Good afternoon, and welcome to Ulta Beauty's conference call to discuss results for the second quarter of fiscal 2022. [Operator Instructions] And 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.

Thanks, John. Good afternoon, everyone, and thank you for joining us today for our discussion of Ulta Beauty's results for the second quarter of fiscal 2022. 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 second 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 that the statements contained in this conference call, which are not historical facts, may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. We caution you not to place undue reliance on these forward-looking statements, which speak only as of today, August 25, 2022. We have no obligation to update or revise our forward-looking statements, except as required by law, and you should not expect to do so. We'll begin this afternoon with prepared remarks from Dave and Scott. Following our prepared comments, we'll open the call for questions. [Operator Instructions] As always, the IR team will be available for any follow-up questions after the call. Now I'll turn the call over to Dave. Dave?

Thank you, Kiley, and good afternoon. We appreciate your continued interest in Ulta Beauty. The Ulta Beauty team delivered outstanding performance again this quarter. For the second quarter, net sales increased 16.8% to $2.3 billion. Operating profit increased to 17% of sales and diluted EPS increased 25% to $5.70 per share. We continue to be very pleased with the broad-based strength of our business. For the quarter, all major categories exceeded our expectations, and we increased our market share in prestige beauty versus last year based on point-of-sale data from the NPD Group. Sales in stores and digital channels also increased -- exceeded our expectations with both channels delivering solid comp growth in the quarter. And we saw healthy sales gain from members across all income demographics. Consumer engagement with beauty remains strong, reflecting a deep emotional connection with the category as well as the continued importance of self-care and wellness. This healthy engagement paired with solid operational execution from our teams, fueled our results. Before we talk about the results, I want to recognize and thank our Ulta Beauty associates. Their collaborative commitment to serving our guests, caring for each other and executing our plans with absolute excellence has enabled us to continue navigating a dynamic environment and deliver outstanding results. The strength in our business, despite a turbulent environment reflects the power of our differentiated model and our ability to capitalize on the strength of the overall beauty category. Our unique enduring value proposition continues to drive our success and our strategic framework anchors our focus as we look forward. This afternoon, I want to share an update on our strategic progress. Our first strategic priority is to drive disruptive growth through an expanded definition of all things beauty. We engage into light beauty enthusiasts with a curated…

Thanks, Dave, and good afternoon, everyone. As Dave indicated, our second quarter results were better than we expected. Strong sales growth due to several factors, including the resilience of the beauty category, stronger-than-expected sales growth from stores and the impact of new brands, drove better-than-expected performance in gross margin and SG&A leverage, resulting in an operating margin of 17%. These results reflect the hard work and commitment of our associates, and I want to thank all of our teams for staying focused on serving our guests and managing our business through this dynamic operating environment. Now to the financial results, starting with the income statement. Net sales for the quarter increased 16.8%, driven by 14.4% growth in comp sales, a $19 million increase in other revenue and strong new store performance. Transactions for the quarter increased 8.3%, primarily driven by growth from stores. Average ticket increased 5.6%, resulting primarily from an increase in average selling price. Average units per transaction were down slightly. The increase in average selling price primarily reflects the impact of product mix and retail price increases executed this year. We estimate that price increases contributed about 300 basis points to the overall comp. During the quarter, we opened 7 new stores and relocated 4 stores. For the quarter, gross margin decreased 20 basis points to 40.4% of sales compared to 40.6% last year. Although we had less total promotional activity during the quarter, overall merchandise margin was lower than last year, primarily due to the impact of brand mix and lapping benefits from favorable inventory reserve adjustments in the second quarter last year. Gross margin was also negatively impacted by higher inventory shrink primarily due to increased theft across the retail landscape, theft and organized retail crime are increasing, and we are seeing similar trends in…

[Operator Instructions] And our first question comes from the line of Rupesh Parikh with Oppenheimer.

Also congrats on a really strong quarter. So I guess I start -- I want to start out with the consumer. So I was curious if you guys are seeing any behavior changes of note and whether you're seeing any side of the trade down or even resistance to price increases? And then just given some concerns out there about volatility and trends, I'm just curious if you're seeing more volatility in the business than what you've seen in the prior months.

Rupesh, thanks for the question. Yes, the short answer on trade down is no. We're not experiencing that or seeing that at this time, similar to what we talked about last quarter. We're seeing strong growth across all aspects of our business. As I mentioned, every category performed in double digits, strength across channels, stores, e-comm services. And as we look at income levels of our guests, we're seeing healthy growth at all income levels. So no real signs or signals of trade down within the marketplace yet. And again, I think that's a reflection of the importance that this category plays in our guest lives, the increasing connection that beauty has, wellness, the desire to express them -- our guests to express themselves to the world in this -- as the world reopens. So the importance of this category is demonstrating itself. And so, so far, we're not seeing it, but we're prepared as we look forward to continue to make any adjustments if and when that behavior starts to show up, as you know, within our model, we're uniquely prepared to adjust. If any of that does show up with our mass to prestige offering, all price points, all different categories. But as of now, we're seeing strong growth. As far as throughout the quarter, the quarter started very strong. We did see a slight moderation towards the end of June and early July as you may have seen with other retailers, but the trends picked up towards the end of the quarter, and we're pleased with what we're seeing so far this quarter. So no big concerns or down trends is across any part of our business right now.

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

So I just want to confirm, a lot of retailers are saying they thought some deceleration beginning around June. It doesn't sound like you guys are seeing that. And then also on the profitability of the business, gross margin sounds like there's a little bit of pressure there versus last year, but last year was so clean. It seems like it's still -- the promotional levels are still well below pre-COVID. Is that a sustainable phenomenon in your opinion?

Let me just -- I'll start with the deceleration and Scott can pick up on the gross margin and some of the things we're seeing there. So again, yes, we did -- our quarter in total was strong. We were pleased with the results throughout the quarter. There was a modest slowdown in the trends right at the end of June, early July as a number of things, both, I guess, within retail and in the world around us, we're showing up. But again, nothing alarming on our business. And we did see trends return to early in the quarter rates as we got to the end of July and then certainly, as I said, into this quarter. So a modest impact. But again, the category itself, the importance it plays in our guest lives, allowed us to kind of ride through any macro disruption and short-term impacts that we saw throughout the quarter.

And as far as gross margin is concerned, again, we're very happy with the results that the business is generating year-to-date. Our longer-term guidance assumes gross margin is going to moderate somewhat from what we saw last year, again, when we started out with our longer-term algorithm. And again, this year, the sales performance has just been extraordinary. So if you're looking at it year-over-year, I'd say product mix has something to do with the variability, UB Media mix and how we're accounting for that in the geography and the P&L has something to do with that. As we look out towards the remainder of 2022, we've been clear about we expect the promotional environment is probably going to get a little bit tougher, especially what we've seen here across the retail universe here most recently. So moderation as we look to the future. It's still a lot of great levers we have in the business. When we talk about Project SOAR delivering benefits over the longer term. Our continuous improvement in EFG efforts still with a lot of benefit to generate for the company over the long term. So I think operating margin, we feel good about opportunities to continue to leverage there, but we think gross margin will certainly moderate as we look ahead.

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

Congratulations on the nice performance. You had mentioned the services business and the improvement there. Can you talk a little bit about what you're seeing there? What that impact could be? And last -- and then next, just on the price increases that you had put in place. Where are we in the scale of price increases by category? And how do you see it blending out for the year?

Thanks, Dana. I'll start and then turn it over to Scott. Our salon team delivered strong quarter growth of double-digit comps during the quarter, and really what we saw with some strength in our hair coloring services. We have strength across all geographies and regions, which was great. And the sales were really fairly consistent throughout the quarter. What we like what we see is these partnerships with the [ Back Bird Saloon ] takeover event, as Dave was mentioning in his spoken notes that Joico, Andrew Fitzsimons [indiscernible] are examples of where you can have a salon expert and really engage with the consumer to try a new brand that they've never made tried before. We're also really driving trial through our personalized offers. So we're getting people to come in and try our services, which is really important. From a staffing perspective, we continue to really invest in our education, in our training for our stylists, particularly focusing on textured hair sales. And then from a pricing perspective, Dave was mentioning, that's not really playing into the comp. This is the first time that we've increased our price in the last 3 years. It was really modest. So really, it's through the growth of the core business and services that's driving that comparable off. So I'm really pleased with how the guest is refining coming out of COVID. Scott?

And price increases as far as product is concerned throughout the channels. Again, where a number of increases in the second quarter, slightly higher than what we saw in the first quarter. We estimate it's about 300 basis points to total comp for the second quarter. Again, the number of SKUs that have been impacted and the total all impact to our assortment is higher than we expected early in the year and we expect there to be in the back half of the year. We've already been alerted by some of our vendor partners that there's some in the queue now, and we expect there to be more as we get deeper into the year. So we'll continue to update quantitatively on how that impacts our business and how we're thinking about it maybe for 2023 when we get further down the road.

And our next question comes from the line of Mark Altschwager with Baird.

With respect to the recovery you're seeing in the makeup category, what are your current views on whether we're seeing with whether what we are seeing is pent-up replenishment post COVID versus perhaps the early innings of a new innovation-driven cycle that could have some legs to it? And then bigger picture, just based on the trends you're seeing in your business year-to-date and the projections for the year, calling for low teens sales growth at the high end, is the 5% to 7% 3-year CAGR still the right way to be thinking about the medium-term growth outlook?

Great, Mark. Yes, on makeup, yes, we're really, really pleased and encouraged with what we're seeing as I mentioned, double-digit growth across mass and prestige. And you know well. You've been following us for a while. That category has had its ups and downs and been struggling for a little bit. And so we're really pleased with the results and we think it's well rounded. There's no doubt there's some elements of maybe pent-up demand, although as we get further into the reopening, we think that's probably a smaller and smaller part of what's driving the business. What we do see happening is just strong innovation across both mass and prestige, really good performance by new brands that we brought in, Fenty, R.E.M., new brand About-Face, great innovation. On the mass side with NYX and ColourPop and e.l.f. and others, but also on the prestige with Benefit, MAC, Clinique and many others. So we're seeing strong innovation that's really connecting. And it's being fueled by some core trends that we think are here to stay for a while that are driving engagement. And it's kind of an interesting time within makeup right now that we're seeing a combination of very bold, playful looks, kind of retro looks, euphoria type engagement driven engagement that are reminiscent of some of the things we saw back in 2016 that are encouraging. But at the same time, there's an equally strong trend around a clean look, glowy, glazed, that are driven by higher usage of foundation and highlighters, which are really important to the category and frankly, have been struggling for a little bit. So we are pleased with the innovation, the -- as people get out and want to express themselves to the world and there are more occasions that's driving more usage and there's some core underlying trends and innovation that are supporting the category. So we're optimistic about the path ahead, and we'll continue to be investing in our makeup business and partnering with our brands to drive this trend for the foreseeable future. As far as our long-term targets, no -- we're not updating or changing that. So yes, the outlook that we shared with you last fall is still on our horizon, and so I'd keep that as our long-term guidance.

Our next question comes from the line of Krisztina Katai with Deutsche Bank.

Congratulations on a very nice quarter. I just wanted to follow up on innovation, especially on the skin care and haircare side of the business, which has been really strong. Can you talk about some of the areas of the business that you are seeing this newness that is driving very strong sequential performance? How we should think about some of the product innovation and just potential launch time for any big launches that are coming up? And then secondly, if you could just touch on your expectations and member growth going forward. You're bringing back a lot of lab consumers, are they all back now? Is there still room there to get them back? And then maybe layer in the opportunity that you see from the target partnership?

Okay. There's a lot of great stuff to talk about in that. Let me just hit a few of that. First, on innovation. So yes, I talked about makeup, let's hit on skin care and haircare. And it's that kind of highlights one of the aspects of our business that we're really excited about right now is the strength we're seeing across all of our categories, double-digit growth in every category, which, again, I think is a reflection of the strength of our model and the power of beauty right now. Within skin care, we're seeing the strong growth that's driven by a combination of new behaviors that were strengthened or developed during COVID around skin health and skincare, new brands that we've launched that continue to drive our business, Drunk Elephant, Fresh, Supergoop!, Vacation, new innovation, great innovation across moisturizers, serums, eye creams, acne by brands like Peach & Lily, OSEA, Hero, so many others, Clinique across the entire assortment. The trends that we're seeing in skincare again, we think will help -- will sustain for a while. We continue to see skinification that consumers, including young Gen Z consumers seen the importance of skincare and how that lays the foundation for their overall skin health and their overall look. There is a growth in science or clinically backed or dermatological improvements. So savvy consumers are looking for these active ingredients, and that's been driving a lot of growth. And there's been a lot of innovation around just core hydration as a recognition that, that's healthy skin is driven by that. So many things coming together to drive that double-digit comp in both mass and prestige on skincare. Haircare, similarly strong growth we think, in strong engagement, both by newness but also the execution of our programs like Gorgeous…

Yes, we're really pleased with how our partnership is progressing and the future opportunities that really provide our guests, brand partners Target in Ulta Beauty. We're leaning in. In fact, one of the nuances that we're introducing this next quarter is that we're creating a dedicated field team that as we scale this partnership, they're going to be really focused on training and education with an emphasis really on loyalty and unlocking that loyalty opportunity with not only our existing members, but with new members as they come into the Ulta Beauty at Target. So we're excited as we continue to expand and grow, and we feel Ulta Media and Target is another way to drive loyalty members into our ecosystem.

And the next question comes from the line of Oliver Chen with Cowen.

Great quarter. As we think in terms of the guidance, what's embedded with respect to pricing? And how would you speak to that against the promotional needs that you'll have fourth quarter is always a very promotional time and you do a lot of great personalization to drive promotions as well? And a follow-up on the new layout. There can be disruption and customers don't necessarily like new layouts sometimes and your inventory needs to change. So I would love your thoughts on timing and execution risk and rationale. It sounds like it's a prudent move to focus on categories, but it comes with different risk factors.

Yes. So I'll start that one. So pricing, we said about 300 basis points of price increases reflected in our 2Q results. And all the price increases that we're aware of through our vendor partnerships are embedded in our guidance, right, for the back half of the year. So we feel like we have that framed up well. When we think about, again, the second quarter spectacular performance above our expectations. Our updated guidance includes, right, the beat on the second quarter and the trends we've seen so far, early stages of the third quarter. When I think about the top line trends, and again, back half of the year, we're going to be lapping some stronger performance last year. We've referenced the competitive environment. We expect that to be tougher as we get into the back half of the year, the promotional environment, again, you know this well, Oliver, in the fourth quarter holiday. We compete with all of retail for gift giving, right? So it's a whole totally different kind of game for a relatively short period of time. So we expect it to be more competitive, more promotional this year than it was a year ago. You've heard us talk about distribution points, additional points of distribution on prestige beauty coming as we get deeper into the year. That's another consideration. Then on the operating income side, we referenced the strategic initiative expenses kind of pushing back later into the year. Some of that's due to just shortages of manpower and delay sometimes in shifting some of the hardware that we need to get some of these projects finalized. So again, nothing to be overly concerned with, but there are some delays as there is in all parts of the world right now, it seems. So nothing unusual there. And then some of the costs, right, the increased cost, inflationary pressures we're seeing in the business. It's going to be heavier in the back half of the year than it was the first half of the year. So all in, we think we're in a good place, and it's reasonable -- it's a reasonable estimate of the guide and what we expect for the second half of the year.

And for new store layouts, we're really focused on our new stores and our planned remodels going forward. While we're always making changes to improving the in-store guest experience, it's been a while since we've really made any significant changes to the store layout itself. Just as a point of reference, our -- today, our merchandise is organized by price point with prestige makeup and skin care in 1 side of the store and mass makeup and skin care on the other, with fragrance in the middle and haircare in the back and salon. Going forward, we really want to have a merchandise layout to magnify our differentiated assortment and really better reflect how a guest really shops with consolidated categories and intuitive adjacencies. So we're going to take mass and prestige makeup together in the front of the store with real clear brand delineation and then also reflect the growth of the category and that's important to the guests that moving skincare upfront. So the mass and prestige skincare are going to be all together, again with clear brand delineation. So you'll be able to tell the difference between mass and prestige, but it will be organized together the way the guest shops it. We're also going to elevate the front of the store to support more editorial storytelling and newness and events and recent trends. And then we're going to also create this new beauty bar at the center of the store that's really going to amplify the service experience and highlight the beauty attainment that is really happening on the sales floor. We're really excited to see this all come to life later yet this fall.

Great job on the BIPOC initiatives as well.

And our next question comes from the line of Chris Horvers with JPMorgan.

As a follow-up question, maybe for Scott, could you talk about how your thoughts on the cadence of the back half changed? It seems like your -- you originally said low single digits for the back half, it seems like you're raising the third quarter comp, but keeping 4Q intact, 3Q gets more leverage. But at the same time, it sounds like you're adding a bit more promotion in the fourth quarter and maybe more investments potentially hitting that fourth quarter as well?

Chris, you don't need me to answer the question. You already figured it all out. So gold star for you today. So I mean, that's it in essence. I mean, again, we talk about guidance and estimates on every one of these calls, people have questions. I mean -- and we really do look at it right up to just before the call. And so what we've seen in the last couple of weeks with sales strength. Again, Dave mentioned this late July bounced back just like how it looked early parts of the quarter. And August, we've kind of continued on the same trend. So we're taken up the third quarter, in essence, for the strength there. And we're kind of being careful with the fourth quarter for the reasons we've already stated. We think promotional environment is going to be higher. And so just navigating that balance between the sales line and the margin investment it takes to close that. So that's exactly right.

Since I answered my own -- since I answered my own question maybe [indiscernible] one in here. I guess maybe can you talk about how the prestige category performed in 2Q versus '19? And was that acceleration relative to what you saw in the first quarter?

Yes. The prestige category is up versus 2019. And so we're encouraged by that. You know that prestige has been -- we talked about this had been the laggard, prestige makeup in particular. And now we're seeing that performance come back. Compared to 2019, it would still be -- have the kind of the lowest, I guess, performance, incremental performance over that as these other categories have been strong, like hair care and skincare really throughout the last couple of years. But yes, we're pleased with the performance. We've been working on this for a while. As you know, the brands have continued to bring innovation and the combination of changing consumer behaviors, opening up engagement and the innovation that I talked about. And I think with -- specifically within Ulta Beauty, as we've -- our merchants have done just a tremendous job evolving our assortment to make sure we have the brands, the products, the innovation that allow us to gain share and lead in the category. So we're pleased with the overall performance and glad to see prestige performing at a high level.

And the next question comes from the line of Mark Astrachan with Stifel.

Just a brief question, I think. curious about the contribution to Ultimate Rewards members from the Target relationship at year-end. Target mentioned, I think it was about $1.5 million guest co-linking accounts from their loyalty program to yours. Are those incremental kind of any learnings that you've gotten as those folks have participated in your program as well?

We've mentioned in the past that there's been a large number that have linked their accounts, but we haven't shared specific details on number of new members and break out by that, and we're not planning on doing that now. But as Kecia mentioned, we're just -- we're really encouraged by what we're seeing. We're really pleased with the overall partnership. The execution has been strong. The consumer reaction has been very positive. And the engagement in Ulta Beauty has really been a positive aspect. So our focus going forward, as I mentioned in the remarks, is to continue to drive that loyalty. That's key to our success is to engage guests in a new way to touch Ulta Beauty and ultimately get them connected to all aspects. We're encouraged by what we're seeing, and we're focused on driving that well into the future.

John, I think we have time for one more question.

And the next question comes from the line of Kelly Crago with Citi.

I'm just curious, we did notice that you did sort of layer back in another sort of store-wide 20% off coupon promotion more recently. And I'm just trying to understand that. I know you pulled away from it during 2021 just because the business was so strong and promotions across the board are low. But I'm just curious some of the comments you're saying about back half of the year, whether or not you're sort of seeing that tick and that's a response to an uptick in promotions across beauty. So just curious any thoughts on that and if we should kind of expect that to be layered into your promotional strategy going forward? And then secondly, on the same line of thinking, just curious with the promotional environment in some apparel categories and some other categories out there, just wondering if in the past, you've had to sort of step up promotions even if the beauty category has been strong. Have you had to get more promotional during the holiday period in the past? Just curious on your thoughts there.

Great. I'm really glad you asked, Kelly. I do want to clarify, I know there's been some comments about a 20% off storewide customer base-wide. That is not -- we have not executed that. We haven't all year executed that. And that -- going back in history, we -- that was a trigger that we used frequently. And then pulling that out is core to our strategy of being more purposeful in how we're connecting with our guests. What you may have seen is more targeted. I mentioned how we've been -- you know we've been on this journey of investing in our personalization and our CRM capabilities. So we use a variety of offers, including 20% off but also points offers or newness offers or other broad communication to pinpoint and target subgroups within our typically smaller subgroups based on a specific behavior that we want to incentivize. One example might be if it's a Diamond member that hasn't shopped with us all year for several months, that guest may get a 20% off coupon, but it's only a small subset of groups. And we test and learn and we drive and we understand the profitability and return of doing that. So any 20% off has not been. There was an offer just -- if some of you saw this week that came out that was 20% off, that is a comp offer and is not storewide. It is -- we have a strategy within our mass side of the business that is -- as you know, mass tends to be a bit more promotional. So if any of you saw an offer this week that was 20% off, that was not storewide that was focused on our non-prestige side of our business, and we've been doing that particular…

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