Good afternoon, and welcome to Ulta Beauty's conference call to discuss results for the first quarter of fiscal 2023. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Kiley Rawlins, Vice President of Investor Relations. Ms. Rawlins, please proceed.

Thank you. Good afternoon, everyone, and thank you for joining us for a discussion of Ulta Beauty's financial and operational results for the first quarter of fiscal 2023. Hosting our call today are Dave Kimbell, Chief Executive Officer; and Scott Settersten, Chief Financial Officer. Kecia Steelman, our Chief Operating Officer, will join us for the Q&A session. Before we begin, I'd like to remind you of the company's safe harbor language. The statements contained in this conference call, which are not historical facts, may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. We caution you not to place undue reliance on these forward-looking statements, which speak only as of today, May 25, 2023. 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 up the call for questions. To allow us to accommodate as many questions as possible during the hour scheduled for this call, we respectfully ask that you limit your time to one question. If you have additional questions, please requeue. 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, everyone. We appreciate your interest in Ulta Beauty. Fiscal 2023 is off to a good start. For the first quarter, we delivered net sales, operating margin and diluted EPS that were consistent with our internal expectations. Net sales increased 12.3% to $2.6 billion, and comparable sales increased 9.3%. Operating margin was 16.8% of sales and diluted EPS increased 9.2% to $6.88 per share. Our store traffic remained healthy and member growth continued to be strong. We delivered growth across key categories, and we strengthened engagement with the Ulta Beauty brand. I want to thank our Ulta Beauty associates for their focus on creating great guest experiences while continuing to adapt to a dynamic environment and executing our transformational agenda. The operating environment continues to evolve and consumers are exploring how best to navigate the economic uncertainty. Inflation concerns remain high and consumers are spending more selectively while also showing a continued willingness to splurge and treat themselves. Engagement with beauty remains strong, reflecting the prioritization of self-care. Category growth is healthy but moderating as we lap 2 years of unprecedented growth. And as category growth normalizes, promotional activity is increasing. While we do not intend to lead promotional intensity, we will respond as appropriate to protect and expand our share using a variety of tools we have developed and invested in over the last several years. Using the consumer lens of how guests experience Ulta Beauty through our multiple touch points to include our physical stores, our e-commerce business and Ulta Beauty at Target, the Ulta Beauty experience is resonating with our guests and gaining share. As we have seen in previous quarters, sales in our mass category grew faster than prestige categories. It is difficult to know with certainty if the robust growth…

Thanks, Dave, and good afternoon, everyone. As Dave said earlier, today, we reported results for the first quarter that were generally in line with our expectations. We entered 2023 anticipating that the unprecedented growth in the beauty category would moderate and that the promotional environment would increase. These trends materialized in the first quarter and are reflected in our results. Starting with the income statement. Net sales for the quarter increased 12.3%, driven by 9.3% growth in comp sales and strong new store performance. In addition, other revenue increased $19 million, primarily due to growth in both credit card income and royalty income from our Target partnership. The comp sales growth for the quarter was driven by an 11% increase in transactions, primarily due to double-digit growth in store traffic, which more than offset a 1.5% decline in average ticket. The decline in average ticket reflected lower units per transaction, which more than offset higher average selling price. We estimate that product price increases, most of which were executed last year, contributed about 400 basis points to the overall comp increase. Looking at the cadence of sales through the quarter, momentum from post-holiday tailwinds continued into February, which also benefited from lapping COVID headwinds last year. Comp sales subsequently moderated to mid-single digits as we move through the quarter. During the quarter, we opened 5 new stores and closed one store. In addition, we relocated one store and remodeled 2 stores. For the quarter, gross margin was down 10 basis points compared to the same period last year at 40% of sales. Higher inventory shrink, lower merchandise margin, higher supply chain costs, and deleverage of salon expenses were partially offset by strong growth in other revenue and leverage of store fixed costs. As Dave shared earlier, we continue to experience…

[Operator Instructions] Our first question is from Simeon Siegel with BMO Capital Markets.

Dave, I know you talked about the mass versus prestige dynamic within the Ulta offering. Do you have any view as to whether you're seeing any signs of external trade down, I guess, either customers trading into or out of Ulta from somewhere else? And then Dave or Scott, I was hoping you could speak a little bit more about the decline in ticket. Any opinions on the lower UPT despite the higher ASP and transactions? I don't know if you think this is because of a purse tightening or if it's a mix dynamic or compare. Just any further color there would be helpful.

Yes. Thanks, Simeon. What we are seeing, as we said in the call, is mass and our business is growing faster than preceding -- we saw that in some previous quarters right now. And so a little bit of detail about that as we look underneath. As we look across income levels, there's actually good -- there's growth across all income levels, across all income cohorts, roughly equivalent across all cohorts, although the growth rate did moderate from Q4 pretty consistently. . As we said, traffic remains strong. Double-digit traffic average spend per member increased. Average ticket did decline as we have fewer units per transaction. When we look at the mass category, it's -- we have some exceptional newness going on and some really high-performing brands in our mass category, brands like e.l.f., NYX, The Ordinary, La Roche-Posay. So we know that is certainly contributing to that. And it's -- so the fact that mass is growing higher than prestige, it's difficult for us to exactly parse apart the core driver of that. But we know for sure, there's a high level of engagement in those brands because they are culturally relevant and driving great engagement. At the same time, we have strong growth and some strong newness on our prestige side of the business as well. Prestige skincare comping double digit as an example of that. So we're watching closely. What we feel is the total category remains strong. Engagement is high. As we've talked in previous quarters, this is an emotionally connected category that's important, and coming out of the pandemic, even more important in overall self-care and wellness and we expect that to continue. But the high level of growth that we've seen in these last 2 years, as we've talked about in several quarters, will moderate. We think ultimately getting back to more the high end of historical average, but we know engagement's high, and we continue to be encouraged by overall consumer engagement.

Yes. So overall, I would just remind you, Simeon, that we did state, so total units are up across the enterprise, right, for the period year-over-year, and total spend per member is up year-over-year as well. So again, great evidence of a healthy, strong business model at play. Very strong traffic trends in both channels, but especially in our brick-and-mortar channel that we're pleased to see. When we look at the specific units per transaction, again, it was down. It's been decelerating a bit over the course of the last 3 or 4 quarters, I guess, I would say. So again, not totally surprising to us to see that. And again, we would take away from that what most people, just looking at the trends and looking at how consumers, are just being a little bit more selective now than maybe they were at this time last year. But we're trying not to read too much into that at this point in time.

Our next question comes from Rupesh Parikh with Oppenheimer.

So I wanted to go back to your commentary on the promotional environment. So clearly, it's gotten more competitive out there. I was just hoping to get more color in terms of what you guys are seeing. And if you look at some of the promotions out there, how is the gap compared to maybe what we've seen maybe pre-pandemic 2019 earlier?

Yes. Well, as I mentioned on the call, we anticipated and planned for it to be more promotional this year coming out of all the trends that we've talked about over the couple of years. And what we saw as the quarter progressed that actually promotional activity did increase and was even a little bit more than we had anticipated through that quarter. So when we look at broader competitive activity, we know this is a strong category. It's an important category for all of our competitors. And our long-term approach to this has been to not to lead the promotional intensity, but to make sure that we are competitive and continue to be the leader and gain share in the environment. And so that's what's driving some of the competitive activity and the increase in promotional. As versus 2019, we're still below 2019, and we've planned and anticipate that, that will be the case through this year. As you know well, Rupesh, the 2019 and leading up to that was a highly promotional period. We're not anticipating getting back to those levels. But as we've talked about really throughout the last several quarters, we anticipated it getting more promotional, and we're certainly seeing that in the environment. As a reminder, we worked hard for the last several years and certainly through the last 2 years to expand our CRM capabilities to grow our loyalty program. 9% growth in our loyalty program, 41 million members now, gives us some new tools, some new capabilities to be more strategic, more pinpointed in our promotional activities targeted with those efforts, and we've employed those and we'll continue to be strategic and thoughtful as we look ahead in the environment as the year unfolds.

Our next question is from Steve Forbes with Guggenheim Securities.

This is Anders Myhre, on for Steve Forbes. I wanted to start with services. So maybe a two-part question. One, outside of the details in the prepared remarks, can you comment further on the trends you were seeing broadly within services and possibly measured by member utilization rate? And two, can you provide an update on the percentage of consumers that make an in-store purchase after receiving a service? I believe in the past, there is approximately 50%. So I wanted to see if there's any moderation there.

Yes. Well, thank you for the question. Yes. So again, our salon service business was really strong again in the quarter. We -- what we like that we've seen is we -- in the prepared remarks, we talked about these backbar events. So not that we specifically ever break out purchase by service guests, but what I can share with you is that our backbar events, what we've seen is 90% of guests that are purchasing through those activations are new to those brands. So the guest experience and services is really resonating when we get them in the chair. [ Hot ] and color is the main driver of our overall services business. And then the trends that we're seeing really are around health care -- hair care around loss of hair treatments, and that also helps with our average ticket. So the business is really strong. Our stylists are really critical to our overall business. We hired over 950 stylists in this last quarter. So the business is strong. We've got capacity, and it's a unique proposition that we have here at Ulta Beauty.

Our next question is from Krisztina Katai with Deutsche Bank.

I had a question on the Ultamate Rewards program, right, which continues to set records, both with membership and spend per member, has your share of wallet increased with your members, given some of the successful high-profile brand launches and also the luxury assortment that you're creating? And I also wanted to ask what type of return do you see on some of the more personalized or tailored promos that you offer whenever needed as you leverage the vast amount of data that you have?

Great. Well, yes, our loyalty program, Ultamate Rewards, is one of our greatest assets, and I'm really excited that the investments that we've made, the work that the team does, the commitment that our store teams have driving that experience continue to pay off. We're really proud of 9% growth in members in Q1, spend per member growth. Our strategies, our plans are working. We do -- separately, we do believe we continue to improve share of wallet of our best guests. I talked about Platinum and Diamond members being -- showing strong growth. We believe we continue to add new experiences, add new brands, engage them in more touch points. Everything that we do really is designed to increase share of wallet. If we have a store-only guest, to get them to shop, to use our salon, to shop online, to download our app, to get our credit card, to shop at Target. All these experiences collectively add to share of wallet. And we have continued evidence that when we do that, it works to increase share of wallet. And one example, a store-only guest that starts shopping us in an omnichannel online way. Their spend with us increases over 2.5x. So we know we're improving share of wallet across our engaged guests. And as we add new members, which we continue to do as we grow, we're on the journey of getting them more engaged with all of our touch points. So we are committed to that. We're finding a lot of success. As far as some of the personalization, that's another aspect of our experience that we've been working hard on for several years, and it is working and paying off. The return of our programs around things like replenishment or engaging in new categories are working. We see strong return. And in fact, the return is strong enough that we're going to continue to invest more in data capabilities, bringing in new tools, leveraging innovation across all ways of experimenting and engaging with our guests. So we're seeing good returns, and we see there's a lot more opportunity for us ahead. In the world of personalization, you will buy our data.

Our next question is from Ike Boruchow with Wells Fargo.

Scott, I was just wondering if you could give more color on the shrink theft component of what's impacting you guys in the P&L. And I'm just asking, it does sound like it's a fairly meaningful dynamic that's taking place. And if there's any way you can kind of quantify that so we kind of know what the impact was in Q1 or what you're now pricing in for the remainder of the year? Anything there would just be a little bit more helpful so we understand just how impactful it is to your gross margin.

Yes. So it was -- when I think about the financial results and totality, and really shrink was the thing that surprised us in the quarter, and that's really the driver when we think about the operating margin adjustment for the year. So we knew sales were going to moderate a little bit after 2 spectacularly strong years. We knew the promotional environment was going to ramp up some. And maybe it's slightly richer than we were expecting, but that's not the driver. The driver is shrink, by far. And so that's what put a pretty meaningful drag on our first quarter, and we're expecting those trends to continue the rest of the year. Again, coming into 2023, we thought the shrink trends were going to moderate a little bit because of some of the investments we were putting behind mitigation tactics. But they haven't resonated yet. We're still hopeful. We're still -- our teams are doing a great job. A lot of effort is going into this. But from a financial standpoint, we're not banking on any improvement the rest of the way. So kind of remain a challenge for the rest of the year.

Ike, I'm glad you asked. I just -- I'd add the -- as I mentioned in the script, this is a really important and critical topic. There's certainly the financial impact that Scott described. But this is impacting our associates. It's impacting our guests. And unfortunately, despite our efforts, and investments, it's getting worse, not better, and we need to -- we're working hard. And I mentioned this, but what it's going to take is our efforts, and I'm going to ask Kecia to describe in a bit more detail some of the steps we're taking. But we're working hard within what we directly control, but we need support from other -- partnership with other retailers, support from local leaders, from law enforcement, from DAs, from national governmental leaders. This is a macro problem that needs a macro answer, and I'm personally heavily involved in it to help try to find solutions, both for our business and hopefully contribute to some answers across retail. But it's an important topic and one that I'm focused on. But we are doing a lot. Kecia, do you want to highlight a few of those things?

Sure. Yes. We'll be in 70% of the chain by the end of this year, with locked fragrance cabinets as fragrance is one of the base target areas that we see them going after. And we're also increasing labor in those specific locations. We're training and educating our associates how best to handle these types of situations. It's upsetting. If you're shopping in a store, and you see this activity happening, it's pretty shocking. I'm sure you've seen some of the reports that have come out there, the camera systems catching these groups coming in. So we've invested in security guards, armed security guards in some locations, partnering with our landlords at what can we do to help police the parking lots and throw them from even coming in. So it's a full court press out there, and we're keeping the communication lines open with our associates when this happens. Like I said, very disturbing and deciding to course-correct as an entire retail group.

Just one final note, Ike, on that one. So for quantification purposes, as a reference point in the first quarter, the shrink deleveraged above expectations, totally offset all fixed store cost.

Our next question is from Korinne Wolfmeyer with Piper Sandler.

I'd just like to touch on -- a little bit on your customer retention efforts. I know you've talked a bit on the loyalty program and how that's been doing. But as we think about maybe consumers doing a little bit more pressure in their wallet and maybe seeking out more, say, mass retailers or lower-cost items. How are you ensuring customers stick with Ulta and keeping that retention rate strong?

Well, Korinne, this is, as you would imagine, a huge focus for our entire team. And everybody in the company really participates in loyalty and retention. And that fundamentally starts with delivering a great experience. We have 50,000 associates in our stores that are committed to delighting our guests every time they walk in, and that's key to retention that every guest experience is a positive uplifting fun, engaging experience. And I'm proud that, that is so consistently the experience that our guests receive and what they love about. Our retention remains strong, and we -- and that was an important driver of our 9% growth in loyalty in Q1. And we've got a number of activities from, as I said, the in-store experience with all of our digital touch points, our experience and connection that we have with our guests through -- through Target, our Ulta Beauty at Target, and all of our personalization and communication efforts really engage and excite and delight our guests. So we are pleased with retention and feel that we have a very strong, probably best-in-class retention rate that we do. And as things -- as the environment shifts, and I talked about some of that in the script and an earlier question about shifts between mass and prestige. And as that changes, again, that is one of the unique aspects of Ulta Beauty. Nobody does what Ulta Beauty does. We're the only ones that offer from entry-level price, the masstige, to prestige, to luxury, all price points, all categories. So as long as we keep delighting and exciting our guests, if they choose to adjust their spending or maybe decide to buy different price points, they can do that within Ulta across all aspects, and that's been a key aspect -- a key part of our business and one that we'll continue to lean on and leverage going forward.

Our next question is from Olivia Tong with Raymond James.

I want to see if you could talk a little bit about the incremental promotions coming from, whether it's certain categories, certain channels that are pushing it harder as they try to expand or whether it's fairly broad-based. And then you said you -- I know you said you won't leave the promos, but of course, you have to be competitive. Can you talk about how your promo levels compare to your peers? And is there more you can do to leverage your loyalty members and the data that you have that you could potentially promote less [ versus previous ] years and still stay at the same level of competitiveness?

Yes. First, I'd say the incremental promotion we see it happening. We see really an intense competitive environment across all parts of the beauty category. And again, because of our model, mass to prestige, to luxury, we are directly competing with everybody that sells beauty. And so we watch and track and we're seeing promotional activity across mass, across prestige, across luxury. And so that's all part of it. And so I wouldn't say it's any one part of the category. As far as exactly, we don't have perfect insight. So we don't know exactly what each of our competitors are doing and understand all of their kind of internal measurements. But we watch very closely, track year-to-year, observe what's happening and then we do get some industry data that gives us a macro picture. So for us, it is just about making sure that we're delivering a great experience to our guests and delivering the right value at the right time. And you touched on it, but we have invested heavily in our capabilities to personalize and be more targeted. And that's what's allowed us to reduce our promotion from the levels that we saw in 2018 and 2019. And even as we plan for a more elevated level this year, as I mentioned earlier, we believe it will be below those levels, in part because of the tools that we have, the fact that now we have 41 million people. We have new personalization capabilities. We've got better CRM experience that allows us to be more pinpointed. That doesn't mean we won't do some broad scale offers here and there as they make sense for us. But under the covers, we're doing a whole lot more value add at a more personalized level, and that's paying off in an important way.

Our next question is from Michael Lasser with UBS.

One of the narratives from the skeptics that's going to come out of this report is that their hypothesis is coming true, trends are going to slow, promotional activity is going to increase and that's going to put pressure on Ulta Beauty's margins, and it's probably going to now feature some element of shrink as well. So if you look at where your margins are on pace to be this year, somewhere in the mid-14% range, you add the increase in shrink and the dilution that that's going to have on your margins. And if promotional activity were to go back to 2019 levels, what would that mean for your margins in that scenario?

Let me start, and I'm going to ask Scott to give a bit more color, but -- or definitely more color on specifically around your question. What I'd say is we're really confident in our business. We guided for this year that we'd be delivering 4% to 5% comp growth, and we're committed to doing that. That's what we set out to do, and we are on track to do that. . We've made an adjustment to our operating margins. Scott will give more detail on that, but that's a reflection of some very specific things. But we remain confident in our long-term operating margin and our profitability over time. And we will go address some of the shrink issues. We do not believe promo is going to get back to historic highs, and in part because of what I just talked about, the impact -- our ability, our capabilities around personalization and others. So I understand that some of those questions might be out there. But I'll tell you, we are committed to delivering what we set out to do. We are off to a good start to doing that in Q1: 9.3% comp, strong operating margin, strong EPS growth. And we believe our model is uniquely positioned to navigate whatever comes our way, and we've got the right team and the right strategies in place. So that's kind of how I feel about it at a macro level. But Scott, any color specifically about Michael's question?

No, I would just add that, again, shrink and slightly richer promotional mix, temporary headwinds, we are very ready and able to be able to react to those kinds of things. So again, to Dave's point, with the toolbox that we have and the levers that we have to optimize this business, we're still very confident the 14% to 15% is the right range to be in. Things like UB Media, that's just kind of really getting off the ground, is a long-term margin accretive part of our business model. Project SOAR, digital store of the future, all these other large strategic initiatives we have underway right now are going to provide meaningful benefits for our stakeholders over a long period of time. So very confident in our [indiscernible].

Our next question is from Susan Anderson with Canaccord.

I was wondering if you could talk about the health and wellness business and how that's been trending relative to the rest of the store? Are you seeing a pretty good response from the consumer in terms of adding that to their basket? And then also, where do you see that going longer term?

Yes, I'm glad you asked as wellness is it's an important growth opportunity. I'd start -- before I talk specifically about the wellness shop and the assortment we have there, I'd say this overall idea of wellness and self-care and the connection it has to beauty, I talked about this for a little while. So you may have heard this before, but it is an important trend coming out over the last couple of years that we think will drive continued growth and engagement. The fact that more and more consumers understand the importance of beauty as part of their overall wellness routine is a very strong positive. It's one that's driving so much innovation, both in products specifically designed for wellness but also across makeup and fragrance and just bringing in more the idea of wellness into all forms of innovation. We did launch our wellness shop in May of 2021. We're currently in about 800 doors. We'll be adding more doors this year to continue to expand that presence. We have a strong presence online. We have 140 brands, 700 SKUs across category focus, and it's a great experience. It's working really well. A number of really engaging brands like Love Wellness, Truly, Kitsch, megababe, GOLDE that we just added, Lemme by Kourtney Kardashian, there's a strong experience, high level of engagement across all 6 of our segments and pillars. And we're really pleased with its impact in connection. But we're also just getting started in that assortment. And so we see good growth in that area over time, and we're excited about the potential of that business for the long term.

Our final question is from Simeon Gutman with Morgan Stanley.

Everyone, I think you had the wrong Simeon to start the call, but it's okay. My question is two parts. The first part is actually related to his earlier question, thinking about the AUR and some of the innovation that's driven some of the inflation, whether or not the customer is reaching some resistant point and the number of items they put in the basket. And second, how to think about shrink and just what level of accrual given we're seeing it still ramping across other retailers, how much you've accrued for and how much could work to get.

Maybe I'll start with shrink. So I addressed here just a few minutes earlier, just directional in the first quarter, shrink basically offset fixed store cost leverage entirely. So again, remember, that's been trending upward over the last couple of years with a huge peer step on the top line, Simeon. And so we would expect that trend to continue through the rest of the year. We're not -- we were expecting some moderation in 2023, but at this stage, it doesn't seem like we're going to be able to deliver that. So not optimistic about how that plays out in gross margin the rest of the way.

Yes. And Simeon, it's good to book end our Q&A by Simeon, so we're glad to do that. And I'd just say, yes, on the point, I mean, I think we covered some of the thoughts there about how we're seeing both spend per member, AUR, the units. I mean there's a lot of positive indicators on our business, and we're still working hard to get a read on how our consumer is navigating. We know there's pressures out there, but we also see a high level of engagement in beauty. And so our focus now is to continue to drive great engagement across all aspects, newness, innovation, our core business, to get them engaged in all of our touch points and make sure that we're delivering a great Ulta Beauty guest experience because we know when we do that, they respond. So we're tracking all that carefully. We'll continue to report out in future earnings calls and make sure that we are leading the category appropriately. So with that, let me just say I'd like to close by, again, thanking all of our Ulta Beauty associates across our stores, distribution centers and our corporate office offices for delivering another strong quarter for our stakeholders. We know the environment will continue to evolve. But as I've said, we remain committed to our long-term growth strategies, and we are very confident in our team as we look forward to build -- continue to build the foundation that we set here in the first quarter. So we look forward to speaking to you all again when we report results for the second quarter on August 24. Thanks. I hope everybody has a nice Memorial Day weekend, and we'll talk to you all again soon.

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