Ulta Beauty Inc (ULTA) 2017 Q2 法說會逐字稿

Greetings, and welcome to the Ulta Beauty's Second Quarter 2017 earnings results conference call.

(Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Laurel Lefebvre, Vice President of Investor Relations.

Please proceed.

Thank you.

Good afternoon, and thank you for joining us for Ulta Beauty's Second Quarter 2017 Conference Call.

Hosting our call are Mary Dillon, Chief Executive Officer; and Scott Settersten, Chief Financial Officer.

Also joining us is Dave Campbell, Chief Merchandising and Marketing Officer.

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.

(Operator Instructions)

I'll now turn it over to Mary.

Thank you, Laurel.

Good afternoon, everyone.

The Ulta Beauty team delivered another quarter of excellent performance with more than 20% top line growth coupled with robust margin expansion and earnings growth.

We exceeded the high end of our guidance for total company sales, driven by strong new store productivity.

Second quarter comp performance was a healthy 11.7% on top of 14.4% comps in the second quarter of last year with balanced traffic and ticket growth.

Category strength was broad-based, with prestige cosmetics still driving the majority of our comp growth and with the skincare, fragrance and haircare all accelerated.

Continued success of our marketing and loyalty program and rapid growth in e-commerce also contributed.

In a period during which our market share gains are accelerating, we elected to prioritize earnings growth and margin expansion over comp sales growth.

As a result, we chose not to run an incremental promotions in July in order to comp over significant clearance activity at the end of the second quarter of last year.

GAAP earnings per share of $1.83 grew 28%.

This growth was driven in large part by gross profit expansion resulting from lower promotional levels year-over-year as well as solid expense management.

We're also benefiting from some strong execution across all parts of our enterprise.

Turning to a more detailed discussion on the elements of our strategy that drove our results in the second quarter.

I'll begin with our strategic imperative to acquire new guests and deepen loyalty of existing guests.

Our loyalty program continues to represent one of our most valuable assets.

As of the end of July, Ultamate Rewards grew to 25.4 million active members, up 23% year-over-year, driven by merchandising and marketing efforts and excellent in-store conversion.

With 1.4 million new members added in the quarter and nearly 5 million new active members acquired over the past year, our share of the beauty enthusiast market has increased to 27%, with plenty of opportunity remaining to attract more members.

Retention rates, sales per member, frequency of purchase and average member ticket are all strong and stable.

Our Ultamate Rewards credit card continues to ramp up.

We just celebrated the 1-year anniversary of the launch and continue to make improvements to the credit card application experience at ulta.com as well as roll-out initiatives to drive credit card application.

Our new grocery store gift card program continues to expand into the Blackhawk network, and we recently launched into additional retailers like Albertsons, Safeway and Publix.

We expect to be rolled out to 22 retailers in 12,000 locations by the end of the third quarter.

This program is off to a great start, and we expect it to be a more meaningful contributor to sales in the fourth quarter when gifting is a much larger part of our business.

Awareness of the Ulta Beauty brand continues to rise.

In the second quarter, we reached 87% aided awareness versus 84% a year ago, and our unaided awareness increased by 7 points at 47% this year versus 40% last year.

Our advertising strategies, including new creative for television and radio and increased investment in digital marketing channels, continue to drive awareness of our brand as the preferred destination for beauty.

Now we'll move on to our strategic imperative to offer innovative and often exclusive products that our guests love.

Our unique assortment continues to drive market share gains across the board.

The most recent NPD year-to-date data reflected 4 points of share gain in the prestige categories versus last year with even bigger gains in prestige cosmetics, while fragrance and skincare are continuing to gain momentum.

We also gained significant share in the mass categories, makeup, skincare and haircare, while the rest of retail was essentially flat.

Our prestige cosmetics category remains strong albeit not quite as fast-growing as last year, while skincare in both mass and prestige, haircare and fragrance are all comping well above plan.

While many of our color cosmetics brands are still driving exceptional growth with newness and innovation, a few of our large brands that has delivered several years of stellar comps are not contributing as much growth this year against tough comparison.

As a reminder, last year was a huge year for innovation in the lip category, and there were several big influencer-driven make-up palettes that drove tremendous growth for a few brands.

The curve momentum we're seeing in the skincare, haircare and fragrance categories is producing more balanced growth in the portfolio and demonstrating the value of our All Things Beauty business model.

While new product introductions in the makeup category haven't been quite as strong as last year, we don't see any indication that the beauty enthusiasts is any less passionate about makeup.

Actually, it's even more engaged with beauty and social media channels.

And the interest in beauty in key growing demographics, like Latinas, millennials and teens continues to work in our favor.

We're confident the pipeline of newness, excitement and innovation is stronger in the back half of the year compared to the second quarter.

Here's why.

We continue to have access to more and more coveted brands.

We recently announced the addition of Bumble and bumble haircare products from the Estee Lauder portfolio, rolling out online and in 500 stores next month.

We launched an exclusive solutions-based skincare makeup line for active lifestyles from Clinique, called CliniqueFIT, to capitalize on the athleisure trend.

We've rolled out about 400 of the 700 prestige boutiques featuring Lancome, Clinique, Benefit and MAC in our plan this year.

So to update on the highly anticipated MAC roll-out, we launched about 600 MAC SKUs online in early May and currently have 60 stores rolled out with plans to build more than 100 MAC boutiques by year-end.

Initial results have been excellent, with MAC quickly becoming the #1 or #2 brand where it's launched.

In addition to offering compelling assortment, MAC boutiques are staffed with highly trained makeup artists, providing makeup services to our guests, which further enhances the experiential nature of our stores.

MAC is a great partner.

And next week, we're introducing 5 handpicked MAC products that are impulse fixers chain-wide.

Many brands that we've successfully launched in a limited number of stores are also expanding into additional doors.

For example, NARS started out with a few SKUs on an etagere then went on an end cap and now expand to 9 feet in a few hundred stores.

We've rolled out Drybar haircare products and tools chain-wide, and the Estee Lauder wall is expanding to hundreds more doors.

We recently reset our exclusive IT Cosmetics brush assortment, making it easier to shop with the new elevated presentation.

We'll also be setting 250 stores with an elevated IT Cosmetics presentation, which offers problem solution shopping, featuring more than 50 new and exclusive SKUs in an expanded footprint to maximize exposure of one of our most popular brands.

We also see opportunity to enhance smaller categories as well.

We've elevated our bath assortment across both mass and prestige brands.

On the mass side, we've launched popular bath brands, da Bomb and frank body.

We're rolling out in select stores and online a prestige bath fixture, featuring new brands, Cowshed, RITUALS and Thymes.

We also remerchandised our sun care department, pulling all brands together in a new sun shop, driving the acceleration of comps in this category, with particular strength in St.

Tropez and Sun Bum brands.

As beauty enthusiasts increasingly look to social media to discover brands, we've accelerated our efforts to add new brands with tremendous engagement on social media.

Many of these brands have millions of followers on YouTube and Instagram, and our guest response with these brands has been very positive.

To give you a few examples of these up-and-coming social-media-driven brands, we're excited to announce an exclusive partnership with Morphe Cosmetics, known for high-quality makeup brushes, palettes and influencer collaboration.

This will be both in-store and online later this quarter.

We continue to expand our Korean beauty offering with the roll-out of K-beauty discovery platform MEMEBOX in several hundred stores, featuring skincare lines, like I Dew Care and Nooni.

And after great success introducing certain brands at ulta.com, we're now adding NuMe haircare tools and e.l.f.

cosmetics to select stores.

Recent online-only additions, such as Dose of Colors, Ofra, Cane + Austin, DERMAFLASH, Colorescience, Zoella Beauty, Velour Lashes, Lottie London and Wunderbrow are all contributing to our stellar e-commerce growth.

And finally, the ULTA Beauty Collection continues to roll out new and rebranded assortment.

Recently launched bath lines and Korean-inspired skincare products are off to a strong start.

We continue to partner with social media influencers within our private label offering, and the palette we just introduced with YouTube star, Melisa Michelle, has been very well received.

Now we'll turn to our services business.

Salon sales grew 15.3% and comped 7.7% in the second quarter, and we're seeing 16% year-over-year growth in the number of 12-month active salon members.

These results demonstrate that Ulta Beauty is achieving significant market share gains in the salon industry.

We completed more than 1.4 million service experiences in the quarter, up 13% compared to last year.

Strength in color services, blowouts and makeup services drove this performance.

Our guests are also showing interest in bold and nontraditional hair color, and we're showcasing this in our fall trend collection, including a soft lavender shade, called geode balayage and a look with crimson and caramel highlights.

We have a thriving salon business that drives meaningful differentiation versus a brick-and-mortar retailer.

As a reminder, less than 6% of our guests (inaudible) best guests, spending nearly 3x more than non-salon shoppers.

We'll continue to drive this important strategy for Ulta Beauty.

In fact, we developed these consumer insights and hypotheses about how to innovate even further in the salon industry.

To go after this opportunity, we just launched a major test on an improved salon business model based on guest and associate insights.

The program is designed to enhance the salon designers and guest experience and the overall effectiveness of our salons.

The new model is now being tested in 2 markets.

The key components of the model are a simplified menu for hair and skin services, a more transparent pricing model to clearly and consistently communicate pricing to our guests, and increased training for our stylists.

This is just one example of innovations we're developing and testing to continue to drive growth and differentiation for the long term.

Now turning to our store roll-out.

We opened 20 stores in the second quarter, ending the quarter with 1,010 stores and tracking to execute our 2017 program of 100 net new stores.

We beat the high end of our total company sales guidance by $12 million due to better-than-expected new store productivity.

New stores are opening above plan, with many of our new stores going forward, opening with all 4 highly productive prestige boutiques, including MAC, Clinique, Lancome and Benefit.

We opened our new Michigan Avenue store in Chicago in June, and it's off to a very strong start with higher-than-expected sales in both products and salon services.

This bodes well for the other urban store openings in our plan later this year.

We also continue to see very low cannibalization of existing store sales, further supporting our view that a brick-and-mortar shopping experience in concert with a great online experience continues to be very important in the beauty category.

To update you now on our e-commerce business.

ulta.com grew 72.3%, maintaining the great momentum we've seen for the past few quarters as we enhance the product assortment and content, improve the shopping experience and shorten the time to fulfill orders.

We saw excellent results from promotions, like our Gorgeous Hair event and online-only promotions.

MAC was a meaningful contributor to our growth after launching on ulta.com in early May.

E-commerce sales were driven by transaction growth.

Total traffic growth was up 73%, and mobile traffic grew 104%, driven by investments in digital marketing, pay channels including pay search, affiliate, display retargeting and paid social, including Facebook, Twitter and YouTube.

We continue to update, enhance our mobile app, which at last count has been downloaded by 4.4 million guests and has a 5-star rating in the iTunes App Store.

Traffic for our mobile app is up 450% year-over-year, with 41 million visits during the quarter.

We continue to make progress with our omnichannel road map.

Currently, we're testing the ability to order from ulta.com in-store and deliver to the guest home if there were any products that were not available once she visited our store.

This program, which we call store to door, is being tested in 40 stores, and we'll work on deploying other projects to strengthen our omnichannel capabilities.

E-commerce profitability continues to improve.

While still slightly less profitable overall compared to our bricks and mortar business, we're agnostic about which channel our guests shop since e-comm sales are largely incremental and represent a means to drive higher wallet share and higher margin dollars from those guests who shop both channels.

Omnichannel customers now represent 8.8% of our loyalty members, up from 7.2% a year ago.

And like our salon guest, she's a very valuable guest, spending 2.7x more than a retail-only guest and has 9.5 transactions per year compared to 4 transactions for retail-only.

Our beauty enthusiast guest is obsessed with newness, and the vast majority of our online purchases are items she hasn't purchased in the last 12 months.

Her shopping behavior online is even more driven by exploration and newness than in-store with very few repurchases of exact items in either channel.

Turning to our progress in our supply chain operations.

Our supply chains team continue to ramp up our Dallas and Greenwood buildings and supported ulta.com's rapid growth in the second quarter, with nearly 80% of e-commerce order volumes shipping out of our new distribution centers.

Our DCs process significantly more e-commerce shipments than forecasted during this quarter while improving productivity, decreasing cost per shipment and keeping labor costs in line with forecast.

Construction of our new distribution center in Fresno, California is on track, and we've begun installation of the material-handling equipment.

We also began hiring for key roles, and we're planning to open in the summer of 2018.

The Fresno DC will add another 670,000 square feet of capacity that can service up to 400 stores and 45,000 e-commerce orders per day.

Fresno will also provide a platform to implement some new distribution technology to increase productivity and significantly reduce transit time for our West Coast customers.

So that wraps up my discussion of our progress on each of our strategic imperative, and I'll turn over to Scott to discuss in more detail the drivers of our second quarter financials and our outlook for the third quarter and the full year.

Thank you, Mary.

Good afternoon, everyone.

Starting with the income statement.

Sales for the quarter grew 20.6% to $1.29 billion, driven by 11.7% comparable sales growth and excellent new store productivity.

The total company comp of 11.7% was balanced, composed of 5.5% transaction growth and 6.2% average ticket growth.

E-commerce sales growth remained very strong, contributing 340 basis points to the total comp.

The retail comp was 8.4%, made up of 3.4% traffic growth and 5% average ticket, driven by increases in average selling price.

The salon business comped 7.7%, driven primarily by ticket growth.

The retail and salon comp combined was 8.3%.

One callout on the sales growth for the quarter, in addition to the color Mary already provided, is lower year-over-year clearance activity in our stores.

During the second quarter of last year, we executed additional markdowns on clearance product to end the quarter with very clean inventories primarily on the mass side of the assortment.

This drove some incremental traffic and sales and a larger overall basket during the clearance period last year.

As we continue to improve how we manage inventory and benefit from newly implemented systems and processes, we didn't need to repeat that additional clearance activity this year.

This lower clearance level was a modest headwind to sales growth but also helped gross margins.

Gross profit leveraged 40 basis points despite comping over a 110 basis point improvement in the second quarter of 2016.

We leveraged rent and occupancy cost, and supply chain expense leveraged slightly following several quarters of deleverage as our new distribution centers and supply chain systems mature.

Product margins improved modestly as we were slightly less promotional year-over-year.

These gains were in part offset by investments to strengthen our salon business and reflect the same dynamics we have been discussing with you for the past several quarters relating to channel, category and brand mix headwinds.

We also delivered 10 basis points of SG&A improvement.

This was driven by corporate overhead leverage lapping last year's write-off, resulting from the closure of our State Street store in Chicago; and excellent control of variable store costs offset by investments in store labor related to our prestige boutique strategy.

Some of the timing benefits we reported in the first quarter related to advertising spend reversed in the second quarter, but we expect advertising expense as a rate of sales to be flat for the full year.

Turning to EPS.

We had a $0.02 benefit in the second quarter related to the new accounting standard that changes how company's record the tax effects of employee stock option exercises and vesting of equity awards.

Adjusted for the lower tax rate, earnings per share increased 26.6%.

Now turning to the balance sheet.

Inventories increased 10.5% on a per-store basis below the comp rate, a testament to the team's strong inventory management given the significant investments in new brands and boutiques as well as the impact of continuing to ramp up the Dallas distribution center.

Capital expenditures were $116 million for the quarter driven by new stores, systems and fixtures for brand expansions.

We ended the quarter with $273 million in cash and short-term investments.

In terms of share buybacks, we stepped up our activity within our 10b5-1 plan in light of the recent volatility in our share price.

During the second quarter, we repurchased approximately 462,000 shares of our stock at a cost of $126.5 million.

The resulting lower share count benefited earnings per share by about $0.01.

As of July 29, 2017, approximately $268 million remained available under the $425 million share repurchase program announced in March 2017.

Turning now to guidance for the third quarter in fiscal 2017.

For the third quarter, we expect sales to be in the range to $1.331 billion to $1.353 billion versus $1.13 billion last year.

We expect comparable sales to increase in the range of 9% to 11% versus 16.7% last year, our toughest comparison of the year.

E-commerce sales are expected to grow in the 50% range.

We plan to open approximately 50 new stores in the third quarter, including our first store in Manhattan, versus 42 last year, with fewer stores opening in the fourth quarter compared to 2016.

So Q3 preopening is expected to deleverage about 20 basis points.

Diluted earnings per share are expected to be in the range of $1.63 to $1.68 versus $1.40 last year, with slight operating margin deleverage expected primarily as a result of the unusual preopening deleverage in Q3.

Also recall some of the upside we achieved in the first quarter came from timing of expenses as some cost related to advertising and test-and-learn projects forecasted in the first quarter were pushed later in the year.

We also have a significant portion of the boutique roll-out for the year falling into Q3, which will weigh on expenses.

This deleverage is related to timing and investments specific to the third quarter and is consistent with our commentary on the cadence of margin impacts since the beginning of the year.

Operating margin rate is expected to leverage in the fourth quarter, resulting in leverage for the full year.

The tax rate for Q3, excluding any impact of the new accounting standards for share-based payments, is expected to be 37.5%, and fully diluted share count is estimated at 62 million.

Now turning to full year guidance.

We plan to open approximately 100 stores, all of which will be our prototypical format.

We are on track to complete 11 major remodels and 7 relocations during the year.

We expect to grow our e-commerce business between 50% and 60%.

We are raising the low end of the range for total company comps, which are now expected to be in the 10% to 11% range.

CapEx is tracking to be $460 million, including new stores, remodels, relocations, approximately 700 prestige brand expansions and investments in systems to improve inventory visibility, which will enable future omnichannel capabilities.

We are flowing through the upside from the second quarter and now anticipate earnings per share growth in the high 20s percentage range.

As a reminder, this includes the impact of the 53rd week, assumes share buybacks in the $350 million range and assumes a full year tax rate of 36.5%, including a tax rate of 37.5% in the back half of the year.

This EPS outlook excludes any impact from the new accounting standard for share-based payments for the remainder of the year.

Operating margin is expected to increase in the 20 to 30 basis point range.

And with that, I'll turn it back over to Mary.

Okay.

Thank you, Scott.

Before we begin the Q&A session, I'd like to just step back for a moment to recap our perspective on the quarter and our business model overall.

As you've seen, we posted another double-digit top and bottom line quarter, far outpacing the result of any benchmark retailer.

We achieved share gains across all categories, topped 25 million loyalty members, performed over 1.4 million beauty services, exceeded new store performance targets and accelerated growth in our highly incremental e-commerce business all while being less promotional than a year ago.

This is a competitive category and our consumer retail habits and expectations rapidly changing, of course, first, beauty has been an attractive category in which to compete and always will be, with over 70,000 physical points of distribution where guests can buy beauty in the U.S. as well as online retailers.

This is not new, and we have never been complacent.

Our rapid share gains, however, show that our guests love beauty at Ulta Beauty, but we don't rest on our laurels.

We all know that shopping behaviors and expectations consumers have for retail are evolving rapidly, and we've been on that from the start.

Our business model today and our continued focus on innovation in the areas that are relevant and differentiating to our guests provide me with the utmost confidence in our ability to gain share across multiple categories for many years to come.

A few points I'd like to reiterate.

We have a unique model that encompasses more brands, categories and price points than anyone else.

Our All Things Beauty positioning protects us from being too reliant on any one category.

We're relevant to a large and diverse set of beauty enthusiasts, and we're increasingly focused on attracting growing demographic groups like teens, millennials and Latinas, who all over-index in beauty.

Our category is highly experiential, where the physical experience is welcome.

In fact, 23 million of our guests shop only in our stores, and our new store openings continue to strengthen.

Why?

Our guests love to discover, explore and feel beauty.

Also, our growing beauty services business must be experienced in store as well.

But of course, a modern retailer also has to provide an exceptional digital experience from discovery to shopping, and we do that as well.

And we will continue to invest in these areas, as evidenced by our e-commerce -- exceptional e-commerce growth.

And finally, we have a powerful and increasingly personalized loyalty program that our guests are highly engaged in.

We're both driving our short-term performance and continuing to imagine and innovate for the future.

We have many levers at our disposal.

We have no blinders on, and we're playing offense to drive our performance and create long-term shareholder value with a balanced approach to driving sales and profits.

And now I'll turn it over to our conference call host to moderate the Q&A session.

(Operator Instructions) Our first question is from Steph Wissink with Jefferies.

Just one point of clarification, Scott, on the labor relation in other boutiques, so labor related to those brand boutiques.

Can you remind us what the cost-share arrangement is with the brands themselves?

And then my question, Mary, related to your comments on loyalty additions, I'm curious if you're seeing any changes in the demographic composition of your newer loyalty members versus what you've experienced in the past.

Maybe I'll start with the loyalty.

Steph, thank you for the question.

And no, I mean, really, what we're seeing is a very consistent profile.

This is a profile, beauty enthusiasts, that cuts across a lot of different demographics, and we're seeing very similar type of new loyalty member.

So they ramp up over time.

They don't start out as engaged in our program as they become over time but we're seeing very stable metrics around spend per loyalty member, frequency of visits and that kind of -- those kind of metrics, so very consistent.

And as far as the boutiques are concerned, we don't get into a lot of details around that for competitive reasons, but I would say the third quarter each year is kind of the peak area where we see expense challenge in the P&L and it's primarily -- some of it is write-offs that we accelerate, right, from the existing store, fixturing and things that we have to remove in order to put those new boutiques into service.

But the real incremental cost of the business in the early days is the labor piece of the equation.

So we've been under that SG&A line on our P&L.

There's been a fairly significant deleveraging of store payroll over the course of the last, call it, 6 quarters.

It's kind of peaking now in the third quarter of 2017 just because of the multiple years now that we're kind of stacking on top of each other with the boutique additions.

But again, over the long term, this is going to drive huge sales and margin dollars for the company.

These our brands that our guests want and have wanted for a long period of time.

So it's definitely the best decision for our investors for the long term.

Our next question is from Simeon Gutman with Morgan Stanley.

So Mary, my question is clearly, your strategy is working and the competition is -- does seem to be increasing.

And it seems like the market's worried about the changing variables that's happened most recently.

So my question is, what are you doing to protect or extend your lead since we last spoke?

Is anything changing in your near-term strategy to address some of the variables that have been changing recently?

Thank you, Simeon.

I would say that really, nothing has changed in a lot of ways.

This is a very competitive category.

It really has been, I think, and it's really not new to us that we will see new competitors come in, loyalty programs, promotions, whatever.

And if you look at it, we -- obviously, we are continuing to gain market share even in this very competitive industry.

And I really think it's because the basic business model is working and we continue to invest in the areas that we think are going to differentiate us for the future that involve the guest experience, services, our omnichannel capability but, at its core, having great brands, new and exclusive and great brand launches that you can't get anywhere else and participating across categories.

So I would say that as we think about it, playing our offense, continuing to really look at our new store productivity, which we're really proud about, our comp growth, our loyalty member growth, we feel that we're really in a great position and continue to lead.

And we'll continue to focus on having the broadest assortment across all categories and price points.

That's another part of our business model that frankly helps provide some great insulation for us; and invest in the differentiators that I've already mentioned.

Our next question is from Brian Tunick with Royal Bank of Canada.

I guess, maybe Scott, given your comments regarding the changes in channel and category and brand, probably not, versus your analyst event where you did say that the EBIT margin recovery wouldn't be pronounced this year.

But any thoughts in where you think EBIT margin opportunity could get to in the next 2 to 3 years just given some of the changes, as you called out, on the mix of business.

And then maybe Mary, as you talk to your brand partners and obviously a lot of fear also about what could happen with the folks out in Seattle, just curious, what's their perspective?

Or what gives you comfort that they're not ready to move on to the bigger platforms?

And how do you think that could influence the business?

So I'll start with the operating margin targets.

So Brian, again, at this point, we're still very comfortable with our mid-teens target, the same target we've been talking about now for some time.

Again, as a reminder for everyone, we're not counting on product margins or merchandise margins to drive us, right, to deliver us to mid-teens.

A lot of the benefits that we expect to get us there is coming out of fixed store cost leverage.

Again, as the fleet continues to mature, we get a lot more leverage out of those mature stores.

In the near term with the boutique investments, we've decided that we're willing to hold back a little bit on the rate in the near term to help those stores drive even higher sales levels over the long term, which should give us additional leverage in those stores and help us on that line.

In addition, in fixed store cost leverage, we've talked about supply chain investments.

So this is kind of a multiyear initiative here.

And again, we're seeing the green shoots of more productivity both in the distribution centers themselves.

Mary just called that out, right, over much better productivity here in the most recent quarter with the e-comm flow-through on the orders and also a lot of the merchandise infrastructure that we've been setting up behind the scenes to help us better manage our inventory flow.

So again, operating efficiencies throughout the supply chain network and just improving our inventory productivity overall will help us get to that mid-teens target.

Okay.

And then we'll cut right to the elephant in the room, I like that.

I'm kidding.

But to pick up on the second part of your question.

Here is what I'd say.

First of all, our brand partnerships are stronger than ever.

I feel very confident about the relationship that we're building with many brand partners across the spectrum in the beauty industry, proud of how our team is a valued partner.

And we've got access to an increasing number of exciting brands that we've talked about and that -- we'll take that for granted, okay.

So first of all, I will start with that.

Secondly, I can't really speak on behalf of brands, and I generally think most prestige brands aren't that interested in that platform.

But having said that, listen, it's not unusual for us to have competitors that carry some of the brands that we carry.

So for example, that platform in Seattle already carry some of the brands that we carry, a few examples, Mario Badescu, Butter London, Stila.

These are some brands that are sold there as well and sold at Ulta Beauty, and they're growing like crazy for us, right.

So it's really not that uncommon to have some of that kind of competitive overlap.

We don't have blinders on about this, but I would say at the end of the day, it's really about how we bring it all together.

So what do we offer to our brand partners really the true -- a true beauty experience, right, from the experiential part of -- that a guest could have in store to try and play and explore all the way through a great online experience.

So for us, it's about -- and one we offer to the guests.

You can't get this anywhere else, the categories, brands, price points, the experience in the store.

So I guess to answer your question that kind of relates to Simeon's as well, it's really about we just play our offense.

We're very focused on the beauty enthusiasts.

We think we understand her really well for shopping needs and what she wants in terms of an in-store experience as well as online as well as offerings -- or service offerings.

And of course, it all gets wrapped together with an industry-leading loyalty program.

So we understand those guests better than anybody else, and she loves our loyalty program.

So there's great incentive for her to give us her purchases both in-store and online increasingly to get her loyalty points.

So that's how we look at it.

Our next question is from Simeon Siegel with Nomura Instinet.

Mary, when thinking about the new store productivity comment you made, do you think the new store sales might be growing to company average levels faster than before as the brand awareness grows?

And I guess essentially, do you think your comp waterfall might be accelerating, which can help explain sales beats even though comps are still within the range?

Well, certainly, our lead hypothesis on why we saw productivity continues to increase is exactly that.

We have -- that was one of the effects.

We have better brand awareness so every new store that opens, there's folks who'd know more about Ulta Beauty.

I would also say we're doing a really great job on not only real estate selections but the grand openings.

We've strengthened the tools that we used to drive awareness and guests into the stores initially.

Our store teams are doing a fantastic job of converting folks early on into the loyalty program.

So all those components together are really helping us to improve our new store productivity.

And we've seen some acceleration over the course of the last couple of years.

And again, this doesn't happen in a vacuum.

When you do, your marketing is better and more on point and your assortments continue to improve and you've got -- making good real estate decisions.

All of these things kind of work in concert to help drive those results.

So as far as the waterfall is concerned, it's intact.

It's healthy.

We just want to keep an eye on that and kind of see itself prove out over a couple of cycles here before we formally, right, make any modifications to our new store model.

Our next question is from David Schick with Consumer Edge Research.

You mentioned forgoing the promo as a modest impact to comp in the quarter.

Any detail on magnitude versus other impacts to the quarter?

And then from choosing not to do it, how has that evolved your thinking on choice and cadence of promo going forward?

Yes.

I don't think we'll quantify the exact amount but I would say a big picture -- I think this is probably pretty obvious.

We're running this business for long-term shareholder returns, and you have choices, I think, you can make all the time.

So at a time that we are -- continually have very strong share gains, I'd say the philosophy is we don't really need to go buy comp.

And so we chose to end the quarter with less versus more promotion year-over-year.

We had a very healthy comp with less promotion year-over-year.

And so that, to me, was obviously the right decision.

I feel very good about -- and it's a little tempting to want to drive it up above a 12, but it just wouldn't have been the right thing for us to do frankly.

So I feel good about that and, I think as we look at our second half plans, feel very confident about the pipeline of newness and promotions that we have coming.

So I would say that it's just really the situational decision that we all think was right.

Our next question is from Erinn Murphy with Piper Jaffray.

I guess just following up on the promotional environment and some of the comments we've heard from the department stores particularly in the last couple of quarters, has that changed how you're approaching the 21 Days Of Beauty this September?

Are there anything, whether it's brand partnerships, that you're going to be deepening during that period?

And then just on the gross margin, when should we start to see the credit card impact neutralize?

Well, let me start with the 21 Days Of Beauty.

I just want to make a comment and then I'll turn it to Dave to give us some more color on that.

But for us, it's not really new that there's promotion happening even in department store channels, although some might have been more aggressive.

We definitely did not need to directly respond to it.

As I said a couple of times, we gained significant market share in prestige while the rest of retail was negative.

So I feel very good that, that proves our -- the reliance -- or I'm sorry, the resilience of our strength of our business model.

21 Days Of Beauty, why don't you...

Yes, 21 Days of Beauty, one of our signature events, coming up actually in just couple of weeks.

We do that every third quarter.

We have seen strengthening performance of that event each -- every one that we've done for the last several -- and the things that have been driving is just stronger brand participation.

The core idea of that program is very strategic, and it's really to help our brands, our key prestige brands get introduced, in many cases, to customers that haven't been buying them.

So it is a migration strategy that our brands have embraced, that we embrace, that helps drive our customers to experience new brands and new parts of our store.

It's a big part of our overall share of wallet strategy.

It's to get every customer buying both mass and prestige and multiple hair -- multiple categories throughout the store.

So it has been working.

As far as this one, we aren't very excited about it, not really going to share yet, for competitive reasons, any specific offers.

But I'd say we feel that we've got a very robust collection.

We've enhanced the marketing of the program.

We have new television coming on air.

We've got strong radio, strong digital activity.

And our guests, I think, are pretty primed forward already, and we're excited that that's coming in just a couple of weeks.

And as far as the credit card question is concerned, it's a little difficult to kind of project exactly when the headwind might fall away a little bit.

I mean, I would just draw attention to last year, what we did.

So again, we're always trying to optimize the business quarter-to-quarter as best we can.

So last year, when the credit card went live, there was a significant step-up in discounting activity, right.

There was a 20% off your initial purchase under the credit card.

But while doing that, we pulled back significantly on other parts of our promotional kind of tray.

So we try to optimize that.

And last year, merchandise margins were flattish to up slightly, I guess, I would say, in the third quarter, right.

So now we're lapping that this year.

So we just got to keep in mind what the sales balance is and what the margin opportunity might be.

So our merchant teams work really hard with us with our analytical support group just to make sure that we've got that in balance and that we're meeting our targets for the year.

So again, as we look to the back half of the year, we'll optimize that as best we can, and we're on target to deliver our 20 to 30 basis points of operating margin leverage.

Our next question is from Jason Gere with KeyBanc.

Just 2 questions.

I guess, one, looking at the long-term comp -- and I know year-to-date, you're at 13%.

You're talking 10% or 11% for the year, and I see the range for the third quarter.

Just I know the fourth quarter does have a tough comp but, I guess, kind of thinking about the holiday season, is there anything that you're seeing out there that might be more promotional?

And how are you balancing, as you did in this quarter between the gross margin improvement and taking sales that are less profitable?

Just wondering if you could talk maybe a little bit how you're thinking about the holiday season and how that comes in.

And then Scott, the follow-up is just as -- and I understand the 20 to 30 basis points of margin improvement for the year with some of the incremental investments out there.

Have you kind of, I guess, break down between gross margin and SG&A?

I'll start with holiday.

I guess it's an interesting question.

We look at holiday every year as the most promotional time of the year, right.

Everybody is planning to win at holiday.

And so I feel really confident that we've got a great lineup of plans, basically, whether it's product offerings, exclusives or marketing, advertising, merchandising.

And the fact that our team does a great job of integrating all of those together year after year to make it even stronger.

So it's -- we obviously keep up -- I mean, it's a quarter you're watching every day, and every segment of the quarter is different, right.

So we'll be all over that but I feel like we're well-situated or well-poised to have a great holiday and expect it to be promotional.

And as far as, I guess, P&L line drivers, right, Jason, just directional.

So we said for the third quarter, gross profit, slight deleverage; and SG&A, flattish.

I mean, the biggest driver is the preopening expense deleverage year-over-year, which again, I want to make people understand that's a good thing, right.

I mean, it's a near-term headwind for us, but we're pulling stores forward, right, from where we had planned earlier in the year.

And so those stores will get open sooner.

They'll start generating profits quicker, and they'll help our store teams be more prepared going into holiday.

It helps a litany of things, shrink among many other things that we deal with day to day.

So that's a good investment from an investor perspective.

As I look out to the fourth quarter, we'll get gross profit back in line.

We'll see -- directionally, again, we should see some expansion there as we cycle through the heavy investments in the third quarter with boutiques and new stores and the retail labor payroll I called out earlier.

And then we should leverage a little bit on SG&A line as well.

So again, I'll let you guys do the detailed math on this one, but that gets you 20 to 30 bps of expansion on operating margin for the full year.

Our next question is from Chris Horvers with JPMorgan.

So my question is, how much do you think the industry growth moderated during the quarter?

I know you mentioned a modest impact from the lack of that clearance promotion in July, but it's also been a while since you haven't put upside to the upper end of your comp.

So is the right way to think about it that moderated a couple of hundred basis points?

And as you approach the third quarter guidance, has that moderation, I guess, forced you to be less conservative as you typically have been in the past around the guidance with you bracketing The Street?

Yes.

Well, I'll start with the first question, which is, it definitely was a quarter where we saw strong growth in all the categories we participate in.

So color cosmetics.

We saw comps accelerate in skincare, both mass and prestige, haircare, fragrance, bath.

So that great benefit of our business model is that we're in every category.

We actually are driving.

We think we're really focused on some of these categories and helping to drive the growth.

We also gained market share across all the categories.

But color cosmetics was softer than it's been for the industry, right.

People talked about this already, but prestige comp comped well above our house.

So we have some brands that we have very strong growth happening from and others that maybe were lapping newness and didn't do it as well as before, same thing in mask.

So as we look at what's coming down the pipe for the second half of the year in terms of innovation and newness, we felt very good about it.

So again, it wasn't a competitive issue.

We gained share but there was -- that segment of total beauty was a little bit softer than it's been.

We're lapping over big units from last year platforms, like liquid lip and contouring and some makeup palettes by some influencers.

So that's all that.

But bottom line, I feel really good -- I know Dave does as well, about the pipeline of brands that we have coming and roll-outs and the unique -- the fact that we participate across the different categories.

And then on how you approach the guidance for the third quarter?

Yes.

So always with a prudent approach.

Yes.

That's always our mantra, trying to be optimistic but realistic at the same time.

So I think I've said many times before -- I mean, the overperformance we've seen here over the last, call it, 2 to 3 years, a lot of it has been the newness and how it's performed way above expectations, right.

So I mean, you can't continue to bat 1.000 every quarter with new product roll-out.

So we saw a little bit more volatility, I guess, right.

So it's not any one thing that you can point your finger at.

The category, in general, was very healthy.

So we're very optimistic.

Again, Mary mentioned newness is on a great pipeline of things coming in the third quarter that has us feel really positive about the business.

But I would say just be a little bit more conservative on what you think what the upside could be on top of what we're guiding at this point.

Our next question is from Ike Boruchow with Wells Fargo.

It's a really quick one for Scott.

Scott, sorry if I missed it, can you tell us how you're planning the gross margin line in Q3 and Q4?

And then talking about pulling out of promotion to balance the comp and margin in July, should we expect more of that going forward?

You used to target a 7% to 9% comp.

You've done -- been well above that for 2 years.

Do you kind of want to ease back into that 7% to 9% and let a little bit more margin come to the model?

Just kind of curious how you think about the business over the next couple of years.

Yes.

Well, I guess they would start with -- it's always a pragmatic approach, right.

We look -- every quarter is a unique set of challenges and opportunities.

We go into it.

I mean, the one thing that we really have as an asset is our nimble ability, right, to flex with the situation.

So our advertising, planning, marketing, merchandising, all the different aspects of our business are able to turn much more quickly than a lot of people are.

So we're able to navigate difficult situations more easily than some.

So as far as the discounting or the clearance win in the second quarter last year, we had great tailwinds.

We looked at our business.

We had things coming in the third quarter.

We said, "Let's be more aggressive with our markdowns and try to move out of some of these products quicker than we normally would." Again, remember, 10,000 square feet, we've got space.

We've got very disciplined management techniques on how to mark product down to make sure we optimize the gross margin outcomes there.

So last year, we got a little more aggressive.

That doesn't happen every quarter, right.

We usually do a clearance event in the second quarter and then kind of at the end of the year.

So that, I wouldn't say, is something that's going to be repeatable here over the next quarter or 2. As far as gross -- go ahead.

No, I was just going to say, can you comment on gross margin for the back half, how you're planning it?

Yes.

So in the third quarter, I think I mentioned slight deleverage in the third quarter largely because a lot of the new store load, right, fixed store costs.

I'm not going to get as much leverage there as I typically do because some of the higher cost stores we're opening in there and some of the other -- the pull forward things that we have flowing into the third quarter now.

When we get to fourth quarter, I think we'll see expansion on the gross profit line because we will have cycled through the peak expense load and the P&L for the boutique additions and the new store additions and some of the labor things I already mentioned.

And then we will get more efficiencies in the supply chain.

Distribution centers are now primed, right, for holiday season, where we can push through a lot more e-commerce volume than we ever had before in a much more profitable fashion.

Our next question is from Matt Fassler with Goldman Sachs.

Since you've been talking about this decision on the July promotion, what did you originally have embedded in your guidance?

Did you have the promotion and the sales associated and margin associated with it embedded in the initial guidance?

Or was it always absent, reflecting a decision as you entered the quarter that this was something you probably wouldn't repeat?

Well, I think it's more a fact of what happened last year.

I mean, it was always in the guidance, right.

I mean, again, the levers we look at over the course of 3 months, you're planning and strategizing about how you're going to deliver the numbers, right.

And what's necessary and what you think you -- what you would like to do to land the plane, so to speak.

So last year, we pulled the lever then said, "Let's be opportunistic here and take advantage of the situation." This year, we looked at it.

Again, we knew we were up against it over the last couple of weeks of the quarter.

We looked at the comp target and we said, "You know what, it's not worthwhile." That's not a wise decision.

We're going to -- we're playing for the long term.

So we don't want to get into chasing these comps in the rest of the year.

So that was...

So that was a decision that you made prior to entering the quarter when you guided a few months ago?

No.

That was a call we made during the course of the quarter.

During the course of the quarter, I understand, okay.

Yes.

That's very helpful.

Secondly, so as we think about trajectory, obviously, you have never guided nor had anyone expected you to make 10% to 15%, 16% comp with any kind of duration.

Those are stellar numbers, as is an 11%, as is a 9%, wherever the numbers end up, any element of your guidance.

All that being said, we've had about 5 points of deceleration from the peak comp to the number you just put up and a little bit more on the way it sounds like, very nominally so into Q3.

Your long term guidance is 6% to 8%, and that's presumably each year for the next couple of years.

At what point do we move past difficult comparisons such that you think we reach a sustainable benchmark?

Is there anything in the industry that would have to change?

Or are the underlying trends within the industry and within your own control, the brand roll-out, the boutique roll-out, the member growth, et cetera, intact to enable stable growth in that 6% to 8% comp range a couple of years hence that you gave a few months ago?

Yes.

So let me start.

So the long-term guidance is actually 7% to 9, right.

And we said heavier in the near term, moderating more as we get down the path.

So I mean, sitting here today, we're looking at opportunity for market share gains.

We're looking at all the levers we have internally with loyalty and credit card, assortment kind of things that we can expand in the future, just overall awareness of the Ulta Beauty brand, real estate opportunities like Manhattan and other places that we've never done business before.

So again, I don't want to seem too optimistic, but we think there's plenty of room to continue to drive very healthy comps for the foreseeable future.

Our next question is from Rupesh Parikh with Oppenheimer & Co.

So I had question on the MAC roll-out.

I think you mentioned in your prepared comments that it's a #1 and #2 brand so far where it's launched.

I was just curious versus your expectations, is the brand as incremental to the store as you expected?

And any sense at this point whether it's bringing new customers to Ulta stores?

Yes.

It has performed very well, both online and in-store.

We're really pleased with the results.

And we believe very strongly that it's incremental.

You know, it's early, but we're quite confident.

In fact, we see that really across many, if not most, of the brands we bring in, particularly large, established brands like MAC, Clinique, Lanc?me, as we see continue to roll those brands out, we see a high level of incrementality across the whole stores.

So we're confident it's going to be there.

We're still early.

We're just at the early part of our roll-out, but we're seeing some strength.

And an important part of that is it's certainly the product sales, but also, as Mary mentioned, the service component to it add in a greater sophistication of makeup service in our store through MAC, has been very, very well received from our guests, and that just adds to more the experiential component of our stores and those that it's rolled out to.

So we're excited about that as well.

Our next question is from Oliver Chen with Cowen and Company.

We had a question related to the integration of the physical and the mobile and the desktop.

What are your thoughts from a consumer experience in terms of the opportunities you have ahead and just making sure you're using your physical assets and being very competitive versus Amazon?

And also, another angle on this is the inventory management side in terms of making sure you have smart supply chains and plan correctly as customers really look to meld these channels and interact with these channels in creative ways just to save time.

Yes.

I'll start.

The -- I think the integration of physical, digital, mobile is really essential to our strategy.

In fact, Mary mentioned that in her remarks, and it's really a key part of our long-term -- short-term, long-term differentiation strategy.

The physical experience, the human component to it, the idea of having a beauty destination that our beauty enthusiast guests can come in and touch and feel and smell and be immersed in beauty is exciting to her, and that's what she looks forward to when she comes to our stores.

At the same time, we're building out all of our digital and mobile efforts.

You heard some of the growth that we've seen in all of our mobile engagement.

That is clearly the dominant interaction point that our guests has outside of our stores.

It's growing in ways not only to help drive online sales but perhaps even more importantly to drive in-store sales.

She's using it to check out her points, to understand about new products that have been ordered, to use our new service, like GLAM LAB.

So it's an experiential extension of our store, and it's really working well to integrate.

And so many of the infrastructure investments that we're making, perhaps most importantly, the DC expansions are just enhancing our capability to service our guests better.

Greenwood and Dallas have already allowed us to increase the speed in which we're delivering and the efficiency in which we're doing it, the cost of which we're doing it.

And as soon as we open Fresno next year, that's going to particularly help the West Coast to speed up deliveries there.

So all these investments will make our outside-of-store experience even stronger at the same time we're integrating and increasing our in-store experience.

Do you -- would you call out any features or capabilities that you think you need that customers are wanting, like car pick-up or try on in-store or other creative ways that will really change the game and move the needle?

We have a real pipeline of ideas.

We're continuing to find ways to innovate within our store experience.

Mary talked about one that's in test right now that we plan to roll out, which is store to door, the ability to -- when an item either is out of stock or perhaps not available in that store at that moment, to have it shipped directly to your home.

And so items like that are a big part of our experience.

We'll be testing in-store, virtual try-on capabilities in many of our stores coming up later this year.

So yes, we have a -- we see that as a big part of our overall strategy, integrating online, offline and making that even easier for her going forward, so very much so.

Ladies and gentlemen, we have reached the end of our question-and-answer session, and I would now like to turn the call back to Mary Dillon, CEO, for closing remarks.

I'd like to thank our 35,000 associates for their passion and commitment that continue to drive some of the best results across all of retail.

We look forward to continuing the strong performance in the back half of 2017 and beyond.

We thank you for your interest in Ulta Beauty and look forward to speaking with all of you soon.

This concludes today's conference.

You may disconnect your lines at this time.

Thank you for your participation.