Good afternoon, and welcome to Ulta Beauty's conference call to discuss results for the first quarter of fiscal year 2022. [Operator Instructions] As a reminder, this conference call is being recorded. And it is now my pleasure to introduce Ms. Kiley Rawlins, Vice President of Investor Relations. Thank you, Ms. Rawlins. Please proceed.

Thank you, John. Good afternoon, everyone, and thank you for joining us today for our discussion of Ulta Beauty financial and operational results for the first quarter of fiscal '22. Hosting our call are Dave Kimbell, Chief Executive Officer; and Scott Settersten, Chief Financial Officer; Kecia Steelman, Chief Operating Officer, will join us for the Q&A session. This afternoon, we announced our financial results for the first quarter. A copy of the press release is available in the Investor Relations section of our website. 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, May 26, 2022. 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 Dave and Scott. Following our prepared comments, we will open the call for questions. [Operator Instructions] And as always, the IR team will be available for any follow-up questions after the call. Now I'd like to turn the call over to Dave. Dave?

Thank you, Kiley, and good afternoon. Fiscal 2022 is off to an outstanding start with the Ulta Beauty team delivering another quarter of excellent performance on top of last year's record results. For the quarter, net sales increased 21% to $2.3 billion, comp sales increased 18%, operating profit increased to 18.7% of sales and diluted EPS increased 54% to $6.30 per share. During the quarter, all major categories exceeded our expectations, and we increased our market share in Prestige Beauty based on point-of-sale data from the NPD Group. We also increased the number of members in our Ultimate Rewards Loyalty Program, introduced innovative digital experiences for our guests and continued to execute major strategic projects, including investments in new stores, supply chain and technology infrastructure, all while successfully navigating supply chain challenges, a tight labor market and operating cost pressures. I want to express my sincere appreciation to all of our Ulta Beauty associates for their collaborative efforts to create great guest experiences, execute against our plans and deliver these outstanding results. Consumers continue to be highly engaged with the beauty category as they participate in more in-person activities, engage in more travel and lean into experiential spending. And while macroeconomic pressures, such as rising inflation are top of mind for consumers, their resilience and emotional connection to beauty continues to drive the recovery of the category. This consumer demand, paired with strong execution of our strategic priorities, fueled our exceptional results. Looking at our operational performance for the quarter, I will focus on the progress we are making with our consumer-facing priorities and then share an update on our optimization efforts. Let's start with our first strategic priority to drive disruptive growth through an expanded definition of All Things Beauty. From a category perspective, fragrance and bath, hair care,…

Thanks, Dave, and good afternoon, everyone. I want to echo Dave's comments and thank our Ulta Beauty associates for delivering another outstanding quarter. Their collaborative efforts and commitment to serving our guests enabled this extraordinary performance. Our first quarter results were stronger than we planned. Robust top line growth due to several factors, including the continued resilience of the beauty category, stronger-than-expected store performance and the impact of new brand launches drove better-than-expected leverage in both gross margin and SG&A, resulted in record operating margin of 18.7%. Now let's dig into the details of our results. Starting with sales. Net sales for the quarter increased 21%, driven by 18% growth in comp sales, an increase in other revenue and strong new store performance. From a channel perspective, stores delivered strong double-digit comp growth, reflecting fewer COVID restrictions than last year, while e-commerce sales were flat, in line with our plan. Transactions for the quarter increased 10%, driven by double-digit growth in store transactions. Average ticket increased 7.3%, resulting primarily from an increase in average selling price. The increase in average selling price reflects the impact of product mix, retail price increases executed in the quarter and lower promotions. Other revenue increased $20.4 million, primarily due to growth in credit card income and higher loyalty point redemptions. The increase in credit card income was primarily due to stronger sales growth. The increase in loyalty point redemptions reflects the improving trend in store traffic and the impact of our proactive member engagement campaigns. During the quarter, we opened 10 new stores and relocated 6 stores. For the quarter, gross margin increased 120 basis points to 40.1% of sales compared to 38.9% last year. The increase was primarily due to leverage of fixed costs, the growth of other revenue and favorable channel mix,…

[Operator Instructions] Our first question comes from the line of Simeon Siegel with BMO Capital Markets.

Congrats on the great results. So great comp. Within the strong ticket growth, could you break out AUR from UPT? And then maybe more broadly, how you're thinking about average ticket going forward? And then just a follow-up, just given how well you guys do with that, any way to know within that 10% transaction growth, how much are the unique guest visits versus an uptick in guest visit frequency?

Yes. Simeon, thanks for the question. So even if I answer directly, the units per transaction were essentially flat year-over-year. So again, we're seeing a lot of the benefit from the continuation what I'd call a moderate promotional environment overall, coupled with the mix of brands we have that entered the assortment here over the course of the last year. So again, you know the names well. We've been talking about Fenty and OLAPLEX and some of the other big hitters here we've added recently. So again, the mix of those 2 are really doing -- making a big contribution to our gross margin here in recent quarters.

And then just within the transactions, frequency versus unique visits?

Yes. We don't really have anything in more detail to share with that at this point in time. Again, we are very happy to see the rebound in store traffic, right. And so a nice healthy transaction growth is always what we're striving for and planned for. And so we're super excited to see the bounce back of the consumer in the stores and making sure, again, that we deliver best-in-class specialty retail omnichannel experience.

Our next question comes from the line of Korinne Wolfmeyer with Piper Sandler.

Congrats on the quarter. So first of all, I'd like to just get your thoughts on the current inflation environment and how that's impacting consumers and maybe more so here in the early parts of Q2? Are you seeing any sort of shift in demand maybe from prestige to mass or vice versa? Or are you seeing mass be maybe more resilient than prestige or vice versa? Just any thoughts here would be helpful.

Yes. Great question. And yes, the inflationary environment, as we -- as both I and Scott said in the remarks, is certainly one that we're watching carefully, and we're staying close to our guests. So far, our guests are managing through it and we're not seeing huge impacts. In fact, as I mentioned in the script, Prestige makeup performed a bit higher than mass makeup. So we're seeing strong results across our portfolio. We haven't experienced meaningful trade down behavior that we can -- we could identify. And it's -- one of the unique things that we feel is core to our model is the breadth of our assortment, all price points, from mass to prestige, all categories, hair care and skin care, makeup and bath and fragrance. And so being able to adjust and adapt as consumers' needs evolve has been true to our model for a long time and allowed us to manage through any disruption in the marketplace. But right now, we're seeing strength across all aspects of our business, which we're obviously really pleased with. But we're also prepared to adjust and adapt if and when consumer behavior adjusts.

And then I'd just like to ask quickly on Target and the shop-in-shops in Target and how they're doing. Are you seeing any like big difference in traffic in the Target shop-in-shops versus Ulta shops? How is ticket value different between the two? And then also, are there any key brands you'd like to call out that are being particularly successful in Target versus Ulta?

Yes, I'll take that one. What I will say is that we're really pleased with the overall partnership with Target. As Dave mentioned, we co-created from brand-relevant digital in-store campaign during our 21 Days of Beauty, and we're really pleased with that performance. I would just say that we will continue to share more as we grow more to scale right now. As of today, we've got 140 stores that are open as of today. We're on track to open 250 plus stores with them this year, but we like what we see. When we get a member engaged in our Ultimate Rewards Program, what we're seeing is that they're behaving very similar to our existing loyalty members. As far as brands go, Ulta Beauty works closely with the partners, with our brand partners on the assortment, et cetera, but Target really owns the sales. So we're not at liberty to comment on the sales-specific performance by brand at this time.

And our next question comes from the line of Olivia Tong with Raymond James.

My first question is just around the makeup recovery and compare and contrast that to the emergence of Prestige hair care and your view in terms of the opportunity in front of you, obviously, makeup is significantly larger. The recovery accounted like, from your earlier comments, is progressing faster than you had anticipated. As you think about the second half of the year and continuing to drive acceleration, can you talk a little bit about the plans in place to keep that going? And then I have a follow-up.

Great. Well, thanks for the question, Olivia. Yes, makeup did recover faster than we had anticipated coming into the year. You all know that we've been working on makeup for a while. It was somewhat soft going into the pandemic and was arguably the hardest hit category of segment beauty during the pandemic. And we're -- so we're excited to see it recovering, and that's driven by an elevated overall engagement in the category in part by more opportunities to go out, more social occasions, more people going back to work in person and then just some of the things that we've been talking about, the engagement, the excitement, the enthusiasm for makeup has remained high as evidenced in social media, just the opportunities to where makeup haven't been as numerous. So we're -- as that opens up, as the world opens up, we're definitely say, more opportunity, a high level of engagement. There's new trends that are coming in to make up that we're excited about, definitely a push towards bold looks, bright, glam, glitter, people are ready to get out in the world and that's shown up in the looks. At the same time, some of the dynamics around a more natural look that requires makeup, same consumers are balancing both of those. We're seeing brow innovation, contouring is being discovered by younger consumers who missed it the first time around long lip wear -- long wear lip is a trend that's that started in the pandemic and is continuing. So we're excited about what we're seeing and then in the Total category. And then Ulta, through our assortment has really been performing quite well adding key brands like Fenty, r.e.m., Chanel, lots of innovation from both mass and prestige, MAC, Clinique, Lancome and NARS on the Prestige side, e.l.f. and NYX are 2 big highlights on the on the mass side. So we're getting a lot of innovation, lot of creativity, all the things that we have been working on and driving towards really came together in a nice way in the quarter. So as we look forward to the second half of the year, we're confident. It's hard to predict exactly how consumer behavior will go. But as more and more people are comfortable going out, more opportunities exist, more people going back to the work, coupled with the continued pipeline of strong innovation, we feel like makeup is on its way to a full recovery. And in fact, in Q1 was up over 2019 results, so pre-pandemic results for the first time in the pandemic. So excited about what we're seeing and looking to continue to drive that forward.

And then on the gross margin, you said earlier that you're still expecting gross margin to be down. It was obviously a much better start to the year than we probably thought. But of course, costs are material as you progress through the year. But relative to your prior expectations, as you think about gross margin being down, is it the same level? And could you talk about like the puts and takes there, maybe a little bit of granularity in terms of your thought process on costs now versus mix improvement and obviously some leverage associated with an improved sales outlook?

Yes. So the great start we got in the first quarter is really kind of a background here driving some of the gross margin. So we still expect it to be down, as you said, but down less than what our initial plan was for the year. So we still have the same variables at play there. We talked about brand mix being a headwind this year. We think the promotional environment will normalize during the year. Again, we didn't see so much of that in the first quarter, but we are expecting more of that to come into play as we get deeper into the year and then supply chain costs. Again, we expected cost generally to be higher this year. We're seeing some costs, especially around fuel, higher than we expected. And we -- the back half of the year, there'll be more headwind from that piece of the equation as well. So overall, I feel like we're in a good place. And if sales stay strong and we're always focused on optimizing the business overall. So helping to deliver great results.

And our next question comes from the line of Steph Wissink with Jefferies.

I have a really quick question on inventory. I'm wondering if you can just talk a little bit about the complexion of the balance sheet inventory? And it feels strange to ask, but do you feel like you have enough to chase if the momentum persists in the business? And Scott, 1 question for you. This is a clarification. Could you just walk through the accounting on the UB Media? I'm not sure I tracked with you in your prepared remarks in terms of the offset to marketing fee, just talk a little bit about how those vendor agreements work, just to understand a bit how that affects the middle of the P&L?

That's 2 for me, Steph. That's not fair. Okay. So we'll go first up on the inventory. So again, it's up 16% year-over-year. We feel like we're in a good position. Again, it looks easy based on the results we're posting here, but our teams are doing an excellent job and working really hard with our vendor partners, the merchants, the inventory planning teams, the supply chain teams to make sure we get the right product in the right place. And so fill rates are good. We're feeling better. Things have kind of bounced back a little bit from what we saw mid- to late last year. So again, focused on high velocity SKUs, new brands to make sure we take advantage where we can there. We do expect that the growth rate, again, will moderate as we get further into the year this year and start anniversary-ing some of the steps we took last year to get more aggressive on inventory. So again, that's one place we always feel confident that we would make more investment if good judgment suggests that. And then on the accounting for the UB Media, so this one again for the accountants in the room. So last year, again, the vendor, the marketing partner program that we had in place, again, we've explained this. We've always been doing this in a smaller scale, I guess, I would say. And so historically, the accounting was all in the gross margin line by and large, okay, the vendor income piece of it. The cost -- the actual marketing cost within SG&A and all the benefits were flowing through the gross margin line kind of in line with all of our vendor money accounting so to speak. And this year, the difference is we're able to offset the incremental advertising costs in the SG&A line and the residual rolls through the gross margin line. I hope that helps.

And our next question comes from the line of Kate McShane from Goldman Sachs.

Just a quick one from us. Just you mentioned increasing points of sales Prestige, just how are you viewing the competitive environment in light of that? And how are you looking to further differentiate yourself as those points continue to roll out?

Yes. We -- the beauty category is attractive and has been highly competitive for a long time. I've been here at Ulta for about 8.5 years now, and it's been hypercompetitive the whole time and for years before that. It's attractive. It's growing. It's engaging. So that's been part of the dynamic for a while. And certainly, it's true now. We're seeing new competitive locations, particularly on the prestige side, at the same time that we're opening up new stores of our own and in our partnership with Target. So there is some shift going on. What we're excited about and proud of is the fact that even in that environment, even in the first quarter with hundreds of new competitive locations, we continue to gain meaningful share in the Prestige category. And I think it's a reflection of the strength of our model. We have something that nobody else offers in the marketplace. The unique combination of an assortment that reflects the way consumers want to buy and shop beauty across price points, mass, prestige, across categories and then most importantly, in an experienced an environment that reflects the human connection that consumers are looking for in this highly emotional category. All of our research suggests that our experience is unique and special. What our team does every day to deliver a unique experience stands out in the marketplace, and that helps us drive our business and drive our market share. You add in loyalty and services and a great digital experience and add all the innovation that we continue to bring in all aspects of our business, we feel like we're doing -- we're playing offense. We're leading through what we know how to do best, which is drive engagement with beauty enthusiasts through all aspects of the beauty journey. And so we feel confident that if we continue to do that, it's going to continue to show up in our results. It's reflected in the strong results we had in the first quarter, the momentum we had coming out of fiscal '21 in our share results, in our loyalty, member growth, and we're -- that's our plan going forward. For us, we've always been focused on our strategy, executing our strategy with excellence. And when we do that, the results follow and that will be our plan going forward.

Our next question comes from the line of Daniel Hofkin with William Blair.

Just a quick question regarding the Target partnership. I don't know if you commented specifically on this, but can you say whether it's having a measurable impact yet on your overall comp sales, obviously not at the Target stores themselves, but in the form of additional traffic to nearby Ulta stores or ulta.com and then kind of how you expect that contribution to evolve over the rest of this year and the next couple of years?

Yes. Dan, what I would say is that any time, as Dave mentioned earlier, we have new points of distribution, there's natural cannibalization that happens. But it's not meaningful yet. We've got just about 140 stores, as I mentioned out of today that are open. We've factored this into our expectations. We do see that whenever we've opened or there's other points of distribution, including our own office Beauty stores, we do see an initial impact that, that dissipates over time, we expect a similar pattern to happen here with our Ulta Beauty and Target locations. So as we continue to roll out more stores, we'll see if that continues to hold true. But we -- what we've seen so far is that seems to be the case.

And then just as you think about the, obviously, overall stellar results, any just differentiation among categories or regions or parts of the quarter that you might call out plus or minus?

Yes. A few things that I might say. One, across categories, we're really pleased that we see strength in all of our major categories. I talked about makeup in detail already. And so that's an important improvement on our business. But at the same time, that improved. It was encouraging to see skincare deliver strong results, haircare continue through innovation and prestige, on tools to drive a lot of engagement and newness across haircare, continues to drive great results. Fragrance, which has been a shining star throughout the last 2 years continues to drive growth. I talked in the script about some of the drivers of that newness, brands, exclusive brands like Billie Eilish as well as innovation on our existing brands, that driving strong growth, sun care, expansion into wellness and driving incremental growth. So category performance was healthy across the board. Channel performance, again, strong results in both driven by our stores and traffic and engagement and the desire to get back and shopping in person, but to have our e-commerce business essentially flat after all the growth we've seen in that business over the last couple of years was in line with our expectation and salon coming back very strong. So our channels are performing well. Through the quarter itself, the first period, the first month or so of the quarter was the strongest as we kind of came out of the gates and then started lapping stimulus. But the other 2 months of the quarter were strong as well and well ahead of our expectations. So around a well-rounded delivery of results with all aspects of our business contributing to the performance that we have.

And then anything you would call out either regionally or in terms of customer demographic differences?

No region. I mean 1 of the things that we really like about our model is our model works in all different types of geographies. Big cities from New York and L.A. to Chicago to smaller remote single-store markets, suburbs, urban, rural, and we saw strong performance across the board. So there was no real region or marketplace distinctions of note. And that to us is a reflection, this is working really well. And then when we look across economic, we saw growth across all income levels as well as we look at our consumer base. So strong growth from our highest income to more moderate income. So -- again, well-rounded growth. Consumers are engaged in the category. The category itself is, we think, more relevant, more important to our consumers, more connected to their overall sense of self-care and well-being. At the same time, there are so many more occasions to go out. We think the category is in great shape, and we're proud to be leading the category and driving these results through our strong execution.

And our next question comes from the line of Michael Lasser with UBS.

Understanding you're looking to be conservative and mindful of the uncertain macro environment, you get to low single-digit comps in the back half. Again given the strength in the cosmetics category, it would imply that haircare and skincare probably turn negative, why would that be the case?

Yes. I guess I would just chalk it up like we indicated, Michael, being prudent all things considered, looking at the world and all the uncertainty and all the warning signs that seem to be flashing a bit right now. So again, there's no -- we took the benefit of what we've seen strong performance so far in the first half of the year, bake that into our full year outlook and didn't really modify the second half of the year based on what our initial plan was for 2022. And so you take that and then you adjust for some of the expense pressures that we're seeing across the business right now, and that's where we think is an appropriate place to land it for the time being. And then we'll continue to modify as we work our way through the rest of the year.

My follow-up question is you're still -- you haven't seen it, but you're still expecting promotions to come back. What is going to be the catalyst to spark an increasing in promotions? And how much have you factored in for that rise in promotions in the back half of the year?

Well, we won't get specific on any like -- specific elements of what we factored in. What I'd say about promotion is the environment is dynamic, as we talked about, highly competitive, and there's uncertainty ahead from consumer behavior. We -- what we know is we've been able to continue to manage our promotions in a smart, strategic way. We've been on a journey for a while to reduce nonstrategic broad-scale discounts and promotions to focus our efforts on personalization, CRM-enabled, highly relevant, strategic efforts that drive not just short-term but long-term results through higher engagement, higher loyalty, higher connection to Ulta Beauty over time. And that's what we are able to do in the first quarter. But as we've said probably through many of these calls, we're well aware that this is a competitive environment. We've got lots of outstanding competitors that are also looking at ways to drive their business. We will not lose share. We'll respond appropriately. We have more tools than we've ever had through our personalization and CRM capabilities to ensure that we are leading the market. But with uncertainty around inflation, consumer behavior, competitive environment, we are prepared to react. We're not going to lead promotional intensity, but we're also going to make sure that we're appropriately engaging with our beauty enthusiasts to drive them to Ulta Beauty.

Our next question comes from the line of Simeon Gutman with Morgan Stanley.

I'm going to ask my question and follow-up. So Kiley -- coming back to the next call. My first question is on the merch margin. Given that haircare seems to be mixing up, shouldn't that have been a positive? And then when Scott, when you made the comment X reserve adjustments, does that mean the merch margin X reserve adjustments could have been up year-over-year? You're using that against the compare? And then the follow-up is what is just changing in the back half? It sounds like you're keeping sales the way you modeled it, if I'm interpreting it right, but what if anything else changed?

That sounds like 3 questions, Simeon, actually. But I'll give it out 3 here. So yes, haircare has been a real contributor here recently. Again, it kind of gets back to the brand mix overall for the business, I would say. So while haircare, generally speaking, is higher margin than the house, some of the mix that's been added here recently, doesn't necessarily follow the same metrics overall. When we're talking about inventory, so it was favorable adjustments last year that was driving the tougher compare this year. So again, last year, cleaner inventories, we were coming off what I'd call some housekeeping, probably late in 2020, right? We closed some stores. We exited some brands later in the year. So we got some book benefit from that last year, which makes it a tougher compare. As far as the guidance overall, what changed, again, the strong sales, the strong start. Obviously, it's helping drive a lot of fixed cost leverage here for the year. For the revenue, it was something that was unexpected, really wasn't in the plan to see those redemptions come back in our loyalty program that way and to see the credit card benefit pop here in the first quarter. So again, we're planning for more of that to continue throughout the year. We've got operating costs that are increasing across the business, specifically in supply chain, but we're seeing in other areas, too, as we mentioned in our prepared remarks. So that's been feathered in as we think about the second half of the year. So again, we feel like we're in a good position. We feel like we've got all the variables covered. Again, we think it's prudent to take a more thoughtful, careful approach and outlook as we're looking ahead to the second half of the year, considering all the uncertainties that are kind of floating out there right now.

John, I think we'll take 1 more question, please.

Okay. And our final question comes from the line of Michael Binetti with Credit Suisse.

Congrats on a great quarter, and thanks for all the detail here. A lot of our questions have been answered. But on the -- I guess as we think about SG&A versus gross margin, on the SG&A, if we look at it on a per store basis or some kind of leveling metric like that, it looks like it was up about 12% versus 2019. Comps up in the mid-20s. I just wonder if there's more noise in the SG&A line in 1Q than I appreciate it. I know you mentioned, Scott, that a few expenses move out of 2Q into 3Q, is there any onetime items to think about in 1Q that led to some underspend in SG&A? And I guess the follow-up is, if I look at some normal SG&A seasonality back pre-COVID it suggests gross profit margin could be down as much as a couple of hundred basis points in the guidance that you gave in 2Q through 4Q, is that the right magnitude of the puts and takes that you laid out for us earlier? Or would you direct me to...

So on the SG&A, there's really nothing. There's no onetime extraordinary items floating around in there. I would call, go back and look at our comments around the marketing expense and how that is being treated year-over-year because that is a rather significant change. Again, that comes from the UB Media change going from what I'd call a small scale kind of operation to a more formalized and larger scale process overall. So we did change the accounting there year-over-year, and that is providing a pretty significant benefit in the first quarter versus a year ago and that's going to continue for the rest of the year, obviously, that comparison. Then when we're talking about gross margin and some of the variability that you called out there in the second half, again, we think it's still in the same range that we guided to early in the year. Again, we -- I would point back to changing an expectation. So again, first quarter promotional environment was moderate to slightly better than what we saw a year ago, which was not our plan for the year, and we expect that to get more aggressive in the back half of the year. So that's baked in there, along with the brand mix. So again, brand mix kind of worked to our benefit in the first quarter. We think some of that will moderate as we get further into the year as well.

We have reached the end of the question-and-answer session. And I would now like to turn the call back over to Dave Kimbell for any closing remarks.

Okay. Great. Well, thank you all for joining us today. The year is off to a great start, and I want to thank the entire Ulta Beauty team for their collective efforts to support our guests and each other while moving our business forward. We look forward to speaking to you all again at the end of August when we report our second quarter results. I hope you all have a great evening. Thanks, again.

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