Good afternoon, and welcome to Ulta Beauty's conference call to discuss results for the second quarter of fiscal 2021. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Ms. Kiley Rawlins, Vice President of Investor Relations. Ms. Rawlins, please proceed.

Thank you, Paul. Good afternoon, everyone. Hosting our call today are Dave Kimbell, Chief Executive Officer; and Scott Settersten, Chief Financial Officer; Kecia Steelman, Chief Operating Officer, will join us for the Q&A session. This afternoon, we released our financial results for the second quarter of fiscal 2021. A copy of the press release is available in the Investor Relations section of our website. 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 25, 2021. 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 operating income and adjusted diluted EPS, which have been presented to reflect our view of our ongoing operations by adjusting fiscal 2020 results 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. We'll begin this afternoon with prepared remarks from Dave and Scott. Following our prepared comments, we'll open up the call for questions. [Operator Instructions] As always, I'll be available for any follow-up questions after the call. Now I'll turn the call over to Dave. Dave?

Thank you, Kiley, and good afternoon, everyone. The Ulta Beauty team delivered excellent results again this quarter, and I want to start by expressing my sincere appreciation to all of our Ulta Beauty associates for their outstanding efforts to drive these results. As I have traveled around the country visiting with our teams across all parts of the company, I continue to feel inspired by their commitment and passion for our guests, our business and for each other. We are excited about the momentum we are seeing in our business and are optimistic about our future. The beauty category is recovering faster than we expected, and the investments we've made over the last year to adapt to the market disruption and strengthen our leadership position are delivering results. Our value proposition is strong, and we are evolving and innovating to lead in the new beauty landscape, capture more market share and drive profitable growth. For the second quarter, net sales increased 60.2% to $1.97 billion. Operating margin increased to 16.9% of sales and diluted EPS was $4.56 per share. These strong results exceeded our internal expectations and reflect our ongoing efforts to serve our guests, especially as we continue to adapt to the changing environment. In recognition of their dedication to our guests and their efforts to deliver these strong results, this quarter, we awarded a onetime discretionary appreciation bonus to eligible store and DC associates. For the quarter, comp sales increased 56.3% driven by strong growth in our brick-and-mortar channel. As consumer confidence, optimism and comfort to shop in physical stores continues to increase, we are seeing more of our members return to stores. Traffic trends in stores improved from the first quarter, but remained lower than 2019 levels. However, comp sales in stores increased this quarter compared to…

Thanks, Dave, and good afternoon, everyone. Starting with the income statement. Q2 sales increased 60.2% as we anniversaried the disruption of stores last year due to COVID-19. We opened 7 new stores during the quarter and closed 1 store. We also remodeled 5 stores and relocated 1 store. Total company comp increased 56.3% driven by a 52.5% increase in transactions and a 2.5% growth in average ticket. As Dave mentioned, the resurgence of traffic in stores drove the strong comp performance. Compared to the second quarter of fiscal 2019, total sales increased 18% and comp sales increased 13.1%. From a mix perspective, cosmetics was 43% of sales compared to 45% last year. Skin care was 17% of sales compared to 18% last year, the fragrance and bath category increased 300 basis points to 12% of sales, and hair care products and styling tools was flat with last year at 21% of sales. The services category increased to 4% of sales compared to 3% last year. Q2 gross profit margin increased to 40.6% of sales compared to 26.8% last year. The increase was primarily due to the leverage of fixed costs, higher merchandise margin, more favorable channel mix and leverage of salon expenses. Strong top line growth drove significant leverage of fixed costs. The improvement in merchandise margin was primarily the result of anniversary-ing higher inventory reserves in the second quarter last year as well as higher sales, lower promotional activity and ongoing benefits from our cost optimization efforts. Recall that we increased inventory reserves by $16.5 million in the second quarter last year primarily to adjust for slow turning and discontinued makeup SKUs and permanently closed stores. As a percentage of sales, salon expenses were lower compared to last year, reflecting strong top line sales and the elimination of the…

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

Congratulations. I mean, really, it's a huge inflection starting last quarter and great to see the momentum continuing. Dave, my first question is for you about Ulta and Target. Obviously, it's early days with just 10 days under your belt. But I wanted to see, what have your early learnings been? If you can help us with any details on that. And then I know the initial target was somewhere around 100 stores. What would be the benchmarks for more aggressive rollout? And then my second follow-up question is for Scott. Just remind us, this is one of the first calls where we haven't spent an inordinate amount of time on freight and the supply chain, although it is an issue. You're not as exposed to the Far East. So can you talk about kind of where you are exposed? And if you can, any kind of basis point impact for the back half?

Great. Well, thanks for the question and the comments, Adrienne. I appreciate it. Yes, let me start on Target and then I'm going to ask Kecia to give some more color because Kecia is leading this for us. But we are, as I said in the comments, we're just thrilled with the partnership and the launch guest response. We feel really confident how we've come out of the gate operationally, working really well. And most importantly, as I mentioned, consumers are thrilled by this. They're really excited about the idea of bringing together 2 great retailers in a unique experience that nobody else is doing. This is totally new to beauty. And so we're really, really pleased with the results and the engagement and the partnership. Kecia, why don't you share a few more details about what we're seeing and maybe the outlook on stores.

Yes. What we're most excited about really is the operational execution across both Ulta Beauty and the Target teams. The seamless integration between our technologies and making sure that we're capturing both the Target Circle members and the Ulta Beauty members and having them link their accounts were out of the gates really strong. We love what we see. The guests are really loving this experience overall. And there's just huge momentum that we're looking forward to continuing on getting the rest of the 100 stores open in Q3.

And then I'll follow up on the international piece and supply chain. So we don't really break out geographic sourcing exposure. But most of our products, lipsticks, serums are made in the U.S. or Europe. We do have some limited exposure to China with the Ulta Beauty brand, private label and a few specific brands in the assortment like Morphe, and some components, of course, which are part of our vendor partners supply chain as well. So again, we're keeping a close eye on that. There's nothing that we see as a critical watch out at this point in time, but we're just trying to plan ahead and making sure we're as well prepared as we can despite any eventual outcomes there or development. So we feel like we're well positioned for holiday and the second half of the year.

Our next question comes from Simeon Siegel with BMO.

Congrats on the great results. Dave, to follow up and Kecia, to follow up on that just slightly from the loyalty angle. So can you just speak to your expectations of the member? But first of all, fantastic loyalty results. Can you just speak to your expectations of member growth maybe over the year and then beyond just with the Target relationship now in effect. And then the follow-up, Scott, as you look past this year, can you just speak to how you're viewing these margin rates as to whether they're a new base or whether you expect just give back from the benefits we're seeing right now?

Great. Thanks, Simeon. Yes, let me start with loyalty and let me just, before I talk specifically about Target, zoom out a little bit. And we're really, really pleased with our loyalty results in the quarter and really through this first half of the year to get back to a new high of 34.6 million members, 8% above last year, 4% above 2019. As I mentioned in the comments, that's faster than we had anticipated. But it's really a testament to an effort across the entire organization from our loyalty team, our analytics team, marketing, merchandising and of course, our store teams and e-commerce teams that are delivering a great experience every day. And the fact that we were able to increase total loyalty members by 2.3 million members, which is the largest growth we've had in any single quarter is just exceptional and again, really proud of the team and the effort. That's come through strong new member acquisition, strong reactivation rates of lapsed members and of course, high retention among our existing members. And so our loyalty program has long been a focus of ours. It's absolutely a key differentiating aspect of our total model. We're very proud of it, and we're continuing to innovate and drive that part of our business. And specifically about Target, I'm not going to give any specific numbers about our outlook other than one of the main reasons that we're really excited about this program is the connection that we see with our loyalty program, both in delighting our existing guests, and we think over time, increasing their total share of spend with Ulta Beauty with another key pillar in our omnichannel experience with our relationship with Target, but also attracting new guests. The Circle program has over 90 million members in it. They have 30 million people walking through a Target every week. So we feel like there is a very large opportunity for us to attract new loyalty guests into our program, get them engaged in the Ulta Beauty at Target experience, but then also introduce them to all things Ulta across all touch points. So we're confident. And too early to kind of talk about the experience so far. But as Kecia said, we're excited about the results so far and see it as a big driver. Scott, do you want to hit on the margin?

Sure, Simeon. So again, we're very, very proud of the results we posted this quarter and appreciative of all the hard work on behalf of our associates and brand partners to deliver great experiences to our guests, which at the end of the day is what delivers those kind of financial results. So I would say the comp performance, again, it was elevated over initial expectations. So the 56% versus last year and a 13% comp versus '19 reflects a mix of benefits, unique external factors, I guess, I would say, combined with the power of our model and all the great execution and things we're doing to drive stronger results and leverage across the P&L. I'd say it makes us increasingly more optimistic. Again, you've heard us say that we believe this is a double-digit EBIT margin business over the long term. Our goal is to expand operating margins, and we feel confident we can do that. I guess I would say we're not going to share too much today. We'll have more to say, more color to share on sales outlook and margin expansion opportunities when we get together at our Analyst Day here in October.

Our next question comes from Chris Horvers with JPMorgan.

So my first question is, your 2-year comp CAGR accelerated in 2Q versus the first quarter. You're fading that back down to get to low double-digit comps in the fourth quarter despite what should be more work from work and learn from school in the back half. Is this just looking out into the uncertainty? And related to that, have you seen any impact from Delta in August from any markets in particular?

Yes. Great. Thanks, Chris. Yes, absolutely, we are so excited and encouraged by the first half results and the trends. And as you said, the strengthening we saw and the momentum we see throughout the first half. And we're feeling encouraged by what we're seeing so far in the third quarter. And that's why we have increased our sales expectation for the full year. I will say, so with that optimism and confidence, it does remain difficult for us with certainty to understand how these variables will impact our business through the remainder of this year. With the resurgence of variants, certainly, that's having a broader impact in the world around us. Our business remains healthy, but difficult to predict exactly how that will play out in consumer behavior. We're optimistic about holiday. We feel like it's going to be a strong holiday. But holiday is always a unique time of year, of course, with a lot of new dynamics going on and uncertainty how COVID and other influences will drive through that. And then we're lapping our business in the second half of the year in 2020 was stronger than the first half of the year, for sure, as we reopened stores and started to gain momentum. So we do believe our sales forecast is prudent. It's achievable, but it's also reflective of the uncertainty that we see out there. And last thing I'd say, as we've been doing throughout all of this, if the recovery is stronger or faster than planned, we're prepared. We're working closely with our brand partners to be ready to adapt and adjust. We're working hard to make sure we have the right inventory, the right store staffing, the right marketing plans to continue to lead the recovery in the beauty categories, we believe we've been doing so far this first half of the year. So optimistic but feel like our guidance is appropriate given the environment.

Makes sense. And as a follow-up, quick math suggests that it seems like you're implying maybe a 36.5%, 37% type gross margin in the back half. Is that in the ZIP code? And if that's the case, what drives the lower rate versus the first half?

Yes. I would just say, we're taking a more tempered view, I guess, of the promotional environment. Again, naturally, holiday is more promotional. We're competing against a wider variety of retailers during the gift-giving season. We've got some incremental supply chain costs that we're baking into the plan to be prudent around fuel costs and things like that. So again, on balance, we think it's a prudent estimate forecast and we think it's achievable. And if things turn out better, sales are stronger, we'll deliver better results.

[Operator Instructions] Our next question comes from Olivia Tong with Raymond James.

First, congrats on the quarter. The first question has to do with the margin because I imagine a lot of this is fixed cost leverage. But how much of this is, how much of the margin, incremental margin is an extension of some of the efficiency and promotional improvements lasting? And how does this, in any way, change your view on customer acquisition costs or additional promotional efficiencies over time? And then you also mentioned that the e-commerce sales are mostly incremental, which is fantastic. So can you talk a little bit about the profile of the customer that maybe primarily shops via online versus in-store? Is it changing? Is the incremental new people still coming in via omnichannel? Are they replacing customers who are back to shopping in-store now? Or can you just give a little bit more color there, that would be helpful.

Yes. So maybe I'll start with the margin. So it's not exactly clear. But if we're looking at the second quarter, again, we describe that the biggest drivers in the second quarter were the reserve adjustments versus last year. Again, this is versus 2020. And so they were pretty significant last year. So of course, we didn't absorb any of that this year. We're doing a much better job with the stronger sales and better discipline in the stores. So that was a pretty significant benefit. Promotional, less discounting was kind of in the middle of the list, I guess, I would say. Fixed cost is another major driver of gross margin expansion in the second quarter and for the first half of the year just because of the much higher sales levels overall. So when I think about those things and of course, the salon manager shift versus last year was another element of that. So again, we're not going to quantify those things. But as I think about the future and we were thinking about the back half of the year, merchandise margin, we still expect to be able to expand it. The promotionality discipline, I think, again, we got a good start on that last year with some good learnings. Those are being played forward now. We still think there's opportunity there for us. There's other things we can do as far as tools and process improvements to help that, aid that over the longer term. Fixed costs, again, once we got sales back on track, fixed cost leverage is the gift that keeps giving. So that's something, again, that we feel pretty confident in. And then there's other things we're working on as part of our ESG efforts that will continue to deliver benefits over the long term. So when we think about gross margin, merch margin being the most important piece of that, we still think there's plenty of opportunity for us over the longer term.

And on your e-com member profile, I'll just hit a couple of high points here, which is, first, our e-commerce business, very healthy and such a strong and important of our total omnichannel mix. And we're really pleased with how that's complementing and integrating with our store experience. And so we're so glad to see strength across both of those channels. Omnichannel guests are among our very best guests. Those that are shopping both in-store and online do demonstrate a high level of incrementality with their e-commerce purchases because what we typically see is those that have been shopping in-store that start shopping online continue to shop in-store at, or in some cases, even higher levels. And it's because they get more ingrained and integrated into the total Ulta Beauty experience. They become more loyal to Ulta Beauty and concentrate more of their beauty spend at Ulta. So last year, with the stores being closed and the dramatic increase in our e-commerce, we introduced a whole lot of new consumers to our e-commerce business. Now some of them have gone back to shopping only in-store, but most of them are continuing to shop in an e-commerce business, I'm sorry, in an omnichannel way. And the behavior is really positive, both helping to deliver our Q2 results. But importantly, as we grow that base of omnichannel shoppers, we'll have even more consumers shopping across channels going forward, which we know will drive total sales in the out-years going forward. So excited about this omnichannel behavior and believe that one of the lasting impacts of this disruption will be a significant increase in our e-commerce business and our omnichannel behaviors.

Maybe if I could just follow up on makeup. You mentioned obviously that the momentum has continued 2Q versus 1Q, even if it isn't back to where it was before. Why do you think it hasn't fully recovered back to where it used to be given the replenishment, given that people are going out, there is a lot of innovation. Do we need another trend or is it just there is still some holdback? Just kind of curious given the strength particularly of other categories outside of makeup.

Sneaking in one more makeup question. But yes, I'll just be brief here, the makeup. We're encouraged by what we see. And I think it's just a testament that the other categories had been strong, skin care, hair care, bath, fragrance. And they remain strong. There's a high level of engagement. But makeup, the trends that we're seeing are encouraging. While it was slightly below 2019 levels in Q2, we had weeks and times during the quarter that it was positive versus 2019. Our mass business, we talked about in Q1, was above 2019 levels, and it accelerated in Q2, also above 2019. And our prestige business is improving. We're bringing in newness. Our biggest brands are performing well. New brands are performing. So I think it's just consumer behavior as we recover is there's a high level of engagement, high level of excitement about makeup, more usage occasions and the momentum is building. Time will tell exactly when we get back to steadily being above 2019 levels and growing from there, but we're encouraged by what we see.

Our next question comes from Steph Wissink with Jefferies.

Hopefully, this is a quick one for you, but wanted to just talk about SG&A leverage because I don't think we've seen on a full year basis that in the guidance for quite some time. So I just wanted to understand a little bit about the key pieces. Maybe, Scott, if you could talk about what components of SG&A you expect to see the best leverage and where you might see some opportunity still in the future periods?

Yes. So if you're looking back at 2020, Steph, I think there's going to be a good story there as far as leverage on SG&A overall. Of course, the better comparison is 2019. So that's where I'll spend my time. As we look back there, there's still, I guess, I would say there's going to be leverage versus '19 now versus our earlier in the year outlook there. Again, a lot of that's due to stronger-than-expected sales. So that's good news. We expect dollars to be higher in '21 than '19 primarily on store growth, number one, wage pressures primarily in the stores and a big variable here is higher incentive compensation levels than what we saw back in 2019. You'll recall, 2019, we missed our internal targets by a fair range. And so that's going to be a headwind, a significant headwind when we're measuring back against 2019. Of course, we have that service manager role as well that's been reallocated from the gross margin line, where it's a good guide down to SG&A, where it's a headwind versus 2019. But again, that's a net benefit for the company overall at the operating margin level. We're also going to be pulling in some incremental advertising, marketing expense in the back half of the year. I think we've mentioned that in some interim investor calls here to take advantage of market share opportunities now and the strength of our business. And of course, we've got good sales trends here, too. So we're going to make some more significant investments there in the back half of the year in digital channels. So again, places we know that it works and it's effective and there are strong ROIs.

Our next question comes from Ike Boruchow with Wells Fargo.

Scott, can you talk a little bit more about just the e-commerce? I mean, I think you said that the dollars doubled versus '19, which I think implies year-over-year was down around 25% to 35%, which makes sense given what you're lapping. But now that your compares are more, I mean, actually they're still tough, but not quite as elevated, do you expect e-commerce growth to return when you get to the third quarter and back half?

Yes. Thanks, Ike. So again, yes, second quarter, a little bit unusual. I mean, we did see some growth in the first quarter. But again, we were lapping kind of just the initial stages, I guess, of the COVID and the shift and the store closings and kind of becoming a digital business 100% kind of overnight back in 2020. So it was what we expected. That was what was in our annual plan to see an overall decrease in the e-com versus last year. Again, brick-and-mortar, again, our guest demonstrating that brick-and-mortar is an important part of the beauty shopping experience and ecstatic to see traffic numbers coming back to the stores and again, sequentially improving here in 2021. So I think Dave called it out in his prepared remarks. We got to remember, last year, second quarter, we doubled our e-commerce business, right? So to expect a little bit of moderation here I don't think is anything extraordinary under the circumstances. As we think about the rest of the year, again, stores, the traffic trends are good. We're encouraged there. So I would expect that e-commerce is going to moderate as we look out to the rest of the year. And I wouldn't expect it to be a growth in absolute terms here as we look over the next couple of quarters. Again, for the full year, we expect e-commerce penetration to be in the low to mid-20% range.

Our next question comes from Kate McShane with Goldman Sachs.

You had mentioned that the comp did come in higher than your expectations. I wondered if that was a commentary on both what you saw in prestige and mass. And within mass, are you seeing an acceleration in market share gains there, whether it's in cosmetics or other categories?

So Kate, I'm sorry, can you repeat the first part of your question. We didn't hear you.

Oh, I'm sorry. I'll speak up a little bit. I just wondered based on your comments that you came in higher than your expectations for comp. Is that a similar commentary both for the prestige category and the mass category? And then just within mass, are you seeing an acceleration in share gains there versus what you saw in Q1?

Got it. Yes. Thanks for the question, Kate. And yes, we're really across the board. Yes, we were higher than our expectations and we're seeing strength versus expectations across really all aspects of our business. I talked about all of our categories demonstrating strong improvement. And in all but makeup, healthy growth versus 2019, and that is true both on the prestige and the mass side. And then within makeup specifically, and while we said it's not quite back to 2019, although getting closer and again showing moments through Q2 where we were above 2019. We saw improvement in both mass and prestige. Mass has recovered faster, but prestige is certainly showing signs. And we're seeing some good, and it's really driven by newness across the board, both some new brands that we brought in, but a strong newness across so many of our brands and different segments of makeup that are exciting our guests, getting them re-engaged in the category. So yes, we're seeing it across both price points and categories, and it's encouraging.

Our last question comes from Krisztina Katai with Deutsche Bank.

Congrats on a very strong quarter. I wanted to touch on the membership base. You mentioned that it reached a new record. You are re-engaging with lapsed consumers and signing on new ones. So where do you think you are in terms of the target customer share of wallet compared to 2019? And then secondly, do you have any views on how the selling and competitive landscape is really evolving here as we exit the pandemic. And how are you thinking about the various players, including department stores, brand, DTC and specialty beauty players like Ulta and Sephora?

Great. Yes. Loyalty, as I mentioned earlier, we're really pleased and encouraged by the results we're seeing, both in the absolute number of active members as well as spend per member. We're seeing nice healthy improvement there, and it's just driven by high-level engagement across categories. And so as we look at share of wallet, we are confident that we're continuing to grow both share of categories and share of wallet, and feel like our efforts to lead the category recovery are driving a high level of engagement. And across the competitive environment, certainly, the beauty category is always highly competitive. This is a disruptive time with a lot of changes. We have a high level of respect for all of our competitors. But our focus is on Ulta Beauty and driving our business forward and leading the beauty category and leading the beauty recovery. Our model is unique. Nobody does what Ulta Beauty does. The assortment that we provide, the loyalty program, the guest experience, which is so important and done with excellence in our stores in particular and across all other touch points. And so we believe we have a unique business model that yes, while we certainly watch and are well aware of competitive activity, we're focused on playing offense and driving our business forward. And again, I couldn't be more proud of the way the team is delivering across every part of our business to ensure that Ulta Beauty is the really definitive leader in the beauty category and driving this recovery that we're very encouraged to see. So with that, thank you, again, for joining us today. I really appreciate your time. And I do want to thank all of our Ulta Beauty associates for their continued agility and commitment to serving our guests and taking care of each other, especially through the changing dynamics of COVID-19. We look forward to sharing more about why we are so excited about the future of Ulta Beauty when we host our 2021 Analyst Day here in the Chicago area in October. So have a good evening and thanks again for joining.

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