Ulta Beauty, Inc.
Q2 2017 Earnings Call Transcript

Published: 25 Aug 2017

[Operator:]

Greetings and welcome to the Ulta Beauty Second Quarter 2017 Earnings Results Conference Call. At this time, all participants are in a listen-only-mode. A question-and-answer session will follow the formal presentation. [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 Relation. Please proceed.

[Laurel Lefebvre:]

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 Kimbell, 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. During the Q&A session, we respectfully request that you please ask just one question to allow us to have time to respond to as many of you as possible during the hour scheduled for this call. I'll now turn it over to Mary.

[Mary Dillon:]

Thank you, Laurel. Good afternoon, everyone. The Ulta Beauty team delivered another quarter of excellent performance with more than 20% topline 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 balance traffic and ticket growth. Category strength was broad-based with prestige cosmetics still driving the majority of our comp growth and with skincare, fragrance and hair care all accelerated. Continued success of our marketing and loyalty programs and rapid growth in e-commerce also contributed. In the period during which our market share gains are accelerating, we elected to prioritize earnings growth in margin expansion over comp sales growth. As a result, we chose not to run 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 asset, as of the end of July ultimate 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 ultimate rewards credit card continues to ramp up. We just celebrated the one-year anniversary of the launch and continue to make improvements to the credit card application experience on ulta.com, as well as rollout 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 it 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 reach 87% aided awareness versus 84% a year ago and our unaided awareness increased by seven 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 a preferred destination for beauty. Now I 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 four points of share gain in the Prestige category 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 cosmetic 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 planned. While many of our color cosmetics brands are still driving exceptional growth with newness in innovation a few of our large brands that had delivered several years of slower comps are not contributing as much growth this year against top comparison. As a reminder, last year was a huge year for innovation in the lip category and there were several big influencer driven makeup palette that drove tremendous growth for few brands. The current 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 enthusiast is any less passionate about makeup. Actually, it's even more engaged with beauty in social media channels and the interest and beauty in key growing demographic like [indiscernible], Millennials and Teens continues to work in our favor. We're confident the pipeline of newness, excitement and innovation is stronger in the backhalf of the year compared to the second quarter. Here is 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 solution based skincare makeup line for active lifestyles from Clinique called CliniqueFIT to capitalize on the [indiscernible]. 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 you on the highly anticipated MAC rollout, we've launched about 600 MAC SKUs online in early May and currently has 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 number one or number two brand where its launched. In addition to offer a 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 five hand-picked MAC products that are impulse fixtures team-wide [ph]. Many brands that we successfully launched in a limited number of stores are also expanding into additional stores. For example, NARS started out with a few SKU's and an added share then went on an end-cap and now it expands in nine feet in a few hundred stores. We rolled out Drybar haircare products in tools chainwide and Estee Lauder balls expanding to hundred more doors. We've 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 problems solutions in shopping featuring more than 50 new and exclusive SKU's in an expanded footprint to maximize exposure of one of our most popular brands. We also see opportunity to hand smaller categories as well. We've elevated our bath assortment across both, Mass and Prestige brand. On the Mass side, we've launched popular bath brands; the Balm and Frank Body, we're rolling out in select stores and online a Prestige bath fixture featuring new brands; Cowshed, Rituals, and Thyme. We also remerchandised our sun care department pulling all brands together in a new sun shop driving an acceleration of comps in this category with particular strength in St. Tropez and Sunburn [ph] brand. As beauty enthusiast 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 to these brands has been very positive. To give you a few examples of these up and coming social media driven brand, we're excited to announce an exclusive partnership with Morphe cosmetics known for high quality makeup brushes, pallets and influence our collaboration; this will be both in-store and online later this quarter. We continue to expand our Korean beauty offering with the rollout 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 Elle [ph] cosmetics to select stores. Recent online only addition such as Dose Of Colors, Ofra, Cane and Austin, DERMAFLASH, Colorescience, Zavala [ph] 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 talent we've just introduced with YouTube star Melisa Michelle has been very well received. Now I'll turn to our services business. Salon sales grew 15.3% and comp 7.7% in the second quarter and we're seeing 16% year-over-year growth in the number of 12 months 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, blowout and make-up services drove this performance. Our guests are also showing interest in bold and non-traditional hair color and we're showcasing this in our fall trend collection including a soft lavender shade called Geode Balayage in 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 currently use our salon but they are our best guests spending nearly three times more than non-salon shoppers. We'll continue to drive this important strategy for Ulta Beauty. In fact, we've developed deep consumer insights and hypothesis 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 guests and associated insights programs designed to enhance the salon designers and guests experience and the overall effectiveness of our salon. The new model is now being tested in two markets; the key components of the model are 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 four 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 two quarters as we enhance the process 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 promotion. 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, paid channels including paid search, affiliate display retargeting, and paid social including Facebook, Twitter and YouTube. We continue to update and enhance our mobile apps which at last count has been downloaded by 4.4 million guests and has a 5-Star rating in 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 roadmap. Currently we're testing the ability to order from ulta.com in-store and deliver to the guests home if there were any products that were not available when she visited our store. This program which we call store-to-door is being tested at 40 stores and we're working 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 guest 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 all channels. Omnichannel customers now represent 8.8% of our loyalty members, up from 7.2% a year ago; and like our salon guests she is a very valuable guest spending 2.7 times more than a retail-only guest and has 9.5 transactions per year compared to four 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 expiration and newness than in-store with very few repurchases of exact items in either channel. Turning to our progress and our supply chain operations; our supply chains teams continue to ramp up our Dallas and Greenwood buildings. It supported ulta.com's rapid growth in the second quarter with nearly 80% of e-commerce order volume shipping out of our new distribution centers. Our DCs processed significantly more e-commerce shipments than forecasted during the quarter while improving productivity, decreasing cost per shipment and keeping labor costs in-line with forecasts. 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 upto 400 stores and 45,000 e-commerce orders per day. Fresno will also provide a platform to implement a 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 will turn it 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.

[Scott Settersten:]

Thank you, Mary. Good afternoon everyone. Starting with the income statement; sales for the quarter grew 20.6% to a $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 comp 7.7% driven primarily by ticket growth. The retail and salon comp combined was 8.3%. One call-out 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 mark downs on clearance product at the end of 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 costs 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 the 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 tiny benefits we reported in the first quarter related to advertising spend reversed in the second quarter. While we expect advertising expenses or 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 companies record the tax effects of employee stock option exercises investing 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 although with a 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 10d5-1 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 a $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 and fiscal 2017. For the third quarter, we expect sales to be in the range of $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 costs 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 petit rollout 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 impact since the beginning of the year. Operating margin rate is expected to leverage in the fourth quarter resulting in leverage for the full year. A tax rate for Q3 excluding any impact to 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 proto-typical 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 twenties percentage range. As a reminder, this includes the impact of the 53rd week assumed 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 standards for share-based payments for the remainder of the year. Operating margin is expected to increase in the 20 to 30 basis points range. And with that, I'll turn it back over to Mary.

[Mary Dillon:]

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've posted another double-digit top and bottom line quarter far outpacing the results 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 at our highly incremental e-commerce business all while being less promotional than the year ago. This is the competitive category and our consumer retail habits and expectations rapidly changing, of course, First Beauty has always been an attractive category in which to compete and it 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 appearance 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 fell 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 offence to drive our performance and create long-term shareholder value with a balanced approach to driving sales and profits. Now I'll turn it over to our conference call host to moderate the Q&A session.

[Operator:]

Thank you. [Operator Instructions] Our first question is from Steph Wissink with Jeffries. Please proceed with your question.

[Stephanie Wissink:]

Thanks. Good afternoon everyone. Just one point of clarification Scott on the labor relation in -- on the boutiques; the 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 am curious if you're seeing any changes in the demographic composition of your newer loyalty members versus what you've experienced in the past? Thank you.

[Mary Dillon:]

Yes, 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 enthusiast that cuts across a lot of different demographics and we're seeing very similar type of new loyalty member. They wrap up overtime, they don't start out as engaged in our program as they become overtime but we are seeing very stable metrics around spend per loyalty member, frequency of visit and those kinds of metrics; so very consistent.

[Scott Settersten:]

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 the expense channel in the P&L and it's -- primarily, some of it is write-off that we accelerate, right, from the existing store fixturing and things that we have to remove in order to put those new boutiques in the service but the real incremental cost to the business in the early days is the labor piece of the equation. So we've been under that SG&A line in our P&L, there has been a clearly significant deleveraging of store payroll over the course of the last -- call it six 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 are brands that our guests want and they wanted for a long period of time. So it's definitely the best decision for our investors for the long-term.

[Stephanie Wissink:]

Thank you.

[Operator:]

Our next question is from Simeon Gutman with Morgan Stanley. Please proceed with your question.

[Simeon Gutman:]

Thanks, good afternoon and nice results. So Mary, my question is; clearly your strategy is working and the competition does seem to be increasing. And it seems like the market is 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?

[Mary Dillon:]

Thank you, Simeon. You know, 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 involves the guest experience, services, our omnichannel capability but at its core having great brands; new and exclusive and great brand launches that they can't get anywhere else and participating across categories. So I would say that as we think about it, playing our offence, continuing to really look at our new store productivity which we're really product about, our comp growth, our loyalty member growth; we feel that we're really in a great position to continue to lead and will continue to focus on having the broadest assortment across all categories and price point that's another part of our business model that frankly helps provide some greatest installation for us and invest in the differentiators that I've already mentioned.

[Simeon Gutman:]

Okay, thanks.

[Operator:]

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

[Brian Tunick:]

Thanks, good afternoon. 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 two to three 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?

[Scott Settersten:]

So, I'll start with the operating margin target. So Brian, again at this point we're still very comfortable with our new teams target, the same target we've been talking about now for some time. Again as a reminder for everyone, we're not counting our 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, the fixed store cost leverage we talked about, supply chain investments; so this is kind of a multi-year initiative here and again we're seeing the green shoots up 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-ecommerce flow through on 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 on inventory productivity overall will help us get to that mid-teens target.

[Mary Dillon:]

Okay. And then we'll cut right through the [indiscernible], I like that. I'm kidding but -- just to take out the second part of your question; here is what I 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 segment of 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 don't take that for granted, okay, so first I'll 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, you know, -- listen, we -- it's not unusual for us to have competitors to carry some of the brands that we carry. So for example, that platform again already carried some of the brands that we carry; a few examples, Mario Badescu, Butter London, Steeler; these are some brands that are sold there as well sold at Ulta Beauty and they are 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 binders on about this but I would say at the end of day it's really about how we bring it all together. So what do we offer to our brand partners really a true beauty experience, right, from the experiential part that a guest could have in-store to try and play a new store all the way through a great online experience. So, for us, it's about what we offer to the guest who can't get this anywhere else; the categories, brands, price points, experience in the store. So I guess to answer your question, it kind of relates to Simeon's as well; it's really about we just play our offence, we're very focused on the beauty enthusiast whether we understand her really; her shopping needs and what she want in terms of an in-store experience, as well as online, as well as offerings -- our service offerings. And of course, it all gets wrapped together with an industry-leading loyalty program. So we understand these guests than anybody else and she loves our loyalty program; so there is great incentive for her to give us her purchases, both in-store and online increasingly to get her loyalty point. So that's how we look at it.

[Brian Tunick:]

Super, it's very helpful. Thanks very much.

[Operator:]

Our next question is from Simeon Siegel with Nomura Instinet. Please proceed with your question.

[Simeon Siegel:]

Thanks, good afternoon guys. Mary when thinking about the new store productivity comment you made, 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 could help explain sales beats even though comps are still within the range? Thanks.

[Mary Dillon:]

Well, certainly our lead hypothesis on why new store productivity continues to increase is exactly that. We have -- this was one of the aspects; we have better brand awareness for every new store that opens, folks who know more about Ulta Beauty. I would also say we're doing a really great job on knowing real estate selections but the grand openings, we've strengthened the tools that we used to drive awareness and gets into the stores initially. Our store is doing [ph] 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.

[Scott Settersten:]

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 to make good real estate decisions all 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 who is out over a couple of cycles before we formally make any modifications to our new store model.

[Simeon Siegel:]

Great. Thanks. Best of luck for the rest of the year.

[Operator:]

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

[David Schick:]

Hi, thanks so much for taking my question. You mentioned foregoing 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 does that evolve your thinking on choice and cadence of promo going forward? Thanks.

[Mary Dillon:]

Yes. I don't think we'll quantify the exact amount. But I would say, big picture, this is probably pretty obvious. We are running this business for a long-term shareholder returns and you have choices I think you can make all the time. So, at a time that we are continuing to have very strong share gain. I'd say the at least we don't really need to go buy comp. And so, we chose in the quarter with less versus more promotion year-over-year. We had a very healthy comp with less promotion year-over-year. So that to me was obviously the right decision. I feel good about it. I mean we will want to drive it above 12 great, but it just wouldn't been the right thing for us to do frankly. So, I feel good about that and I think as we look at our, now as we look at our second half plans, we feel very confident about the pipeline in newness and promotions that we have coming. So, I would say that just a situational decision that we all think was right.

[David Schick:]

Very helpful. Thanks.

[Operator:]

Our next question is from Erinn Murphy with Piper Jaffray. Please proceed with your question.

[Erinn Murphy:]

Great. Thanks. Good afternoon. I guess just following up on the promotional environment and some of the comments in the department stores particularly in the last couple of quarters. Has that changed how you are approaching the 21 days of Beauty this September? Are there anything, whether its brand partnership that you are 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? Thanks.

[Mary Dillon:]

Well, let me start with the 21 Days of Beauty. I'll just make a comment and maybe I'll turn it to Dave to give us some more color on that. But you know, for us it's not really new that there is promotion happening in the store channel. So, some might have been more aggressive, we definitely did not need to directly respond to it. As I said a couple times, we gain significant market share in prestige while the rest of retail was negative. So, I feel very good that that proves that the reliance, or the resilience of our strength of our business model. 21 Days of Beauty, why don't you?

[Dave Kimbell:]

Yes. 21 Days of Beauty one of our signature events coming up actually in just a couple of weeks. We do that every third quarter. We had seen strengthening performance of that event each and every one that we've done for the last several and the things that have been trying to manage a 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 embraced 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 is to get every customer buying both mass and prestige and multiple categories throughout the store. So, it has been working. As far as this one, we are 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 got strong radio, strong digital activity and our guests I think are pretty prime board already and we're excited that that's coming in just couple of weeks.

[Scott Settersten:]

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 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 with a 20% off your initial purchase under the credit card but while doing that we pulled back significantly on other parts of our promotional trait. 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 laughing at this year so we just got to keep in mind what the failed balances and what the margin opportunity might result 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 are 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.

[Erinn Murphy:]

Great. Thank you, guys.

[Operator:]

Our next question is from Jason Gere with KeyBanc. Please proceed with your question.

[Jason Gere:]

Okay thanks guys. Just two 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, thanks to the range for the third quarter, just another 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 it might be more promotional and how you're 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, how that comes in and then Scott, the follow-up is just as I understand the 20 to 38 basis points of margin improvement for the year with some of the incremental investment out there. How do you kind of I guess breakdown between gross margin and as SG&A?

[Mary Dillon:]

I'll start with holiday. I guess it finishes in question. We look at holiday every year as the most promotional time of the year. Right, everybody is playing to win at holiday and so I feel really confident that we've got a great line-up of finance basically whether it's product offerings, exclusives or marketing advertising merchandising. In fact, I would say our team does a great job of integrating all those together year after, making it stronger. So, you know it's - we obviously keep - I mean it's third quarter you're watching every day and every segment is of the other quarter is different, right. So, we'll be all over that, but I feel, we're well - officially they are well poised to have a great holiday and expect it to be promotional.

[Scott Settersten:]

And as far as I guess P&L line drivers right, Jason, I just directional, so we said for the third quarter, gross profit slightly leveraged and SG&A flattish. I mean the biggest driver is the pre-opening expense deleverage year-over- year, which again I want to make sure people understand that's a good thing.

[Jason Gere:]

Okay. Very good. Thank you very much guys.

[Operator:]

Our next question is from Chris Horvers with JPMorgan. Please proceed with your question.

[Chris Horvers:]

Thanks, good evening. So, my question is how much do you think that the industry growth moderate during the quarter and I and they mentioned that a modest impact from the black in that clearance promotion in July but those have been a while since you haven't put upside to the -- comp. So, is the right way to think about it that rated a couple of hundred basis points and as you approach the third quarter guidance does that moderation against -- should be less conservative as you've typically been in the past around the guidance with the industry?

[Mary Dillon:]

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 participated in. So color cosmetics we saw comps accelerate in skincare both massive - haircare, fragrance, bath. So that's great benefit of our business model as we were in every category. We actually are driving. We think we're really focused on some of these categories in helping them drive to growth. We also gained market share across all the categories. But color cosmetics was softer than it has been for the industry, people talked about this already. But prestige comes well above our house, but we have some brands that we have very strong growth happening from the others that maybe we're lacking newness and didn't do it as well as before taking them out. 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 feel very good about. So again, it wasn't a competitive issue we gained share but there was that segment of total Beauty was a little bit softer that it's been. We're lacking over big newness from last year platforms like liquid lip and - make up like an influence or so. That's all there but bottom line, I feel really good and it will take up well above the pipeline or brands that we are coming in rollouts and the unique -- the fact that we participated across the different categories.

[Chris Horvers:]

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

[Scott Settersten:]

Yes, so always with the prudent approach, that's always on our mind, trying to be optimistic but realistic at the same time. So I think I've said many times before, I mean the over performance we've seen here over the last -- call it two to three 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 bet 1,000 every quarter with new product rollout. 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 is very healthy, so we're very optimistic. Again, Mary mentioned newness is our great pipeline of things coming into the third quarter as such really, really positive about the business. But I would say it's just be a little bit more conservative on what you think what the upside could be on top and lower guidance at this point.

[Chris Horvers:]

Thank you very much.

[Operator:]

Our next question is from Ike Boruchow with Wells Fargo. Please proceed with your question.

[Ike Boruchow:]

Good afternoon, everyone. Just a really quick one for Scott; Scott, sorry if I missed it. Can you just tell us who 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 seven to nine competitive, you've done well above that for two years. Do you kind of want to ease back into that seven to nine and let that little bit more margin come to the model, just kind of curious how you think about the business over the next couple of years.

[Scott Settersten:]

Well, I guess I would start with -- it's always a pragmatic approach, right. When you 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 situations, 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 add the entity year. So that I wouldn't say is something that's going to be repeatable here over the next quarter or two. As far as -- go ahead…

[Ike Boruchow:]

No, I was just going to say can you comment on gross margin; for the backhalf how are you planning it?

[Scott Settersten:]

Yes, so on the third quarter I think I mentioned slight deleverage in the third quarter largely because a lot of the new store [indiscernible], fixed store costs are not going to get as much leverage there as they typically do because some of the higher cost stores were opening 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 cycle through the peak expense load and the P&L for the Boutique editions and the new store additions and some of the labor things I already mentioned. And then we'll get more efficiencies in the supplied chain, distribution centers are now primed right for a holiday season where we can push through a lot more e-commerce volume than we ever had before in a much more profitable fashion.

[Ike Boruchow:]

Thanks very much.

[Operator:]

Our next question is from Matt Fasler [ph] with Goldman Sachs. Please proceed with your question.

[Unidentified Analyst:]

Thanks a lot, good afternoon. 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 the margin associated with it embedded in the initial guidance or was it always absent reflecting a decision as you enter the quarter and this is something you probably wouldn't repeat?

[Mary Dillon:]

Well, I think it's more of fact that what happened last year. I mean it was always in the guidance, right; I mean -- again, the leverage we look at over the course of three months you're planning and strategizing about how you're going to deliver the numbers, right and what's necessary and what you would think you would like to do and land the plan so to speak. So last year we pulled the lever here and 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 this over the last couple of weeks of the quarter, we looked at the comp target and we said it's not worthwhile, that's not a wise decision; we're playing for the long-term so we don't want to get into changing this comp thing for the rest of the year. So that was all.

[Unidentified Analyst:]

So that was the decision that you make prior to answering the quarter when you were guided a few months ago?

[Mary Dillon:]

No, that was a call we made during the course of the quarter.

[Unidentified Analyst:]

During the course of the quarter, I understand.

[Mary Dillon:]

Yes.

[Unidentified Analyst:]

Okay, that's very helpful. Secondly, so as we think about trajectory; obviously you had never guided, nor had anyone expected you to maintain a 15-16 comp with any kind of duration, those are stellar numbers as is in 11, as is in 9; wherever the numbers end up, any element of our guidance. All that being said, we've had about five points of deceleration from the peak comp to the number you just pull up and a little bit more on the way -- it sounds like fair nominally so. Into Q3 your launch from guidance from six to eight 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 the underlying trends within the industry and within your own control, the [indiscernible] etcetera intact to enable stable growth in that 6% to 8% comp range a couple of year sense that you gave a few months ago?

[Mary Dillon:]

Yes, so let me start. So the long-term guidance is actually seven to nine, right; and we've said, nearing the near-term moderating more as we get on 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 kinds of things that we can expand in the future, just overall awareness as the BT brand, you know, real estate opportunities like Manhattan and other places that we've never done business before. So -- again, I don't want to see too optimistic but we think there is plenty of room to continue to drive very healthy comp store for the foreseeable future.

[Unidentified Analyst:]

Great, thank you so much.

[Operator:]

Our next question is from Rupesh Parikh with Oppenheimer & Company. Please proceed with your question.

[Rupesh Parikh:]

Thanks for taking my question. So I had a question on the macro level; I think you mentioned in your prepared comments that it's a number one and number two brand so far where it's launched. I was just curious versus the expectation; is the brand as incremental to the store as you expected? And any signs at this point whether it's bringing new customers to alter stores? Thank you.

[Scott Settersten:]

Yes, it has performed very well, both online and in-store. We're really pleased with the results and we believe very strongly that incrementally 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, [indiscernible], as we continue to roll those brands out. We see a high level of incrementality across the whole store. So we're confident it's going to be there, we're still early, we're just at the early part of our rollout 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 components who are adding a greater sophistication of makeup service in our store through Mac has very, very well received from our guests and that just adds to more the experiential component of our stores and those that is rolled out to. So we're excited about that as well.

[Rupesh Parikh:]

Okay, great. Thank you.

[Operator:]

Our next question is from Oliver Chen with Cowen & Company. Please proceed with your question.

[Oliver Chen:]

Thank you, nice quarter. 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 on the inventory management side in terms of making sure you have smart supply chains and planned correctly as customers really look to melt these channels and interact with these channels in creative ways just to save time. Thanks.

[Scott Settersten:]

Yes, I'll start. I think the integration of physical, digital and mobile is really central to our strategy; in fact Mary mentioned that in her remarks and it's really a key part of our 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 the immerse [ph] 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've heard some of the growth that we've seen in all of our mobile engagement that is clearly the dominant interaction point that our guest 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 is using it to check out her points to understand about new products that have been ordered to use our new service by Glam Lab [ph]. 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 guest better; Greenwood and Dallas already allowed us to increase the speed in which we're delivering and the efficiency in which we're doing, the cost of which we're doing and as soon as we opened Fresno, next year that's going to particularly help the West Coast to speed up deliveries there. So all these investments will make our outsider store experience even stronger, at the same time we're integrating and increasing our in-store experience.

[Oliver Chen:]

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

[Scott Settersten:]

We have a real pipeline of ideas and we're continuing to find ways to innovate within our store experience. Mary talked about one that's in test ride, now that we plan to play out [ph] which is store-to-door, the ability to go on 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 big part of our experience where we'll be testing in-store virtual try-on capabilities in many of our stores coming up later this year. So we have -- 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 set.

[Oliver Chen:]

Okay, thank you. Best regards.

[Operator:]

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.

[Mary Dillon:]

I'd like to thank our 35,000 associates for their passion and commitment as that continues 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.

[Operator:]

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