Ulta Beauty, Inc. (ULTA) Q3 2020 Earnings Report, Transcript and Summary

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 Fall Haul event beyond makeup to include key self-care categories while reducing the length of the event to drive greater productivity. And to further elevate our hair authority through our Gorgeous Hair event, we leverage engaging storytelling around healthy hair, color care and black-owned brands. Now turning to our performance by category. We continue to increase our market share across most major prestige beauty categories. Starting with one of our strategic growth categories, skincare delivered positive comp growth driven by newer brands like The Ordinary, TULA and Beekman 1802 as well as existing brands like CeraVe, First Aid Beauty and La Roche-Posay. From our proprietary consumer insights work, we know most beauty enthusiasts are maintaining or expanding their skincare routines as a form of self-care. Increased interest for home skincare treatments as well as newness and innovation in body treatments, face serums and eye creams are driving strong category growth. Leaning into these trends and the opportunity to increase our market share in this category, we continue to expand our assortment while also increasing space and marketing support for this key growth category. Fragrance and bath was our strongest category this quarter, delivering double-digit comp growth, driven by newness, exclusive and unique Ulta Beauty programs. Guests responded well to our fragrance gift with purchase programs as well as our Fragrance Crush program, which highlights a favorite fragrance each month. Sales of fragrance also benefited from our exclusive launch of R.E.M. from Ariana Grande and innovation from established brands like YSL and Marc Jacobs. The bath category continues to deliver strong growth. And this quarter, we introduced newness from brands like Truly, Hempz, Ulta Beauty Collection and Tree Hut. Reflecting ongoing DIY beauty and self-care trends, haircare and hairstyling tools also delivered positive comp sales growth this quarter. Within haircare, color continued to deliver strong growth driven by brands like Arctic Fox and Madison Reed. Textured hair brands, Curlsmith and Pattern by Tracee Ellis Ross, also delivered nice growth. Our leader business also continued to perform well, and newness from Dyson and the continued popularity of one-step tools drove strong growth in styling tools this quarter as guests leverage more options to achieve different looks. Makeup continued to be challenged given shifts in consumer behavior and delays in planned newness and innovation. Despite these headwinds, subcategories that focus above the mask continued to perform better, including lashes, brow and eye. Newness, while more limited than last year, continues to be important to guests, with nostalgic themes like Ulta Beauty Harry Potter collection, Makeup Revolution's Nightmare Before Christmas and ColourPop's Hocus Pocus collection, all resonating really well with guests. Although the pandemic has accelerated channel shift, our consumer insights and results continue to confirm that our members prefer to shop in physical stores for beauty even as they have increased their adoption of online shopping. As expected, with stores opened for the full quarter, store traffic trends improved and e-commerce growth moderated from trends we saw in the first half of the year. For the quarter, our e-commerce business delivered sales growth of about 90%. And buy online, pickup in store was strong again this quarter. Turning now to services. Our services business continues to be adversely impacted by COVID-related capacity constraints and local restrictions. At the end of the third quarter, salon and brow services were available in nearly all stores, but we've not resumed skin or makeup services based on ongoing safety concerns. Although trends improved from the second quarter, sales from our services business were down more than 30% in the third quarter primarily due to a decline in transactions. Average ticket was higher, reflecting pent-up demand for cut, color and style services. At the end of the quarter, we had 31.7 million active members in our Ultamate Rewards Program, essentially flat with the second quarter and about 6% lower than the third quarter last year. While we're pleased with our new member acquisition and reengagement trends this quarter, we will continue to focus on reactivation of members who haven't shopped with us since the pandemic began. Now importantly, retention rates among our platinum and diamond members who are most engaged with our brand remain very strong. We continue to see an increase in members shopping with us online. As we've discussed before, omnichannel members are our most engaged and most productive members, historically spending 3x more per year than store-only guests. In the third quarter, omnichannel members were about 22% of the total compared to about 12% in the third quarter last year. As our teams continue to manage the day-to-day operations in the current environment, we're also building the foundation for profitable growth in 2021 and beyond. Specifically, we're focused on 5 strategic priorities to expand our market share gains and extend our competitive advantages. And during the third quarter, we made progress on each of these priorities. Starting with our continued focus on building the capabilities to win in an omnichannel world. We are committed to meeting guests wherever they want to shop. In April, in response to COVID-related constraints, our digital and store teams moved quickly to launch a new curbside pickup option. To make it easier for our guests and our store teams, we have recently enhanced this option with the launch of a curbside customer alert notification. We've refreshed curbside signage and established dedicated Ulta Beauty parking spaces at select stores. We've also expanded our store locator functionality to include greater visibility to store-specific service offerings and separate store and curbside hours. And in the Ulta Beauty app, we now provide store-specific occupancy levels for greater transparency and guest safety. To support our growing e-commerce business, this quarter, we opened our Jacksonville fast fulfillment center, expanded e-commerce operations in our Chambersburg, Greenwood and Dallas distribution centers and expanded our ship-from-store program to 105 stores. These investments have increased our e-commerce shipping capacity and will improve delivery speed to guests. This quarter, we also completed the rollout of our new booking tool for services in the app and on ulta.com. This new digital application enables guests to easily book or reschedule salon, brow and other service appointments. Adoption of the tool continues to increase, and nearly 1/3 of our service appointments were booked through this new tool in the most recent quarter, resulting in more convenience for our guests and more efficiency for our associates. Our second priority is to reimagine how guest experience and discover beauty in the new normal. Product discovery is a hallmark of the beauty shopping experience, and we're welcoming more guests to experience the fun of GLAMlab, our virtual try-on tool. Our store associates have done a great job introducing GLAMlab to guests as a safe alternative to testers in stores, which are currently for display purposes only. To help facilitate even more in-store engagement, we've introduced new QR codes on select shelf strips that take guests directly into the GLAMlab experience, making it even easier for guests to virtually try on products while they're in stores. Building on our successful virtual try-on capabilities, last quarter, we introduced a skin analysis tool, which uses augmented reality technology and artificial intelligence to assess skincare needs and offer personalized product recommendations. This quarter, we enhanced this tool to include new routine recommendations and the ability for guests to save analyses to track changes. In addition to offering guest digital tools, we're also testing one-on-one video consultations across all beauty categories in collaboration with our brand partners and our own services team members. Our third priority is to engage and delight beauty enthusiasts with a curated beauty assortment focused on exclusivity and leading brands. Reflecting the growing importance of clean beauty, in October, we launched Conscious Beauty at Ulta Beauty at all stores and on ulta.com and on our app, and the enthusiasm and feedback from our guests and brand partners has been tremendous. This holistic initiative provides greater transparency to help guests choose brands and products that reflect their personal values and individual needs. Through this initiative, we're certifying brands across 4 key pillars: clean ingredients, cruelty-free, vegan and sustainable packaging, and highlighting participating brands for their positive impact on communities. And today, more than 200 brands are participating in the program, and more than half have been certified in more than 1 pillar. As part of the launch, we established the Conscious Beauty Advisory Council, a coalition of experts at the forefront of clean beauty, product development and packaging sustainability. With the help of our advisory council, we will ensure that Conscious Beauty at Ulta Beauty will continue to evolve and grow as expectations and standards for clean beauty continue to change. In tandem with the launch of Conscious Beauty, we collaborated with Credo Beauty, a pioneer in Clean to introduce the Credo Collection at Ulta Beauty, a curated collection of prestige and masstige brands. Available in select stores and in ulta.com, this collection features 9 clean brands handpicked by the Credo experts across multiple categories, including skincare, haircare and cosmetics. Our fourth priority is to leverage insights from our Ultamate Rewards Program to cultivate brand love and loyalty, deepen guest engagement and increase spend per member. We continue to build content that reflects our brand purpose and drives meaningful connection with our guests. After suspending most of our marketing efforts in the first half of the year while stores were closed, this quarter, we launched Where Dreams Begin, a campaign that reflects the next chapter of our brand journey. Launched across linear television and digital streaming platforms, the work reinforces our brand purpose and celebrates optimism, togetherness, self-care and self-expression in a world increasingly challenged by uncertainty and division. We continue to enhance our ability to create personalized offers and recommendations based on a holistic, data-led understanding of guest preferences and behaviors. This quarter, we increased our use of propensity modeling to help reactivate members, and we continue to strengthen our ability to optimize offers in e-mail and online, enabling us to maximize the return on select promotions. Our fifth and final strategic priority is to drive holistic cost optimization. We continue to work to create a more cost-efficient store labor model. As we discussed on the last earnings call, we made the difficult decision to eliminate 2 store leadership roles, the salon manager and the prestige manager, and created a new service manager role responsible for services, events and prestige retail. Effective November 1, this new structure creates a stronger linkage between services and products. This quarter, we also made another difficult decision to suspend our expansion to Canada. This was not an easy decision to make and in no way reflects a lack of confidence in the international growth opportunity for Ulta Beauty. Our teams work diligently to position us for a successful entry into Canada next year, and I'm proud of what they accomplished in such a short period of time. However, after much consideration, we determined that prioritizing our efforts to strengthen and grow our U.S. operations must be our top priority in the current operating environment. So these are just a few of the examples we've taken to adjust our model to reflect the challenges and opportunities we see today. We've also maintained significant limitations on corporate hiring and controllable expenses, and we continue to look across the enterprise for additional ways we can optimize our cost structure while also investing in new capabilities to support future growth. We've made a lot of progress in pursuit of our strategic priorities, which positions us to drive continued market share growth in the fourth quarter and beyond. Certainly, 2020 has been a year like no other, and it's difficult to predict exactly what the holiday season will bring this year. With Shop Safe Standards in all stores and enhanced digital shopping options, our teams are ready to meet our guests wherever and however they want to shop with us this holiday season. We're encouraged by the sales trends we've seen so far in the quarter, but uncertainty remains as we navigate ongoing disruption from a resurgence in the virus and continued economic uncertainty. As we execute through this holiday season, our top priorities are to reengage existing members and capture new guests with relevant content, compelling offers and unique products, and also to deliver engaging omnichannel experiences. Ulta Beauty is well positioned for this gift-giving season as consumers seek moments of joy, connection and self-care. Our holiday campaign is focused on helping guests see the joy this holiday season. Leveraging influencers from our Ulta Beauty Collective, we're sharing ways to practice self-care. We're celebrating community and relationships with gifting ideas, and we're highlighting the magic and generosity of the season. We kicked off the holiday season at the beginning of November with the distribution of our holiday print magazine, a reimagining of our holiday offers and multiple member appreciation events. Building on newness and exclusives introduced earlier this year, we've launched several new brands just in time for holiday season. In skincare, we're excited to launch Alicia Keys' new brand, Keys Soulcare, exclusively at Ulta Beauty, with a limited selection of products for the holiday season. The full assortment will be available in early 2021. In makeup, we're excited to welcome HOURGLASS, a cruelty-free luxury beauty brand to the Ulta Beauty family. And while we offer Chanel fragrances in stores, we're excited to announce we've recently launched Chanel fragrances on ulta.com for holiday gifting and beyond. To help our guests give the best gifts this year, we have introduced a new digital gift guide, including a 3-step quiz to inspire and help find the perfect gift. And for those who prefer to give gift cards, we've expanded our designs to include more inclusive options, and we've expanded our distribution in third-party outlets as well for added guest convenience. In anticipation that more guests will utilize digital channels this season, we've made curbside and BOPIS pickup easier than ever. These enhancements, combined with the investments we've made to increase our ship-to-home capacity, position us well to deliver a great omnichannel experience this holiday season. The operating environment continues to be dynamic and challenging. As COVID-19 prevalence increases, so are market-specific government restrictions, resulting in some reductions in operating hours, limitations on in-store capacity and, in some cases, mandated store closures. Our priority is to ensure the safety and well-being of our associates, guests and brand partners, and we'll continue to monitor the situation closely and adjust our operations as needed. Now before I turn the call over to Scott, I want to highlight the exciting new partnership I'm sure you've all read about. In 2021, Ulta Beauty will partner with another powerhouse retailer, Target Corporation, to disrupt the retail industry and redefine how guests experience beauty. Next fall, we'll introduce Ulta Beauty at Target, a shop-in-shop experience online and in select Target locations. With 1,000 square feet of space, Ulta Beauty at Target will offer a curated assortment of established, emerging and prestige brands across multiple categories. Our vision is to create an extension of our welcoming Ulta Beauty experience with dedicated Target team members trained to provide elevated service and offer deep product expertise with a dedicated space that inspires trial and discovery. Leaning into the power of our respective loyalty programs, we intend to reward guests with benefits across both programs for all purchases made within the shop. Leveraging a royalty structure, this unique collaboration brings together Ulta Beauty's category authority and brand relationships with Target's traffic-driving business model and industry-leading fulfillment services. Together, we will deliver industry-leading guest experiences across multiple touch points, provide the prestige beauty category and participating brands with an unparalleled platform for growth, drive market disruption and capture more market share. For Ulta Beauty, this partnership will build on our strength as the nation's largest beauty retailer, bring our beauty authority to life in a new way and create additional touch points for millions of loyal and new guests to discover and engage with Ulta Beauty, ultimately leading to more members as well as greater spend per member. Expanding our omnichannel capabilities to more deeply connect with guests is a strategic priority for us. We believe this new channel will create more opportunity to drive demand for the full beauty experience for discovery, services and play available in all Ulta Beauty stores. Importantly, we'll be able to leverage our robust CRM capabilities to engage guests who shop Ulta Beauty at Target with targeted personalized communications to highlight and enhance their total Ulta Beauty experience. In closing, we know guests are changing how they shop for beauty, but their engagement with the category remains strong. In fact, the role of beauty is more important now than ever. In this new normal, beauty has become more than makeup, more than product. Today, beauty is a critical link to acts of self-care and wellness. And as a well-loved brand with a diverse assortment and a wide range of price points, outstanding service offerings and knowledgeable and passionate associates, Ulta Beauty is well positioned to lead and shape how guests experience beauty in this new normal. And now I'll turn the call over to Scott for a discussion of the financial results. Scott?

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 the onset of the pandemic, the largest driver of gross margin deleverage was fixed cost due to lower sales. I would note that the trend improved from what we experienced in the second quarter due to the stronger sales trend. Channel shift was also a large contributor to gross margin deleverage again this quarter, albeit less than we experienced in the second quarter as stores were open for the entire quarter. These headwinds were partially offset by an increase in merchandise margin, which was primarily driven by our lower promotional activity as well as continuing benefits from our efficiencies for growth or EFG efforts. SG&A expenses decreased to $416.4 million compared to $449.2 million in the third quarter of last year. The largest driver of the decrease was lower store payroll and benefits as we reduced investments in labor to reflect lower demand. Store expenses were also lower as we adjusted and managed to softer traffic in stores. Marketing expense was also lower year-over-year, reflecting reduced spend on print, offset by higher investment in digital channels. These reductions more than offset a modest increase in corporate overhead and PPE and COVID-related expenses. The increase in corporate overhead primarily reflects higher compensation and benefit expense partially offset by investments to support strategic growth initiatives made last year. As a reminder, in the third quarter of last year, incentive compensation expense decreased versus the prior year, reflecting financial performance that was below targeted levels as well as a lower stock price. This quarter, we recorded a charge of $23.6 million for impairment, restructuring and other costs. As Mary mentioned earlier, we suspended our planned expansion to Canada, resulting in a $15.9 million charge related to long-lived asset impairments, lease termination costs and severance. Our teams continue to wind down this effort, and we now expect to incur between $30 million to $40 million of Canada exit expenses in fiscal 2020. In the third quarter, we also recorded $5.7 million in severance associated with the elimination of the salon manager and prestige manager roles and recorded $2 million of lease termination costs related to the previously announced permanent closure of 19 stores. Preopening expense was $4.2 million in the quarter, a decrease from $6.5 million a year ago. We resumed new store openings in early August and opened 17 stores in the third quarter compared to 31 new stores a year ago. Interest expense related to the drawdown of our revolver totaled $1.4 million compared to interest income of $900,000 a year ago. Diluted GAAP earnings per share was $1.32 compared with $2.25 reported for last year's third quarter. Adjusted diluted earnings per share, excluding charges related to impairment, restructuring and other costs, was $1.64 compared to $2.23 a year ago, which excludes stock compensation and other tax credits. Moving on to the balance sheet and cash flow. For the quarter, total inventory decreased 11% compared to the third quarter last year, and inventory per store decreased 12.5% year-over-year as we adjusted to recent demand trends and reduced holiday receipts. To maintain flexibility and manage inventory risk, we have reduced our exposure to limited edition holiday sets and are leaning more into core product. We ended the quarter with $560.9 million in cash and cash equivalents. At the beginning of the pandemic, we drew down $800 million on our $1 billion revolver and suspended our stock buyback program as precautionary measures to increase liquidity. Reflecting on our confidence that we have sufficient liquidity to support our operations and investment priorities, we repaid $800 million of borrowings that were outstanding under the facility on September 2. We remain confident in our ability to generate strong cash flow, and we may resume our stock buyback program this quarter, depending on market and operating conditions. We currently have $1.58 billion remaining under our current repurchase authorization. Turning now to the rest of 2020. The overall operating environment remains uncertain, and it continues to be difficult to forecast our business with precision. Therefore, we are not providing EPS guidance at this time. However, I want to provide some color on how we are thinking about the fourth quarter. We are encouraged by the sales results for November. However, the operating environment continues to be dynamic, and it is difficult to predict how the effects of the pandemic, including any lockdowns or restrictions, may impact consumer demand through the rest of the quarter. As such, we now expect our fourth quarter comps to be in the range of down 12% to 14%, slightly better than the expectation of mid-teen comp declines we shared on our last earnings call. Two callouts as you think about your models. As Mary shared, we have realigned our store management structure to create a more cost-efficient store model. As a result of these changes, we will see a reduction of salon payroll and cost of goods sold and an increase in store payroll and SG&A relative to last year. Second, we expect to incur $15 million to $20 million of PPE and COVID-related expenses in the fourth quarter. Overall, we expect SG&A dollars in the fourth quarter will be similar to last year's levels. We continue to adjust our capital spending plan. Our updated plan for 2020 is to invest between $150 million and $160 million in capital expenditures, including approximately $65 million for new stores, remodels and merchandise fixtures, $65 million for supply chain and IT, and about $25 million for store maintenance and other. We expect to open approximately 30 new stores and relocate 5 stores in 2020. We are still finalizing our plans for next year but continue to expect to open at least 30 new stores in 2021. We remain confident in the long-term opportunity to continue to expand our store fleet. One final comment. We recognize that our long-term profitability potential is top of mind with investors, and I want to take this opportunity to reiterate our confidence that Ulta Beauty is a double-digit margin business. However, given the uncertainty and lack of visibility as to when the operating environment will stabilize and recover from the pandemic, it is difficult to say with certainty when we will return to double-digit margins. To start, we have healthy product margins, and our merchant teams continue to work to improve merchandise margins as we expand and enhance our assortment through both negotiation efforts as well as EFG opportunities. As sales stabilize and return to growth, we'll be able to leverage fixed costs. In addition to our ongoing EFG efforts, our real estate team is capturing significant benefits from lease renegotiation efforts, reflecting the market impacts of COVID-19, and these efforts will help us reduce occupancy costs over the longer term. Although e-commerce will likely continue to be a headwind to overall EBIT margins, we are improving e-commerce profitability as we increase utilization of BOPIS, leverage size and scale with growth and get closer to our guests through the expansion of our supply chain network. And we see additional opportunities to mitigate rate impacts in the future. As we discussed on our last earnings call, we continue to make progress on our journey to strengthen the effectiveness and profitability of our promotions. And we are actively taking steps in the near term to rightsize our cost structure in the new operating environment. Longer term, we are also working to identify additional opportunities across the enterprise to optimize our cost structure while also supporting investment to support growth capabilities. And now I'll turn the call back over to the operator to moderate the Q&A session.

[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.