Greetings, and welcome to Ulta Beauty's Third Quarter 2019 Earnings Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. .

It is now my pleasure to introduce your host, Ms. Kiley Rawlins, Vice President, Investor Relations. Thank you. You may proceed. .

Thank you, Devin. Good afternoon, and thank you for joining us today for Ulta Beauty's Third Quarter Earnings Conference Call. Hosting today's call are Mary Dillon, Chief Executive Officer; and Scott Settersten, Chief Financial Officer. Dave Kimbell, President and Chief Merchandising and Marketing Officer, is also with us today..

This afternoon, we released our financial results for the third quarter of fiscal 2019. A copy of the press release is available in the Investor Relations section of our website at www.ulta.com..

Before we begin, I'd like to remind you of the company's safe harbor language. The statements contained in today's 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 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 5, 2019. 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..

We'll begin this afternoon with prepared remarks from Mary and Scott. Following our prepared comments, we will open the call for questions. [Operator Instructions] Now I'll turn the call over to Mary.

Mary?.

Thank you, Kiley, and good afternoon, everyone. The Ulta Beauty team delivered another quarter of solid top line performance, gross margin expansion and EPS growth despite the current challenges facing the U.S. beauty category. .

Our differentiated model is winning in the marketplace. We continue to gain market share across all major beauty categories, and we're extending our leadership position by creating stronger connections with our guests and engaging them in better and more exciting ways..

Our financial performance for the quarter was generally in line with our internal expectations. To recap, total sales grew 7.9%. Comp store sales increased 3.2% on top of 7.8% growth in the third quarter of last year. Gross margin expanded by about 40 basis points, and diluted earnings per share increased 3.2%..

As we discussed on the last earnings call, we believe the makeup category in the U.S. is experiencing a down cycle. Like other consumer categories, makeup has experienced a number of up and down cycles.

The most recent growth cycle began in 2014, driven by new application techniques in looks like contouring, highlighting and brow styling and new products, such as palettes, minis and travel sizes. The rise of social media influencers, video tutorials and selfies also contributed to strong growth in the category..

After several years of robust growth, the category began to decelerate in 2017 and turned negative in late 2018, resulting from a lack of engaging newness and incremental innovation. This negative trend has continued through 2019 with further deceleration in the most recent quarter..

Now makeup looks and trends are constantly evolving, driven by industry innovation, fashion and pop culture. And while we've seen sales decline in the U.S. makeup category this year, consumers are still buying and wearing makeup.

For example, we're seeing interest in a more natural look, which is different than bare face, and actually requires multiple products to create a neutral and glowy look..

Alternatively, some popular culture influences are leaning into bold, unconventional applications of color and adornments like sequins and pearls. And at the spring 2020 fashion shows this fall, we saw a variety of looks ranging from natural and glowy to embellished brows, glitter and sequined eye shadows, and graphic eyeliner. .

We know it will take time to bring newness and innovation to the category, but we're confident that the makeup category will emerge from this down cycle and return to growth. Longer-term growth drivers, such as demographic trends, remain favorable. .

For example, Latinas are one of the fastest-growing population segments in the U.S. and they overindex in makeup usage. And Gen Z consumers who are already highly engaged in beauty, are expected to increase their usage of makeup as they age and enter the workforce, as we saw with millennial consumers..

In addition, our proprietary research confirms that beauty enthusiasts are still passionate about makeup, use makeup as a tool for self-expression and enjoy expressing themselves with multiple looks.

In the near term, we're collaborating with our brand partners to identify trends in white spaces in the category, and we're actively working on these efforts to drive incremental category innovation to reignite growth.

And while it's difficult to predict the exact timing, we're confident that these efforts, combined with favorable demographic trends, will result in a return to growth for the U.S. makeup category. .

In the meantime, we're leaning into categories that are experiencing stronger growth. For example, the skincare category is seeing nice growth in both the prestige and the mass segments. The category has experienced meaningful newness in brands innovation in terms of new brands, new products and new routines.

And we're seeing that the Gen Z demographic is more engaged in skincare than other cohorts were at the same age, which bodes well for longer-term growth for the category..

We're taking a number of actions to ensure we fully capture the opportunity of these skincare trends. For example, this year, we've added more than 30 new skincare brands to our assortment, increasing our offering across mass and prestige.

And we're increasing the focus on skincare in our marketing campaigns as well as leveraging flex space in stores to highlight key brands and newness in this growing category. .

In addition, we've expanded our multibrand Skin Bar model into 100 more stores. An important differentiator for Ulta Beauty is our ability to connect product with services to create deeper customer engagement.

Almost every Ulta store offers a full array of skincare services and has a licensed esthetician onsite to provide guests with personalized recommendations. .

About 20% of our stores feature our multibrand Skin Bar model, which offers guests the opportunity to experience quick services like a 10-minute express facial or a 20-minute mineral infusion and to interact with different brands, including Dermalogica, Murad and Kiehl's.

And the configuration of the Skin Bars frees up an average of 12 additional feet of retail space for skincare products and demystifies the skin service experience as services are performed directly on the sales floor.

As a result of all these efforts, new brands, increased marketing and expanded skin services, we've continued to increase our market share of the U.S. skincare category..

To wrap up what we're currently seeing in the U.S. beauty market trends, the skincare fragrance and hair categories are expanding, growth in the overall U.S. beauty industry continues to be constrained by softness in the makeup category.

We continue to believe that the headwinds facing the makeup category are largely cyclical, resulting from a lack of incremental innovation and compelling newness. .

We remain confident the makeup category will return to growth but recognize that it will take time.

The Ulta Beauty model is winning within the beauty space, and we remain confident that our differentiated business model, our strategic investments and our highly engaged associates will enable us to drive further market share gains, positioning us well for when the makeup cycle recovers..

Now I'd like to give you an update on the progress we've made this quarter on our strategic imperatives. Beginning with our efforts to strengthen the Ulta Beauty brand at increased loyalty, I am pleased to share that we continue to make great progress in both of these areas.

From an overall awareness standpoint, our aided brand awareness remains strong at 92% and unaided brand awareness increased 2 points to 57% compared to the same period a year ago. .

Our integrated marketing campaigns, including fall refresh, 21 Days Of Beauty and our Gorgeous Hair event all help keep us top of mind and draw engagement with guests while celebrating the emotional and inclusive power of possibilities at Ulta Beauty.

I'm particularly proud of our fundraising campaign for the Breast Cancer Research Foundation, in which we brought to life stories of how donations can lead to life-changing medical advancements by featuring researchers alongside breast cancer survivors through print, in-store, digital and social media. .

We continue to expand our social media capabilities, focusing on creating moments and spaces to drive meaningful conversations and connect with beauty enthusiasts in relevant ways. Reflecting this strategy, we've launched our first-ever TikTok campaign to support the launch of Florence by Mills, a new beauty brand from Millie Bobby Brown.

Using this rising platform to showcase that the possibilities are beautiful, we ran a campaign using #BeautyIs that encouraged users to define and showcase beauty on their terms, a powerful message that Millie's brand shares.

As a result of this and other social media campaigns and conversations launched this year, I am really proud to say that Ulta Beauty recently earned the #1 spot in Engagement Labs ranking for social influence amongst top Beauty & Personal Care brands in the U.S. .

On the brand loyalty side, we've seen tremendous growth in members and engagement since converting our loyalty program to Ultimate Rewards in 2014. at the end of the third quarter, we had 33.9 million active members in our Ultimate Rewards loyalty program, an increase of 11% versus the third quarter last year.

Sales from loyalty members continue to represent more than 95% of our total revenues. And importantly, we continue to see growth in average spend per member. .

In addition to converting new members to our program, our team is focused on driving strong member engagement, especially among our new and second year members as well as reactivated members who have lapsed.

To ensure we're creating a strong first impression, we've revamped our communications on the welcome to provide enhanced education about benefits of our program with personalized relevant content, along with targeted promotions to drive frequency of purchase and engagement.

As a result of these efforts, we've seen positive improvement in our member retention trends..

Recognizing that the group of new members will naturally slow as the program matures, we're increasingly focused on how we can drive greater spend per member. We continue to test and optimize personalized e-mail and push recommendations and replenishment reminders based on previous transaction activity.

And we've just started to test targeted recommendations based upon other guest behaviors to improve the relevance of our recommendations to our guests..

Expanding participation in the Ultimate Rewards credit card program is another key strategy to drive higher spend per member as we know that members who participate in the credit card program shop us more often and spend more with us. And in the third quarter, we again saw strong growth in our credit card portfolio. .

Now moving on to our strategic imperative to delight guests with a one-of-a-kind world-class beauty assortment, the new and exclusive product launches we brought to market this year are delivering results. In the third quarter, newness drove about 25% of our total comp, driven primarily by new brands and products in skincare and haircare.

From a category standpoint, we saw strong comp sales growth this quarter in skincare, fragrance, accessories and haircare. .

Skincare continues to be one of our strongest growth categories with prestige, mass and sun care all delivering double-digit comps again this quarter. Much of this growth is a result of strong brand and product innovation as well as new skincare routines.

In prestige skincare, newer brands like Kiehl's and TULA Life continue to drive strong guest engagement, while more established brands like First Aid Beauty and Dermalogica benefited from strong product newness. Recently launched brands, Sunday Riley and Kylie Skin also performed well. .

In mass skincare, we saw strong growth across a number of brands, including The Ordinary, which we launched in select stores early in the quarter. Dermatologist-recommended brands, such as CeraVe, and newer natural brands, such as STAREs and Derma E, also continues to drive great guest engagement.

Sales in sun care were strong again this quarter, driven by self-tanning and sun protection products. .

Fragrance delivered high single-digit comp growth this quarter, driven primarily by the launch of exclusive fragrances by Ariana Grande, Jennifer Lopez and KKW Fragrance, as well as newness from luxury brands, YSL, Dolce & Gabbana and Versace..

In the haircare category, we saw a mid-single-digit comp growth reflecting the success of our Gorgeous Hair event and the impact of new brands like IGK and Pattern, a new brand by Tracee Ellis Ross for curly, coily and textured hair available exclusively at Ulta Beauty. Sugarbearhair vitamins also continue to drive growth in the mass hair category. .

As expected, the overall makeup category was down slightly this quarter, driven by a low single-digit decline in prestige cosmetics. Despite the challenging headwinds facing the U.S. prestige makeup market, Ulta Beauty continued to capture significant market share gains.

During the quarter, we saw strong growth from our iconic prestige brands, partially driven by the expansion of these brands to additional doors. .

Clinique and Lancôme, in particular, experienced nice growth, even after excluding gains related to distribution growth. Newer brands, including Kylie Cosmetics and KKW Beauty, also delivered nice growth in the quarter. These gains were more than offset by solid performance of other established brands in the portfolio..

Now looking forward to the fourth quarter, we've launched 2 exciting new prestige brands just in time for the holiday season. First, we're offering an assortment of pure items by Laura Mercier on ulta.com. Our Platinum and Diamond members have premium access to the new assortment now, which will be available to all Ulta Beauty guests next week.

We've also just launched an exclusive capsule collection with Thrive Causemetics, a digitally native brand founded by entrepreneur and beauty product developer, Karissa Bodnar. .

Thrive sales products at our vegan, cruelty free and without parabens, latex and sulfates, and for every product purchase, the company makes a product donation to help women.

Ulta Beauty is honored to be the exclusive retail partner to Thrive Causemetics and delighted to offer our guests the opportunity to discover and explore the products in-store for the very first time. The capsule collection includes a number of Thrive's most notable products, all for a compelling value.

Look for more to come from both of these brands in 2020..

Although the U.S. mass cosmetics markets continued to experience sales declines, our mass cosmetics division delivered a mid-single-digit comp increase in the quarter, reflecting growth from our exclusive brick-and-mortar brands, including Morphe, ColourPop and Juvia's Place.

Recently launched Florence by Mills, a new brand created by Millie Bobby Brown, also performed well..

Now shifting to our imperative to transform the in-store and beauty services experience, I am pleased to share that we're seeing a nice strengthening of our salon business, driven primarily by growth in color and texture treatments. Last quarter, we completed the rollout of our services optimization program in all stores.

And as a result of these investments, we're delivering better trends in comp sales, average ticket, guest retention and satisfaction, and product attachment. We're also seeing increased stylist retention as well as stronger recruitment of experienced stylists with an established book of clients..

We continue to implement new ways to make the shopping experience easier for guests. In the second quarter, we completed the rollout of buy online, pick up in-store to all stores, and we continue to be very pleased with how our customers are responding to this new convenience.

And this quarter, we expanded our mobile pilot point-of-sale to 100 store -- higher-volume stores, which will enhance the guest experience by reducing checkout wait times, especially important during the busy holiday season..

Now turning to real estate activity in the quarter, we opened 28 net new stores, relocated 2 stores and remodeled 3 stores compared to 39 net new stores, 1 relocation and 4 remodels in the third quarter last year, ending the quarter with 1,241 stores.

New-store productivity remained strong with first year sales trending ahead of plan, and we remain on track to open 80 stores this year. .

We also executed a number of refreshes this quarter, expanding the distribution for our iconic prestige brands, which include Benefit, Clinique, Lancôme, MAC and Estée Lauder, to more doors.

Today, almost all Ulta Beauty stores carry the Clinique and Benefit brands, more than 90% of stores carry Lancôme, slightly more than half of the chain carries Estée Lauder, and nearly 1/3 of stores now carry MAC..

Turning now to some highlights in our reinvent digital imperative. We continue to make progress in creating a more seamless omnichannel experience that meets the guests wherever they want to engage and shop.

This quarter, we refreshed the Ulta Beauty app to incorporate more personalization and a stronger linkage to ultimate rewards to reinforce the value of our loyalty program.

The new version includes a prominent loyalty dashboard that makes it easier for guests to track the value of their loyalty points, shows how points can add up and be more valuable, and features a fun birthday module to highlight the benefits of their birthday month. .

We've also combined our message center and offer hub, making it easier for members to activate target offers and quickly access eligible offers, and we've added new replenishment reminders and handpicked recommendations. Both are powered by our in-house artificial intelligence engine, Waze. .

We also continue to leverage augmented reality and artificial intelligence to create compelling beauty experiences for our guests to drive stronger brand loyalty.

Within the Ulta Beauty app, guests are using GLAM LAB to virtually try on makeup for eyes, lips and cheeks, and we recently added a foundation option to help them navigate the wide variety of available shades by virtually trying them on. .

To further extend the reach of virtual try-on experiences beyond the mobile app, this quarter, we began to experiment with try on capabilities on ulta.com. We also continue to experiment and learn as we create more virtual beauty advisers.

In addition to the existing skincare adviser, we recently launched a foundation finder and a mascara and lash adviser to help our guests find what works best for their needs. .

And late in the third quarter, we launched Afterpay as another payment option at ulta.com. Popular with millennials and budget-focused consumers, Afterpay allows shoppers to receive products immediately and pay for them in 4 installments.

We're very encouraged by the early response and enthusiasm for Afterpay, and we're excited to have it in place for the holiday season. .

We've made a lot of progress this year in pursuit of our strategic imperative, all of which position us well to drive growth in the fourth quarter. To recap, heading into the fourth quarter this year, buy online, pickup in-store is available on ulta.com and through our app, and pickup is available in all stores.

Afterpay is available on ulta.com and in our mobile app. .

We've refreshed our Ulta Beauty apps to serve our best guests better with more personalized experiences and easier access to their Ultimate Rewards benefits. We've completed services optimization in every store. We have more loyalty members and enhanced personalization capabilities.

We have a lot of newness across the box, including exclusives from Millie Bobby Brown, Tracee Ellis Ross, Thrive, KKW Beauty, and Kylie Cosmetics, as well as a great collection of exclusive holiday gift sets curated by a merchandising team and brand partners. .

And we have a great talented team of store associates who are prepared and excited to serve our guests this holiday season. We kicked off the 2019 holiday season with a new in-store event in mid-November we called the Ulta BeautyFest. Our goal is to create an immersive event across our 1,200-plus stores to engage our guests and associates.

With tremendous support from 60 of our key brand partners, our store teams hosted 2 days of demonstrations, influencer activations and giveaways. The event generated a lot of traffic to our stores, and I'm pleased with how our teams executed our plan. .

While we certainly have identified opportunities to improve the event. Overall, the guest response was positive with many of our guests making it a fun family event..

The holiday season is in full flow, and our teams are executing well. Our holiday campaign this year reflects the diversity of our guests and honors all the reasons to give, chances to gather and ways to glow.

We've elevated our Beauty Blitz program, work collaboratively with our brand partners to create new exclusive items and kits for gifting and glamming, and simplified the flow and presentation in stores and online to make it easier for guests to find gifts.

We expect the beauty category will likely be more promotional this holiday season, but I'm confident that our holiday marketing campaigns and our merchandise exclusives, combined with new strategic capabilities, position us really well to deliver a successful holiday..

In closing, while we've refined our full year guidance to reflect the year-to-date performance, our expectations for fiscal '19 have not materially changed since our last earnings call.

We are working through our 2020 planning process and prioritizing our investment agenda for a year that's likely to remain challenged from a top line perspective, given the headwinds facing the cosmetics category.

We'll make thoughtful choices regarding the pacing of investment as we look to deliver earnings growth in the short term, while also protecting longer-term growth potential..

While we haven't finalized all of our decisions, we have decided to delay the opening of our Jacksonville fast fulfillment center until 2021. We've also decided to maintain our investments to build international capabilities, which would support our entry into the Canadian market.

We intend to provide more detail about our expectations for 2020 on our year-end call in March, as we normally do. .

And with that, I'll turn it over to Scott to discuss the drivers of our third quarter financials and outlook for the fourth quarter and full year in more detail. .

Thank you, Mary, and good afternoon, everyone. As Mary said earlier, today, we reported results for the third quarter that were generally in line with our internal expectation..

Starting with the income statement. Top line growth of 7.9% was driven by a 3.2% comp, strong new-store productivity and robust growth in other income primarily driven by continued growth of our credit card program. The total company comp of 3.2% was composed of 2.3% transaction growth and 0.9% average ticket growth.

Despite softness in the cosmetics category, we were pleased to see a modest increase in store traffic during the quarter. .

From a category standpoint, cosmetics was 51% of sales, down about 200 basis points from last year while the skincare, bath and fragrance category increased 200 basis points to 21% of sales.

As a percent of sales, haircare products and styling tools decreased about 100 basis point to 18% of sales, while the services category was flat at about 6% of sale. Although we no longer break out e-commerce growth specifically, ulta.com growth was at the low end of our expected range of 20% to 30% growth, driven by traffic..

Gross profit margin of 37.1% improved 40 basis points year-over-year from 36.7%, driven by stronger merchandise margin and leverage of rent and occupancy expense. This was partially offset by investments in our services business, while our supply chain operations were roughly flat as a percent of sales..

Merchandise margins were higher year-over-year, reflecting ongoing benefit from our efficiencies for growth, or EFG, cost-optimization program and lower promotional activity as compared to last year, which more than offset headwinds from category and channel.

While promotional activity was lower as compared to last year, largely because we anniversaried the impact of last year's clearance event, promotional activity in Q3 this year was higher than we initially planned. Many of these incremental promotions were targeted using data from our loyalty program..

SG&A rate of 26.7% deleveraged by 140 basis points compared to the prior year's rate of 25.3%. We experienced corporate overhead deleverage primarily related to anticipated investments in growth initiatives, including our efforts around digital innovation, such as omnichannel and personalization and international expansion.

We also saw deleverage in store labor and benefits versus last year primarily due to continued investments to support the guest experience. This was partially offset by lower incentive compensation expense, reflecting our current financial performance as well as lower stock price.

We saw leverage of marketing expense as we lapped the investments from a year ago related to the launch of our new marketing campaign..

Operating margin of 10% of sales was down 80 basis points.

Diluted GAAP earnings per share grew 3.2% to $2.25, which included a $0.02 per share benefit primarily due to an increase in federal income tax credit compared to $2.18 reported for last year's third quarter, which included a $0.02 per share benefit due to income tax accounting for share-based compensation..

Turning to the balance sheet and cash flow. We continued to manage our inventory well, improving inventory productivity while maintaining strong in-stock positions.

Total inventory grew 8.9% and increased 2.1% on a per-store base, nicely below the comp rate due to an increase in net new stores and the timing of inventory shipments ahead of the holiday season.

We continue to focus on investing inventory in our top sellers, new brands and product launches and ensuring that we are in a strong inventory position going into our peak holiday season..

Capital expenditures were $89.9 million for the quarter driven by our new-store opening program, investments in IT systems, and store remodels and relocations. We ended the quarter with $208.8 million in cash and equivalents.

Taking advantage of a lower share price, we repurchased more shares this quarter through our stock repurchase plan than initially planned. .

In the quarter, we repurchased 529,000 shares at a cost of $128.6 million, leaving $388.8 million available on our $875 million authorization as of quarter end. We continue to expect to repurchase approximately 70 million of shares in fiscal 2019. .

Turning now to guidance. Our expectations for fiscal 2019 have not materially changed since our last earnings call. For the full year, we continue to expect to open approximately 80 new stores, all of our traditional 10,000 square-foot prototypes.

We plan to remodel 12 stores and relocate 8 stores and execute 270 store refreshes or mini remodels to enable the addition of new brands and improvements to overall fixturing. .

We anticipate driving top line growth of approximately 10% with total company comparable sales planned in the 4.7% to 5% range compared to the previous guidance of 4% to 6%. We continue to expect e-commerce to grow in the 20% to 30% range.

We expect to deliver diluted earnings per share in the range of $11.93 to $12.03 with approximately 60 to 70 basis points of operating margin deleverage. This compares to previous guidance of $11.86 to $12.06.

Our updated EPS guidance includes the $0.02 of income tax benefit earned in the third quarter and a narrower range, reflecting the fact that there's only one quarter remaining in the year..

We continue to expect to deliver gross profit improvement for the year, driven by merchandise margin expansion, rent and occupancy expense cost leverage and the benefits of our credit card program. These benefits will be offset by SG&A deleverage due to investments in store labor, growth initiatives and digital innovation. .

We now plan to spend between $305 million and $315 million in CapEx. The reduction from previous guidance primarily reflects our decision to delay the opening of our fast fulfillment center in Jacksonville until 2021.

We now expect full year CapEx will include approximately $170 million for new stores, remodels and merchandise fixtures; $90 million for supply chain and IT; and about $50 million for store maintenance and other. Depreciation and amortization expense is expected to be approximately $300 million. .

We expect our tax rate for the year to be approximately 23%. This projected tax rate does not include any estimate for the potential Q4 impact of share-based compensation or federal income tax credit. .

The fully diluted share count for the year is expected to be approximately 58 million. Our plan assumes share repurchases in 2019 in the $700 million range. .

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

[Operator Instructions] Our first question comes from the line of Michael Binetti with Credit Suisse. .

Congrats on a nice quarter. I want to ask about, I guess, on the gross margin, you mentioned third quarter were -- was lower. The promotions were a little lower on the clearance but a little above your expectations. I'd love any help you could offer us on how to connect that to the fourth quarter.

Do you still think the fourth quarter gross margin will be positive? I think the fourth quarter embeds EPS growth of about 1.5% to 4%, so maybe a little bit below the mid-single digits you were talking about previously. .

I'm just trying to see if you could help us on whether that's a little bit more conservatism on the gross margin or on the SG&A line?.

Sure, Michael. So looking back at the third quarter, I would say, overall, we're happy with the results. I would -- as we said in our prepared remarks, we were lapping that large clearance event last year, so we got some natural leverage there year-over-year.

And we were slightly more promotional in the end than we had anticipated back in August when we last spoke to you. And as we look out here towards the fourth quarter.

We're guiding now to gross margin overall being flattish versus what we said back in late August, which we thought we could be a little better than flat, even at the low end of the guidance, and really, the biggest change there is just looking at the overall retail universe, so to speak. .

I mean we expected it to be more promotional in the beauty space. And I think we communicated that to a lot of folks we've talked to over the last few months. But what we've seen with the ratcheting up really in the overall retail environment right now with the kind of the compressed shopping season. We're starting earlier.

We've got deeper discounts across the board. And I'd just remind everyone that, in holiday season, unlike in the rest of the 3 quarters of the year, we compete with everyone in retail for wallet share, right, in the gift-giving period. .

So this is a critical time for us. We're driving a lot of new guests to our stores. We've got roughly 80 new stores versus last year and a much larger e-commerce business with engagement there. So it's critical for us to make sure we keep healthy traffic driven to both -- through both of those channels, and we're not going to be deterred on that.

We'll spend some margin right there if we need to, and we're being prudent, I would say, with our outlook here based on all the facts and circumstances here as we speak today. .

So again, merchandise margin, a little weaker in the fourth quarter than we anticipated. And that's really the only change with the gross margin flat outlook year as we look ahead. .

Okay. Could I just follow that with a quick follow-up? I think, a year ago, you had us out for an Analyst Day. You gave us the rough framework of how you were thinking about the next few years. You just mentioned to us they pushed out some spending on Jacksonville.

Does that -- do the expected efficiencies that you we baking into the multiyear plan on the margin change at all as we think multiyear out through our model because of that -- does that change at all on Jacksonville?.

So our EFG program, again, efficiencies for growth, we're seeing benefits. You're seeing benefits in the P&L right now. We're seeing them in the merch margin line item, we're also seeing them in fixed store costs there around real estate. That's helping drive some of the leverage that we're seeing there year-over-year. .

So we're still confident in that 150 to 200 range that we shared last year. We're still confident there. We're in the early innings there. We explained then that it's a multiyear kind of program, and it starts out slow, and there's lots of different levers there. Some delivers faster, some delivers slower.

So we still feel confident with what we've got in front of us and that we can execute against that. .

Our next question comes from the line of Christopher Horvers with JPMorgan. .

Mary, you mentioned that the industry growth slowed in 3Q relative to 2Q. Curious how you would characterize the growth since the falloff in August that you described to us last quarter. Has the industry growth been relatively flat since August, down in that, I think it was like low double digits.

And have you seen any variation in cosmetics versus skincare? And all related to that, how's your market share capture evolved against the changing industry trends?.

Yes sure. Well, first of all, I'd say within the category, the issue about lack of growth is really about makeup, right? So other categories, skincare, fragrance, hair, all positive, and we've seen really strong comps in all of those categories.

Makeup has been -- it was a little bit sort of bumpy around August, I'd say, big picture, Q2 was negative, and then Q3 was slightly more negative than that. .

So not as bad as the double digits that we're seeing at the time that we have the call, so we were anticipating it will continue to be pressured. And basically, we're right, the data supports that. And it's -- again, I'll just reiterate. I -- it's tough to be in a cycle, but the cycle in the U.S. feels very much about innovation.

Not just being as incremental to categories that has been in prior years. .

And you can imagine, we're working very closely with our brand partners, big and small, and this should really bring back strong growth, and we believe the category will return to growth.

There's always shifting preferences, but demographic trends really continue to be favorable for us, and our brand partners are very laser-focused on white space innovation, category growing opportunities. .

So tough to predict when that'll turn, but we feel confident it will. Our market share capture continues to be, I think, one of the strongest parts of our story. So -- and it's a little easy to get distracted by the short term.

Our long-term view is that we have the winning model, and we are, I think proven by the fact that we're driving market share growth, new guest to our loyalty program. And for us to continue to do that in this time is really important. It sets us up, we think, really well for the future. .

So do you think then as you sort of -- given that the category growth has been relatively consistent, albeit bumpy, do you think that, as you look ahead, it's just going to be a function of, get us to July, August next year and things will sort of flatten out from a market growth perspective?.

I wish I could give you that exact timing. It's pretty [indiscernible] today. So nice try, though. But I mean we feel good about that it will turn. And I don't want to give a specific time frame. But you can imagine everybody in the industry in makeup would like to see this get improved, and it will. .

Our next question comes from the line of Dana Telsey with Telsey Advisory Group. .

As you think about the marketing that you're doing this year as compared to last year in the holiday season, especially given that Kylie launched last holiday season, how is it different this year? And as you head to 2020 with the issues with Colour Cosmetics, how are you thinking about the marketing game plan and what you allocate to it relative to sales?.

Yes. We were very positive about our total impact in the marketplace through marketing and the innovation that we're bringing into the marketplace, new brands. In marketing, specifically, we are continuing the campaign that we launched last year, Possibilities Are Beautiful. It's had a very strong reaction in the marketplace.

Consumers have seen it very positively. As Mary mentioned in her remarks, our awareness continues to grow, and we're confident that we'll continue to see that success through the fourth quarter and into 2020. .

We did have some big launches last year. You mentioned, Kylie, but we continue to bring new brands across the store this year. Mary mentioned a few of those in haircare, brands like Pattern with Tracee Ellis Ross, IGK in skincare, many of the brands that are coming in and driving growth and in makeup as well. .

So we're working hard to continue to evolve the assortment to drive growth and reach our guests in new and compelling ways behind our Possibilities Are Beautiful campaign. So we're optimistic with that, are seeing the results, and we'll continue to drive that through 2020. .

Our next question comes from the line of Mark Altschwager with Robert W. Baird. .

So just wanted to ask about the updated comp guidance. I mean it doesn't still imply a strengthening in Q4 despite the tougher compare. Maybe update us on the drivers you see there to the strengthening sequentially. And then, just given the backdrop you're expecting the makeup category to remain under pressure.

I mean to the extent that you're able to deliver those -- that level of comp in Q4 despite the backdrop, I guess, what changes as we get into next year, just as we think about the comp growth algorithm?.

Well, we're not guiding for next year right now, so I understand the question. I'd say, as we think about the fourth quarter, I guess, the guidance that we gave at the midpoint is moderately better than Q3. But you're right, we have a lot left that we're lapping.

But I think as Dave just described, we feel like we've got a really good array of tools from the offerings, the marketing, the promotions, et cetera. And we feel like we're off to a good start. .

And so as I said also in my call -- I mean, in my comments, there's quite a few things we have this quarter or this year that we didn't have last holiday. I think BOPUS might be one example of that. The buy online, pick-up store capability is something that we did not have last year, and it's off to a strong start for us this year.

Stronger, I'd say our Ulta Beauty app is even better than before in terms of the ease of execution -- the ease of understanding what your points are and how they add up. .

Afterpay is another one that we have this year that we didn't have last year. Our service optimization has been rolled out now across every store, and a lot of newness in the box. And again, there's Millie Bobby Brown, Tracee Ellis Ross, Thrive, KKW Beauty. There's a lot of things that are incremental to a year ago.

So we look at it and feel confident that the way we're guiding is as accurate as we can make it. And coming up against a big quarter last year, I think is -- we're in a good place to do that. .

And then just maybe quickly following up, I mean, I understand that we don't want to get into specifics for next year, but to the extent that we remain in a slower-growth mode, maybe speak to some of the areas in SG&A that you have the ability to pull back and you're comfortable pulling back on? I know you mentioned that the DC -- that any other kind of bigger buckets we should think about as we try to triangulate that leverage point.

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Actually, before -- maybe, Scott, you can take that, but I'll add because I forgot you had a second part -- a tricky 2-part question. But when you ask about that, well a little color on 2020. As I said, we would expect that the makeup category headwinds are with us for a while.

That said, we are in a great position because we operate, I think everybody knows this, but across so many categories of beauty, and we have the ability to flex, and we are flexing. We had talked a lot about skincare as a category in our comments, more brands, more space, more activation. .

So we think that, while even with the headwinds of beauty, of makeup, and that will create some tough top line environment for us in 2020, we have other categories that we're going to continue to grow well in. .

And as far as 2020 is concerned, I guess, I would just add that we've talked to a lot of investors here over the last couple months, and our communication, I think, has been consistent that we're not taking this lying down.

I mean we're -- it's all hand on deck here looking at the business now in a new -- what we expect to be a lower-growth environment here for the foreseeable future. So we're looking at any and all levers on the business to see what we can do to control cost in a new kind of operating environment. .

So we're being realistic about the current operating environment and competitive threats, but we continue to strongly to believe in our ability to drive long-term profitable growth.

So as we are building our 2020 plans, we've got an eye towards balancing short-term top line pressure with the need to reduce cost in our business while also ensuring that we position Ulta Beauty to continue to win in the long term. .

Jacksonville is just one example of something that came up that we made a decision here on recently, and there's many more of those in the queue right now that we're talking with our Board about and thinking through all the pluses and minuses, weighing the strategic benefits and the cost implications. .

And we'll have more to say about that in our March call. .

Our next question comes from the line of Ike Boruchow with Wells Fargo. .

A question for Scott. I was actually surprised and pleasantly surprised that you guys were able to get leverage in the fixed cost component of your cost of goods sold. Could you kind of tell us what's going on there? I know there's been a lot of investment and some deleverage.

But on a 3% comp to get some leverage, can you just explain this to us, Scott, what exactly is going on within the fixed costs?.

And then is that kind of -- like, is that sustainable? Should we think that way going forward that, if you can comp a 3, you can get leverage within COGS?.

Ike, there's a lot of variables that roll through any one quarter through that line. So the number, quality and timing of store openings, lease renewals, depreciation. Things we've been talking around, the EFG initiatives that we have. So the team's making great progress on that, and we're seeing some of that roll through 2019. .

So we're very happy with what we were able to deliver on the third quarter. We're going to stay focused on EFG and optimization, and all those things are working. Our real estate team is doing a great job working with our landlord partners to make sure we got fair economic deals as we look across a 1,200-plus store fleet.

So we still think there's good progress to be made there. .

And I just want to -- just to remind people, again, as we continue to look at how we can manage our business in a lower top line environment, this is a good example of things that we can do.

Again, it's not necessarily going to be a straight line or a hockey stick up and to the right, Ike, but it shows that we're flexible, and we can manage the business. .

Got it. And this is a quick one for Mary. I'm going to give this a shot. So you guys said you expect the makeup headwinds to stay there for a while, lower-growth environment for the foreseeable future.

I guess, what I'm asking -- I'm not asking for guidance, but Mary, would you expect this 3% comp to kind of be the trough of the business? Or is it just impossible to tell at this point? I just figured I'd ask you that. .

A second nice try. I like that. Yes. I guess, I just want to be clear though, I mean, I hope this comes through, that we feel very strongly that our business model is working, and we're no less confident in the long-term attractiveness of our business model at all. We're outperforming the rest of the market in terms of gaining market share.

I feel very good about our capabilities, our brand awareness, our omnichannel capabilities, which are so important right now, right? Our digital capabilities, we're the destination preferred for teens. That's really important as we think about the future of the business. .

And so, everything from services to how we operate in store, I think, are just really exceptionally well-executed right now. So being a little patient and taking a long view on the category is an important stance for us and not getting ahead of our skis on this. .

And so if we could call it better, we would. We don't have control of everything that happens in this industry, obviously, but we've got great partners that are working hard with us to make sure that we continue to bring this back to growth. .

So -- but I think, as Scott said, we were, I think, taking a realistic and cautious look or view of the current operating environment and planning for that. I think that's the most pragmatic thing for us to do as we plan for 2020. But I don't -- so in terms of what that number looks like, we'll talk more about that when we get to March.

But that's how we're viewing this. .

Our next question comes from the line of Michael Goldsmith with UBS. .

In response to the deceleration in cosmetic, how have your conversations with suppliers evolved? Have they been more willing to provide more support than they have in the past? Are they taking a more collaborative view on innovation? Are they talking about their product pipeline and introductions any differently? And then also, are you seeing any signs of stabilization from the prestige business?.

Yes. I would say our brand partners across the board are very engaged and very focused as we are in both understanding and turning around the challenges in the makeup category. And so their level of engagement has always been high.

What I'd say is different now than what we've been experiencing over the period of growth over the last few years is much deeper effort to understand consumer behavior, a much more robust focus on driving new forms of innovation that'll really be incremental to really uncover new habits and behaviors for consumers. .

So we're seeing that across the board with our end partners, and we're very -- feeling very positive about the engagement that we're getting, the level of focus that they have because they're obviously very incented to drive return to growth in this category. So we feel good about it.

I think as both Mary and Scott has said, it's hard to predict exactly when the category is going to turn around, but we're working hard every day.

And we have a lot of bright spots that, while the category is challenged, the work we're doing to bring in new brands to bring in exclusive brands, brands like Morphe, Juvia's Place, new launches like Thrive, KKW. .

So even in a tough market, we're gaining share because our strategy is working by both partnering with new brands and then returning to growth with existing brands. So everybody is working hard on this, and we feel confident that the category will return to growth. And we're working to make sure that's as soon as possible. .

And just following up on that point, it seems like outside the deceleration in cosmetics, other categories were generally steady, maybe fragrance accelerated a bit here -- decelerated a little, but is there any risk in the reduced interest in cosmetics could bleed into other categories and start to drag them down?.

Well, we do feel -- continue to see strength across the nonmakeup parts of our business, and that's a great part of our overall model because we do have all things beauty all in one place. So strength in hair and skin and bath and sun and fragrance. And as we mentioned, traffic was modestly positive. So consumers are absolutely still coming into store.

We're gaining new members. So we had strong new member growth because they're attracted to the whole portfolio. .

So we're not anticipating a big impact on the other parts of the business. If anything, as consumers are maybe slowing in their engagement and makeup to a moderate extent, we're certainly seeing greater growth and focus on skincare and the merging of those categories in some ways as brands are looking for ways to drive new growth.

So no, we don't think that will have a long-term impact. And as I said, we're optimistic that makeup will stabilize and get back to a growth spot over time. .

Our next question comes from the line of Adrienne Yih with Barclays. .

Mary, I was wondering if you could talk about the purchase -- Coty purchased a majority share of Kylie Cosmetics.

How does that impact your exclusive relationship? And then if you could also talk maybe, David, about the KKW launch in the third quarter? When did it launch? And then in terms of SKU count, was it same, larger than the Kylie launch last year?.

And really, really quick one. Scott, can you give us any color on areas where you could cut SG&A or in the EFG program for next year. .

So yes, let me start with your question about Coty and Kylie. So Kylie -- we've had a fantastic relationship with the Kylie business and the Kylie team. It has certainly contributed to our comp growth. We're pleased with the brand. It's been driving excitement and new guest, and so we're really happy with the overall performance. .

And the Kylie-Coty partnership is new and still being finalized, but we have a great relationship with Coty, and we anticipate a lot of positive opportunity to continue to grow those brands together going forward. So we're really positive about that. .

KKW has been a nice addition to our business. We launched it in all stores on a customized end cap late in the third quarter, and we're very pleased with the results, and again, the partnership we've had with that brand. It's a different assortment.

Kylie, if you remember, when we launched, was a limited assortment, predominantly lip kits and some individual lip that's expanded over time. .

KKW has a broader assortment across different segments of makeup. And so it is a different assortment and a different approach, reflective of the different strengths of each of those brands. So again, glad to have KKW in our portfolio and feeling good about the early results of that business. .

Yes. So with respect to 2020 in SG&A. I know that's at the top of everyone's list, is what does 2020 look like? And we -- it's still a little just -- it's too early for us to give too much detail on that.

But when we think about SG&A, the types of costs that are in there and roll through our SG&A line are store labor, variable store expenses, corporate overhead people costs, and then innovation investments, right, that roll through there that are long term in nature that are going to help us grow our business. .

So when we think about EFG, EFG sprinkles all through the P&L. So there's a lot of work underway there to try to optimize the business, whether it's in the gross margin line through some of the merchandise margin things we've talked about with transitions and even the clearance event that we mentioned that we're getting a benefit of this year.

I mean that's part of EFG as well. I mean we're doing a lot of work on how the transitions work in our stores so that we have less clearance items at the end of the day that we have to take markdowns on. .

So it's going to be a balanced view. I would tell you that EFG applies equally on the margin -- gross margin line as it does on SG&A, and we're just going to be very thoughtful as we think about what the right balance is for 2020 and beyond. .

Our next question comes from the line of Omar Saad with Evercore ISI. .

I wanted to follow up on some of the commentary around color, makeup and cosmetics. I know you guys are focused on it. You're working with your brand partners, all different levels. It sounds like the whole industry is really focused on this issue. .

Is there anything that you can see in your, obviously, robust data stream that gives some insight into the behavior around this category? Are there certain types of customers where you're seeing that spend and that category slow, whether it's age or regional or demographic? Or is it pretty much across the board?.

And I guess, I'm ultimately asking the question, is there any change in behavior as new generations come of age and enter the category in terms of how they're consuming the category?.

Yes. I'm happy to take that. First of all, let me step back and say, we're all showing a heck a lot of makeup still. It's not like people aren't wearing makeup. I think that's really important that this is about growth versus year ago, really, at that most macro level.

It's really about -- our main thesis is that there just isn't as many items that people are adding to their basket that are creating -- that are new rituals like things like contouring or doing your brows. .

So people are buying lots of makeup, and we'd say, engagement in the category is still quite high but just not at the level it was with the kind of newness that we'd seen for a few years. That's all solvable. That's around finding new consumer insights around white spaces and whatnot.

So I think that that's kind of at a macro, what we think is happening. .

The -- when we think about it, there's also, I think, some misnomers about Gen Z. I mean all of our data on Gen Z show that they're very engaged in the category. And in fact, the good news, too, is that they're also getting engaged in skin at a younger age than people did with older consumers when they were at that age.

That means they'll carry that habit forward. As they get into the workforce, they start wearing and using more makeup. So that, we think, is a positive factor. And as we also said, just looking at other demographic trends, we feel very positive about the ability that we don't see people turning away from makeup. In fact, we see them turning more to it. .

The other thing I'd say is that there's always been a segment of women in the U.S. that don't wear makeup and aren't engaged in the category. That's not new. We've never counted on that segment. It's a small segment. We never counted on that segment for growth for our business model.

We focus on the beauty enthusiast, which represent 77% of sales in the U.S. in terms of beauty, and that's -- and we still only have 1/3 of them in our Ultimate Rewards program. .

So we've got lots of potential. We think it's 77% of spend, beauty enthusiasts out there for us to continue to grow with. So we think that, as the category and the industry gets back to more incremental type category growth, we'll see this begin to change. .

Is there anything that you can read into this natural trend that's informative for the color trend, Mary?.

Yes. And I've mentioned this in the script, too. Certainly, a more -- we see -- I'd say it's almost like a bifurcation of things. We see a natural -- more natural look, for sure, but anybody who wears makeup knows that, that requires, sometimes, quite a few products to achieve that. It's not a bare face.

You might look tomorrow and see celebrities out there taking barefaced selfies.

If everybody looked like that, we'd be having a different conversation, but that's not -- so even a barefaced more natural look is really about using products that create that look, a dewy look, a more neutral eye, et cetera? Conversely, if you look at what's happening in the Paris fashion shows in the spring, there was some very cool extreme eye makeup looks, too.

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So it all kind of -- not everybody does one thing, I guess, is the best way to think about it. And even a more natural look presents plenty of opportunity for product innovation. .

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

Thank you.

I'd just like to close by thanking all of the Ulta Beauty associates across our stores, distribution centers, and our headquarters for delivering another quarter of solid financial results, at the same time, executing against our longer-term strategic imperatives and working really hard to get our stores, website and DCs ready for this busy holiday season.

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So we look forward to speaking with all of you again in March, and we'll be reporting our fourth quarter results then and hope you all have a happy holiday. .

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day..