Earnings Call Transcript - ULTA Q3 2020

Operator, Operator

Greetings, and welcome to the Ulta Beauty Third Quarter 2020 Earnings Results Conference Call. As a reminder, this conference is being recorded.

Kiley Rawlins, Vice President of Investor Relations

Thank you, Sumali. Good afternoon, and thank you for joining us today for our discussion of Ulta Beauty's results for the third quarter of fiscal 2020. Hosting today's call are Mary Dillon, Chief Executive Officer; and Scott Settersten, Chief Financial Officer. Dave Kimbell, President, will join us for the Q&A session. Before we begin, I'd like to remind you of the company's safe harbor language. The statements contained in this conference call which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual, future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. We caution you not to place undue reliance on these forward-looking statements, which speak only as of today, December 3, 2020. We have no obligation to update or revise our forward-looking statements, except as required by law, and you should not expect us to do so. In today's comments, we will discuss certain non-GAAP financial measures, including adjusted diluted EPS, which has been presented to reflect our view of our ongoing operations by adjusting for impairment and restructuring-related costs. A reconciliation of these measures to the corresponding GAAP measures can be found in our earnings release, which is available in the Investor Relations section of our website.

Mary Dillon, CEO

Thank you, Kiley, and good afternoon, everyone. Today, we reported financial results that reflect the strength of the Ulta Beauty model and improving trends in consumer demand. I continue to be very proud of how well our teams are responding and navigating through this difficult period. And I want to thank all of our Ulta Beauty associates for their continued agility, creativity and commitment to serving our guests and taking care of each other during this unprecedented period. For the third quarter, net sales were $1.6 billion and GAAP diluted EPS was $1.32 per share. Adjusted diluted EPS for the quarter was $1.64 per share. Building on the momentum we saw at the end of the second quarter, third quarter comp store sales declined 8.9%. The mid-single-digit comp declines we experienced in August continued through September, with October sales impacted by our decision not to repeat certain promotional activity from last year. As we discussed on our last earnings call, we're working to optimize promotional events to remain competitive while also improving profitability. In the third quarter, we executed several promotional events that drove strong guest engagement and profitable sales. We launched our first-ever We Love Our Members event to reengage and welcome Ultamate Rewards members back to Ulta Beauty, having completed our phased store reopening process. We rewarded guests with member-only points and services offers and amplified the offers across owned, earned and paid channels to reinforce the value of our rewards program. We successfully executed a more focused 21 Days of Beauty, one of our most strategic events intended to drive mass migration to prestige products. To excite and reengage guests, we accelerated our digital and streaming-first approach to support expanded messaging for our compelling beauty steals, newness and exclusive products. We expanded the focus of our Fall Haul event beyond makeup to include key self-care categories while reducing the length of the event to drive greater productivity. And to further elevate our hair authority through our Gorgeous Hair event, we leveraged engaging storytelling around healthy hair, color care, and black-owned brands. Now turning to our performance by category. We continue to increase our market share across most major prestige beauty categories. Starting with one of our strategic growth categories, skincare delivered positive comp growth driven by newer brands like The Ordinary, TULA, and Beekman 1802 as well as existing brands like CeraVe, First Aid Beauty, and La Roche-Posay. From our proprietary consumer insights work, we know most beauty enthusiasts are maintaining or expanding their skincare routines as a form of self-care. Increased interest in home skincare treatments as well as newness and innovation in body treatments, face serums and eye creams are driving strong category growth. Leaning into these trends and the opportunity to increase our market share in this category, we continue to expand our assortment while also increasing space and marketing support for this key growth category. Fragrance and bath was our strongest category this quarter, delivering double-digit comp growth driven by newness, exclusive and unique Ulta Beauty programs. Guests responded well to our fragrance gift with purchase programs as well as our Fragrance Crush program, which highlights a favorite fragrance each month. Sales of fragrance also benefited from our exclusive launch of R.E.M. from Ariana Grande and innovation from established brands like YSL and Marc Jacobs. The bath category continues to deliver strong growth. And this quarter, we introduced newness from brands like Truly, Hempz, Ulta Beauty Collection and Tree Hut. Reflecting ongoing DIY beauty and self-care trends, haircare and hairstyling tools also delivered positive comp sales growth this quarter. Within haircare, color continued to deliver strong growth driven by brands like Arctic Fox and Madison Reed. Textured hair brands, Curlsmith and Pattern by Tracee Ellis Ross, also delivered nice growth. Our leader business also continued to perform well, and newness from Dyson and the continued popularity of one-step tools drove strong growth in styling tools this quarter as guests leverage more options to achieve different looks. Makeup continued to be challenged given shifts in consumer behavior and delays in planned newness and innovation. Despite these headwinds, subcategories that focus above the mask continued to perform better, including lashes, brow and eye. Newness, while more limited than last year, continues to be important to guests, with nostalgic themes like Ulta Beauty Harry Potter collection, Makeup Revolution's Nightmare Before Christmas, and ColourPop's Hocus Pocus collection all resonating really well with guests. Although the pandemic has accelerated channel shift, our consumer insights and results continue to confirm that our members prefer to shop in physical stores for beauty even as they have increased their adoption of online shopping. As expected, with stores opened for the full quarter, store traffic trends improved and e-commerce growth moderated from trends we saw in the first half of the year. For the quarter, our e-commerce business delivered sales growth of about 90%. And buy online, pickup in store was strong again this quarter. Turning now to services. Our services business continues to be adversely impacted by COVID-related capacity constraints and local restrictions. At the end of the third quarter, salon and brow services were available in nearly all stores, but we've not resumed skin or makeup services based on ongoing safety concerns. Although trends improved from the second quarter, sales from our services business were down more than 30% in the third quarter primarily due to a decline in transactions. The average ticket was higher, reflecting pent-up demand for cut, color and style services. At the end of the quarter, we had 31.7 million active members in our Ultamate Rewards Program, essentially flat with the second quarter and about 6% lower than the third quarter last year. While we're pleased with our new member acquisition and reengagement trends this quarter, we will continue to focus on reactivation of members who haven't shopped with us since the pandemic began. Now importantly, retention rates among our platinum and diamond members who are most engaged with our brand remain very strong. We continue to see an increase in members shopping with us online. As we've discussed before, omnichannel members are our most engaged and most productive members, historically spending 3x more per year than store-only guests. In the third quarter, omnichannel members were about 22% of the total compared to about 12% in the third quarter last year. As our teams continue to manage the day-to-day operations in the current environment, we're also building the foundation for profitable growth in 2021 and beyond. Specifically, we're focused on five strategic priorities to expand our market share gains and extend our competitive advantages. And during the third quarter, we made progress on each of these priorities. Starting with our continued focus on building the capabilities to win in an omnichannel world. We are committed to meeting guests wherever they want to shop. In April, in response to COVID-related constraints, our digital and store teams moved quickly to launch a new curbside pickup option. To make it easier for our guests and our store teams, we have recently enhanced this option with the launch of a curbside customer alert notification. We've refreshed curbside signage and established dedicated Ulta Beauty parking spaces at select stores. We've also expanded our store locator functionality to include greater visibility to store-specific service offerings and separate store and curbside hours. And in the Ulta Beauty app, we now provide store-specific occupancy levels for greater transparency and guest safety. To support our growing e-commerce business, this quarter, we opened our Jacksonville fast fulfillment center, expanded e-commerce operations in our Chambersburg, Greenwood, and Dallas distribution centers and expanded our ship-from-store program to 105 stores. These investments have increased our e-commerce shipping capacity and will improve delivery speed to guests. This quarter, we also completed the rollout of our new booking tool for services in the app and on ulta.com. This new digital application enables guests to easily book or reschedule salon, brow and other service appointments. Adoption of the tool continues to increase, and nearly one-third of our service appointments were booked through this new tool in the most recent quarter, resulting in more convenience for our guests and more efficiency for our associates. Our second priority is to reimagine how guests experience and discover beauty in the new normal. Product discovery is a hallmark of the beauty shopping experience, and we're welcoming more guests to experience the fun of GLAMlab, our virtual try-on tool. Our store associates have done a great job introducing GLAMlab to guests as a safe alternative to testers in stores, which are currently for display purposes only. To help facilitate even more in-store engagement, we've introduced new QR codes on select shelf strips that take guests directly into the GLAMlab experience, making it even easier for guests to virtually try on products while they're in stores. Building on our successful virtual try-on capabilities, last quarter, we introduced a skin analysis tool, which uses augmented reality technology and artificial intelligence to assess skincare needs and offer personalized product recommendations. This quarter, we enhanced this tool to include new routine recommendations and the ability for guests to save analyses to track changes. In addition to offering guests digital tools, we're also testing one-on-one video consultations across all beauty categories in collaboration with our brand partners and our own services team members. Our third priority is to engage and delight beauty enthusiasts with a curated beauty assortment focused on exclusivity and leading brands. Reflecting the growing importance of clean beauty, in October, we launched Conscious Beauty at Ulta Beauty in all stores and on ulta.com and on our app, and the enthusiasm and feedback from our guests and brand partners has been tremendous. This holistic initiative provides greater transparency to help guests choose brands and products that reflect their personal values and individual needs. Through this initiative, we're certifying brands across four key pillars: clean ingredients, cruelty-free, vegan and sustainable packaging, and highlighting participating brands for their positive impact on communities. And today, more than 200 brands are participating in the program, and more than half have been certified in more than one pillar. As part of the launch, we established the Conscious Beauty Advisory Council, a coalition of experts at the forefront of clean beauty, product development and packaging sustainability. With the help of our advisory council, we will ensure that Conscious Beauty at Ulta Beauty will continue to evolve and grow as expectations and standards for clean beauty continue to change. In tandem with the launch of Conscious Beauty, we collaborated with Credo Beauty, a pioneer in Clean to introduce the Credo Collection at Ulta Beauty, a curated collection of prestige and masstige brands. Available in select stores and on ulta.com, this collection features nine clean brands handpicked by the Credo experts across multiple categories, including skincare, haircare and cosmetics. Our fourth priority is to leverage insights from our Ultamate Rewards Program to cultivate brand love and loyalty, deepen guest engagement and increase spend per member. We continue to build content that reflects our brand purpose and drives meaningful connection with our guests. After suspending most of our marketing efforts in the first half of the year while stores were closed, this quarter, we launched Where Dreams Begin, a campaign that reflects the next chapter of our brand journey. Launched across linear television and digital streaming platforms, the work reinforces our brand purpose and celebrates optimism, togetherness, self-care and self-expression in a world increasingly challenged by uncertainty and division. We continue to enhance our ability to create personalized offers and recommendations based on a holistic, data-led understanding of guest preferences and behaviors. This quarter, we increased our use of propensity modeling to help reactivate members, and we continue to strengthen our ability to optimize offers in email and online, enabling us to maximize the return on select promotions. Our fifth and final strategic priority is to drive holistic cost optimization. We continue to work to create a more cost-efficient store labor model. As we discussed on the last earnings call, we made the difficult decision to eliminate two store leadership roles, the salon manager and the prestige manager, and created a new service manager role responsible for services, events and prestige retail. Effective November 1, this new structure creates a stronger linkage between services and products. This quarter, we also made another difficult decision to suspend our expansion to Canada. This was not an easy decision to make and in no way reflects a lack of confidence in the international growth opportunity for Ulta Beauty. Our teams worked diligently to position us for a successful entry into Canada next year, and I'm proud of what they accomplished in such a short period of time. However, after much consideration, we determined that prioritizing our efforts to strengthen and grow our U.S. operations must be our top priority in the current operating environment. So these are just a few of the examples we've taken to adjust our model to reflect the challenges and opportunities we see today. We've also maintained significant limitations on corporate hiring and controllable expenses, and we continue to look across the enterprise for additional ways we can optimize our cost structure while also investing in new capabilities to support future growth. We've made a lot of progress in pursuit of our strategic priorities, which positions us to drive continued market share growth in the fourth quarter and beyond. Certainly, 2020 has been a year like no other, and it's difficult to predict exactly what the holiday season will bring this year. With Shop Safe Standards in all stores and enhanced digital shopping options, our teams are ready to meet our guests wherever and however they want to shop with us this holiday season. We're encouraged by the sales trends we've seen so far in the quarter, but uncertainty remains as we navigate ongoing disruption from a resurgence in the virus and continued economic uncertainty. As we execute through this holiday season, our top priorities are to reengage existing members and capture new guests with relevant content, compelling offers and unique products, and also to deliver engaging omnichannel experiences. Ulta Beauty is well positioned for this gift-giving season as consumers seek moments of joy, connection and self-care. Our holiday campaign is focused on helping guests see the joy this holiday season. Leveraging influencers from our Ulta Beauty Collective, we're sharing ways to practice self-care. We're celebrating community and relationships with gifting ideas, and we're highlighting the magic and generosity of the season. We kicked off the holiday season at the beginning of November with the distribution of our holiday print magazine, a reimagining of our holiday offers and multiple member appreciation events. Building on newness and exclusives introduced earlier this year, we've launched several new brands just in time for the holiday season. In skincare, we're excited to launch Alicia Keys' new brand, Keys Soulcare, exclusively at Ulta Beauty, with a limited selection of products for the holiday season. The full assortment will be available in early 2021. In makeup, we're excited to welcome HOURGLASS, a cruelty-free luxury beauty brand to the Ulta Beauty family. And while we offer Chanel fragrances in stores, we're excited to announce we've recently launched Chanel fragrances on ulta.com for holiday gifting and beyond. To help our guests give the best gifts this year, we have introduced a new digital gift guide, including a three-step quiz to inspire and help find the perfect gift. And for those who prefer to give gift cards, we've expanded our designs to include more inclusive options, and we've expanded our distribution in third-party outlets as well for added guest convenience. In anticipation that more guests will utilize digital channels this season, we've made curbside and BOPIS pickup easier than ever. These enhancements, combined with the investments we've made to increase our ship-to-home capacity, position us well to deliver a great omnichannel experience this holiday season. The operating environment continues to be dynamic and challenging. As COVID-19 prevalence increases, so are market-specific government restrictions, resulting in some reductions in operating hours, limitations on in-store capacity and, in some cases, mandated store closures. Our priority is to ensure the safety and well-being of our associates, guests and brand partners, and we'll continue to monitor the situation closely and adjust our operations as needed. Now before I turn the call over to Scott, I'd like to highlight the exciting new partnership I'm sure you've all read about. In 2021, Ulta Beauty will partner with another powerhouse retailer, Target Corporation, to disrupt the retail industry and redefine how guests experience beauty. Next fall, we'll introduce Ulta Beauty at Target, a shop-in-shop experience online and in select Target locations. With 1,000 square feet of space, Ulta Beauty at Target will offer a curated assortment of established, emerging and prestige brands across multiple categories. Our vision is to create an extension of our welcoming Ulta Beauty experience with dedicated Target team members trained to provide elevated service and offer deep product expertise with a dedicated space that inspires trial and discovery. Leaning into the power of our respective loyalty programs, we intend to reward guests with benefits across both programs for all purchases made within the shop. Leveraging a royalty structure, this unique collaboration brings together Ulta Beauty's category authority and brand relationships with Target's traffic-driving business model and industry-leading fulfillment services. Together, we will deliver industry-leading guest experiences across multiple touch points, provide the prestige beauty category and participating brands with an unparalleled platform for growth, drive market disruption and capture more market share. For Ulta Beauty, this partnership will build on our strength as the nation's largest beauty retailer, bring our beauty authority to life in a new way and create additional touch points for millions of loyal and new guests to discover and engage with Ulta Beauty, ultimately leading to more members and greater spend per member. Expanding our omnichannel capabilities to more deeply connect with guests is a strategic priority for us. We believe this new channel will create more opportunity to drive demand for the full beauty experience for discovery, services and play available in all Ulta Beauty stores. Importantly, we'll be able to leverage our robust CRM capabilities to engage guests who shop Ulta Beauty at Target with targeted personalized communications to highlight and enhance their total Ulta Beauty experience. In closing, we know guests are changing how they shop for beauty, but their engagement with the category remains strong. In fact, the role of beauty is more important now than ever. In this new normal, beauty has become more than makeup, more than product. Today, beauty is a critical link to acts of self-care and wellness. And as a well-loved brand with a diverse assortment and a wide range of price points, outstanding service offerings and knowledgeable and passionate associates, Ulta Beauty is well positioned to lead and shape how guests experience beauty in this new normal.

Scott Settersten, CFO

Thanks, Mary, and good afternoon, everyone. We appreciate your support of Ulta Beauty and hope you and your loved ones are staying safe and healthy. I will reiterate Mary's comments and thank all of our dedicated associates for their tireless efforts in safely serving our guests and keeping our operations running smoothly during this difficult time. I'll begin with the income statement. Net sales for the quarter declined 7.8%, and total company comp declined 8.9%. Given the challenges from the COVID-19 pandemic, we are very pleased with this performance as top line results for the quarter were better than our internal expectations. Average ticket increased 7.6%, primarily driven by an increase in units per transaction, while transactions declined 15.4%. We experienced nice conversion in both channels but continued to be impacted by softer traffic to stores. As expected, e-commerce growth slowed relative to the second quarter but continued to deliver very strong growth versus last year. Our e-commerce operations delivered a comp increase of 90% for the quarter as guests continue to take advantage of our omnichannel capabilities. Buy online, pickup in store was strong again this quarter, totaling about 16% of e-commerce sales, approximately double the penetration in the third quarter last year. From a mix perspective, makeup was 45% of sales, down 600 basis points from last year. Skincare, bath and fragrance collectively increased 500 basis points to 26% of sales. Haircare products and styling tools increased 300 basis points to 21% of sales, while the services category was down 200 basis points to about 4% of sales. As Mary indicated, our service business continued to be negatively impacted by COVID-related capacity constraints. Gross profit margin was 35.1%, a decline of about 200 basis points compared to 37.1% a year ago. Similar to what we have seen since the onset of the pandemic, the largest driver of gross margin deleverage was fixed cost due to lower sales. I would note that the trend improved from what we experienced in the second quarter due to the stronger sales trend. Channel shift was also a large contributor to gross margin deleverage again this quarter, albeit less than we experienced in the second quarter as stores were open for the entire quarter. These headwinds were partially offset by an increase in merchandise margin, which was primarily driven by our lower promotional activity as well as continuing benefits from our efficiencies for growth or EFG efforts. SG&A expenses decreased to $416.4 million compared to $449.2 million in the third quarter of last year. The largest driver of the decrease was lower store payroll and benefits as we reduced investments in labor to reflect lower demand. Store expenses were also lower as we adjusted and managed to softer traffic in stores. Marketing expense was also lower year-over-year, reflecting reduced spend on print, offset by higher investment in digital channels. These reductions more than offset a modest increase in corporate overhead and PPE and COVID-related expenses. The increase in corporate overhead primarily reflects higher compensation and benefit expense partially offset by investments to support strategic growth initiatives made last year. As a reminder, in the third quarter of last year, incentive compensation expense decreased versus the prior year, reflecting financial performance that was below targeted levels as well as a lower stock price. This quarter, we recorded a charge of $23.6 million for impairment, restructuring and other costs. As Mary mentioned earlier, we suspended our planned expansion to Canada, resulting in a $15.9 million charge related to long-lived asset impairments, lease termination costs and severance. Our teams continue to wind down this effort, and we now expect to incur between $30 million to $40 million of Canada exit expenses in fiscal 2020. In the third quarter, we also recorded $5.7 million in severance associated with the elimination of the salon manager and prestige manager roles and recorded $2 million of lease termination costs related to the previously announced permanent closure of 19 stores. Preopening expense was $4.2 million in the quarter, a decrease from $6.5 million a year ago. We resumed new store openings in early August and opened 17 stores in the third quarter compared to 31 new stores a year ago. Interest expense related to the drawdown of our revolver totaled $1.4 million compared to interest income of $900,000 a year ago. Diluted GAAP earnings per share was $1.32 compared with $2.25 reported for last year's third quarter. Adjusted diluted earnings per share, excluding charges related to impairment, restructuring and other costs, was $1.64 compared to $2.23 a year ago, which excludes stock compensation and other tax credits. Moving on to the balance sheet and cash flow. For the quarter, total inventory decreased 11% compared to the third quarter last year, and inventory per store decreased 12.5% year-over-year as we adjusted to recent demand trends and reduced holiday receipts. To maintain flexibility and manage inventory risk, we have reduced our exposure to limited edition holiday sets and are leaning more into core product. We ended the quarter with $560.9 million in cash and cash equivalents. At the beginning of the pandemic, we drew down $800 million on our $1 billion revolver and suspended our stock buyback program as precautionary measures to increase liquidity. Reflecting our confidence that we have sufficient liquidity to support our operations and investment priorities, we repaid $800 million of borrowings that were outstanding under the facility on September 2. We remain confident in our ability to generate strong cash flow, and we may resume our stock buyback program this quarter, depending on market and operating conditions. We currently have $1.58 billion remaining under our current repurchase authorization. Turning now to the rest of 2020. The overall operating environment remains uncertain, and it continues to be difficult to forecast our business with precision. Therefore, we are not providing EPS guidance at this time. However, I want to provide some color on how we are thinking about the fourth quarter. We are encouraged by the sales results for November. However, the operating environment continues to be dynamic, and it is difficult to predict how the effects of the pandemic, including any lockdowns or restrictions, may impact consumer demand through the rest of the quarter. As such, we now expect our fourth quarter comps to be in the range of down 12% to 14%, slightly better than the expectation of mid-teen comp declines we shared on our last earnings call. Two callouts as you think about your models. As Mary shared, we have realigned our store management structure to create a more cost-efficient store model. As a result of these changes, we will see a reduction of salon payroll and cost of goods sold and an increase in store payroll and SG&A relative to last year. Second, we expect to incur $15 million to $20 million of PPE and COVID-related expenses in the fourth quarter. Overall, we expect SG&A dollars in the fourth quarter will be similar to last year's levels. We continue to adjust our capital spending plan. Our updated plan for 2020 is to invest between $150 million and $160 million in capital expenditures, including approximately $65 million for new stores, remodels and merchandise fixtures, $65 million for supply chain and IT, and about $25 million for store maintenance and other. We expect to open approximately 30 new stores and relocate 5 stores in 2020. We are still finalizing our plans for next year but continue to expect to open at least 30 new stores in 2021. We remain confident in the long-term opportunity to continue to expand our store fleet. One final comment. We recognize that our long-term profitability potential is top of mind with investors, and I want to take this opportunity to reiterate our confidence that Ulta Beauty is a double-digit margin business. However, given the uncertainty and lack of visibility as to when the operating environment will stabilize and recover from the pandemic, it is difficult to say with certainty when we will return to double-digit margins. To start, we have healthy product margins, and our merchant teams continue to work to improve merchandise margins as we expand and enhance our assortment through both negotiation efforts as well as EFG opportunities. As sales stabilize and return to growth, we'll be able to leverage fixed costs. In addition to our ongoing EFG efforts, our real estate team is capturing significant benefits from lease renegotiation efforts, reflecting the market impacts of COVID-19, and these efforts will help us reduce occupancy costs over the longer term. Although e-commerce will likely continue to be a headwind to overall EBIT margins, we are improving e-commerce profitability as we increase utilization of BOPIS, leverage size and scale with growth and get closer to our guests through the expansion of our supply chain network. And we see additional opportunities to mitigate rate impacts in the future. As we discussed on our last earnings call, we continue to make progress on our journey to strengthen the effectiveness and profitability of our promotions. And we are actively taking steps in the near term to rightsize our cost structure in the new operating environment. Longer term, we are also working to identify additional opportunities across the enterprise to optimize our cost structure while also supporting investment to support growth capabilities.

Operator, Operator

Our first question is from Erinn Murphy with Piper Sandler.

Erinn Murphy, Analyst

My question, Mary, is for you on the Target partnership. I was hoping you could talk a little bit more about the brand production process and the inventory buying process between both Target as well as Ulta, and then how do you intend to integrate the Ulta Rewards Program at Target from a technology perspective?

Mary Dillon, CEO

Thank you. I'm excited to discuss our partnership. We have a robust business model and a proven track record, and we're very confident about our long-term growth potential. We're particularly eager to enhance guest experiences and growth through our collaboration with Target. To summarize, we are thrilled to be working with such an amazing retailer led by an outstanding CEO, Brian Cornell, along with a great team. Both of our brands are well-loved by consumers. The idea of featuring Ulta Beauty inside Target has received positive feedback, with 9 out of 10 people expressing their approval. Our brand identities and team strengths complement each other well. Ulta brings its expertise in beauty, while Target contributes its scale and the vast number of guests who will discover Ulta Beauty in their stores, along with their advanced omnichannel capabilities. As we move forward, we are in the early stages of negotiations related to our brand, and there's a lot of positivity and enthusiasm. This partnership presents an exciting new avenue for growth and an opportunity to reach millions of new customers. We're optimistic about this potential. Target will manage the inventory, and we've discussed this publicly, establishing that we maintain the brand relationships as part of our initial partnership agreement. We're also beginning to integrate technology, which is essential. Customers who shop at Ulta Beauty inside Target will have the chance to sign up for Ultamate Rewards if they are not already members, and existing members will earn both Ultamate Rewards and Target loyalty points. They will have the ability to redeem Ultamate Rewards at Ulta Beauty. We believe this is a vital aspect of creating a successful partnership that benefits everyone involved—guests, Ulta Beauty, and Target.

Operator, Operator

Our next question is from Joe Altobello with Raymond James.

Joseph Altobello, Analyst

So first question, in terms of the experience that you guys had in October, you mentioned comps were down mid-singles in August, September and saw a little bit of a down draft in October given the fact that you guys didn't repeat a promotion you did last year. Was that different from what you expected? And I'm curious, did it cause you guys to rethink your promotion strategy as we head into the holiday season?

Mary Dillon, CEO

Yes. I would say it wasn't a surprise. We made a specific decision to reduce our level of promotion, and without the promotion, our comparable sales are even stronger. We believe this is an important step as we continue to refine our promotion strategies to maximize profitability, but it does not affect our competitiveness. We started the holiday season early to encourage customers to begin their shopping in November due to capacity constraints. We have a strong program planned for the holiday season that we believe will be competitive. As I mentioned in the script, we are pleased with the results we are seeing. Everything is proceeding as we expected.

Joseph Altobello, Analyst

And in terms of the guide for Q4, you mentioned the comp down 12% to 14%. It does sound like November was off to a fairly decent start. So maybe help us understand why you're assuming a pretty significant slowdown in December.

Mary Dillon, CEO

Yes. Well, stepping back, again, we're pleased with the momentum that we're seeing, and the demand signals are strong. And we did feel good about how we started in November. It's a pretty simple answer to your question. We're in the middle of this unprecedented pandemic. And as you know, we just reached peak levels of hospitalizations yesterday in the U.S. So it's uncertain. Certainly, we know we're set up well. Our e-commerce business is performing extremely well. Our stores are doing a great job. But there's uncertainty about what will happen, I guess, I'd say as we get closer to the holiday in terms of store traffic, and that would be true for everybody. So we're just trying to meet the guests where they are, be pragmatic about this. Certainly, the news about the vaccine is positive, but there's many difficult weeks ahead. So we feel good, but we're also being cautious about the uncertainty that's going to, we think, play out in the next several weeks and few months.

Operator, Operator

Our next question is from Oliver Chen from Cowen.

Oliver Chen, Analyst

The e-commerce growth continues to be outstanding, but it decelerated from prior amazing quarters. So what are you seeing there in terms of category performance? And what's happened in different areas of growth in that business? I would also just love more details on Ultamate Rewards in that member count and how that may trend and what's under your control in terms of keeping the member count at or above 31.7 million.

Mary Dillon, CEO

Sure. Oliver, that's a three-part question and it's impressive. I may have Dave assist with some of the details. We are very pleased with the e-commerce traffic and comparable sales, and we did expect it to moderate somewhat as we opened more stores. We welcome that change because historically, omnichannel customers tend to be our most valuable, spending three times more than those who only shop in-store. While we anticipate a slight decline in e-commerce demand as stores open, the demand is still up 90% compared to last quarter, which makes us feel very positive. Regarding the second part of your question about e-commerce category performance, I'll let Dave share more on that, and then we can discuss Ultamate Rewards at the end.

David Kimbell, President

Yes, Oliver, the performance of our e-commerce categories closely reflects the overall performance of the company that we discussed earlier. We are seeing strong results in skincare, haircare, bath, and fragrance, while makeup continues to face challenges, though there are some positive developments. Overall, there is no significant difference between our e-commerce and in-store categories, with notable strength and growth occurring outside of makeup. We are pleased with these results. Regarding our loyalty program, I want to emphasize how proud we are of what we consider one of the best loyalty programs in retail. Despite the challenges we encountered this year, our guests remain very fond of the program and are highly engaged. Our brand partners also see great value in the insights and access they gain from this program. Our elite members, including diamond and platinum guests, remain very active, and the program is performing exceptionally well. We are grateful to have this program, especially this year during challenging times. However, we did experience a decline this year mainly due to store closures, which affected our conversion of new members and retention. While our e-commerce business has grown, with an increase in our member penetration, the majority of users in our loyalty program are still store-based. We have noticed a decline in retention among the least engaged members, or non-elite guests. Importantly, as Mary mentioned earlier, retention among our most tenured guests remains very strong, and we continue to see solid performance from them. With nearly 32 million members, we still believe this is very strong, and we are focused on reactivating guests and enhancing engagement with both our engaged and elite members. Remember that our loyalty numbers are calculated on a rolling 12-month basis, so as each month passes, we will be compared to a pre-COVID period over the next few months. We are working diligently to reengage our guests and know that we will continue to encounter challenges with less tenured guests for some time, but we are dedicated to retaining them and anticipate strength as we move forward into 2021.

Operator, Operator

Our next question is from Rupesh Parikh from Oppenheimer.

Rupesh Parikh, Analyst

So I guess, Scott, just going back to some of the commentary that you provided for guidance for Q4. I was curious if you can provide maybe the puts and takes for gross margins. And then related to that, I just want to get a sense of what you guys are seeing right now in the promotional environment during the holiday season.

Scott Settersten, CFO

Thanks, Rupesh. As we look at the fourth quarter, it's key to remember the sales guidance. We expect a weaker top line in Q4 compared to Q3, reflecting last year's trends. This will naturally bring some margin pressure. We're anticipating that gross margin in Q4 will be consistent with Q3 levels, driven by similar factors such as the deleveraging of fixed costs in stores and across the supply chain, due to lower sales volumes. However, we may enjoy some positive offsets through improved merchandise margins like those seen in Q3. While discussing margins, I should also mention SG&A. As we've indicated previously, there’s been a shift in payroll related to services management from cost of goods sold to SG&A, so keep that in mind when updating your models. In SG&A, we do foresee more deleverage in Q4 compared to Q3, driven by increased store payroll and benefits as we boost store labor to ensure an excellent guest experience during the holiday period, along with rising store expenses primarily due to COVID and PPE-related costs. Finally, regarding our advertising and marketing, we've mentioned earlier this year that there would be a heavier focus in the fourth quarter as we approach the holiday season, viewing this as an opportunistic investment compared to earlier spending this year.

David Kimbell, President

The holiday season is always a very promotional time for retailers, and we are not just competing with other beauty retailers but also with various other categories for gift-giving occasions. This naturally leads to an increase in promotions. As mentioned earlier, we have adjusted our promotional strategies and cadence, and we’re observing this across the category. We are making more efforts to distribute promotional activities to give customers more opportunities to feel comfortable shopping both in-store and online for their gift-giving and personal occasions. Overall, the competition is strong. Some competitors have been more promotional, and certain brands are being more aggressive with limited-time offers in their direct-to-consumer efforts. However, I wouldn’t describe this as a dramatic shift in promotions. We are closely monitoring the market, and we have effective tools in place. The promotional efforts we have implemented this holiday season have been successful, and we are confident in our plans for promotions leading up to Christmas and post-holiday as well. We feel good about our position and are managing and monitoring it daily.

Scott Settersten, CFO

And Rupesh, I just want to clarify, I did mean deleverage. So gross margin deleverage in Q4 versus Q3, same with SG&A.

Operator, Operator

Our next question is from Simeon Siegel with BMO Capital Markets.

Simeon Siegel, Analyst

Maybe at a higher level, Mary or Dave, I know this might be an odd time to ask, but how are you assessing your share of customer spending in relation to historical targets? Additionally, do you have any insights on how the sales environment may evolve after the pandemic? I'm considering the potential decline of department stores alongside the rise of online beauty, direct-to-consumer brands, and big-box retailers. Any changes you've observed would be helpful. Also, Scott, did you mention your expected savings from Canada for next year?

Mary Dillon, CEO

Thank you. This is a multi-part question. First, regarding the broader environment, we are continuously engaged in strategic planning, keeping an eye on future trends and shifts in consumer, channel, and competitive behaviors. The pandemic has certainly accelerated many trends that were already emerging, particularly the rise of e-commerce and some disruption in physical shopping, which is starting to recover. We anticipate a shakeout in the retail format landscape, revealing long-term winners and losers. A significant part of our strategy involves meeting customers in new ways and through various channels, enhancing our omnichannel capabilities. This includes options like Buy Online, Pick Up In Store, curbside pickup, e-commerce, shipping capacity, and digital tools. Our partnership with Target offers a key opportunity to thrive during this period of disruption and reach new customers through innovative omnichannel approaches. Additionally, we see strength in the direct-to-consumer segment. Overall, we believe e-commerce will be more dominant than it would have been otherwise, with growth pulled forward. However, our customers in this category still value the in-store shopping experience, which is encouraging as we envision the future of retail. I'm pleased that we had digital solutions like GLAMlab to quickly transition to virtual try-ons for makeup and skincare, which is beneficial now. I believe we’re well positioned amid these evolving shifts, though we must remain vigilant for new trends and opportunities. Would you like to discuss share of wallet next?

David Kimbell, President

Certainly, it's a very disrupted time to measure consumer dynamics, and we're closely monitoring share of wallet. We continue to gain share, particularly in the prestige segment across categories like makeup, skincare, and haircare, which we've consistently observed. As discussed in earlier calls, we experienced a temporary loss in share during the pandemic when our stores were closed while our mass competitors remained open. However, we're seeing that business strengthen and perform well in Q3, giving us confidence. We'll wait for everything to stabilize in 2020 to fully assess the impact on share of wallet. We entered this pandemic with strong momentum and growth across all categories and price points, and despite the disruptions, we believe our model is robust. We're well positioned to accelerate out of this situation and continue driving growth and share in all areas.

Scott Settersten, CFO

Regarding our plans for Canada, we haven't provided specific details about our expansion strategy in recent years. To put it simply, it's a startup investment similar to many others, and typically, there are challenges that arise during the initial phases. We will avoid those challenges next year by not proceeding with the expansion. However, as Mary mentioned, that isn't the reason for our decision to hold off; it was simply about determining our top priorities and where to focus our efforts given the current disruptions we are facing.

Operator, Operator

And our last question would be from Mark Altschwager with Baird.

Mark Altschwager, Analyst

Great. I guess a two-pronged one related to stores. Maybe just first is, with respect to the store opening plans, you mentioned at least 30 next year, what are the factors you're considering today that would most impact the final plan for 2021? And is there a scenario where you could get back to something closer to the prior cadence? And then the second part, just related to Target. From a store perspective, I mean, if that partnership is successful, does it change your view on the longer-term store target for Ulta?

Scott Settersten, CFO

Yes. I'll start with the last question. Our outlook on the range of stores we've been discussing, which is 1,500 to 1,700 in the U.S., remains unchanged, even with the recent announcement regarding Target. Since real estate is one of our core strengths, we have been actively considering the impact on our future store growth and any adjustments this might require. We don't anticipate significant changes, but we will monitor the situation closely as we collaborate with the Target team. Regarding next year, we plan to open at least 30 stores, which will depend in part on our partnerships with landlords. Many of these leases are negotiated years in advance, so we have signed commitments for specific projects. We're currently reassessing all existing agreements and those in progress to ensure we're making sound decisions and selecting the most promising locations. This is a careful process, and we believe our analytical capabilities and real estate team put us in a strong position for the future.

Mary Dillon, CEO

I'm just going to add one thing to Scott's answer, which is on top of it, the way that we thought about the Target partnership, I’d say, is really an amplifier to our business model. As Scott said, we believe we can still build out the number of stores that we've mapped out. And this yet gives us yet another point of distribution, a way to reach millions of new guests with a trial and discovery version of Ulta Beauty, right, that we amplify back to the Ulta Beauty full business model as well. And so as we map out the future of those locations, plus our store locations, working in partnership with Target to make this a win for everybody.

Operator, Operator

And we have reached the end of the question-and-answer session. I would now like to turn the call back over to Mary Dillon for closing remarks.

Mary Dillon, CEO

Thank you for joining us today. I'd like to close by thanking all of the Ulta Beauty associates across our stores, distribution centers, and offices for their truly relentless effort to navigate through this challenging environment while also working hard to get our stores, website and DCs ready for the holiday season. We know this holiday season will be like no other, but our team is ready and excited to help our guests see the joy of the season. And we hope that you, your colleagues and your loved ones stay safe and healthy. We look forward to speaking to all of you again in March when we report our fourth quarter and full year results. Thank you.

Operator, Operator

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