Ulta Beauty, Inc.

Greetings and welcome to the Ulta Beauty second quarter 2020 earnings results conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Kylie Rawlins, Vice President, Investor Relations. Please proceed.

Thank you, Diego. Good afternoon, and thank you for joining us today for our discussion of Ulta Beauty's results for the second quarter of fiscal 2020. Hosting today's call are Mary Dillon, Chief Executive Officer, and Scott Setterson, Chief Financial Officer. Dave Kimble, President, will join us for the Q&A session. Before we begin, I'd like to remind you of the company's Safe Harbor language. The statements contained in this conference call, which are not historical facts, may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. We caution you not to place undue reliance on these forward-looking statements, which speak only as of today, August 27, 2020. We have no obligation to update or revise our forward-looking statements except as required by law, and you should not expect us to do so. In today's comments, we will discuss certain non-GAAP financial measures, including adjusted diluted EPS, which has been presented to reflect our view of our ongoing operations by adjusting for store impairment charges and costs associated with the permanent closure of 19 stores. A reconciliation of these measures to the corresponding GAAP measures can be found in our earnings release. which is available in the investor relations section of our website at www.alta.com.

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We'll begin this afternoon with prepared remarks from Mary and Scott. Following our prepared comments, we'll open the call up for questions. To allow us to accommodate as many questions as possible during the hour scheduled for this call, we ask that you please limit your time to one question and one follow-up question. To ask a second question, we ask that you re-queue. As always, the IR team will be available for any follow-up questions after the call. Now I'd like to turn the call over to Mary. Mary? Thank you, Kylie, and good afternoon, everyone.

Let's start with an overview of where we are today. First, I will say that since the beginning of the pandemic, we've navigated through the crisis with our associate and guests at the center of every decision made. I'm really proud of how our teams have responded to this challenging period. And I want to thank my leadership team and all of our Ulta Beauty associates, especially our store and distribution center associates for their agility, creativity, and commitment to serving our guests and taking care of each other during this unprecedented period. On our last earnings call, we were in the early stages of our reopening process. During the second quarter, we reopened stores for retail, expanded curbside capabilities to nearly all stores, and began relaunching select services, all with a thoughtful consideration for the safety of our associates and guests, balanced with our desire to reopen quickly. By the end of June, more than 90% of our stores were open for retail, and by mid-July, our reopening process was complete. Reflecting local regulations and guidance, the resumption of our service offerings has been on a more measured pace. Today, salon services are available in about 88% of stores, and brow services are offered in about 85% of the fleet. We've not resumed skin or makeup services, but we're working closely with medical experts to ensure we have strong safety protocols in place when it's appropriate to resume these services. In this new normal, we're operating Ulta Beauty stores with new shop safe standards, limited physical capacity to accommodate social distancing, and reduced operating hours. To date, we have reactivated approximately 17,000 of our furloughed associates who are able to return to work. We're committed to maintaining a safe experience for our associates and our guests. As different markets manage fluctuating COVID-19 cases, we will continue to monitor guidance from government and health authorities as well as local transmission levels to determine if we need to modify our shopping options or revert to closures in the near term. Now turning to our second quarter results. For the second quarter, total net sales were $1.2 billion, comp sales declined 26.7%, and gap-diluted EPS was $0.14 per share, excluding the impact of impairment charges and costs associated with the previously announced store closures, adjusted diluted EPS was 73 cents per share. Comp sales improved significantly throughout the quarter from down 37% in early May as we began reopening stores to down only 10% in July after most of the stores had reopened. Sales trends have continued to improve with comps down in the mid single digit range for the first three weeks of August. We're excited about the positive signals we're seeing from guests. However, we believe it'll take some time to fully return to pre-COVID levels and expect demand will continue to be suppressed for the rest of the year, given the likely ongoing disruptions we'll see as we continue to live with the realities of COVID-19, whether the continuation of working from home, managing the complexities of educating our children, the ongoing need for social distancing, mask wearing, and need to avoid large gatherings, or coping with near-term employment and economic uncertainties. Longer term, we're confident beauty will recover and thrive given the strong emotional connection consumers have with the category. We know beauty enthusiasts remain passionate about beauty and Ulta Beauty. We see it through the engagement in our social channels. And while the connection with beauty has not diminished, how consumers engage with the category is changing. Health and safety concerns have led to fewer physical shopping trips but higher average tickets. And while we've seen greater adoption of online shopping, we're really encouraged to see guests coming back to stores as well. From a channel perspective, e-commerce achieved record growth in the quarter, delivering sales growth in excess of 200%. Curbside pickup and buy online pickup in store were very strong during the quarter, totaling about 20% of total e-commerce orders as guests embraced this limited-touch, beauty-to-go option. Despite reducing advertising and promotional activity during the quarter, we maintained our unaided awareness in the mid-50% range and increased our aided awareness to 94%. And our focus on driving meaningful connection with our guests through relevant content and inspirational brand messaging through our digital and social channels is having an impact. Our brand health is very strong with improvements in consideration, connection, integrity, and and advocacy, reflecting our response to the safety and social concerns of our guests. Building a brand's affinity during this tumultuous time will continue to pay dividends over the long term. Now turning to our performance by category. During the second quarter, we increased our market share across most major prestige beauty categories, and we saw an improving trend in our share of mass beauty as we reopened stores. Reflecting our paced reopening process, Comps lined across all major categories for the full quarter. As stores reopened, sales trends improved, with skincare, fragrance, bath, and PCA delivering double-digit comp growth in July. The makeup category continues to be challenged due to shifts in consumer behavior and limited newness and innovation in the category. Even with these headwinds, some subcategories of makeup perform better than others, including lashes, brow, and eye. Sales and services decreased for the quarter, reflecting our measured reactivation of hair and brow services and limited capacity due to social distancing. As salons reopened, we saw significant increases in average ticket, driven by pent-up demand, particularly for color and texture services. Importantly, we're seeing strong double-digit growth in rebooking rates as our stylists deliver a safe and enjoyable experience and proactively focus on scheduling future visits.

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The number of active members in our Ultimate Rewards loyalty program decreased by 4% compared to the second quarter last year to 31.9 million members. As a reminder, active members are members who have shopped with us at least once in the last 12 months. During the quarter, we saw modest growth in our Diamond and Platinum membership levels. However, new member growth and retention rates were pressured due to store closures and lower levels of marketing and promotional activity. New member acquisitions through our digital channels continue to expand at healthy rates, and we continue to see previously in-store only members engage with us online with greater frequency. On the channel members are our most engaged and most productive members, historically spending three times more per year than store only guests. So we're pleased to see that omnichannel guests grew to 21% of our members in the second quarter, nearly double the penetration in the same quarter last year. And online only members represented 7.5% of our members, two and a half times the penetration last year. With our fleet open and trends improving, we're shifting our attention to strengthening the business in this new normal and expanding our market share in the second half of the year, while also setting the foundation for profitable growth in 2021 and beyond. On the last earnings call, we introduced five strategic priorities where we're accelerating efforts to expand our market share gains and extend our competitive advantages. I'd like to give you an update on our progress in each of these areas. But first, I'd like to share our perspective on racial equality, inclusion, and diversity. As a priority and a value, this is not new for us, but certainly our focus has been sharpened and elevated by the recent awakening in our country to the forces of systemic racism, and the important dialogue and actions that have resulted. At Ulta Beauty, diversity and inclusion have always been core values, an important part of who we are. In the seven years I've been CEO, we have worked hard to represent the wonderful diversity of our country and how we show up as a brand and as a retailer in everything we do, from our marketing communications to our brand partnerships and our team. I'm proud that our board is 18% black and more than half are women. Our executive team is 13% black and 50% women. And our Ulta Beauty team overall includes 47% people of color and 92% of our associates are women. That said, there is still much more to do. Today, more than ever, we're working to accelerate our leadership in this space. We're using our social channels to amplify black voices and beauty, and we're working to grow our roster of black-owned brands. We recognize this is a journey, but we're firmly committed to creating an inclusive experience for our guests, building a diverse representative workforce, and serving as an authentic leader of diversity and inclusion in corporate America. Let me now recap the progress we're making on our five strategic priorities. Our first priority is to expand our omnichannel business to more deeply connect with guests across channels and unlock the potential of our combined physical and digital footprint. This is not a new priority for us. We've been on this journey for several years, and we've made progress. However, the pandemic has accelerated consumer engagement and desire for online and contactless shopping, and we believe our e-commerce penetration will remain meaningfully higher than pre-COVID-19 levels. Our customer insights and member data show many of our members prefer to transact in-store where they can discover and interact with products and other beauty enthusiasts. But we also know our members engage online to research, learn, and discover new products. As the pandemic has accelerated the adoption of these digital channels, we're expanding our investments in digital innovation with enhancements to the Ulta Beauty app and Ulta.com to create more personalized and seamless shopping experiences. We've also continued to enhance and expand our ability to provide members with personalized recommendations based on insights from our loyalty data. Today, through the Ulta Beauty app and on Ulta.com, we provide members with unique recommendations across a variety of experiences, including new products, products based on category preferences, reminders for replenishment, or hand-picked items, all powered by our internal AI platform. We also recently launched app-only offers and exclusives to drive member app engagement, and we've introduced sponsored ads to allow our brand partners to influence specific product placements. We continue to drive innovation to make it easier for guests to shop with Ulta Beauty. In July, we began rolling out our new service booking tool in the app and on Ulta.com, which enables guests to easily book or reschedule salon, brow, and other service appointments. More than 1,000 stores are actively using this new tool, and the feedback from guests and stylists has been great. We're also testing new notification processes to expedite the curbside pickup experience with the goal of having a more seamless digital experience in place for holiday. As we work to enhance the digital experience for guests, we've launched a guest service chat bot on Ulta.com for ease, convenience, and speed in resolving basic guest questions. And we launched a new guest service customer engagement platform that allows our call center team to seamlessly respond to guest needs across a variety of contact channels and across internal platforms. We continue to invest in our fulfillment capacity to support a larger e-commerce business. As discussed in the last earnings call, we pulled forward the opening of our Jacksonville Fast Fulfillment Center and we're on track to be operational to support higher levels of e-commerce demand this holiday season. In addition, we're expanding our ship from store program to 100 stores to increase shipping capacity and improve speed to guests while also leveraging store labor and inventory. Longer term, we'll continue to evaluate our infrastructure to determine how we can leverage our supply chain network and store footprint to support a growing omnichannel business. We're actively reviewing our network to identify opportunities to improve product flow from brand to guest while enhancing inventory productivity and guest service levels. Similarly, we're looking at our store footprint through an omnichannel lens to ensure we're strategically positioned to optimize share and profitability opportunities in every market. Moving on to our second strategic priority, we are reimagining guest experience and discovery. We know guests still want the opportunity to test and play, but we also recognize the increased importance of safety. As we think about supporting discovery in the new channel, we're leveraging digital tools like GLAM Lab, our virtual try-on tool. Since the COVID-19 crisis began, guest engagement with the tool has increased meaningfully, with product views in the second quarter increasing more than 150% from the first quarter. In addition, in the second quarter, we expanded our virtual try-on capabilities to include hair color, false lashes, and the benefit brow bar. While these are newer capabilities, our guests are actively playing and engaging with these innovative tools. Longer term, we intend to support discovery, trial, and play by offering a combination of limited safe product testing with an expanded selection of single-use samples and seamless digital innovation like Glam Lab and 3D printing. In addition, we're retooling our approach to in-store education, events, and services, and reimagining our fixtures and visual merchandising with a focus on safety, flexibility, and cost effectiveness. We know human connection and the physical shopping experience are important to beauty enthusiasts, so we're rethinking the whole store experience from focus and curbside to the flow and feel of the store and the role of the associate as a trusted guide. Our vision is to continue to be the most loved destination in beauty by reimagining the end-to-end guest experience at Ulta Beauty. And we'll share more about these efforts on future calls. Turning now to our third area of strategic focus, to drive winning category strategies and engage and delight beauty enthusiasts with a curated, relevant, and unique beauty assortment. Newness and product innovation drive beauty category growth. And while we've successfully launched Newness online this year, Many of our planned brand launches and expansions in stores have been necessarily delayed because of store closures. With the reopening process complete, our store teams are working hard to deliver more exciting newness across all categories. Clean beauty continues to be a growing area of interest among our guests. Last month, we announced the launch of Conscious Beauty at Ulta Beauty, an initiative intended to help guests find brands and products that reflect their personal values. Through this initiative, we will certify brands across five key pillars, clean ingredients, cruelty-free, vegan, sustainable packaging, and positive impact. Our goal is to give guests access to more choices, guide them along their journey, and celebrate the brands and products that are aligned with this mission. Conscious Beauty at Ulta Beauty will launch this fall in all stores, online at ulta.com, and on our app. In conjunction with this launch, we established sustainable packaging goals, with a pledge to ensure 50% of all packaging sold will be made from recycled or biosource materials, or will be recyclable or refillable by 2025. As part of this effort, we'll pilot a circular shopping experience with Loop, a reusable packaging pioneer in early 21. COVID-19 has amplified many of the category trends we've experienced over the last year. Most notably, the emergence of self-care has fueled consumer interest in skincare and hair. We're accelerating our focus in these areas to drive market share growth. In skincare, our merchant teams have made terrific progress in expanding our assortment and improving the profitability of this important growth category. We continue to expand our brand portfolio across all price points, including brands like Beekman 1802, L'Occitane, and Glamglow, and expanding brands like The Ordinary, Urban Skin RX, and ELF Skincare. In addition, we're highlighting a number of new skincare brands from our Spark platform, including Kinship, UpCircle, and Fifth & Roots. To support these launches, we're dedicating more space for skincare in prominent areas of the sales floor and on Ulta.com. And next year, we plan to implement more holistic changes to the layout and select new stores, which allocates more prominence and easy-to-navigate space for skin, more intuitive adjacencies, and space in the front of the stores for curated events. In addition to product newness, we're investing in digital innovation to help our guests identify and address skin care concerns with the launch of a new skin analysis tool in the Ulta Beauty app. This new skin analysis tool uses augmented reality technology and AI to assess skin care needs and offer personalized recommendations and skin care tips. In hair, we're expanding our focus on texture and color with the introduction of brands like Arctic Fox, Creole Essence, and the expansion of brands like Pattern and CurlSmith. To support these launches, we've increased our storytelling through our marketing vehicles, elevated the visibility of our stylists via social media, and relaunched our salon takeovers to increase visibility to key brands. Makeup remains our largest category, and we remain confident in the long-term opportunity. But changes in consumer behavior, a reduction in wearing occasions and events, and the delay of new product innovation coming to market will likely continue to challenge growth in the category in the near term. Makeup is still an important, profitable category for us, and we're prioritizing newness in high-growth areas, including Laura Mercier, Pixi, and the newly launched KVD Vegan Beauty. We're also working to improve the space productivity of prestige color and prestige skin categories through recent planogram realignment. Moving on to our fourth strategic priority, we'll continue to drive innovation in the Ultimate Rewards Program in meaningful ways. personalizing experience across touchpoints, and creating stronger connections with our members. We have a large differentiated loyalty program with strong member engagement. Recent store closures and disruptions will constrain member growth this year, but we believe in the long-term opportunity to expand our loyalty program. To increase membership, we're focused on converting new members, both online and in-store, and re-engaging with members we haven't seen in a while. As consumers shift increasingly to online shopping, we're seeing more non-members engaging with us online. Since the pandemic began, we've seen more than 2 million online transactions from non-members, more than four times the number over the same period a year ago. To increase our conversion of these online guests, we're enhancing our communications on Ulta.com because we can reach them through email, and we're proactively communicating and promoting the value of ultimate rewards with these guests. To re-energize our in-store efforts, we provided additional associate training during store closures, and if stores have reopened, we've seen in-store member acquisition rates rebound at higher levels than pre-COVID. With the reopening process complete, we're actively implementing re-engagement strategies, starting with Member Appreciation Month in August, where we celebrated our members, welcomed them back to Ulta Beauty with new bonus points offers, incentives for app downloads, and exclusive app offers. In addition to communicating directly with our members, we've highlighted these offers across all of our digital channels, including Ulta.com, to raise visibility and awareness of our Ultimate Rewards program. In addition, we're using our customer insights and predictive tools to create relevant, real-time, anticipatory interactions across channels to reactivate and engage targeted membership segments and to drive greater loyalty. And finally, our fifth area of focus is to drive strategic holistic cost structure optimization. As we've discussed previously, we've made progress through our efficiency for growth or EFG efforts to improve our merchandising effectiveness and enhance core processes across our real estate and supply chain operations. But we recognize the rapid growth of e-commerce and increasing external cost pressures combined with the need to build critical capabilities to support our growth strategies all require us to evolve our thinking about how we operate. So in addition to the near-term actions we're taking to stabilize and recover the business, at the same time, we're also looking at opportunities to optimize our cost structure. A few examples include store optimization. We have a strong profitable store fleet, and as with any portfolio, there's always top and bottom performers. Last month, we announced our decision to permanently close 19 stores this year to strengthen our overall portfolio. In addition, we've slowed new store growth to manage operational risks this year. The role of physical retail in beauty remains crucial to the shopping experience, and while we know the role of e-commerce will continue to grow, we also continue to believe we can ultimately operate between 1,500 to 1,700 stores in the U.S. As we plan growth beyond this year, we will seek to balance the opportunity for lower rents with the opportunity to upgrade existing locations. Second example, promotional efficiency. We continue to refine and strengthen our promotional strategies. While we will continue to lead into strategic events to drive market share, we're moderating or eliminating less profitable or less strategic promotions. For example, this summer we eliminated our Jumbo Love Leader event, replacing it with a more focused promotional event for hair care. We limited the number of participating brands, reduced the average discount rate, and eliminated additional marketing coupons. These changes delivered significantly more profit despite negatively impacting the comp in the hair category, and our core business was stronger during and after the event.

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Another example is store labor model. We're implementing changes to our store management structure. This fall, we will eliminate the store manager and prestige manager roles and create a new single service manager role responsible for services, events, and prestige retail. This change will create a stronger linkage between services and product and provide our guests with better customer service and expertise. It will also result in a more cost-efficient labor store model, store labor model. Now, one additional comment about our labor model. In April, we furloughed 33,000 associates, and to date we've brought back about 17,000 associates. Given our reduced operating hours, we know not all of our part-time associates will be able to work the shifts available given personal needs and availability. We also want to be realistic about capacity constraints, service limitations, and the likelihood that demand will take time to recover. As such, not all of our furloughed associates will likely return to Ulta Beauty this year. These are a few examples of steps we're taking to adjust our cost structure for the new environment. We are also looking at additional opportunities across the enterprise to optimize our cost structure while also building new capabilities to support our competitive advantage and our future growth. So in closing, we believe a near-term environment will continue to be dynamic, but I'm confident our team can successfully navigate the challenges. In longer term, I remain optimistic about the growth opportunity for the beauty category and for Ulta Beauty. We have a strong and differentiated business model with diversity across categories and price points, and outstanding service offerings. We're actively evolving and investing to extend our brand leadership, and I remain confident that Ulta Beauty will continue to innovate and lead, capture market share, and drive profitable growth as we continue to be the most admired beauty retailer. And now I'll turn the call over to Scott for discussion of the financial results. Scott?

Thanks, Mary, and good afternoon, everyone. Starting with the income statement. Sales for the second quarter declined 26.3%, and total company comp declined 26.7%. Overall, sales for the quarter were in line with our internal expectations, with sales from e-commerce a little stronger and stores a little softer than expected. Average ticket increased 14.9%, while transactions declined 36.2%. As Mary mentioned, the beginning of the quarter was significantly pressured due to store closures, but we experienced improvement in the business as the quarter progressed. We are very pleased with the performance of our e-commerce operations, which exceeded our internal expectations and delivered a comp increase of more than 200% for the quarter, as guests continue to take advantage of our omni-channel capabilities, including curbside pickup and buy online pickup in stores. As expected, e-commerce growth slowed as stores reopened, but continued to deliver strong triple-digit growth versus last year. From a mixed perspective, makeup was 43% of sales, down 400 basis points from last year. Skincare, bath, and fragrance collectively increased 600 basis points to 28% of sales, as the penetration of all three categories increased year over year. As a percent of sales, hair care products and styling tools was flat at 21% of sales. The services category was down 300 basis points to about 3% of sales as all services were suspended for much of the quarter. Gross profit margin was 26.8%, a decline of 9.6 percentage points compared to 36.4% a year ago. Many of the trends we saw in the first quarter continued in the second quarter as we transitioned through the store reopening process. Similar to what we saw in the first quarter, the largest driver of margin deleverage were fixed costs due to significantly lower sales. Although not readily apparent in the gross margin results this quarter, we continue to reduce overall store occupancy costs. In addition to our ongoing EFG efforts, our real estate team is capturing significant benefits from lease negotiation efforts, reflecting the market impacts of COVID-19. These ongoing efforts will help us continue to reduce our occupancy costs over the long term. Channel shift was also a large contributor to gross margin deleverage this quarter, albeit less pressure than we experienced in the first quarter due to increased utilization of curbside pickup and buy online pickup in store and higher shipping volumes. As we shared last quarter, we would not anticipate this magnitude of deleverage on gross margin from channel shift to continue once we return to a more normalized operating environment. We also experienced deleveraging salon expenses. While we furloughed many of our stylists as stores were closed, we continued to pay salon managers and our elite stylists. In addition, as Mary mentioned, as salons have reopened, our guest capacity has been constrained by safety protocols and social distancing, resulting in lower sales. In addition to these factors, we increased inventory reserves by $16.5 million during the quarter, primarily to adjust for slow turning and discontinued makeup SKUs and permanently closed stores. The sales pressure we have seen in makeup over the last several quarters has been exacerbated by COVID-19, which has resulted in changes in consumer behavior, as well as delays in newness and innovation within the category. As we believe these factors will persist in the short term, we decided to move aggressively through slower turning make-up SKUs to ensure that we maintain healthy inventory levels. In addition, we wrote off $1.4 million of inventory related to the previously announced 19 stores that will close in the third quarter. These headwinds were partially offset by the impact of lower promotional activity, as we chose to pull back on many promotional levers during the quarter. as well as benefits from our credit card program. SG&A expenses decreased to $271.6 million compared to $392.8 million in the second quarter of 2019. A large portion of the decrease compared to last year was due to employee retention credits of $48.2 million made available under the CARES Act. It's important to keep in mind that the employee retention credits were recorded in the second quarter but reflect credits for payroll taxes paid in both the first and second quarters. The decrease in SG&A is also attributable to lower store payroll and benefits, as many store associates were furloughed for much of the quarter. We also pulled back on marketing by significantly reducing spend on print material while investing into our digital channels. Store expenses were also lower, reflecting that many stores were closed for much of the quarter. These reductions more than offset an increase in corporate overhead, reflecting the impact of investments to support growth initiatives we made in 2019 that have not yet been anniversary, and the impact of 37.5 million of PPE and other COVID-19 related expenses incurred in the quarter. We recorded a charge of 40.8 million for impairment, store closure, and other costs. As discussed on our first quarter earnings call, we perform reviews on long-lived assets on a quarterly basis, or when events or circumstances indicate that asset values may not be recoverable based on current expectations for future cash flows through the remaining lease term. This quarter, there were 26 stores where the projected cash flows are lower than the current asset balance, which based on market value of the rent relative to our contractual obligation of the property, resulted in impairment charges of 20.9 million. We have a strong and productive fleet of stores, but the dynamic operating environment may result in additional impairments as we complete our quarterly testing process. We also recorded an impairment charge of 19.9 million related to the previously announced permanent closure of 19 stores. Pre-opening expense was $3.9 million in the quarter, a decrease from $5 million a year ago. As a reminder, pre-opening expense represents primarily rent expense associated with stores we control but are not yet open. Given the disruption related to COVID-19 pandemic, we chose to not open any new stores during the quarter. We resume new store openings in early August and are on track to open 19 stores in the second half of fiscal 2020. Interest expense related to the drawdown of our revolver totaled 2.6 million compared to interest income of 1.7 million a year ago. Diluted gap earnings per share was 14 cents compared to earnings per share of $2.76 reported for last year's second quarter. Adjusted diluted earnings per share Excluding charges related to impairments, store closures, and other costs was 73 cents compared to adjusted diluted earnings per share of $2.72 a year ago. Moving on to the balance sheet and cash flow. We ended the quarter with $1.16 billion in cash and cash equivalents and remain confident that we have sufficient liquidity to fund our operations now and in the future. For the quarter, total inventory grew 4% compared to the second quarter last year, primarily reflecting inventory needed to support 51 net new stores. Inventory per store decreased slightly as we have closely monitored demand as stores reopened and adjusted inventory levels accordingly. Turning now to the rest of 2020. We're not providing an earnings outlook at this time. However, I want to share with you how we're thinking about the rest of the year. As Mary mentioned, we're pleased with the sales performance we have seen since we reopened stores, but we believe it is prudent to take a cautious approach to the second half. Given the ongoing uncertainty, we are currently planning comps to be down in the low double-digit to mid-teens range in the second half, reflecting a number of factors. First, we believe the near-term environment relative to containing the pandemic and related economic impacts will continue to be dynamic and challenging. And like others, we have seen volatility in our business as local markets experience higher transmission levels of COVID-19. Two, we are pulling back on our promotional activity to drive profitability. Of course, we're watching the competitive environment closely and will adjust if needed. And finally, we expect store traffic this holiday season will be impacted by ongoing consumer health concerns and limited physical capacity in our stores, as well as our decision to close stores for Thanksgiving. We anticipate our gross profit margin will be leveraged in the second half, but not as much as we experienced in the first half. Compared to the first half trends, we expect less deleverage from fixed costs and channel mix as sales improve, and e-commerce penetration normalizes to a level higher than last year but lower than what we saw in the first half when stores were closed. We expect to incur between $35 and $40 million in PPE and COVID-19 related costs in the second half. As Mary discussed, we are actively taking steps across the organization to right size our cost structure in the new operating environment. We have limited the number of new hires and look to repurpose open positions. We delayed and reduced merit increases for our corporate, store, and salon associates. We reduced marketing, travel, and other controllable expenses and moderated our pace of investments to build international capabilities. Looking forward, we continue to identify additional opportunities across the enterprise to optimize our cost structure while also building new capabilities to support competitive advantage and future growth. In addition to cost management efforts, we continue to refine our capital spending plans. Our updated plan for the year is to invest between 180 and 200 million, including approximately 65 million for new stores, remodels, and merchandise fixtures, 90 million for supply chain and IT, and about 30 million for store maintenance and other. We expect to open approximately 30 new stores in 2020 and relocate five. We are still finalizing our real estate plans for next year, but plan to open at least as many new stores in 2021 as we do in 2020. While we have slowed our new store growth opening pace in the near term in response to COVID-19 and evolving market conditions, we remain confident in the longer term opportunity to continue to expand our fleet. And now I'll turn the call back over to our operator to moderate the Q&A session.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star followed by the number 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. We respectfully request that you ask one question only to allow us to have time to respond to as many of you as possible. To ask a second or follow-up question, we ask that you recue one moment, please, while we poll for questions. Our first question comes from Adrienne Yee with Barclays. Please state your question.

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

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

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

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

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

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Hey, Tex, can someone else get a turn?

Thank you. Our next question comes from Ike Boberchow with Wells Fargo. Please state your question.

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

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

Thank you. Our next question comes from Stephen Forbes with Guggenheim Securities. Please state your question.

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

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

Thank you. Our next question comes from Michael Benetti with Credit Suisse. Please see your question.

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

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

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

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

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

Thank you. Our next question comes from Paul Trussell with Deutsche Bank. Please state your question.

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

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

Thank you. Our next question comes from Simeon Gutman with Morgan Stanley. Please state your question.

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

Yeah, so we're thinking about the second part of your question, Simeon, but as far as the first question there, so fixed cost overall is something that we have been focused on for a couple of years already. So when we talk about efficiencies for growth or EFG, real estate is a core pillar in the work that we do there. So again, thinking about the whole portfolio, when we're dealing with landlords, not just individual stores and looking further out into the future on renewals and opportunities to reposition stores or renegotiate overall economics on those stores. So that's been underway now for a period of time. And so we've got an embedded process in the business and we're feeling really good about what we're doing. So COVID-19 just kind of put that on steroids here in the near term. So again, you've seen other Retailers talking about challenges they've had. So we're doing a lot of the same things behind the scenes. We feel like we've got a better process. We've got strong relationships. We're a retailer of choice for many landlords. The beauty category being being a healthy one to add to the mix and we drive a lot of traffic to centers. So we feel like we're in a good position to make sure we get the best overall economic deals. That's something that we, you know, will be part of our long term plan. We're getting benefits now and we will to scale that up over the long term. As far as the 20 to 40 basis point headwind in our historical guidance, I mean, that's, again, that's, the page has been turned on that here over the last, call it three to five months, and we've been reacting and leveraging and trying to optimize the overall impact there. I think I mentioned earlier, DC throughput efficiencies are getting better. As the business scales up to 2 and 3x times, we are getting efficiencies out of the network overall. I mean, there are headwinds. You've seen the news reports here on some of the surcharges that are coming from some of the shipping operations here in the US. So that's another bit of a wild card that we're balancing against. But it's a little too early to really be able to quantify what the impact on that is. I would say in the big scheme of things, that's a smaller item compared to some of the other headwinds that we're dealing with now here in 2020. But again, we've got a great team in supply chain that's smart and thinking about all the long-term impacts of this over the long term. And again, when we put it into the mosaic that we're dealing with, whether it's specific digital, you know, gross margin headwinds or other things in the business, PP&E costs, we're kind of putting all the PP, all the puzzle pieces together here to kind of try to come up with the best overall operating margin answer that we can. Thank you.

Our next question comes from Steph Wissink with Jefferies. Please state your question.

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

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

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

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

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