn the call over to Mary. Mary?

Thank you, Kylie, and good after afternoon, everyone. Let's start with an overview of where we are today. First, I will say that since the beginning of the pandemic, we've navigated through the crisis with our associate and guests at the center of every decision made. I'm really proud of how our teams have responded through this challenging period and I want to thank my leadership team and all of our Ulta Beauty associates, especially our store and distribution center associates for their agility, creativity and commitment to serving our guests and taking care of each other during this unprecedented period. On our last earnings call, we were in the early stages of our reopening process. During the second order, we reopened stores for retail, expanded curbside capabilities to nearly all stores and began relaunching select services, all with a thoughtful consideration for the safety of our associates and guests, balanced with our desire to reopen quickly. By the end of June, more than 90% of our stores were open for retail. And by mid-July, our reopening process was complete. Reflecting local regulations and guidance, the resumption of our service offerings has been on a more and more measured pace. Today, salon services are available in about 88% of stores and brow services are offered in about 85% of the fleet. We've not resumed skin or makeup services, but we're working closely with medical experts to ensure we have strong safety protocols in place when it's appropriate to resume these services. In this new normal, we're operating Ulta Beauty stores with new shop safe standards, limited physical capacity to accommodate social distancing and reduced operating hours. To date, we have reactivated approximately 17,000 of our furloughed associates who are able to return to work. We're committed to maintaining a safe…

Thanks, Mary, and good afternoon, everyone. Starting with the income statement. Sales for the second quarter declined 26.3% and total company comp declined 26.7%. Overall, sales for the quarter were in line with our internal expectations, with sales from e-commerce a little stronger and stores a little softer than expected. Average ticket increased 14.9%, while transactions declined 36.2%. As Mary mentioned, the beginning of the quarter was significantly pressured due to store closures, but we experienced improvement in the business as the quarter progressed. We are very pleased with the performance of our e-commerce operations, which exceeded our internal expectations and delivered a comp increase of more than 200% for the quarter, as guests continue to take advantage of our omnichannel capabilities, including curbside pickup and buy online pickup in stores. As expected, e-commerce growth slowed as stores reopened, but continued to deliver strong triple-digit growth versus last year. From a mix perspective, makeup was 43% of sales, down 400 basis points from last year. Skincare, Bath & Fragrance collectively increased 600 basis points to 28% of sales as the penetration of all 3 categories increased year-over-year. As a percent of sales, haircare products and styling tools was flat at 21% of sales. The services category was down 300 basis points to about 3% of sales as all services were suspended for much of the quarter. Gross profit margin was 26.8%, a decline of 9.6 percentage points compared to 36.4% a year ago. Many of the trends we saw in the first quarter continued in the second quarter as we transitioned through the store reopening process. Similar to what we saw in the first quarter, the largest driver of margin deleverage were fixed cost due to significantly lower sales. Although not readily apparent in the gross margin results this quarter,…

[Operator Instructions] Our first question comes from Adrienne Yih with Barclays.

Nice to see the progress. Mary, I wanted to go back to the comment you made, newness is sort of coming through nontraditional brands. So I want to go back to -- given that prestige brands are contending with the contracting mall-based distribution channel, are you seeing either broader SKU assortment from existing prestige brands? And is there an opportunity to expand beyond fragrance into some brands like Chanel or Dior? And then my follow-up for Scott, just a clarification, the negative low double-digit to negative mid-teens. If you're running negative single-digit now at the beginning of the third quarter, should we expect the third quarter to be stronger than the fourth quarter with all the uncertainty, or maybe the 2 of them similar in nature from a year-on-year standpoint?

So Adrienne, thank you for your questions. And maybe I'll start with the second one first because, yes, so I think right directionally, we'd say we're expecting Q3 to be somewhat better than Q4. There's a lot of uncertainty, as everybody knows, but we've got resets and launches coming in Q3. I think holiday is just something we're all a little more cautious about, given new ways that people are going to think about shopping and hours available, et cetera. So we're thinking directionally that way.

Yes. And as far as the comp sequence is concerned, I would just point maybe to looking at the promotional calendar. I know a lot of you guys track this stuff very closely. So you can schedule out what types of things we did last year over the course of the third and fourth quarters. And with the background color being we're trying to pull back on some of those things, right, we talked about in our comments. So overall, directionally, I would say the fourth quarter, probably slightly weaker on balance just because of the volume of sales there and some of the promotional activity that historically have taken place in the fourth quarter overall.

And Dave, would you take the first part of the question? Thank you.

Yes, absolutely. As it relates to your question on assortment and evolution of that, for sure, we're continuing to see disruption in the prestige marketplace. And that's something we've seen for a while, and a dynamic that we feel like we've been taking advantage of and continuing to grow share across all categories in the prestige side of the business. And that comes from all different types of brands. Certainly, exclusive and new brands like Kylie, some of our established and dependent brands, brands like Tart and Urban Decay and Two-faced, where we launched exclusive innovation across those brands. And on the more prestige luxury side, we have made specific advancements on that. You asked specifically about Chanel. And yes, we have a strong fragrance business but we have rolled out in the Chanel Beaute line, a small number of stores with an expanded portfolio in the makeup side. So we see continued opportunity across all aspects of that business to capture more share, expand our assortment and meet our guests' needs in multiple ways.

Our next question comes from Ike Boruchow with Wells Fargo.

This is Lauren Frasch on for Ike. Given the massive acceleration in e-commerce that we've seen in 2020, could you talk a bit about the current margin profile of e-com initiatives and any initiatives you might be taking on to improve that? And then as a follow-up, how does that new acceleration in online penetration play into your vision of longer-term margins for the overall business?

Yes. That's a broad question. But let me first start out by saying, just, I guess, reiterating how proud we are of our teams, the e-com digital teams, the distribution centers, our store associates and all the support people that work with them. I mean it was a spectacular outcome to deliver a complex, that 200% year-over-year expansion, just really a great outcome overall, with the thought being, that's the average for the quarter. At some point during the quarter, it was higher than that, right, higher than 200%. So very proud of the outcomes there. When we think about, over time, the e-commerce business, we haven't been shy about sharing the challenges we have with rate. I mean, everybody is very aware of that overall. So when we think about what we're trying to balance is rate versus dollars and speed versus cost. And we've talked to investors in recent years about the heavy investment cycle we've been in to support that part of our business. And it's really worked to our advantage now, right, in this time of crisis and change pivot point with consumers. So very happy what we've been doing in recent years to support that business, and obviously, that's going to be the trend for the future as well. So we'll continue to be focused there. When we think about the margin profile overall in the future, again, our historical guide was that it was going to be a 20 to 40 basis point headwind. Obviously, that's not what it is in this time and space. We're happy with the sequential improvement we saw from the first quarter, right? And we expect that to continue to moderate sequentially as we go deeper into 2020. And we're thinking and working collectively on other levers we can pull to try to mitigate some of that rate headwind, specifically in the e-commerce space. So things like BOPIS, we've been talking about and curbside now that we have that available to us. And again, those are higher-ticket transactions typically and better margin profile file overall. Our DCs are operating more efficiently now, so that helps offset some of that headwind. And then we're thinking about other parts of the business, right? Mary pointed to cost optimization. So it's not just an e-commerce question. It's more of what else are we looking at overall for the enterprise to help optimize the overall margin profile of the business, not just the e-com piece of it. So the entire team is focused on that, and we're doing a lot of work now framing up 2021 in how we deliver the best overall financial result there and then start marching back to healthier operating margins.

Our next question comes from Steven Forbes with Guggenheim Securities.

Mary, maybe a question for you. You mentioned in the prepared remarks about the doubling of the omnichannel penetration rate, right, among the members. Curious if you could just discuss how the behaviors of these new omnichannel members has compared, right, to the legacy group. Are they repeating faster, shopping more categories or sort of think like potentially consolidating their spend, right, with Ulta, just given the trip consolidation pieces? We'd love to hear how you sort of think about that doubling in this quarter.

Yes. Well, it's too early to really kind of parse out the exact dynamics of their behavior, but we like where it's heading. I mean, omnichannel guests, I said this earlier, I think you probably know this, but they're most engaged guests, and they spend 3x historically as much as somebody who's shopping in-store only. So this is sort of a forced migration to more folks to get it into this. And so while you can debate sort of the margin impacts of e-com, we know the total value of this customer is quite significantly strong. Because most of our guests historically have started a store-only, and then started to shop online with us as we saw their spend triple, they basically were keeping pretty similar what they were buying in-store and just adding incrementally online, and the categories tended to be similar. So we would expect a similar behavior, except we've got a lot of folks now who started first online, right? And so -- and as we open up our stores and saw people coming back, I mean, certainly, traffic isn't where it was, but we're pleased with the pace of people coming back to the stores. I think it just kind of continues to support that premise that beauty enthusiasts like the idea of shopping, both physically and digitally. They get good things on the side both of those things. So I mentioned this also that as we saw a lot of new people shopping us who weren't rewards members, we also have the opportunity, now that we have their e-mail, to convert them into the loyalty program. So I think this is all good. I mean, the thing -- that swift increase that happened showed that: a, we were in the right place, from an e commerce perspective. I mean that e-commerce business doesn't just happen on its own. Our team was doing a great job of connecting with guests and social and digital channels to drive -- make sure we're driving awareness and staying top of mind at a time that there was a lot of things on people's minds, right? So we pivoted out of what we would have done traditionally and really focused on understanding where people were in terms of self-care and things like that. So it was strategically, I think, a great pivot. And we'll continue to watch it closely, but we think it's a good thing for our business.

Our next question comes from Michael Binetti with Crédit Suisse.

Nice job on the quarter. I guess, Mary, I found it a little, on the plan of pullback on promotions in the back half, somewhat counterintuitive. I think there's obviously an unprecedented numbers of department stores that have been closing around you, and it seems to me that, that's a really good opportunity for you guys to grab market share. You seem like the heir apparent for that share. I mean, are you -- would you be willing to walk away from a new customer opportunity if you do see a path to that customer as those doors start to close in the back half? And then I guess as a...

Oh, you're going to ask a 2-part question, okay. I'll call you on that. Let me just start with that one. Maybe, Dave, maybe you can add to it. But I'd say high level, of course, we're focused on driving market share gains, and there's opportunities out there. Having said that, all we're doing is saying, let's be as targeted and strategic as we can about how to do that. We are -- I mean, through this entire pandemic, we've been gaining share in Prestige Beauty, and while -- and so we know that we're competing well even with a somewhat less promotional kind of cadence than we would have had at that time. So the idea is to still compete at the peak times of things like holiday, do strategic promotions that we work really well for us, and just be more efficient with how we do this. And certainly, if we see opportunities to get more aggressive or need to, we will. I mean we're not -- we understand that there's an opportunity to convert, especially as we convert people into our loyalty program, and that becomes very sticky. So I think it's a good, good balanced way to think about this, but we're obviously keeping a close eye on it. Is there anything you'd add to that, Dave, that I didn't hit on there?

Just to reinforce, yes, this idea of just being much more strategic in our approach towards promotional optimization, but we are not pulling, eliminating all promotions. In fact, starting this Sunday will be 21 Days of Beauty, one of our biggest and most important, most strategic events of the year. And it's a good example of an event that is promotional but it has a strategic role in driving what we call mass migration, introducing our guests many times for the first time to a new prestige brand. So focusing on activities like that, optimizing programs like our loyalty program, personalization efforts that more pinpoint and direct target -- direct promotional activity, specifically to people that we know respond to it will -- just allow us to be more efficient with that spend, and ultimately, be more effective in the marketplace.

Got you. If I could ask a follow-up. I mean, how best to connect that to the progression of margins as you think multiyear? I think what I heard here today that was incremental. I heard more efficient promotions, more efficient labor model. You have Jacksonville coming back online -- or coming online again, so e-com should be more efficient. I think you talked about negotiations, other EFG initiatives. What are the headwinds we should think about that would offset some margins as you try and orient yourselves? I guess we're looking at 2019 since we're trying to forget about 2020 for several reasons here.

Yes. So when we work -- I mean, we're in the throes of it right now, Michael, looking at 2021 operating plan and looking at new embedded cost headwinds to the business overall. So some of the things we've talked about historically around channel mix headwinds and store payroll headwinds, and some new, like PP&E cost implications and how long that might be with us. So there's a lot of ores in the water, so to speak, right now. The team is focused on it. Again, we're focused on overall operating margins, trying to squeeze out the best overall financial results, and we're focused on double-digit operating margins over the longer term. We still think that, that's kind of the minimum threshold for this business. We got healthy product margins. It's part of the base of our operating model, and there's still lots of levers for us to pull on, and we're just making decisions now on which ones we're going to push and pull for next year. So we'll have more to say on that as we get further along this year.

Our next question comes from Paul Trussell with Deutsche Bank.

Good job in the quarter. Wanted to ask about stores. You mentioned that as stores reopen, online still remained very strong, up triple digits. How should we think about the productivity and the profitability of your store fleet? And while your long-term target remains intact, do you view the cadence of store openings, on an annual basis, potentially any different going forward, both in the U.S. and your approach to opening in Canada?

Well, I guess I'll start. So just the basic runway on the store buildout program, so we pulled back, we moderated this year for obvious reasons, right? So you're in that 30 new store opening range for 2020. And as we stated in our remarks, next year, the way we're looking at it now because, again, you're working on leases as years in advance, right? Working with landlord partners, lining up the right kind of space and making sure you got the right co-tenancy mix there. So these are far down the road kind of decision. So we feel good about at least 30 new stores for next year, and hopefully, maybe more depending on how some of the pandemic impacts other retailers in our centers across the U.S. right now. So we still feel good. Again, I think we mentioned in the remarks that we're looking at the optimal footprint, right? So the fleet we have now versus the fleet we would want if we had a white sheet of paper to work with, and then layering on top of that, the omnichannel sales opportunity for us for the long-term and just making sure we got the right number of stores with the right incremental -- digital sales offering as well. So again, looking at it today, we still feel like 1,500 to 1,700 is a good range. I mean, that's definitely something we feel comfortable with. And that we just want to make sure that it's optimal, right? So we're in the midst of that work now, and we'll have more to share on that later in the year.

Our next question comes from Simeon Gutman with Morgan Stanley.

My question and follow-up in one is financial related. First, can you talk about the fixed cost per store? They sound like they're going lower. Are you able to quantify so we can understand leverage or even deleverage going forward? And then related to something that was asked earlier, Scott, the 20 to 40 basis points you mentioned in e-commerce or as penetration went up, margins got hit. Was that number inclusive of what was happening to the store-only business, and that was the overall result to the business? Or was that a channel-exclusive comment that as that mix to that channel increased, that was the pure impact to the overall business? Hopefully, that makes sense.

Yes. So we're thinking about the second part of your question, Simeon. But as far as the first question there, so fixed cost overall is something that we have been focused on for a couple of years already. So when we talk about efficiencies for growth, or EFG, real estate is a core pillar in the work that we do there. So again, thinking about the whole portfolio when we're dealing with landlords, not just individual stores and looking further out into the future on renewals and opportunities to reposition stores or renegotiate overall economics on those stores, so that's been underway now for a period of time. And so we're -- we've got an embedded process in the business, and we're feeling really good about what we're doing. So COVID-19 just kind of put that on steroids here in the near term. So again, you've seen other retailers talking about challenges they've had, so we're doing a lot of the same things behind the scenes. We feel like we've got a better process. We've got strong relationships. We're a retailer of choice for many landlords, the beauty category being a healthy one to add to the mix, and we drive a lot of traffic to centers. So we feel like we're in a good position to make sure we get the best overall economic deals. That's something that will be part of our long-term plan. We're getting benefits now, and we will continue to scale that up over the long term. As far as the 20 to 40 basis point headwind in our historical guidance, I mean, that's -- again, that's -- the page has been turned on that here over the last, call it, 3 to 5 months. And we've been reacting and leveraging and trying to optimize…

Our next question comes from Steph Wissink with Jefferies.

First part of the question is for Scott. You gave us some great detail for the back half on gross margin. I'm wondering if you're willing to give us some direction on SG&A. In the quarter, you had a few transitory elements. So I'm just curious if you can help us unpack -- or I think retention credits, you mentioned around $48 million. Some of your store staff are still furloughed. Maybe just help us think about the puts and takes as you think about first semester versus second. And then Mary and Dave, so related to that is on marketing. I think, Mary, you mentioned that your unaided awareness was stable despite pulling back pretty significantly on marketing. So I'm wondering if that's reshaping how you're thinking about marketing the Ulta brand, if you're seeing that you're better known and better selected today than you've been in the past, if that changes how much you think you need to spend on brand marketing going forward?

I'll start with that one, because I'm sure our Head of Marketing probably wasn't thrilled when I make that comment. I thought that's a logical question. No, I would say that I think -- well, Dave is closer to it than I am. But the notion of being able to retain and maintain great aided awareness, unaided awareness and strong brand equity means there's consistent kind of investments you have to make over time, I guess, I'd say, through the lens of things that, like media, like advertising. So we have pulled back maybe some pieces here and there because we really didn't have the ability to -- need to create that kind of demand. But our marketing team does an amazing job of just constantly looking at return on investment and improving what we do every day to maximize the levers that we use. So I think our marketing investment has gotten, tell me if I'm wrong, more efficient over time, and it will continue to do so. So okay, Scott?

So SG&A in the back half of the year. So you're right, the CARES Act, $48 million was a onetime kind of thing for the second quarter and won't recur in the back half of the year, but then we'll have the PP&E cost. PPE costs, the $35 million to $40 million in the back half, that's primarily SG&A costs. So a lot of it is store labor. When you think about metering people in and out of the stores and making sure we're guiding them to safe shopping practices. And then you got cleaning of the stores and related supplies to all that. Store payroll and benefits is the largest bucket in the SG&A line item. Directionally, you've heard us talk about some of the changes we're making here. Mary mentioned a few of those. And so lower in the second half versus last year by some of those actions that were taken. Marketing, lower in the second half versus last year, but not as low as it was in the first half. Some -- we pulled some expenses out of the first half and we're putting in the second half to -- we've got some great new advertising, right? Television advertising coming here, so we're really excited about. Overhead, then would be the last bucket, and there's going to be some growth versus last year because some of those investments we made, growth investments, are still yet to be anniversaried and will be when we get through the full year.

So thank you. Thanks, everybody, for joining us today. We're out of time. I just want to express my sincere appreciation to all of our Ulta Beauty associates for their efforts as we continue to navigate well through this unprecedented environment. I just hope that you and your colleagues and your loved ones are safe and healthy, and we look forward to speaking with all of you again in December when we report our third quarter results. Thank you.

Thank you. This concludes today's conference. All parties may disconnect. Thank you for your participation.