Ulta Beauty Inc

NASDAQ:ULTA

Earnings Call Transcript 2022-Q1

[Operator]

Good afternoon, and welcome to Ulta Beauty's Conference Call to discuss Results for the First Quarter of Fiscal Year 2022. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [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.

[Kiley Rawlins, Vice President of Investor Relations]

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 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 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. To allow us to accommodate as many questions as possible during the hour scheduled for this call, we respectfully ask that you please limit your time to one question and one follow-up question. If you have additional questions, we ask that you re-queue. 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?

[Dave Kimbell, Chief Executive Officer]

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 Ultamate Rewards loyalty program, introduced innovative digital experiences for our guest 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, makeup, and skin care all delivered double-digit comp growth against the first quarter last year.

Importantly, sales of makeup exceeded pre-pandemic levels in both mass and prestige cosmetics. The makeup recovery is progressing faster than we expected coming into this year. Compared to the first quarter of 2021, prestige cosmetics outperformed mass cosmetics, driven by new and expanding brands and a strong 21 Days of Beauty event.

From a trend standpoint, foundation, concealers, eyeliners, and lipstick continue to deliver strong comp growth. New brands like Fenty Beauty, REM Beauty by Ariana Grande, and Treslúce, a mass cosmetics brand founded by Latin Musician, Becky G, contributed to growth during the quarter.

While new product launches from a wide range of brands, including Clinique, Lancome, NARS, e.l.f. and NYX also delivered strong sales growth. In addition, this quarter, we expanded MAC into 233 additional stores and introduced CHANEL Beauty into 104 stores.

Even as they increase makeup usage, beauty enthusiasts are maintaining their skincare routines. As a result, skin care delivered another quarter of strong double-digit sales comp on top of robust double-digit growth in the first quarter last year.

Moisturizers, eye serums, and acne treatments continue to drive category growth in the quarter. We also saw strong growth in sun protection and self-tanning that consumers increased travel and social activities.

Newness continued to appeal to guests with new brands, including Drunk Elephant, Fresh, Supergoop! and Good Molecules, as well as new products from Tula, StriVectin and First Aid Beauty, contributing to the category growth during the quarter and established brands, including Peter Thomas Roth and La Roche-Posay continue to benefit from engaging social media content.

Haircare delivered another quarter of double-digit growth, driven by strong guest engagement with newness and our core assortment as well as successful salon back bar takeover events.

Trends focused on hair health like damage repair, color care, and scalp treatments continue to resonate with guests and interest in hair styling aids increased with the rise of social occasions.

New brands like OLAPLEX as well as new product launches from Briogeo, contributed to category growth in the quarter. And Tyson's Hair Wrap styling tool continue to be a member favorite.

Guests continued to engage with core professional brands like Redken, Pureology, and Biolage and our salon back bar takeovers drove strong growth for Fekkai and IGK as our stylists engaged guests with these brands.

Consumer strong engagement with the fragrance category continued, driving double-digit growth on top of a phenomenal results last year. Exciting newness, a strong Valentine's Day and strategic events, including 21 Days of Beauty and Spring Haul, contributed to this performance.

The in-store launch of Ulta Beauty exclusive Billie Eilish, as well as Newness from Gucci and Carolina Herrera resonated with guests, and our monthly Fragrance Crush program drove growth for established brands like YSL and Valentino.

In addition to driving core category growth, we are investing in key cross-category platforms to drive guest engagement and market share growth. Since launching Conscious Beauty in 2020, we have continued to expand brand participation, increase guest awareness and drive trial. At the end of the first quarter, more than 280 brands offered certified products in at least one pillar.

And while we continue to certify existing brands and SKUs, many new brands are launching with certification in place. One such example is Andrew Fitzsimons, a hair care brand that offers proprietary bonding technology at accessible price points, which was certified across all four pillars when it launched in the first quarter. Another example is SKIP, an Ulta Beauty exclusive hair and body care brand packaged in a fully recyclable, shower-friendly paper beauty carton, which also launched in the first quarter.

Moving now to our efforts to continually expand and support our assortment of BIPOC brand. We launched five new BIPOC brands, BeautyStat, ROSEN Skincare, FENTY BEAUTY, [indiscernible] Beauty and MIELLE Organics. We also expanded Black Girl Sunscreen into all stores.

To promote trial, we introduced a spotlight display in select stores to showcase our bipack founders. In recognition of Black History Month, we launched a compelling omnichannel campaign to recognize, celebrate and support the black community and black-owned brands. We feature black-owned brands in stores and across enhanced digital and print channels, and we offered compelling loyalty rewards on black-owned brand purchases to drive awareness.

Finally, our Wellness shop continues to resonate with guests as they prioritize self-care and wellness journeys. We recently expanded the shop to an additional 266 stores, now reaching about 55% of our fleet and refresh the digital landing page on ulta.com. With easy ways to explore our curated assortment and helpful tips about easy self-care routines, guests can now more readily incorporate wellness into their busy schedules.

Turning now to our efforts to evolve the omnichannel experience through a connected physical and digital ecosystem, All In Your World. Store traffic trends were strong in the quarter as guests capitalized on their preference for in-store shopping with fewer COVID restrictions in place than last year and store capacity returned to normal levels. While store traffic is still below pre-pandemic levels, the trend is improving.

As a core differentiator for Ulta Beauty, beauty services deepen engagement and loyalty through human connection. Consumers are resuming their beauty service routines as they participate in more in-person activities. In the first quarter, our beauty services delivered double-digit comp growth, primarily due to increased capacity and new offerings, including OLAPLEX Repair & Protect and Express Color by Redken.

To meet growing guest interest and services and experiences, we continue to expand our in-store events and enhance our service offerings. In April, we relaunched makeup services in all stores, just in time to support special events such as proms, graduations and weddings. As guests are coming back to shop in stores, they are also maintaining their use of convenient engaging digital channels. Reflecting these trends, we continue to enhance our omnichannel offerings, including buy online, pickup in store and same-day delivery.

During the quarter, BOPIS increased 26% to 21% of e-commerce sales, compared to just 16% last year. While still limited, guests are increasing their use of our same-day delivery options. Based on engagement trends, we recently expanded same-day delivery to five new markets, including New York City. And today, about 30% of our stores offer guests this convenient option.

During the first quarter, we continued to expand and enhance our digital experiences. As part of our Digital Store of the Future Journey, we introduced a new homepage for both ulta.com and our mobile app. We also launched two Virtual Try-On tools, each powered by technology developed by companies we’ve invested in through our digital innovation fund.

First, we launched GLAMlab skin advisor 2.0, powered by global artificial intelligence startup, pot.ai [ph]. This best-in-class skin analysis technology enables us to provide guests with a more accurate skin diagnosis, which has resulted in stronger satisfaction with the tool.

We also launched GLAMlab hairstyle try-on powered by RE/STYLE, a beauty tech start-up that uses artificial intelligence and machine learning to enable virtual try-on of more than 50 different hair styles, including options by gender and texture. We also introduced innovative AR and virtual reality experiences to support our launch of Fenty Beauty and R.E.M. Beauty.

Finally, we continue to enhance and expand our partnership with Target. This leading partnership is part of our long-term strategy to build brand loyalty and engagement with Ulta Beauty.

We are seeing existing ultimate reward members, take advantage of the convenience of shopping while earning points at Ulta Beauty at Target. And we are leveraging Target's strong traffic to introduce Ulta Beauty and Ultamate Rewards to new guests. During the first quarter, we opened 26 Ulta Beauty at Target shops, ending the quarter with 127 locations.

One of our priorities in 2022 is to leverage marketing to build engagement as we scale. As an example, in support of our 21 Days of Beauty event, we co-created brand-relevant digital and in-store communications with Target to support this strategic Ulta Beauty event, which resulted in strong performance and guest engagement across both channels.

Moving to our efforts to drive love, loyalty and emotional connection with Ulta Beauty, by expanding and deepening our presence at the heart of the beauty community. During the first quarter, we continued to optimize our marketing mix to reach guests through the most relevant channels and platforms. We leveraged audience data to execute a targeted digital-first approach to 21 Days of Beauty and Spring Haul, driving greater awareness and increased sales.

We launched content partnerships to engage new audiences and increase awareness of our cross-category platforms, and we created innovative marketing campaigns to support key brand launches.

We ended the quarter with 37.7 million active members in our Ultamate Rewards loyalty program, 17% above the first quarter last year. This increase was primarily driven by continued member reactivation growth, new member acquisition and strong retention.

Our strategy is to reengage lapsed members, many of whom dropped off during the pandemic are delivering results. Additionally, new member conversion remains strong in stores and online conversion rates are improving, as we increase the visibility and value of Ultamate Rewards throughout the guests online journey.

I'm also excited to share that we launched UB Media, our retail media network. Through UB Media, we will harness the power of our exclusive first-party data to transform the way brands connect with beauty enthusiasts.

Building on our successful digital marketing partner program, UB Media offers brand partners an enriched portfolio of advertising products and channels as well as enhanced measurements in reporting, including audience and creative insights.

The media network offers advertising, access fee display, video, search, product listing ads, social and influencers on both open web platforms and Ulta Beauty-owned properties.

In addition to unlocking a new income stream while helping brand partners build digital campaigns to effectively engage audiences, we expect to see sales benefits as campaigns leave consumers back to Ulta Beauty properties to transact.

Underlying these customer-facing priorities is a focus on to drive operational excellence and optimization. Last fall, we shared our updated supply chain strategy, including our plan to build market fulfillment centers, or MFCs, to supplement our existing DC network capacity and provide greater speed to stores and e-commerce guests in specific markets.

We recently broke ground on our first MFC in Greenville, South Carolina, and expect the facility will be fully operational in the third quarter next year. In addition, our planned retrofit of our full service distribution center in Greenwood, Indiana is on track to be complete in the second quarter of 2023.

I am confident our infrastructure investments, including key supply chain and IT investments, will enable Ulta Beauty to continue to deliver strong results and capitalize on future growth opportunities.

In closing, a few weeks ago, I had the privilege to welcome nearly 2,000 members of the Ulta Beauty team to our Annual Field Leadership Meeting, bringing together our general managers, district managers, field support teams and brand partners for several days of recognition, leadership development, and product education.

The excitement was palpable and the optimism about our future was truly inspiring. We celebrated everything we have accomplished throughout the last two challenging years and set the stage to deliver on the incredible opportunities ahead for Ulta Beauty. I left the event even more excited about all we can do together as one Ulta Beauty team to refine -- redefine how the world sees and expresses beauty.

As we look forward, the world around us continues to be dynamic. Product prices and operating costs are rising and consumers are increasingly concerned about the impact of inflation.

While it is difficult to forecast how inflation may impact consumer behavior going forward, we are monitoring guest engagement and remain encouraged by the underlying trends we see in our business and in the beauty category. I am confident our team will continue to navigate near-term pressures, and I remain excited about the long-term opportunity for Ulta Beauty to continue to deliver profitable growth.

And now, I will turn the call over to Scott for a discussion of the financial results. Scott?

[Scott Settersten, Chief Financial Officer]

Thanks Dave and good afternoon everyone. I want to echo Dave's comments 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 six 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, partially offset by lower merchandise margin. Robust topline growth and benefits from our occupancy cost optimization efforts resulted in meaningful leverage of store fixed costs. Despite experiencing double-digit growth in supply chain costs, primarily resulting from increases in wage rates, transportation costs and fuel surcharges, strong topline growth during the quarter enabled us to leverage supply chain costs.

As sales growth moderates through the rest of the year, we expect higher supply chain costs to become more of a headwind. Reflecting strong sales performance of stores, channel mix was favorable this quarter. As a percentage of sales, e-commerce sales were about 400 basis points lower than the first quarter last year. Although the impact of lower promotions was favorable during the quarter, merchandise margin was lower than last year, primarily due to the impact of brand mix and lapping benefits from favorable inventory reserve adjustments last year.

As planned, SG&A increased 12.9% to $501 million. As a percentage of sales, SG&A decreased 150 basis points to 21.4% compared to 22.9% last year. Lower marketing expenses and leverage of store payroll and benefits due to higher sales were partially offset by deleverage of corporate overhead, reflecting investments related to our strategic priorities.

As Dave shared, we recently launched UB Media, a more sophisticated and expanded version of our digital marketing partner program. Reflecting the expected scaling of this platform, we are offsetting the incremental marketing expense of the digital campaigns we manage for our brand partners, with the vendor income that is a direct reimbursement for these specific costs within total marketing expense. This resulted in about 70 basis points of favorable impact to SG&A in the quarter.

Operating income increased 43.4% to $437.7 million compared to $305.3 million last year. As a percentage of sales, operating margin increased 290 basis points to 18.7% of sales compared to 15.8% last year. Diluted GAAP earnings per share increased 53.7% to $6.30 per share compared to $4.10 per share last year.

Moving on to the balance sheet and cash flow statement. Total inventory increased 16% to $1.57 billion, compared to $1.35 billion last year. In addition to the impact of 28 additional stores, the increase reflects inventory purchases to support key brand launches, as well as continued efforts to maintain strong in-stocks of key items to support expected demand and mitigate anticipated global supply chain disruptions.

Capital expenditures were $71.1 million for the quarter, compared to $34.6 million last year. The increase in capital expenditures reflects a more normalized investment cadence versus the last couple of years and includes investments in IT systems, merchandising improvements and store maintenance and other.

Depreciation was $62.8 million compared to $70.6 million last year, primarily due to a shift of IT investments from capital to cloud expense. We ended the quarter with $654.5 million in cash and cash equivalents.

In the first quarter, we repurchased 332,000 shares at a cost of $132.8 million. At the end of the quarter, we had $1.87 billion remaining under our current $2 billion repurchase authorization.

Turning now to our outlook. Reflecting our strong first quarter performance and sales trends we've experienced so far in the second quarter, we are increasing our outlook for fiscal 2022. We now expect net sales to be between $9.35 billion and $9.55 billion with comp sales growth between 6% and 8%.

Our updated outlook reflects trends year-to-date, while continuing to consider uncertainties that could impact the second half of the year, including inflationary risk to consumer spending and the impact of increased points of distribution for Prestige Beauty.

We anticipate comp growth will be in the low to mid-teens in the first half and then moderate to low single-digit growth in the second half. We now expect operating margin for the year to be between 14.1% and 14.4% of sales.

We anticipate operating margin will leverage in the first half, but deleverage in the second half, as sales growth moderates and cost pressures and planned investments have a greater impact.

We continue to expect gross margin for the full year will be lower than fiscal 2021, driven primarily by lower merchandise margin, resulting from the impact of brand mix, more normalized assortment management activity and a more normalized promotional environment. In addition, we believe fuel prices will continue to be volatile, resulting in higher supply chain costs than initially planned.

We continue to expect SG&A expense will deleverage for the year, driven primarily by $70 million to $75 million of expenses related to our strategic priorities, including investments to support UB Media, Ulta Beauty at Target, Project SOAR, and other IT capabilities as well as higher wage rate growth across the enterprise, partially offset by lower marketing expense and incentive compensation.

In addition, we are seeing inflationary pressure on operating expenses like service provider fees, labor, supplies and travel, and we expect these trends to continue throughout fiscal 2022. These assumptions result in updated full year guidance for diluted EPS growth in the high single to low double-digit range.

For modeling purposes, some expenses initially planned for Q2 are expected to shift into Q3, primarily reflecting availability of resources and equipment. As a result of these shifts and a stronger than initially planned sales trend, we now expect to deliver earnings growth in the second quarter.

In closing, fiscal 2022 is off to a great start, but uncertainties remain. Our updated outlook reflects stronger topline performance and greater cost pressures as well as economic and global uncertainties that could adversely impact consumer spending later in the year.

While our updated expectations for fiscal 2022 are above our longer term targets for comp sales and operating margin, we are not changing our long-term financial targets at this time. Given our limited visibility into the economic environment and expected cost pressures as we move through the rest of the year and into 2023.

And now I'll turn the call back over to our operator to moderate the Q& A session.

[Operator]

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Simeon Siegel with BMO Capital Markets. Please proceed with your question.

[Simeon Siegel, BMO Capital Markets]

Thanks. Hey everyone. Congrats on the great results. Nice to see. 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 you unique guest visits versus an uptick in guest visit frequency? Thanks a lot.

[Scott Settersten, Chief Financial Officer]

Yes, Simeon, thanks for the question. So, units -- to 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 two are really doing -- making a big contribution to our gross margin here in recent quarters.

[Simeon Siegel, BMO Capital Markets]

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

[Scott Settersten, Chief Financial Officer]

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.

[Simeon Siegel, BMO Capital Markets]

Sounds great. Congrats again and best of luck for the rest of year.

[Operator]

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

[Korinne Wolfmeyer, Piper Sandler]

Hi, good afternoon and 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? Thank you.

[Dave Kimbell, Chief Executive Officer]

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.

[Korinne Wolfmeyer, Piper Sandler]

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?

[Kecia Steelman, Chief Operating Officer]

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 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, etcetera, but Target really owns the sales. So, we're not at liberty to comment on the sales-specific performance by brand at this time.

[Korinne Wolfmeyer, Piper Sandler]

Thank you.

[Operator]

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

[Olivia Tong, Raymond James]

Thank you. 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, could you talk a little bit about the plans in place to keep that going? And then I have a follow-up. Thank you.

[Dave Kimbell, Chief Executive Officer]

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 wear makeup haven't been as numerous.

So we're -- as that opens up, as the world opens up, we're definitely see more opportunity, a high level of engagement. There's new trends that are coming in to makeup 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, MELÉ, Coco, NARS on the prestige side, e.l.f. and NYX are two big highlights on the on the mass side. So we're getting a lot of innovation, a 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.

[Olivia Tong, Raymond James]

Great. 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? Thanks so much.

[Scott Settersten, Chief Financial Officer]

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.

[Olivia Tong, Raymond James]

Great. Congrats and best of luck for the rest of the year.

[Operator]

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

[Steph Wissink, Jefferies]

Thank you. Good afternoon everyone. 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 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. Dave, you just talked a little bit about how those vendor agreements work, just to understand a bit how that affects the middle of the P&L?

[Scott Settersten, Chief Financial Officer]

That's two 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 anniversarying 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 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.

[Steph Wissink, Jefferies]

I think it does. Helpful as always. Thank you.

[Scott Settersten, Chief Financial Officer]

Thanks.

[Operator]

And our next question comes from the line of Kate McShane from Goldman Sachs. Please proceed with your question.

[Kate McShane, Goldman Sachs]

Hi, good afternoon. Thanks for taking our questions. 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?

[Dave Kimbell, Chief Executive Officer]

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.

[Kate McShane, Goldman Sachs]

Thank you.

[Operator]

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

[Daniel Hofkin, William Blair]

Good afternoon. 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 their 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?

[Kecia Steelman, Chief Operating Officer]

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.

[Daniel Hofkin, William Blair]

Okay, great. 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?

[Dave Kimbell, Chief Executive Officer]

Yes. A few things that I might say. One, across categories, we're really pleased that we see strength on 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, hair care 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 two 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 in 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 two 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.

[Daniel Hofkin, William Blair]

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

[Dave Kimbell, Chief Executive Officer]

No region. I mean, one 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.

[Operator]

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

[Michael Lasser, UBS]

Good evening. Thanks a lot for taking my question. 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. And given the strength in the cosmetics category, it would imply that haircare and skin care probably turn negative, why would that be the case?

[Scott Settersten, Chief Financial Officer]

Yes, I guess I would just talk 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.

[Michael Lasser, UBS]

Thank you very much for that Scott. 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? thank you.

[Dave Kimbell, Chief Executive Officer]

Well, we won't get specific on any like -- specific elements of what we factor 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.

[Michael Lasser, UBS]

Good luck.

[Operator]

And our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.

[Simeon Gutman, Morgan Stanley]

Hey everyone. I'm going to ask my question and follow-up. So, kindly welcome me back to the next call. My first question is on the margin. Given that hair care seems to be mixing up, shouldn't that have been a positive?

And then when Scott, when you made the comment ex-reserve adjustments, does that mean the margin ex-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? Thank you.

[Scott Settersten, Chief Financial Officer]

That sounds like three questions, Simeon, actually. But I'll give a swing 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 and the 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 going out there right now.

[Simeon Gutman, Morgan Stanley]

Thank you, very much.

[Kiley Rawlins, Vice President of Investor Relations]

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

[Operator]

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

[Michael Binetti, Credit Suisse]

Hey guys. 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. And 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 the 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 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...

[Scott Settersten, Chief Financial Officer]

So on the SG&A, there's really nothing. There's no onetime extraordinary items voting 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.

[Michael Binetti, Credit Suisse]

Okay, great. Thanks a lot everyone.

[Operator]

Thank you. 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.

[Dave Kimbell, Chief Executive Officer]

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.

[Operator]

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