Ulta Beauty, Inc.

Good afternoon and welcome to Ulta Beauty's conference call to discuss results for the first quarter of fiscal 2023. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. We ask that you please limit yourself to one question and then re-enter the queue for any additional questions. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Kylie 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 Kimball, Chief Executive Officer, and Scott Setterson, Chief Financial Officer. Keisha 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 hours scheduled for this call, we respectfully ask that you limit your time to one question. If you have additional questions, please re-queue. 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, Kylie. 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 uncertainties. 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 two 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 of mass products is due to strong engagement with innovative mass brands, such as Elf and La Roche-Posay, or due to increased consumer price sensitivity. Importantly, Ulta Beauty is the only beauty retailer that offers a wide variety of price points, from entry-level mass to luxury and everything in between. And as such, we are uniquely positioned to capture any consumer shifts within price points in the beauty category. Skincare was our best performing category again this quarter, with both prestige and mass delivering double-digit comp growth. Driven primarily by newness, engaging social media content, and strong performance through 21 Days of Beauty and Spring Haul. Newness from innovative brands like The Ordinary, Drunk Elephant, and Hero Cosmetics, as well as new brands, including Bubble, Beauty Counter, and Bioma, contributed to growth during the quarter. In addition, social media platforms continued driving content category engagement, resulting in robust growth for dermatologist-recommended brands like La Roche-Posay and trend-forward brands like CauseRx. The fragrance and bath categories delivered low double-digit percent growth this quarter, lapping two consecutive years of strong double-digit growth. Newness for Mariana Grande, Carolina Herrera, and Valentino contributed meaningfully, and our monthly Fragrance Crush program fueled strong engagement with newer brand Billie Eilish as well as established brands Lancome and Dior. In addition, Valentine's Day gift-giving was healthy across both men's and women's fragrances. Makeup delivered high single-digit growth for the quarter, driven by newness and guest engagement with 21 Days of Beauty and Spring Home. Soft bronzing, glossy lips, and expressive eyes and nails are trends driving growth for the category. New brands like Dior, About Face, and Natasha Denona drove sales during the quarter, while new products from a wide range of brands including e.l.f., Fenty, and NYX also contributed to growth. In addition, the expansion of MAC into more stores, combined with compelling newness, continued to drive sales. Finally, The hair category was flat for the quarter, with growth in hair care products and color offset by lower demand for tools as we lapped strong newness last year. Products focused on hair health, including bonding, scalp treatments, and hydration, as well as those focused on styling, are resonating strongly. Newer brands, like Donna's Recipe, Odell, and Divi, as well as new products from Mastige Brands, EBA NYC, Batiste, and Andrew Fitzsimmons, were notable drivers for the category. Trend-relevant products from Way, Redken, and Kenra resonated with guests, while engaging social media content drove healthy growth for Myel and IGK. Our services business delivered double-digit comp growth again this quarter, driven by growth in cut and style, blowout, and makeup services. As we have expanded our service offerings and enhanced our stylist talent, More members are using services. And our salon back bar takeovers, which give our stylists a unique opportunity to introduce new brands and products to guests, drove sales growth and new member acquisition for participating brands. Now, similar to what other retailers have shared, we continue to see pressure from inventory shrink this quarter, and we have updated our full-year guidance to reflect the persistence of this trend. While shrink is the result of various factors, theft, specifically organized retail crime or ORC, is an increasingly concerning challenge, especially as we've seen a rise in violence and aggression during these incidents. Our first priority is the safety and well-being of our associates and our guests. We are committed to ensuring a safe work environment and are investing in fixtures, training, support structures, and increase staffing and security to aggressively address this concerning trend. ORC impacts all of our stakeholders, guests, associates, brand partners, investors, and communities, and it will not be solved by retailers alone. Given the complexity, it will take collaboration across retail, manufacturing, law enforcement, and legislative levels to solve these problems. Now, working together, I am optimistic we can create meaningful impact and bring forward creative, sustainable solutions to restore safe shopping experiences for everyone. As we have previously discussed, beauty is not immune to macroeconomic challenges, but has historically been more resilient compared to other discretionary categories due to its deep emotional connection with consumers. We believe this connection is even greater today today given the importance of beauty as a form of self-care and wellness. As we navigate this dynamic operating environment, our strategic framework guides our priorities and positions us to build on our market leadership and drive long-term profitable growth. Let me give you an update on the progress we've made against this framework in the first quarter. Starting with our efforts to drive growth with an expanded definition of all things beauty, Our strategy is to delight beauty enthusiasts with our thoughtfully curated assortment focused on inclusivity and leading trends. During the first quarter, we further enhanced our assortment with the launch of several exciting brands, including Natasha Denona, a luxury artistry brand known for high-quality makeup palettes across eye, face, and cheek, Beauty Counter, a clean beauty pioneer offering high-performing skincare and makeup with unmatched ingredient safety standards, and Odell, a hair care brand focused on clean, accessible products for the whole family. To drive engagement and capture additional market share this quarter, we launched Luxury at Ulta Beauty in 200 stores and on Ulta.com. Driven by social platforms and strong Gen Z interest, luxury brands are fueling beauty category growth. Our vision for luxury at Ulta Beauty is to provide guests with a uniquely modern luxury beauty experience, strategically curated to reflect what guests are engaging most in, including iconic luxury with brands like Dior and Lancôme Absolue, clean luxury with brands like Hourglass and Chanel Numéro 1, and luxe artistry brands like Natasha Denona. In addition to strengthening our core assortment, we continue to expand, evolve, and amplify our cross-category platforms. Let me share some first quarter highlights. We ended the quarter with 306 brands certified in at least one conscious beauty pillar, including newly certified brands Nutritious by Estee Lauder, Winky Lux, and Mayo. In celebration of Earth Day, to promote sustainability and to drive discovery, we launched a collectible Ulta Beauty reusable tote and a Conscious Beauty Essentials Sample Kit with hero products from 14 certified brands, including Boucher, Beekman 1802, and Acure. We continue to support black-owned and founded brands with the launch of new brands, Hanahana Beauty and Gold. We created a black-owned and founded brands discovery kit featuring 11 brands, and 100% of the purchase price of this kit was donated to Big Brothers Big Sisters of America. In recognition of Black History Month, we celebrated and supported the black community through rich Ode to Black Beauty storytelling and used our digital and social platforms to highlight innovative brands like New Sugar, Beauty Bakery, and Sunday to Sunday. As we meet beauty enthusiasts wherever they are on their beauty journey, all in your world, we are investing to enhance guest experiences across all of our touchpoints. This quarter, we completed the two-year phased rollout of the guest-facing elements of our digital store, delivering a fresh, innovative, front-end guest experience across both Ulta.com and our app. Today, guests enjoy more seamless navigation and checkout experiences, can discover and browse new experiences, including Buy More, Save More, Luxury at Ulta Beauty, and our new Foundation Finder, and also benefit from enhanced search and recommendation capabilities. Later this year, we will finish the transition by converting our back-end infrastructure to support enhanced checkout, order, and inventory management and pricing and promotion capabilities. The completion of the front-end of our digital store is a major milestone in our journey to enhance our omnichannel experiences, and it is worth noting our teams executed these changes while maintaining an active digital platform and delivering our e-commerce growth goals. While we experienced a minor disruption during the transition, I am proud of how our digital, IT, and guest services teams have worked together while minimizing the guest impact. To support omnichannel guest experiences, we continued to expand our buy anywhere, fill anywhere capabilities. This quarter, we introduced same-day delivery in six new markets, bringing the number of stores with this convenient option to 540 stores across 18 markets. In addition, we're making it easier for store associates to assist guests in ordering products online when not available in-store through our upgraded POS system. We have refreshed store POS systems in 1,100 stores and are on track to complete this transition before holiday. Turning to our partnership with Target, we opened four Ulta Beauty shops in the quarter, ending with 359 locations. This touch point introduces new guests to Ulta Beauty and enables re-engagement of last guest. And we are leveraging our CRM capabilities to ensure bounce back to Ulta Beauty. Our dedicated field team continues to support this important partnership with training and field engagement, and we are working together with our target partners to deliver an outstanding guest experience. Beauty is a personal, emotionally connected category. To increase consideration, loyalty, and engagement, we are creating authentic connections with our guests with work that sits at the heart of the beauty community. In the first quarter, we executed impactful activations around key cultural moments, including Black History Month, Prom, and Earth Day, and delivered improved brand health metrics with significant increases in awareness across Gen Z, Black, and Hispanic consumers. These trends confirm that the Ulta Beauty brand is continually becoming stronger, more relevant, and more meaningful to guests. We ended the first quarter with 41 million active members, 9% higher than the first quarter last year, driven by new member acquisition, lapsed member reactivation, and healthy retention rates. Spend per member also increased, driven primarily by trip frequency and growth of elite members. Increased visibility, personalized reminders, and incentives are driving growth of Diamond and Platinum members. At the end of the first quarter, the number of members in these higher tiers increased more than 30% compared to the same period last year, which is a strong indicator of high loyalty and elevated engagement in all that Ulta Beauty has to offer. Our multifaceted go-to-market plan to drive member growth and nurture the member life cycle is delivering results. To drive new member acquisition and reactivate lapsed members, we refreshed store associate training and created new tools to help associates communicate the program's benefits. We enhanced the integration of our loyalty program across our refreshed digital experiences and introduced guest-facing signage in stores to drive awareness. And we executed targeted reactivation campaigns and tested new personalized digital communications to improve retention and contactability. Turning to UB Media, our retail media network, we are harnessing the power of our exclusive first-party data to transform the way our brands connect with beauty enthusiasts. With dedicated resources and new tools in place, this quarter we engaged with more brands, managed more digital campaigns, and expanded our product portfolio to include advertising opportunities on Ulta-owned digital properties. As UB Media continues to scale, we are confident it will add meaningful value to our company over time. Reflecting our priority to drive operational excellence and optimization, we are executing an ambitious multi-year roadmap of transformation initiatives, which will unlock new capabilities and operating efficiencies to fuel our future growth. We are upgrading our enterprise resource planning platform, expanding and optimizing our supply chain with new facilities, systems, and processes, transitioning our digital store to modern technology and architecture while upgrading our order management system, expanding our data management systems to enable further analytical capabilities, and upgrading POS systems in all stores. We have made good progress against our roadmap and expect to deliver major milestones over the next several months. While change of this magnitude can be disruptive, our teams have consistently moved quickly and collaboratively to limit impact to guests and associates. Our success is enabled by our people, and we are investing purposefully in our teams to protect and cultivate our world-class culture and talent. In the first quarter, we launched a refreshed and modernized Ulta Beauty competency model across the enterprise to drive further consistency in talent management processes, Establish clear measures of success and enhance culture with common language. We also launched a new service award recognition program to elevate the associate experience and reward associates in meaningful ways. And we hosted 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. I walked away from this event inspired by our talented associates and their passion for serving our guests and driving Ulta Beauty's growth. Finally, we continue to expand our environmental and social impact. This quarter, we partnered with Pact Collective to test a packaging recycling program in select locations with the goal of collecting the beauty industry's hard to recycle packaging so that it is diverted from landfills and put to its highest and best use. We also published our 2022 ESG report, which describes our approach to priorities in these areas and provides key updates on our ESG initiatives, their connectedness to our business, and the positive impact of beauty as a force for good. In closing, fiscal 2023 is off to a good start. Our teams are executing well against an ambitious transformational agenda while navigating a dynamic environment. While we expect the operating environment will continue to evolve, we are confident the resilience of the category combined with the power of our proven business model and world-class team position Ulta Beauty for continued profitable growth. And now, I will turn the call over to Scott for a discussion of the financial results. Scott?

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 of COVID headwinds last year. Comp sales subsequently moderated to mid-single digits as we moved through the quarter. During the quarter, we opened five new stores and closed one store. In addition, we relocated one store and remodeled two 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 the leverage 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 a worsening trend of theft and organized retail crime. We are actively working to stabilize and mitigate these trends through investments in staffing, training, and fixtures, and we are working collaboratively with law enforcement and third-party organizations to address these challenges. In addition to greater pressure from shrink, gross margin was impacted by lower merchandise primarily due to increased promotional activity and category mix shifts, which more than offset benefit from price increases. We also incurred additional costs in the quarter related to our supply chain optimization efforts. SG&A increased 22.2% to 612 million, which was slightly better than our plan. As a percentage of sales, SG&A increased 180 basis points to 23.2%. compared to 21.4% last year, primarily due to deleverage of store payroll and benefits, corporate overhead, and marketing expense, partially offset by leverage of incentive compensation and store expenses due to higher sales. Store payroll and benefits expense increased, driven primarily by higher average wage rates and increased staffing levels compared to the same period last year. Corporate overhead expense deleveraged in the quarter, primarily due to investments related to our strategic priorities, including Project SOAR, other IT capabilities, and UB Media. Marketing expense increased, reflecting investment in strategies to drive member acquisition and retention, increase brand awareness, and expand omni-member penetration. Operating margin was 16.8% of sales compared to 18.7% of sales in the first quarter of 2022. As expected, the decline in operating margin primarily reflects the impact of SG&A deleverage and lapping our extraordinary results in the first quarter of fiscal 2022. Net interest income for the quarter increased to $7.3 million, driven by higher average interest rates and higher average cash balances during the quarter. The company's tax rate decreased to 22.8% compared to 24.2% in the first quarter last year. The lower effective tax rate is primarily due to greater benefit from income tax accounting for stock-based compensation. Diluted gap earnings per share increased 9.2% to $6.88 compared to $6.30 last year. Moving on to the balance sheet and cash flow statement. Total inventory increased 11.5% to $1.8 billion compared to $1.6 billion last year. In addition to the impact of 41 net new stores, the increase reflects the impact of higher purchases to support demand, product cost increases, and inventory to support new brand launches and expansion of existing brands. Capital expenditures were $109.8 million for the quarter compared to $71.1 million last year. The increase in capital expenditures was primarily related to investments in IT and supply chain, as well as new remodeled and relocated stores. Appreciation decreased to $57.9 million compared to $62.8 million last year, primarily due to lower store depreciation and a shift of IT investments from capital to cloud expense. We ended the quarter with $636.4 million in cash and cash equivalents. In the first quarter, we repurchased 541,000 shares at a cost of $285.8 million. At the end of the quarter, we had $816 million remaining under our current $2 billion repurchase authorization. Turning now to our outlook. We have refined our expectations for the full year to reflect our first quarter actual performance and recent trends. We are maintaining our expectations for annual comp sales growth and diluted earnings per share, but are updating our outlook for operating margins. We continue to expect comp sales growth for the year will be between 4% and 5%, with growth moderating as we move through the year. As we shared on our last call, we expect comp growth for the first half to be in the upper single-digit range and then moderate to low single-digit growth in the second half. We now expect operating margin for the full year will be between 14.5 and 14.8% of sales, primarily reflecting an updated view of gross margin. We have increased our expectations for gross margin deleverage from our original outlook to include the impact of higher shrink in a more competitive and promotional environment. We continue to expect SG&A deleverage driven primarily by 60 to 70 million of incremental spend to support strategic investments, as well as the impact of ongoing inflationary pressures. We have updated our assumptions for interest income to reflect the current interest rate environment and are now planning for about $17 million of interest income for the year. We have also incorporated our first quarter tax rate into our full year forecast and now expect the effective tax rate for the year will be approximately 23.8%. These assumptions result in guidance for diluted earnings per share in the range of $24.70 to $25.40 per share. In closing, fiscal 2023 is off to a solid start. We remain optimistic about the health of the beauty category, confident in our team and our growth strategies, and steadfast in our belief that our proven business model uniquely positions us to deliver for our guests, associates, and shareholders. And now I'll turn the call back over to our operator to moderate the Q&A session.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we pull for questions. Thank you. Our first question is from Simeon Siegel with BMO Capital Markets. Please proceed with your question.

Thank you. Hey, everyone. Good afternoon. 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 in transactions? I don't know if you think this is because of a purse tightening or if it's a mixed dynamic or compare, just any further color there would be helpful. Thanks a lot, guys.

Yeah, thanks, Simeon. What we are seeing, as we said in the call, is mass on 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 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 remained 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, we have some exceptional newness going on and some really high-performing brands in our mass category, brands like Elf, NYX, The Ordinary, La Roche-Posay. So we know that is certainly contributing to that. So the fact that mass is growing higher than prestige, it's difficult for us to exactly parse apart that. you know, 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, you know, 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, you know, 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 these last two years, as we've talked about in several quarters, will moderate. We think ultimately getting back to more of the high end of historical average, but we know engagement's high and we continue to be encouraged by overall consumer engagement.

Yeah, 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 three or four 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.

Great. Thanks a lot, guys. Best of luck for the rest of the year. Thanks.

Thank you. Our next question comes from Rupesh Parikh with Oppenheimer. Please proceed with your question.

Good afternoon. Thanks for taking my question. So I want 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, you know, if you look at some of the promotions out there, how's the gap compared to maybe what we've seen maybe, you know, pre-pandemic 2019 and earlier?

Yeah, well, as I mentioned on the call, we anticipated and planned for it to be more promotional this year coming out of, you know, all the trends that we've talked about over the last couple of years. And, you know, you know, 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, you know, 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 activity you know, 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, you know, 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. You know well, Rupesh, that 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 two years to expand our CRM capabilities, grow our loyalty program, you know, 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 will continue to be strategic and thoughtful as we look ahead in the environment as the year unfolds.

Thank you.

Thank you. Our next question is from Steve Forbes with Guggenheim Security. Please proceed with your question.

Good evening. This is Anders Meyer 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 are seeing broadly within services and possibly measured by member utilization rates? 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 was approximately 50%. So I wanted to see if there was any moderation there. Thank you.

Yes, well, thank you for the question. Yes, again, our salon service business was really strong again in the quarter. What we've liked that we've seen is we prepared remarks. We talked about these back bar events. Not that we specifically ever break out purchase by service guests, but what I can share with you is that our back bar events, what we've seen is 90% of guests that are purchasing through those activations are new to those brands. So the guest experience in services is really resonating when we get them in the chair. Cut 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 Alta Beauty.

Great. Thank you.

Thank you. Our next question is from Christina Kasai with Deutsche Bank. Please proceed with your question.

Hi. Good afternoon, and thank you for taking the question. I had a question on the Ultimate Rewards Program, right, which continues to set records both with membership and Spend4Member. 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? Thank you.

Great. Well, yes, our loyalty program, Ultimate 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 to 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. Separately, we do believe we continue to improve share of wallet of our best guests. I talked about Platinum and Diamond members 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, we 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 two and a half times. 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, yeah, 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 program. 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. We're seeing good returns, and we see there's a lot more opportunity for us ahead in the world of personalization fueled by our data.

Thank you so much. Best of luck. Thanks.

Thank you. Our next question is from Ike Borchow with Wells Fargo. Please proceed with your questions.

Hey, everyone. Scott, I was just wondering if you could give more color on the shrink theft component of what's impacting guys on 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 just so we understand just how impactful it is to your gross margin.

Yes, so it was, you know, 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 two 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. 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 improvements the rest of the way. So it's going to remain a challenge the rest of the year.

I'm glad you asked. I'd add, 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. Unfortunately, despite our efforts and investments, it's getting worse, not better, and we're working hard. I mentioned this, but what it's going to take is our efforts, and I'm going to ask Keisha 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 in 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 they're focused on. But we are doing a lot. Nisha, do you want to highlight a few of those things?

Sure, yeah. We'll be in 70% of the chain by the end of this year. with locked fragrance cabinets because fragrance is one of the big target areas that we see them going after. 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 of 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 on what can we do to help police the parking lots and deter 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. It's, like I said, very disturbing, and we've got to get this course corrected as an entire RECA group.

Okay, just one final note, Ike, on that one. So for quantification purposes... as a reference point in the first quarter to shrink, de-leverage, you know, above expectations, totally offset all fixed-door costs.

Thank you. Our next question is from Corinne Wolfmeyer with Piper Sandler. Please proceed with your question.

Hey, good afternoon, and thanks for taking the questions. I'd just like to touch on, you know, 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, you know, maybe consumers doing a little bit more pressure in their wallets and maybe seeking out more, say, mass retailers or lower-cost items, how are you ensuring, you know, customers stick with Ulta and keeping that retention rate strong? Thank you. Yeah.

Well, Corrine, it 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 experiences a positive, uplifting experience. fun, engaging experience, and I'm proud that that is so consistently the experience that our guests receive and what they love about us. Our retention remains strong, 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, but all of our digital touchpoints, our experience and connection that we have with our guests 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 the environment shifts, I talked about some of that in the script in an earlier question about shifts between mass and prestige. 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 to prestige, to luxury, all price points, all categories. 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 part of our business and one that we'll continue to lean on and leverage going forward.

Thank you. Our next question is from Olivia Tong with Raymond James. Please proceed with your question.

Great, thank you. I wanted to see if you could talk a little bit about where the incremental promotion is 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 lead the promos, but of course you have to be competitive. So can you talk about how your promo levels compare to your peers' You know, 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 peers and still stay at the same level of competitiveness?

Thank you. Yeah. First, I'd say the incremental promotion, we see it happening. We see, you know, really an intense competitive environment across all parts of the beauty category. And again, because of our model, mass engagement, 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. You know, as far as exactly, you know, we don't have perfect insight. 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 added at a more personalized level and that's paying off in an important way.

Thank you. Our next question is from Michael Lasser with UBS. Please proceed with your questions.

Good evening. Thank you so much for taking my question. 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 let Scott give a bit more color, or definitely more color on that. specifically around your question. What I'd say is we're really confident in our business. We had guided for this year that we'd be delivering 4% to 5% 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 margin, and 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. 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, our ability, our capabilities around personalization and others. So I understand that some of those questions might be out there. But I tell you, we are committed to delivering what we set out to do. We are off to a good start doing that in Q1. 9.3% cap, 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 in slightly richer promotional mix, temporary headwinds. We are very... you know, 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 leverage that we have to optimize this business, we're still very confident that 14 to 15 is the right range to be in. You know, 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 Store, 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 own.

Thank you very much, and good luck.

Thanks, Michael.

Thank you. Our next question is from Susan Anderson with Panacord. Please proceed with your question.

Hi, good evening. Thanks for taking my question. 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? Thanks.

Yeah, I'm glad you asked because wellness is an important growth opportunity. I'd start, before I talk specifically about the wellness shop and the 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've talked about this for a little while, so you may have heard this before, but it is an important trend coming out of 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 routines 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 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, cross-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, Gold that we just added, Lemmy by Kourtney Kardashian. There's a strong experience, high level of engagement across all six of our segments and pillars, and we're really pleased with its impact and 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.

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

Thank you. Our final question is from Simeon Gutman with Morgan Stanley. Please proceed with your question.

Hey, 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 resistance point in 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 so rampant across other retailers, how much you've accrued for and how much could it be worse again? Thanks.

Maybe I'll start with shrink. So I addressed here just a few minutes earlier just directional. In the first quarter, shrink basically offsets fixed door costs leveraged entirely. So again, remember that's been trending upward here over the last couple of years with the huge gear 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. So I'm not optimistic about how that plays out in gross margin the rest of the way.

Yeah. Yeah. And, Simeon, it's good to bookend our Q&A by Simeon, so we're glad to do that. And I'd just say, yeah, 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. 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 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 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 24th. Thanks. 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.