Good afternoon, and welcome to Ulta Beauty's conference call to discuss results for the third quarter of fiscal '22. [Operator Instructions] As a reminder, this conference 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's results for the third 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 third 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, December 1, 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'll 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'll turn the call over to Dave. Dave?

Thank you, Kiley, and good afternoon, everyone. We appreciate your interest in Ulta Beauty. The Ulta Beauty team delivered outstanding performance this quarter with strong revenue growth driving operating margin expansion and double-digit earnings growth. We accomplished these results because the Ulta Beauty teams continue to execute at a high level, and I want to thank all of our associates for their commitment to delivering great guest experiences, ensuring operational excellence, strengthening our culture and working together as one team to move our business forward as the leader in beauty. For the third quarter, net sales increased 17.2% to $2.3 billion, and comp sales increased 14.6%. Operating margin increased to 15.5% of sales and diluted EPS increased 35.5% to $5.34 per share. Reflecting these results and our updated fourth quarter expectations, we have increased our outlook for the full year. Scott will share more details about our expectations later in the call. Our third quarter results are a testament to the resilience of the beauty category and our team's ability to drive strong guest engagement that fueled broad-based growth across our business. All major categories exceeded our expectations, and we increased our market share in Prestige Beauty versus the fiscal third quarter last year based on dollar sales according to point-of-sale data from the NPD Group. We delivered growth across our store and digital channels and achieved record loyalty membership of 39 million members. Additionally, we continue to see growth in spend per member across all income demographics. Our strategic framework, anchored by the power of our differentiated model, continues to drive our ambitions and successes as we work to expand our market leadership and drive profitable growth. This afternoon, I'll share an update on our progress against several of our strategic pillars. Starting with our efforts to drive disruptive…

Thanks, Dave, and good afternoon, everyone. Today, we reported results that were better than our initial expectations. Strong double-digit revenue growth resulted in record-setting third quarter operating margin performance. These excellent results reflect the continued focus and hard work of our store, DC and corporate teams. And I want to thank all of our Ulta Beauty associates for working together to deliver another outstanding quarter for our shareholders. Now to the financial results, starting with the income statement. Net sales for the quarter increased 17.2% driven by comp sales growth of 14.6% and strong new store performance. In addition, other revenue increased $20 million, primarily due to credit card income growth, higher loyalty point redemptions and an increase in royalty income from our partnership with Target. Breaking down the comp performance further, comp transactions for the quarter increased 10.7%, primarily driven by strong growth from in-store transactions. Average ticket increased 3.5% due to an increase in average selling price partially offset by slightly lower average units per transaction. The increase in average selling price primarily reflects the impact of retail price increases executed this year. We estimate that price increases contributed about 500 basis points to the overall comp increase. While average units per transaction was slightly lower than last year, the total number of units sold increased about 10% on a comp basis. During the quarter, we opened 18 new stores, relocated one store and remodeled 8 stores. For the quarter, gross margin increased 160 basis points to 41.2% of sales compared to 39.6% last year. The increase was primarily due to the leverage of store fixed costs, other revenue growth and higher merchandise margin partially offset by higher inventory shrink. Robust top line growth and benefits from our ongoing occupancy cost optimization efforts resulted in healthy leverage of…

[Operator Instructions] And our first question comes from the line of Steven Forbes with Guggenheim Securities.

Dave, Scott, I wanted to focus and start with member engagement. But Dave, curious if you can expand on how member engagement trends within the recent member cohorts differ or I guess, are similar from the more mature cohorts in terms of retention, repeat behavior, the maturation of wallet share, channel preferences, really just any color that helps maybe underpin your conviction for a positive comp outlook next year.

Great. Thanks, Steve. Yes, as I said in the remarks, our loyalty program, our membership is vital and critical to our long-term success and one that we're extremely proud of what we've built the relationship that we have with our guests. Yes, I guess, a few things that I'd call out. Naturally, our longer tenured. You get -- if you're tenured 3-plus years, we see kind of a higher level of retention, higher level of engagement that tends to grow over time. Greater percentage of our guests, the longer they're here, move into our higher levels, platinum and diamond levels. So naturally, with that tenure comes greater engagement. And as I mentioned, one of the drivers of our third quarter growth, 9% growth in our total membership was healthy retention and it's been a big focus for our entire team. Our loyalty team, our store teams, our digital, everybody that participates into delivering a great experience. So that's key and really job one is engaging and retaining our existing guests. Our newer members that we acquire in stores, online and increasingly with our partnership with Target play an important role. Their spend per member makes sense. It's on average lower, and we work hard to get them into the full Ulta Beauty experience. Often they enter into one category or one experience. They might come in store, we try to move them online. They might come in to makeup, we try to move them into skincare, get them into services. We have a full suite of activities and experiences designed to engage our new members through -- and including their what we call their sophomore year, their second year with us, which is important pivot year into long-term retention. So we look across all spectrum, what we're excited about now and encouraged by is we're seeing strength across all sectors, all income demographics, all geographies. We have a healthy member base. That's what's driving the 9% growth in our loyalty and of course that, in turn, played a big role in the sales performance we had in the third quarter.

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

Congrats, great quarter. I guess, Scott, I was going to focus on the margins with you. Merch margin is better in 3Q. It sounds like you're off to a good start on the promotional side in 4Q as well. You're going to end the -- I mean, it's a good problem to have, you're going to end the year closer to 16% margins. Your long-term target is 13% to 14%. I guess, just with merch margins as elevated as they are and as healthy as they are, are you guys starting to think more longer term about the AUR dynamics in the business and maybe that this elevated level of merch margin that you're at might be more sustainable than maybe what you had originally thought and maybe that 13% to 14% actually can move a bit higher? I mean it more is a high-level question, not necessarily 2023, but that's kind of where I was coming from.

Yes. Thanks, Ike. I think probably gets to a larger picture versus the AUR piece of your question there. So let me start it, because I know this is at the top of the list for all investors right now as we're thinking about next year. So let me start by saying we are very proud of what the Ulta Beauty team has been able to deliver over the last several years with respect to our operating margin profile overall. We continue to lead the beauty category, capture market share gains and deliver some of the strongest operating margins in all of retail, while also absorbing significant cost pressures driven by an e-commerce business that we doubled the size of since 2019, along with wage pressures, supply chain disruptions, fuel costs and other inflationary pressures across the business. And also continuing to make significant investments to innovate and build a healthy and vibrant business for the long term. Having said that, we've been very transparent with investors all year when discussing the continued beauty rebound in 2022, and that sales trends have been much stronger than what we expected back in the fall of 2021 when we provided our long-term financial outlook. And that sales performance is driving stronger-than-expected operating margins driven primarily by fixed cost leverage, price increase benefits and gross margin that are extraordinary this year and more moderate promotion levels and that the sales increases have been outpacing the inflationary cost pressures that we've seen in our business. So again, big picture, let me just lay out a couple of the bigger variables here as we're thinking about modeling for next year. So again, back to what we referenced in the script, we do expect we can grow sales next year in line with our longer-term 3%…

And our next question comes from the line of Lorraine Hutchinson with Bank of America.

Your sales guidance continues to include pressure from increased points of distribution for prestige. Can you talk about what you're seeing in the fleet when one of these new stores open and how meaningful it is?

Yes. We're certainly watching, monitoring, tracking all competitive activity across the landscape. And as I've said before, our focus continues to really be on offense for us to really leverage what we do best, the unique differentiated model we have. Nobody does what Ulta Beauty does. So our competitive strategy is to lead and to drive our business forward. Having said that, we are watching, there are changes. When stores, competitive stores open, depending on the circumstances, the situation, we can see a relatively minor impact. Typically, over time, our business sustains and recovers any short-term impact. So we're confident. And again, our focus is on delivering what our experience is. What we found over time is doing that allows us to continue to find growth and deliver an experience that our guest continues to want to find at Ulta Beauty.

And our next question comes from the line of Ashley Helgans with Jefferies.

Congrats on the quarter. So we just wanted to ask about the promotional landscape that you've seen heading into holiday. And if you feel discounting at other retailers has been as heavy as initially expected?

Yes. I guess we'd say for holiday, a little early to know exactly. I mean we're right in the middle of the battle here, I guess, with our biggest weeks of the holiday period still ahead of us. And we know we've been -- I think we shared this at our last call and really any time we're talking about holiday. Holiday is a more promotional period. The November, December period is different than the other 10 months of the year because the gifting aspects, the idea that we're not just competing with beauty, we're competing with other gift categories across retail. The landscape, it's hard for us to judge midstream exactly. What we've been delivering is an aggressive promotional, but not wildly different than what we've done in the past. So we've seen consistency there. So far, we're really encouraged by what we're seeing, feeling like Ulta Beauty is well positioned and competing effectively, but we're also monitoring, tracking and ensuring that we close out this next, I guess, 24, 25 days with excellence as we complete the holiday and that's our focus going forward.

Our next question comes from the line of Mike Baker with D.A. Davidson.

I just wanted to ask a little bit about cadence, the month throughout the third quarter. And then November, you said it slowed. I guess I'm just wondering, within your 6% to 8% guidance for the fourth quarter, we know the comparisons get easier in December relative to November. Is that contemplated within the guidance? Or maybe another way to ask it is, is November slow? Did it slow below 6% to 8% and you need to pick up to get there? Or is it within that range?

Well, what I will say is, first on the third quarter, we saw a strong growth throughout the quarter, although October was modestly -- decelerated modestly, but still double-digit growth in each period of the quarter. As is suggested in our 6% to 8% guidance for the fourth quarter, we're anticipating deceleration from what we saw in the third quarter and really throughout the year. And we've been kind of anticipating this all year as we -- our comps are strong. And again, we're in a different type of period in holiday. We're not going to get into specific week-by-week replay yet. We'll -- as I said, we're right in the middle of it. We've got big weeks ahead of us. We'll obviously share, when we share our fourth quarter results, all the details. But what I will say is, again, reflected in the 6% to 8% is an anticipated healthy growth, but not to the level of what we saw in the third quarter, and we're encouraged by what we're seeing so far in the holiday period, knowing that there's a lot of ground still to cover as we complete holiday. And January is a big important period for us as well. So still a lot ahead of us, but encouraged by what we're seeing so far.

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

Great. Scott, I was wondering if you can talk about -- you had mentioned sort of the vendor contribution that was offsetting some of the lower marketing spend. So does that mean that they want to present their brands more aggressively, and therefore, are taking more space either on the 21 Days of Beauty or gift with purchase that type of thing. And then I also wanted to know, Dave, at the beginning of the pandemic, you pulled out of the international Canada opening. Now that the domestic business seems to be on pretty good footing, how are you thinking about kind of reentry into that market?

Yes. So I'll start. So the first part of your question, yes, it's an accounting recognition of how the debits and credits flow through the P&L, Adrienne. So there's really nothing related to the vendor choices or how we work or execute any of those kinds of things. It's just accounting convention, matching up expense with income when it's incremental expenses related to these marketing activities and then the rest of it kind of rolls through the gross margin through our inventory accounting.

And on your question about Canada and international, as you stated, we obviously stopped that early in the pandemic. Right now, we have no plans, consistent with what we shared at our Analyst Day. No plans to expand internationally at this time, although we are always looking for opportunities to find new growth potential. And so in our future at some point, that's possible, but nothing in our immediate plans for sure.

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

Congrats on the quarter. So I'd like to expand a little bit on what you're seeing within the specific product categories. I mean you did note pretty strong growth for all categories. But as we head into the early parts here of Q4 and the holiday season, can you talk about kind of specific trends you're seeing for cosmetics, skincare, fragrance? What categories are maybe requiring a little bit heavier promotional activity for holiday? Just any color you can provide there would be helpful.

Well, I'll start with saying, yes, we're really encouraged by what we saw in the third quarter. And really, we've seen this trend for the first 3 quarters, a strong growth across all categories, which is obviously a great place to be. The strength we're seeing in our business is not outweighted by one specific category. It's balanced across our portfolio. And it's because we've -- our team across both merchandising, marketing, our stores have done a great job engaging our guests in our entire assortment. And so we're excited and encouraged to see strength across -- double-digit growth across all key categories. Each one has unique stories, makeup driven by this increased engagement in social activities, plus strong product trends that are highlighted through social media and new product growth that a spectrum of newness that's really working. So a collection of activity that's coming together, both product newness, marketing newness and engagement opportunities. Skincare continued strength by both science-backed, clinically proven dermatologists recommended solutions. So that engagement that many people elevated through the pandemic has sustained. It's actually our fastest-growing category in the third quarter. Haircare, we've been driving that growth as a leader in haircare and strong trends, a healthy portfolio of newness that continues to drive great engagement. And then really all year, pleased with fragrance and bath. As I look in the innovation and engagement, I mentioned Gen Z being a part of that and really the whole portfolio working quite well across that important category. As we look in the fourth quarter, again, not getting in -- we won't get into any specifics right now. We're in the middle of holiday. And so there's a lot to cover. I wouldn't say there's anything jumping out uniquely for any category from a promotional standpoint. And we come in really with a focus in the fourth quarter of what we call gifting and glamming. And the gifting component is a mix of holiday-specific, but core items that serve all year long, and the team has done a nice job with a balance there. So we feel great about our assortment. It's -- again, we're encouraged by what we're seeing to this point in the holiday and confident that we'll be able to deliver a strong holiday across all of our categories.

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

I have two questions. First one on newness. Because you had a few brands that really anchored newness, and I would imagine contributed towards the upper end of your average ranges this year, so could you talk about your view on innovation, the level of innovation as you think about the next 12 months versus the prior 12? And then you also mentioned in your prepared comments that mass is outperforming for stage, but in your view, wasn't definitively trade down. So could we dig into that a little? Is there more newness in one versus the other? Or any other reason that you think that mass is starting to outperform prestige if it wasn't related to a [ stretched ] consumer?

Yes. So just on the broader idea of newness, it's important to our business and the beauty category always. And as I mentioned in our remarks, typically 20% to 30% of sales are new items, and that's the range that we will land this year and anticipate we'll be able to continue to be in that range going forward. As I -- we did -- Scott mentioned, we had some really important new brands in 2022. But we're excited and encouraged by the outlook. This category, both big brands like some mentioned, but also new and emerging brands that take off and connect. I mentioned a couple of those like Good Molecules, among others. So we've got a portfolio of brands as we look forward into next year and confident about newness, both new brands and newness from our existing brands. That plays a big role. And as we work with all of them and see their pipeline, we're encouraged by what we're seeing. The trends are strong across each of the categories. And we're seeing healthy growth. And we think newness will play an important part in that going forward, knowing that we've got some of these big brands that Scott mentioned earlier to launch or to lap. As it relates to the mass and prestige, we did see mass growing somewhat faster than prestige. But both sides were strong and healthy. So I wouldn't say the strength in mass or the somewhat higher growth in mass as we look at it and do -- and analyze our members didn't come at the expense of prestige. It just a came because mass is strong and there's good newness brands like e.l.f., NYX, Ordinary, La Roche-Posay [indiscernible] strong newness and engagement. And so they're just capturing and growing. But prestige is doing really well, too. So I don't look at them being a little bit higher than prestige as coming at the expense of just their -- several of these brands and some of our bigger brands are hitting the mark and that's working. All of our analysis suggests that we have not seen clear signs of trade down. But I'd reinforce, if there is that, we are uniquely positioned to deliver and support our guests regardless of what choices they make from a price point.

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

Scott, can you help stress test a couple of the key variables that are going to impact Ulta's gross overall operating margin in 2023 between the expense spending that you slated for this year and the step-up that you had originally planned for 2023. Is it reasonable that we think around about that as like a $50 million, 5-0, increase in the next year? And then the second part of the question, you're on pace to have a 15.5% to 15.6% operating margin this year. If you were to take the level of promotional activity from 2019 and apply it, all else being equal, to this year, is it reasonable that you would have like a 14.5% operating margin. So a worst case, if promotions go back to 2019 levels, that would be like 100 basis points to the operating margin.

Is this the Michael Lasser that I know? I mean...

I'm trying.

I appreciate your question, Michael. Yes, and I understand. But we can't -- we're not going to piecemeal out the bits and pieces of the variables and the formula for our EBIT margin for next year. It's just -- it's too hard, and that's why we said we would -- we'll update in March if it's appropriate, okay? And we kind of see how 2022 shakes out here in totality. And then look at our '23 plan, which we're in the heat of battle on right now, finalizing here, which the final step of that is as we get finalized through the holiday season, so to see what the numbers look like. So we either -- as I've laid out for Ike here a little bit earlier in the call, all the different variables and of course, they're all on wide continuums, right? And so we're doing our best to assess each one of those. And coming up with our best idea of how we think it's going to shake out for next year. Again, we're very optimistic about the long-term options for our business. I mean we're in a great position. We've got lots of levers to push and pull, to deliver healthy operating margins over the long term.

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

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

Congrats on the nice quarter. Maybe since you mentioned it a few times now, how much is shrink versus 2019 as a percent of sales? I'm wondering if that's becoming a meaningful number? And maybe you could just help us orient how much incentive comp influences the margin this year. I don't know if I heard that. And I guess, just maybe touching on Ike and Michael's question, you seem to be getting the higher margins the right way here with all the extra sales and gross profit dollars from driving the business and leveraging the fixed costs. You'll be at a revenue level this year we didn't expect to see until 2024, and you're still seeing the algo next year. I know you gave the long list to Ike in the middle of the P&L, but it feels like you earn some upside to the framework at that 13% to 14%. I'm just wondering if you can give us color on what you think relative to the framework you laid out remain structurally higher or what you think needs more investment than what you thought at the Analyst Day framework to bring all those extra dollars down to that 13% and 14%.

Yes, Michael. So working backwards. So the shrink part of your question, I mean, shrink when you think about our category, we are especially susceptible to some of the trends that you see across retail. But that's not new to us. We've been dealing with this since the very early days because of the category we operate in. So I want to make sure I say thank you to our teams, to our LP teams, our store operations teams and all the support personnel that have been working hard to try to mitigate the losses that we've seen step up here, accelerate over the last couple of years. Again, when times get tough, shrink goes up. We've seen that in retail over a long period of time. On the incentive compensation, I would say, we -- for the year, it's going to be flattish versus 2021. Again, our performance has been super strong this year. And then back to the operating margin question, which everyone has, again, we really can't provide any more quantitative detail at this point in time. I would just point back to the long laundry list of different variables that I described earlier in the call. And just that we're a pragmatic team. We're trying to optimize with all the things that we have, the challenges and the opportunities, we're going to do our best to lean in where we can and try to optimize and deliver the best overall financial performance that we're capable of, whether it's the fourth quarter or 2023. You can rely on us for that.

All right. With that, I'm going to wrap it up. And I want to first thank you. Thank you for your interest and engagement in Ulta Beauty. And I want to close by thanking our more than 40,000 Ulta Beauty associates for delivering another excellent quarter while also executing against our strategic priorities. Our teams have been working hard to get our stores, digital channels and DCs ready for this holiday season, and I sincerely appreciate their focus and commitment to delivering meaningful guest experiences across every single touch point. We hope you all have a happy and healthy holiday season, and we look forward to speaking to all of you again in early March when we report results for fiscal 2022 and share our plans for fiscal 2023. Have a great evening, everybody. 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.