Greetings, and welcome to the Ulta Beauty Third 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 of Investor Relations. Please proceed.

Thank you, Sumali. Good afternoon, and thank you for joining us today for our discussion of Ulta Beauty's results for the third 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, December 3, 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 impairment and restructuring-related costs. A reconciliation of these measures to the corresponding GAAP measures can be found in our earnings release, which is available in 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 comments, we'll open the call for questions. [Operator Instructions] As always, Patrick and I will be available for any follow-up questions after the call. Now I'll turn the call over to Mary. Mary?

Thank you, Kiley, and good afternoon, everyone. Today, we reported financial results that reflect the strength of the Ulta Beauty model and improving trends in consumer demand. I continue to be very proud of how well our teams are responding and navigating through this difficult period. And I want to thank all of our Ulta Beauty associates for their continued agility, creativity and commitment to serving our guests and taking care of each other during this unprecedented period. For the third quarter, net sales were $1.6 billion and GAAP diluted EPS was $1.32 per share. Adjusted diluted EPS for the quarter was $1.64 per share. Building on the momentum we saw at the end of the second quarter, third quarter comp store sales declined 8.9%. The mid-single-digit comp declines we experienced in August continued through September, with October sales impacted by our decision not to repeat certain promotional activity from last year. As we discussed on our last earnings call, we're working to optimize promotional events to remain competitive while also improving profitability. In the third quarter, we executed several promotional events that drove strong guest engagement and profitable sales. We launched our first-ever We Love Our Members event to reengage and welcome Ultamate Rewards members back to Ulta Beauty, having completed our phased store reopening process. We rewarded guests with member-only points and services offers and amplified the offers across owned, earned and paid channels to reinforce the value of our rewards program. We successfully executed a more focused 21 Days of Beauty, one of our most strategic events intended to drive mass migration to prestige products. To excite and reengage guests, we accelerated our digital and streaming first approach to support expanded messaging for our compelling beauty steals, newness and exclusive products. We expanded the focus of our…

Thanks, Mary, and good afternoon, everyone. We appreciate your support of Ulta Beauty and hope you and your loved ones are staying safe and healthy. I will reiterate Mary's comments and thank all of our dedicated associates for their tireless efforts in safely serving our guests and keeping our operations running smoothly during this difficult time. I'll begin with the income statement. Net sales for the quarter declined 7.8%, and total company comp declined 8.9%. Given the challenges from the COVID-19 pandemic, we are very pleased with this performance as top line results for the quarter were better than our internal expectations. Average ticket increased 7.6%, primarily driven by an increase in units per transaction, while transactions declined 15.4%. We experienced nice conversion in both channels but continued to be impacted by softer traffic to stores. As expected, e-commerce growth slowed relative to the second quarter but continued to deliver very strong growth versus last year. Our e-commerce operations delivered a comp increase of 90% for the quarter as guests continue to take advantage of our omnichannel capabilities. Buy online, pickup in store was strong again this quarter, totaling about 16% of e-commerce sales, approximately double the penetration in the third quarter last year. From a mix perspective, makeup was 45% of sales, down 600 basis points from last year. Skincare, bath and fragrance collectively increased 500 basis points to 26% of sales. Haircare products and styling tools increased 300 basis points to 21% of sales, while the services category was down 200 basis points to about 4% of sales. As Mary indicated, our service business continued to be negatively impacted by COVID-related capacity constraints. Gross profit margin was 35.1%, a decline of about 200 basis points compared to 37.1% a year ago. Similar to what we have seen since…

[Operator Instructions] Our first question is from Erinn Murphy with Piper Sandler.

My question, Mary, is for you on the Target partnership. I was hoping you could talk a little bit more about the brand production process and the inventory buying process between both Target as well as Ulta, and then how do you intend to integrate the Ulta Rewards Program at Target from a technology perspective?

Great. Thank you. Well, let me just start about the fact by reiterating we're very, very excited about the partnership. We've got a strong business model and track record to start with and feel very confident about our long-term growth prospects. And of course, we're really thrilled to unlock even more excitement for guests and growth with our Target partnership. Just to recap, we're thrilled. It's an amazing retailer. Brian Cornell is a fantastic CEO, and they've got a fantastic team. These are 2 very strong retail brands that are loved by consumers. And the concept of Ulta Beauty inside Target, 9 out of 10 people loved it, complementary brand DNA and team DNA. And of course, I think we both bring very different strengths to the equation from Ulta. It's our beauty authority, our best-in-class understanding of the beauty category, and for Target, certainly, the scale of Target and the millions of guests that will discover Ulta Beauty at Target is a huge benefit for us as well, as well as their omnichannel capabilities. As we think about bringing this forward, I think our brand -- we're early in the process with our brand negotiations and discussions. It's a lot of positive, a lot of enthusiasm. I think as a category and for brands, it's a great new platform for growth and for new customers, millions of new customers who discover brands. And so we feel very optimistic about that. Target will own the inventory. And that -- I think we've talked about that publicly. So that's what we really own the brand relationships, and that's part of the partnership that we developed from the start. Early on in terms of integration of technology, but certainly a very important part of this is that our -- is that the customers that participate in the Ulta Beauty at Target will be able to earn -- will be able to sign up if they're not currently members in Ultamate Rewards. If they're Ultamate Rewards members, earn loyalty points as well as Target loyalty points. And then for Ultamate Rewards, redeem those at Ulta Beauty. So we think that's a critical part as we think about the way to really create a flywheel here that works -- creates a win, win, win, I'd say, for guests and for Ulta Beauty and for Target.

Our next question is from Joe Altobello with Raymond James.

So first question, in terms of the experience that you guys had in October, you mentioned comps were down mid-singles in August, September and saw a little bit of a down draft in October given the fact that you guys didn't repeat a promotion you did last year. Was that different from what you expected? And I'm curious, did it cause you guys to rethink your promotion strategy as we head into the holiday season?

Yes. I would say it's not -- wasn't a surprise. I mean we made a very specific decision to pull back some level of promotion. And adjusted without the promotion, of course, the comps are even stronger. So we think it's an important step, and just continuing to refine our promotion strategies to make them be as ultimately profitable as possible, but it's not a pullback on our ability to be very competitive. So the holiday season, we started early because we needed to get people to start early in November, right, given the capacity constraints. And we've got a very robust program throughout the holiday season that we think is very competitive. And so far, as I said in the script, we feel good about the results that we're seeing. So I think it played out exactly as we had expected.

And in terms of the guide for Q4, you mentioned the comp down 12% to 14%. It does sound like November was off to a fairly decent start. So maybe help us understand why you're assuming a pretty significant slowdown in December.

Yes. Well, stepping back, again, we're pleased with the momentum that we're seeing, and the demand signals are strong. And we did feel good about how we started in November. It's a pretty simple answer to your question. We're in the middle of this unprecedented pandemic. And as you know, we just reached peak levels of hospitalizations yesterday in the U.S. So it's uncertain. Certainly, we know we're set up well. Our e-commerce business is performing extremely well. Our stores are doing a great job. But there's uncertainty about what will happen, I guess, I'd say as we get closer to the holiday in terms of store traffic, and that would be true for everybody. So we're just trying to meet the guests where they are, be pragmatic about this. Certainly, the news about the vaccine is positive, but there's many difficult weeks ahead. So we feel good, but we're also being cautious about the uncertainty that's going to, we think, play out in the next several weeks and few months.

Our next question is from Oliver Chen from Cowen.

The e-commerce growth continues to be outstanding, but it decelerated from prior amazing quarters. So what are you seeing there in terms of category performance? And what's happened in different areas of growth in that business? I would also just love more details on Ultamate Rewards in that member count and how that may trend and what's under your control in terms of keeping the member count at or above 31.7 million.

Sure. Well, Oliver, that's a 3-pronged question. That's impressive. And I'll -- maybe Dave and I will tag team a little bit. E-commerce traffic and comp, we -- we're very pleased with how that's going, and in fact, expected it to moderate somewhat as we open up stores. And that -- we like that. It's -- obviously, as people are coming back to stores, historically, what we've seen is omnichannel guests are our best guests because they add the e-commerce purchase on top and really spend 3x as much as somebody who is store-only. So as we open up stores, expected to see some moderation of e-commerce demand, but it's still up 90% last quarter. So we feel very good about that. In terms of -- I think the second part of your question was about category performance on e-com, which Dave will be happy to take, and then we can just get into Ultamate Rewards at the end of the 3-pronged question.

Yes. Oliver, category performance on e-com really mirrors the total company performance that we highlighted in the script. So strength across skincare, haircare, bath, fragrance, exceptionally strong and continued challenges although some bright spots in makeup. So nothing different about our e-commerce business versus our store from a category standpoint with real strength and growth coming outside of the makeup category. So we're pleased with that. As it relates to the -- our loyalty program, I'll just start with saying we are really -- remain incredibly proud of what we believe is one of the best loyalty programs in all of retail. And even with some of the challenges we faced this year, we know our guests continue to love the program. They're highly engaged in that program. Our brand partners continue to find a lot of value through the access and the insights that they get by engaging in that program. Our elite guests, our diamond and platinum guests are still highly engaged. It is working at a very high level, and we're really glad that we -- we've always been glad to have it, and we certainly have been happy to have that as part of our arsenal this year as we face this unprecedented times. But yes, we did see a decline this year, primarily due to store closures. That hurts our new member conversion, and it also impacts retention because, as you know, while our e-commerce business is growing, and we have a significant increase in penetration of our member base at our e-commerce, it's still a majority store-based user loyalty program. And some of those guests, particularly the least engaged, the non-elite guests, we have seen a bit of a hit on retention with those least tenured guests. Importantly, as I think Mary mentioned in the script, our retention with our most tenured guests, the platinum and diamond, remains very strong, and we're seeing a lot of strong performance in that. So with nearly 32 million members, we're -- we feel like it's still very strong, and we're focused on reactivating guests, continuing to drive strong engagement with our engaged guests and those elite guests. But as a reminder, we do calculate loyalty -- the number of our loyalty program over rolling 12 months. And so as each month goes by, we're still lapping a pre-COVID period through this -- through the next several months. So we're working hard to reengage our guests, but we'll continue to be lapping a period where we weren't facing the challenges, particularly in our store fleet. So we're anticipating some challenges with our less tenured guests for a little while but focused on retaining them and seeing strength as we emerge out of this in 2021.

Our next question is from Rupesh Parikh from Oppenheimer.

So I guess, Scott, just going back to some of the commentary that you provided for guidance for Q4. I was curious if you can provide maybe the puts and takes for gross margins. And then related to that, I just want to get a sense of what you guys are seeing right now in the promotional environment during the holiday season.

All right. Thanks, Rupesh. So first, I think with fourth quarter, it's important to keep in mind what the sales guidance is. So again, we expect a softer top line in Q4 versus Q3. Again, that's compared to last year's trends, right? So that comes with inherent margin pressure, generally speaking. We anticipate gross margin to leverage in Q4 similar to Q3 levels, with many of the same drivers that we've seen through the last couple of quarters primarily deleverage of fixed cost in the stores and across the supply chain, on lower sales volumes. And then this -- we can have some nice offsets with improving merchandise margins similar to what we saw in Q3. I guess as long as I'm talking about margins, I'll just pivot over to SG&A as well. Just as a reminder, we've made some comments in the call about the shift in the payroll, right, from -- related to the services manager going from cost of goods sold down to SG&A. So that's something to keep in mind as you update your model and just a little bit more color there. So we expect -- in SG&A, we do expect more deleverage in Q4 versus Q3, with the pressure being from store payroll and benefits as we ramp up store labor again and make sure we deliver excellent guest experience during the holiday season and then some increasing store expenses primarily due to the COVID and PPE-related costs. Lastly there, I'd say on the advertising or marketing side, there was a shift. We talked about this earlier in the year. So marketing is going to be heavier in the fourth quarter as we go into holiday. We view that as opportunistic spend versus what we saw earlier in the year.

Then on your promotional question for the holidays, of course, as we've talked about before, holiday is always a very promotional time frame for every retailer. And we see it as not just competing against other beauty retailers, but really other categories as well as we're competing for the gift-giving occasions. So naturally, we see an increase in promotionality. We also, as Mary mentioned, have -- we've pulled up our promotions and changed the cadence a bit, and we're seeing that across the category as well as more effort to spread promotional activity around, to give guests more opportunities to feel more comfortable shopping both in store and online to manage their gift-giving and personal occasions. Overall, we see it as competitive. We've seen some competitors be a bit more promotional. We've seen brands a bit more aggressive in some limited time offers, in their DTC. I wouldn't classify that as a dramatic or radical shift in promotionality. And as always, we're watching the market very closely. We've got great tools in place. We feel like the efforts we've implemented so far this holiday season this quarter have been effective. And we're confident in the promotional plans that we have, both leading up through the rest of Christmas and then post holiday as well. So feel good about the position and certainly managing and monitoring it on a daily basis.

And Rupesh, I just want to clarify, I did mean deleverage. So gross margin deleverage in Q4 versus Q3, same with SG&A.

Our next question is from Simeon Siegel with BMO Capital Markets.

Maybe a little higher level. Mary or Dave, I get pandemic might be a weird time to ask this, but how are you thinking about where you are in terms of the target -- your target customer share of wallet versus where you've told us historically? And then maybe any views you have on how the selling landscape might change post pandemic? So just thinking about potentially shrinking department stores but growing online beauty, maybe DTC brands, big box, et cetera. Just any of the changes you're seeing there. And then, Scott, did you say what you expect to save from Canada next year?

Okay. Thank you. It's another 3-pronged question. Starting with the broader environment, I would say, we are always in a strategic planning mode, right? Looking around the corners, thinking about the future, looking at what's happening with consumer behavior, channel behavior, competitive behavior. There's no question about that. The pandemic has accelerated many things that were on the horizon anyways and certainly increased e-commerce shopping, no surprise, disruption in some physical shopping, which is coming back. And we think there's a bit of a shakeout -- maybe accelerated shakeout in terms of who the winners and losers will be long term in terms of retail format. So part of what we -- a big part of what we do is think about how can we meet guests in new ways and new channels, new formats to meet them where they're going to be. And that has been a strategy for us already, which is increasing our omnichannel capabilities. So whether it's BOPIS, curbside, e-commerce, shipping capacity, digital tools, but we certainly -- that's another great opportunity for us with the Target partnership is to really disrupt at a time that there is disruption happening and accelerate the opportunities for us to drive growth through accessing new customers in new omnichannel ways. So D2C brand, certainly, there's strength in that segment as well. We think overall, e-commerce will be bigger than it would have been, it's been pulled forward. I think we all know that. But we see that our customer in this category also still really wants the in-store shopping experience. And so that's kind of exciting for us as we are always thinking about what that store of the future and experience of the future would look like. And frankly, I'm very happy that we had digital tools available like GLAMlab to immediately pivot to virtual try-on for makeup and now skincare in a way that is very helpful right now. So I think we're well positioned given the shifts. I don't think the shifts are done. I think we just have to assume that we have to continue to look around corners for new shifts and opportunities. Share of wallet, do you want to take that?

Yes. I'd just say certainly, it's, as you said in your question, a really disrupted time to try to measure consumer dynamics. And so we're watching closely on share of wallet. What we do know is we continue to gain share, and we talked about this, I think, in previous calls and discussions, gaining share on the prestige side, we're across categories within prestige, makeup, skincare, haircare. We've seen that consistently. As we talked in previous calls, we lost -- we feel like we lost some share as our stores were shut earlier in the pandemic in the mass side, and our mass competitors remained open, which would imply a bit of a short-term hit on share of wallet, but we're seeing that business strengthen and perform really well in Q3. And so confident in that. So we're going to wait for the dust to fully settle on 2020 to really assess the impact of share of wallet. What we do know is we came into this pandemic with real momentum and strength across categories and price points, gaining share, gaining share of wallet, gaining customer growth. There's been disruption, but we think our model, as Mary said, is quite strong. We think we're very well positioned to accelerate out of this and continue the path of driving growth and share across all dimensions.

And then finally, on the Canada piece, we haven't really quantified any element of the Canadian expansion plans here over the last couple of years we've been talking about this. So suffice it to say, it's a start-up investment like a lot of other things, and there's typically some deleverage that comes along with that during their early phases. That wasn't -- so we will avoid that next year, obviously, by not moving ahead with that. But back to Mary's comments, that's not the reason why we stepped away from that. I mean it was just a question of what were the highest priorities and where should we be focusing our efforts in light of all the disruption we're dealing with these days.

And our last question would be from Mark Altschwager with Baird.

Great. I guess a 2-pronged one related to stores. Maybe just first is, with respect to the store opening plans, you mentioned at least 30 next year, what are the factors you're considering today that would most impact the final plan for 2021? And is there a scenario where you could get back to something closer to the prior cadence? And then the second part, just related to Target. From a store perspective, I mean, if that partnership is successful, does it change your view on the longer-term store target for Ulta?

Yes. So I guess maybe I'll go to the last piece of that first. So no, it doesn't change our outlook really on that range that we've been talking about and reaffirming over the last few years. So 1,500 to 1,700 stores in the U.S. We still feel comfortable that that's very doable range even with the new Target announcement here recently. So as you can well imagine, real estate being one of our core competencies, this has been on the front burner, just thinking about the impact to store growth in the future and how -- what changes this might drive us to. So we don't see any big pendulum swing with respect to that, although that's something we'll keep our eyes on, right, as we move down the pathway with the Target team. And so as far as next year, the cadence, so yes, at least 30 stores, markets partly related to our ability to work with our landlord partners. I mean you know a lot of these leases we're working years in advance, right? So there are signed leases and commitments to move forward with certain projects. So again, we're relooking at all of those, all the signed agreements that we have and all the others that are in the queue, just to make sure we're making good decisions and going with the best of the best kind of locations that we feel very confident in. So it's a thoughtful process, but we feel like we've got really great capabilities there analytically, and our real estate team is best in class. So we feel confident in the future.

I'm just going to add one thing to Scott's answer, which is on top of it, the way that we thought about the Target partnership, I'd say, is really an amplifier to our business model. As Scott said, we believe we can still build out the number of stores that we've mapped out. And this yet gives us yet another point of distribution, a way to reach millions of new guests with a trial and discovery version of Ulta Beauty, right, that we amplify back to the Ulta Beauty full business model as well. And so as we map out the future of those locations, plus our store locations, working in partnership with Target to make this a win for everybody.

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

Thank you for joining us today. I'd like to close by thanking all of the Ulta Beauty associates across our stores, distribution centers and offices for their truly relentless effort to navigate through this challenging environment while also working hard to get our stores, website and DCs ready for the holiday season. We know this holiday season will be like no other, but our team is ready and excited to help our guests see the joy of the season. And we hope that you, your colleagues and your loved ones stay safe and healthy. We look forward to speaking to all of you again in March when we report our fourth quarter and full year results. Thank you.

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