Earnings Call Transcript - ULTA Q3 2022

Operator, Operator

Good afternoon, and welcome to Ulta Beauty's conference call to discuss results for the third quarter of fiscal '22. As a reminder, this conference is being recorded. And it is now my pleasure to introduce Ms. Kiley Rawlins, Vice President of Investor Relations. Thank you, Ms. Rawlins, please proceed.

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's results for the third quarter of fiscal 2022. Hosting our call are Dave Kimbell, Chief Executive Officer; and Scott Settersten, Chief Financial Officer. Kecia Steelman, Chief Operating Officer, will join us for the Q&A session. This afternoon, we announced our financial results for the third quarter. A copy of the press release is available in the Investor Relations section of our website. Before we begin, I'd like to remind you of the company's safe harbor language. The statements contained in this conference call, which are not historical facts, may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC. We caution you not to place undue reliance on these forward-looking statements, which speak only as of today, December 1, 2022. We have no obligation to update or revise our forward-looking statements, except as required by law, and you should not expect us to do so. We'll begin this afternoon with prepared remarks from Dave and Scott. Following our prepared comments, we'll open the call for questions. And as always, the IR team will be available for any follow-up questions after the call. Now I'll turn the call over to Dave. Dave?

David Kimbell, Chief Executive Officer

Thank you, Kiley, and good afternoon, everyone. We appreciate your interest in Ulta Beauty. The Ulta Beauty team delivered outstanding performance this quarter with strong revenue growth driving operating margin expansion and double-digit earnings growth. We accomplished these results because the Ulta Beauty teams continue to execute at a high level, and I want to thank all of our associates for their commitment to delivering great guest experiences, ensuring operational excellence, strengthening our culture and working together as one team to move our business forward as the leader in beauty. For the third quarter, net sales increased 17.2% to $2.3 billion, and comp sales increased 14.6%. Operating margin increased to 15.5% of sales and diluted EPS increased 35.5% to $5.34 per share. Reflecting these results and our updated fourth quarter expectations, we have increased our outlook for the full year. Scott will share more details about our expectations later in the call. Our third quarter results are a testament to the resilience of the beauty category and our team's ability to drive strong guest engagement that fueled broad-based growth across our business. All major categories exceeded our expectations, and we increased our market share in Prestige Beauty versus the fiscal third quarter last year based on dollar sales according to point-of-sale data from the NPD Group. We delivered growth across our store and digital channels and achieved a record loyalty membership of 39 million members. Additionally, we continue to see growth in spend per member across all income demographics. Our strategic framework, anchored by the power of our differentiated model, continues to drive our ambitions and successes as we work to expand our market leadership and drive profitable growth. This afternoon, I'll share an update on our progress against several of our strategic pillars. Starting with our efforts to drive disruptive growth through an expanded definition of All Things Beauty, our strategy to engage and delight beauty enthusiasts with a thoughtfully curated assortment focused on inclusivity and leading trends is delivering results. Our double-digit comp this quarter was a result of growth from our core assortment, price increases executed this year, and compelling newness. Although pricing contributed more to our comp than last quarter, the majority of our third quarter comp was fueled by growth from our core assortment and newness. Historically, sales of new products have averaged 20% to 30% of our sales, and the overall mix of newness this year has been in line with our historical experience. Turning to performance by category. Skincare, fragrance and bath, haircare, and makeup all delivered double-digit comp growth against the third quarter last year. From a segment perspective, we saw double-digit sales growth across both prestige and mass, with mass generally outperforming prestige. While it's hard to know with certainty if we are starting to see consumers trade down, as the only beauty retailer that offers a wide variety of price points from entry-level mass to high-end luxury and everything in between, Ulta Beauty is uniquely positioned to capture any consumer shifts within price points in the beauty category. Turning to the performance of our core categories, starting with our fastest-growing category, skincare. Beauty enthusiasts are maintaining their skincare routines with a focus on science-backed and dermatologist-recommended products. Guests are engaging with newer brands like Drunk Elephant, Supergoop! and Good Molecules, while new products from established brands like The Ordinary, Hero Cosmetics, and La Roche-Posay also contributed to sales growth. To drive discovery and support guest education, this quarter, we introduced our skincare we love wall in all stores. This curated presentation highlights exciting brands and best-selling items across key categories. The fragrance and bath category delivered another impressive quarter as Gen Z guests engaged with the category, leveraging multiple fragrances to express themselves. Recently launched Ulta Beauty exclusive Billie Eilish as well as new scents from Burberry, Gucci, and Victor and Rolf drove meaningful sales growth. While our monthly fragrance crush program drove engagement with established brands, including Versace and Jimmy Choo. In addition, the category benefited from strong guest engagement with our holiday fragrance gift sets, which were available earlier this year. Haircare, our second largest category, delivered solid growth, primarily driven by newness and innovation. Key category trends include hair health, damage repair, and targeted treatments. Prestige brands, including various brands saw strength in treatments and core assortments, while mass brands, including Eva Nyc, Batiste, and Kristin Ess, and professional brands such as Pureology, Redken, and Kenra, continued to resonate with guests. Within the category, strong hair product growth was offset by softer performance in hair tools as we lapped strong performance last year. Finally, our largest category, makeup, delivered double-digit comp growth driven by newness and the strength of our key events, including 21 Days of Beauty and Fall Haul. Growth in foundation, concealers, blush, and lip continue to lead the category. New brands like Fenty, r.e.m. beauty, and N°1 DE CHANEL drove sales during the quarter, while new products from a wide range of brands, including Clinique, e.l.f. and NYX also contributed to growth. In addition, the expansion of MAC, Chanel Beauté, and Bobby Brown into more stores has continued to drive prestige sales. Now let me give you an update on our key cross-category platforms. Conscious Beauty, Black-Owned and BIPOC brands, and Wellness. With 290 certified brands, Conscious Beauty continues to resonate strongly with beauty enthusiasts, reflecting growing interest in products that are good for the world. This quarter, we certified 15 new brands, including 8 cosmetics, Morphe, and DIME Beauty, and introduced the Conscious Beauty essentials kit, featuring minis for more than 15 brands such as Dermalogica, COOLA, and our own Ulta Beauty Collection. During the quarter, we expanded our BIPOC brand assortment with 4 new BIPOC brands: newly launched brands including BREAD BEAUTY SUPPLY, sugardoh, and Undefined Beauty. As another way we look to create foundational industry change, we proudly launched our MUSE Accelerator program to support early-stage BIPOC brands as they prepare for retail readiness. Our inaugural class included 8 BIPOC founders, with innovative brands across skincare, makeup, fragrance, haircare, and wellness. In addition to financial support, each MUSE Accelerator participant took part in an intensive 10-week training program, learning from Ulta Beauty leaders, industry subject matter experts, and leading BIPOC brand owners. We are honored and excited to be a part of their journey as they build their business and expand their reach. Finally, we continue to increase our presence in wellness. During the quarter, we further enhanced our assortment to reflect our guest evolving needs. And in September, we expanded our offering to include intimate wellness as the sixth online-only pillar of the wellness shop. While wellness represents a small part of our overall business today, we believe it is a significant longer-term growth opportunity given the incrementality of the purchase and the strong emotional connection consumers have with self-care. Turning now to our efforts to evolve the omnichannel experience through a connected physical and digital ecosystem, all in your world. Store traffic trends accelerated this quarter and exceeded pre-pandemic levels for the first time, representing an important milestone in our COVID recovery. In addition to strong sales growth from stores, we continue to deliver growth in e-commerce, further reinforcing the incrementality of this important channel. The convenience of BOPIS for e-commerce orders continues to resonate with guests. During the quarter, BOPIS increased 18% to 23% of e-commerce sales, compared to 20% last year. Our services business accelerated and delivered another quarter of double-digit comp growth, primarily due to higher stylist retention, increased stylist productivity, and increased capacity in our salons as we lapped capacity constraints due to the pandemic. Our targeted CRM efforts to drive awareness, trial, and frequency are working, delivering increases in salon appointments from both existing and new members. Additionally, our in-store back bar events continue to drive product attachment and new guest acquisition for participating brands. As industry leaders, we're always working to enhance guest experiences across all of our platforms. During the quarter, we introduced a new layout in about a dozen stores to showcase our categories better, improve navigation, enhance the services experience, and create more opportunities for discovery. The most noticeable changes include the repositioning of skincare, an important growth category, to the front of the store. All products grew by category with delineated fixtures and visuals and a flow from prestige to masstige to mass. Elevated gondolas that showcase key iconic and service brands, new beauty bars that offer our brow and makeup services as well as supporting in-store events, dedicated space in the front of the store to feature brand and product launches across categories, and a relocated checkout closer to the salon. We are excited to introduce this new store layout to guests. And as we've done in the past, we intend to introduce this new experience in new stores, remodels, and relocations. At this time, we have no plans to retrofit existing stores. Stores are a critical part of our ecosystem. And while most of Ulta Beauty's transactions occur in-stores, we know the guest journey often begins online. To assist guests along their journey, we offer a suite of virtual digital tools, including GLAMlab, Skin Advisor, and our hairstyle tool, among others. The latest addition is a fragrance finder designed to help guests explore fragrances by favorite brand or ingredient, launched just in time for the holiday season. Finally, we continue to be excited about the long-term opportunity with our strategic Target partnership. This touchpoint enables us to connect and reconnect with members. And while the partnership isn't material yet to our overall member growth, it has contributed positively. Importantly, we are seeing members bounce back to Ulta Beauty after becoming an active member while at the Ulta Beauty at Target shop. Now let me give you an update on some of the steps we're taking to drive love, loyalty, and emotional connection with Ulta Beauty. Recognizing that beauty is personal, we are on a multiyear journey to create stronger, more emotional connections with our guests and bring our brand purpose to life. Launched in September, our latest brand-building campaign, Beauty And, is rooted in insights from cultural leaders and beauty enthusiasts. The creative content on owned and paid channels has driven broad improvement in top-of-mind awareness and is resonating with our guests, particularly Black and Latinx beauty enthusiasts. Turning to our loyalty program, our efforts to nurture loyalty in personalized ways are driving member growth and delivering incremental value. We ended the quarter with 39 million active members, 9% higher than the third quarter last year. Overall spend per member increased driven by increased frequency and higher average ticket. While price increases are having an impact, we are encouraged to see unit growth per member. Our loyalty program is a strategic asset and an important driver of our long-term growth. We prioritize member engagement, loyalty, and retention across every Ulta Beauty touch point. The growth and strength of our loyalty program starts with ensuring that our existing guests stay engaged. Nurturing our existing members through our Member Love events and life cycle marketing strategies has enabled us to maintain healthy retention rates, which have contributed to member growth and higher spend per member. Member reactivation remains a priority, and we are leveraging CRM tools to personalize offers and reengage members in more targeted ways. And, of course, conversion of new members also contributes to overall member growth, and we continue to acquire new members in our stores, digital platforms, and through our partnership with Target. Shifting now to our plans and expectations for holiday. The holiday season is in full flow, and our teams are executing well. While predicting holiday shopping patterns this year is challenging, I am optimistic about the opportunity for Ulta Beauty this holiday season. Our engaging holiday messaging, one-of-a-kind assortment, with exceptional seasonal options and diverse touchpoints, all paired with our team's unrelenting passion for delivering great guest experiences, position us well to deliver another successful holiday season. Grounded in robust consumer insights, our holiday marketing strategy positions Ulta Beauty as the place for gifting, glamming, and self-care this season. Our intent is to empower guests to celebrate the season however they want. Our integrated media plan for the holiday aims to build broad awareness of Ulta Beauty as a holiday destination, spark connection with key audiences, leverage our beauty expertise and drive consideration and purchase. Our merchandising team has built an outstanding holiday gifting assortment, whether guests want to gift others or treat themselves, we have thoughtfully curated options across every category and budget, with a balanced approach to the mix of seasonal holiday items and core items that make great gifts. We entered the holiday season with well-staffed stores and distribution centers, and our teams are excited, engaged, and ready. For the first time since 2019, our store teams gathered in person to review our holiday strategies. I know their excitement and enthusiasm for our plans will be felt in every guest interaction. Our corporate and distribution center teams have worked cross-functionally to ensure Ulta Beauty is positioned to deliver for our store teams and our guests. In closing, I am incredibly proud of our year-to-date results, and I'm excited about our holiday plans. Even as consumers continue to navigate economic headwinds, we believe the beauty category will remain resilient, and we are confident that our differentiated model and growth strategy, combined with our outstanding associates, will continue to position Ulta Beauty as the preferred beauty destination. 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. Today, we reported results that were better than our initial expectations. Strong double-digit revenue growth resulted in record-setting third quarter operating margin performance. These excellent results reflect the continued focus and hard work of our store, distribution center and corporate teams. I want to thank all of our Ulta Beauty associates for working together to deliver another outstanding quarter for our shareholders. Now to the financial results, starting with the income statement. Net sales for the quarter increased 17.2% driven by comp sales growth of 14.6% and strong new store performance. In addition, other revenue increased $20 million, primarily due to credit card income growth, higher loyalty point redemptions and an increase in royalty income from our partnership with Target. Breaking down the comp performance further, comp transactions for the quarter increased 10.7%, primarily driven by strong growth from in-store transactions. Average ticket increased 3.5% due to an increase in average selling price partially offset by slightly lower average units per transaction. The increase in average selling price primarily reflects the impact of retail price increases executed this year. We estimate that price increases contributed about 500 basis points to the overall comp increase. While average units per transaction was slightly lower than last year, the total number of units sold increased about 10% on a comp basis. During the quarter, we opened 18 new stores, relocated one store, and remodeled 8 stores. For the quarter, gross margin increased 160 basis points to 41.2% of sales compared to 39.6% last year. The increase was primarily due to the leverage of store fixed costs, other revenue growth and higher merchandise margin partially offset by higher inventory shrink. Robust top line growth and benefits from our ongoing occupancy cost optimization efforts resulted in healthy leverage of store fixed costs. The improvement in merchandise margin was primarily due to benefits resulting from the timing of retail price changes partially offset by brand mix. As we have discussed, we have executed a number of price increases from our brand partners this year. Generally, when the new price is effective at the shelf, we are still selling the inventory purchased at the lower cost. As a result, there's a short-term benefit to cost of goods as we move through the lower cost inventory. As expected, our promotional activity increased from the second quarter, but the impact to margin was not meaningful compared to last year. SG&A increased 18.6% to $597.2 million. As a percentage of sales, SG&A increased 30 basis points to 25.5% compared to 25.2% last year, primarily due to increases in store payroll and benefits and corporate overhead partially offset by lower marketing expenses. Store payroll and benefits deleverage this quarter primarily due to increased labor hours to maintain service standards, higher average wage rates to support recruitment and retention and a timing shift of incentive compensation accruals. Corporate overhead expense deleveraged in the quarter, primarily reflecting investments related to our strategic priorities including Project SOAR and other IT capabilities, UB Media, and Ulta Beauty at Target. These headwinds were partially offset by lower marketing expense. As we have discussed on previous calls, this year, we are offsetting the incremental marketing expense of digital campaigns we manage for our brand partners, with vendor income that is a direct reimbursement for these specific costs within total marketing expense. Similar to what we saw in the first half, this resulted in about 70 basis points of favorable impact to SG&A in the quarter. Operating income for the quarter increased 27.3% to $361.9 million. As a percentage of sales, operating margin increased 130 basis points to 15.5% of sales compared to 14.2% last year. Diluted GAAP earnings per share increased 35.5% to $5.34 per share, compared to $3.94 per share last year. Moving to the balance sheet and cash flow. Total inventory increased 10.3%. In addition to the impact of 41 additional stores, the increase reflects purchases to support key brand launches and increases in inventory costs as well as ongoing efforts to maintain strong in-stock to support expected demand. Capital expenditures in the quarter were $83.5 million compared to $51.1 million last year. The increase was primarily related to investments in new remodeled and relocated stores, IT projects, and merchandising improvements. Depreciation was $58.5 million compared to $65.2 million last year, primarily due to a shift of IT investments from capital to cloud expense. We ended the quarter with $250.6 million in cash and cash equivalents. During the quarter, we repurchased 340,000 shares at a cost of $137.5 million. At the end of the third quarter, we had $1.4 billion remaining under our current $2 billion repurchase authorization. Turning now to our outlook. We have raised our financial guidance for fiscal 2022 to reflect our strong third quarter performance and increased expectations for the fourth quarter. We now expect net sales for the year will be between $9.95 billion and $10 billion, with comp sales growth between 12.6% and 13.2%. This guidance reflects our expectation that fourth quarter comp growth will be between 6% and 8%, up from our previous expectation for a low single-digit increase. Sales growth moderated in November as we lapped last year's strong performance, but we are pleased with the sales trends we saw through the Thanksgiving holiday shopping weekend, including Cyber Monday. We still have several important weeks left in the holiday season, and the operating environment continues to be dynamic. Our Q4 comp outlook reflects both the expected resilience of the beauty category as well as potential risks from shifts in consumer spending, increased points of distribution for Prestige Beauty, and higher promotional activity. For the year, we plan to open approximately 47 net new stores and remodel or relocate 33 stores. Our new store performance continues to be strong. But like many other major retailers, we are seeing project delays resulting from external real estate and construction issues as well as supply chain disruption for key equipment. These external factors have impacted our fiscal 2022 plans and will likely shift new stores originally planned for fiscal 2023 into 2024. We continue to expect to open about 100 stores over the next 2 years, but the timing of opening between fiscal 2023 and 2024 may shift as we navigate these external challenges. The operating environment is fluid, and we will provide specific targets for fiscal 2023 when we report in March. We now expect operating margins for the year will be between 15.5% and 15.6% of sales. We expect gross margin for the year will increase with leverage of fixed costs and growth in other revenue, partially offset by lower merchandise margin, higher shrink, and higher supply chain costs. We continue to expect SG&A expense for the year will increase between 15% and 16% or approximately flat as a percentage of sales, driven primarily by $60 million to $65 million of expenses related to our strategic priorities as well as higher wage rate growth across the enterprise, partially offset by lower marketing expense. Reflecting these assumptions, we now expect diluted earnings per share for the year will be between $22.60 and $22.90. One final update. We now expect to spend between $300 million and $350 million in CapEx in fiscal 2022, including approximately $160 million for supply chain and IT; $140 million for new stores, remodels, and merchandise fixtures; and about $30 million for store maintenance and other. We expect depreciation for the year will be around $250 million. While we are not providing guidance for next year on this call, we want to share some high-level thoughts for your consideration as you model fiscal 2023. The beauty category has been stronger this year than expected. Barring a major economic event, we would expect category growth to continue in 2023, albeit at lower rates, reflecting strong consumer engagement with the category, and we remain confident we can deliver comp sales growth in fiscal 2023 within our longer-term targeted range of 3% to 5%. In this sales scenario, we would expect operating margin deleverage versus our fiscal 2022 guidance. In addition to inflationary pressures on wage rates and other operational expenses, we expect to increase investment spending related to our strategic priorities, reflecting timing shifts from fiscal 2022 and the planned ramp-up of key IT and supply chain investments. Finally, fiscal 2023 will be a 53-week year for Ulta Beauty. We are still finalizing our budget for fiscal 2023 and plan to provide specific financial guidance and update our longer-term growth targets if appropriate on our March earnings call. And now I'll turn the call back over to our operator to moderate the Q&A session.

Operator, Operator

And our first question comes from Steven Forbes with Guggenheim Securities.

Steven Forbes, Analyst

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

David Kimbell, Chief Executive Officer

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

Operator, Operator

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

Ike Boruchow, Analyst

Congratulations on a great quarter. Scott, I wanted to discuss margins with you. The merchandise margin improved in the third quarter, and it seems like you're off to a good start with promotions in the fourth quarter as well. It's a positive situation to be in, as you're poised to end the year with margins closer to 16%. Your long-term goal is 13% to 14%. Given the current high level of merchandise margins, are you starting to consider the long-term implications for average unit retail dynamics in the business? Is it possible that the elevated margin levels might be more sustainable than initially anticipated, and could the target of 13% to 14% actually be revised upward? I'm asking this more as a general inquiry rather than specific to 2023.

Scott Settersten, Chief Financial Officer

Thank you, Ike. This touches on a broader perspective in relation to your question about AUR. Let me start by saying we are immensely proud of what the Ulta Beauty team has achieved over the past several years regarding our overall operating margin profile. We continue to lead the beauty sector, gain market share, and maintain some of the strongest operating margins in retail while managing significant cost pressures from the growth of our e-commerce business, which we have expanded since 2019, as well as from rising wages, supply chain issues, fuel costs, and general inflation. We remain committed to investing in innovation to ensure a healthy and vibrant business in the long run. We've been transparent with investors this year about the beauty industry's recovery in 2022, with sales trends surpassing our expectations from fall 2021 when we shared our long-term financial outlook. This strong sales performance has resulted in operating margins that are better than anticipated, primarily due to fixed cost leverage, benefits from price increases, and noteworthy gross margins this year, along with lower promotional levels. Sales growth has outpaced the inflationary cost pressures we've encountered. Looking ahead, I want to highlight a few key variables for modeling next year. We expect to grow sales next year within our long-term target of 3% to 5% comp growth. Our merchants have done an exceptional job, and we are optimistic about the upcoming lineup of new products next year. However, we will be comparing it to an extraordinary range of new products introduced this year, including leading brands in key categories. Price increases are a significant factor. We are navigating unfamiliar territory concerning the extent and frequency of price adjustments, and how consumers will respond over time remains to be seen. While consumer resilience has been strong, there is uncertainty about how far we can push prices without affecting sales. Additionally, we plan to leverage our powerful loyalty program and the advantages of our credit card and expect continued benefits from our Ulta Beauty at Target partnership next year. Regarding gross margin, promotional levels are likely to be higher next year compared to the last couple of years. The increase in store traffic has positively impacted our margins, balancing some of the challenges from our digital operations. The benefits from pricing strategies have also been favorable this year, although it is uncertain how meaningful these will be next year. Wage pressures are expected to remain, while fuel costs may stabilize. Our supply chain investments will increase next year, and we anticipate growth in UB Media. In SG&A, we foresee ongoing upward pressure on store payroll due to rising wages, though perhaps not at the same rate as this year. Inflation impacts are evident across various aspects of our business, but we've managed to mitigate many of these effects. Strong sales growth has helped to mask some of the pressures. Moving forward, we plan to ramp up our strategic investments, including digital initiatives like UB Media and UB at Target. We have strategies to address these challenges, continuing to demonstrate our ability to deliver significant benefits from our EFG efforts. We have ample opportunities for margin enhancement and cost optimization, and we are building capabilities for sustained improvement in our cost structure. In conclusion, despite facing a more uncertain environment next year, we are well-positioned with a robust business model in a growing category that boasts healthy margins. We are confident that we can grow our top line next year, building on our exceptional performance in 2021 and 2022. Overall, we feel good about our current position.

Operator, Operator

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

Lorraine Hutchinson, Analyst

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

David Kimbell, Chief Executive Officer

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

Operator, Operator

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

Ashley Helgans, Analyst

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

David Kimbell, Chief Executive Officer

It's a bit early to provide a definitive outlook for the holiday season as we are still in the thick of it, with our busiest weeks ahead. We previously mentioned that the holidays tend to be more promotional, and the November and December period differs from the rest of the year due to the gifting nature of the season. We're not just competing in the beauty sector but also against other gift categories in retail, making it challenging to assess our position at this midpoint. We have been implementing aggressive promotions, which are consistent with our past strategies. So far, we are optimistic about our performance and believe Ulta Beauty is well positioned to compete effectively. However, we are continually monitoring the situation to ensure we finish this holiday season successfully over the next 24 to 25 days, which is our primary focus moving forward.

Operator, Operator

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

Mike Baker, Analyst

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

David Kimbell, Chief Executive Officer

In the third quarter, we experienced strong growth throughout the period, although we noticed a slight deceleration in October. Nonetheless, we still achieved double-digit growth in every part of the quarter. As indicated by our guidance of 6% to 8% for the fourth quarter, we expect some deceleration compared to what we experienced in the third quarter and throughout the year. This has been somewhat expected as our comparisons are robust. Additionally, we are in a different phase for the holiday period. We won't dive into week-by-week details just yet, but we are in the midst of significant weeks ahead. When we report our fourth-quarter results, we will provide all the specifics. However, our guidance of 6% to 8% reflects a healthy anticipated growth, although not at the same level as the third quarter. We are optimistic about our early holiday performance, keeping in mind that we still have much to accomplish as the holiday season progresses. January is also a crucial period for us, so we have a lot in store, and we are encouraged by our current observations.

Operator, Operator

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

Adrienne Yih-Tennant, Analyst

Great. Scott, could you explain the vendor contribution you mentioned that is offsetting some of the reduced marketing spend? Does this suggest that they want to promote their brands more actively and are therefore taking up more space on initiatives like the 21 Days of Beauty or gift with purchase? Additionally, Dave, at the start of the pandemic, you decided to pull out of the international Canada opening. Given that the domestic business appears to be stabilizing, what are your thoughts on reentering that market?

Scott Settersten, Chief Financial Officer

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

David Kimbell, Chief Executive Officer

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

Operator, Operator

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

Korinne Wolfmeyer, Analyst

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

David Kimbell, Chief Executive Officer

We're very encouraged by the results from the third quarter, which is part of a strong growth trend we've seen over the first three quarters across all categories. This growth isn't driven by a single category; instead, it's balanced across our entire portfolio. Our teams in merchandising, marketing, and stores have successfully engaged our guests with our full assortment, leading to double-digit growth in all key areas. Each category has its own story, influenced by increased social engagement and effective product trends amplified through social media, as well as a range of new products that are performing well. Skincare remains particularly strong, driven by science-backed, clinically proven, and dermatologist-recommended solutions, with this engagement, which surged during the pandemic, continuing to grow. It's currently our fastest-growing category. In haircare, we're leading the growth with a healthy range of new offerings that engage customers effectively. Throughout the year, we've also been satisfied with our fragrance and bath segments. As for Gen Z, they're playing a significant role, and our entire portfolio is resonating well within this vital market. Looking ahead to the fourth quarter, while I won't divulge specifics as we’re in the midst of the holiday season, I can say that we are focusing primarily on gifting and glamming. The gifting aspect includes both holiday-specific items and essential products that are relevant year-round, and our team has struck a good balance there. Overall, we feel optimistic about our assortment and are confident that we will achieve a strong holiday performance across all categories.

Operator, Operator

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

Olivia Tong Cheang, Analyst

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

David Kimbell, Chief Executive Officer

Yes, newness is a crucial aspect of our business and the beauty category. Typically, about 20% to 30% of our sales come from new items, and we expect to remain in that range this year and in the future. As Scott mentioned, we introduced some significant new brands in 2022, and we're optimistic about the outlook moving forward. The category features both well-established brands and emerging ones that have gained traction, such as Good Molecules. We are confident in our portfolio, which includes both new brands and new offerings from existing brands. The trends across categories are strong, and we anticipate that newness will continue to be important, especially with major brands also making their mark. In terms of mass and prestige, mass grew slightly faster than prestige, but both segments remain strong. The growth in mass hasn't come at the expense of prestige; rather, it reflects the strength of new brands like e.l.f., NYX, Ordinary, and La Roche-Posay that are driving engagement and growth. Prestige brands are also performing well. Our analysis indicates that there haven't been clear signs of consumers trading down, but if that were to occur, we are well-equipped to support our customers regardless of their price point choices.

Operator, Operator

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

Michael Lasser, Analyst

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

Scott Settersten, Chief Financial Officer

Is this the Michael Lasser that I know? I appreciate your question, Michael. Yes, I understand. However, we cannot break down the individual components of the variables and the formula for our EBIT margin for next year. It's simply too complicated, and that's why we mentioned we would provide an update in March if it seems appropriate. We want to see how 2022 concludes overall. We are also currently finalizing our '23 plan, which is under active development, and we will assess the numbers after the holiday season. As I mentioned earlier in the call to Ike, we are looking at various factors, which span wide ranges. We are doing our best to evaluate each one and come up with our best estimate for next year. We remain very optimistic about the long-term prospects for our business. We are in a strong position, with many options available to achieve healthy operating margins over the long term.

Kiley Rawlins, Vice President of Investor Relations

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

Operator, Operator

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

Michael Binetti, Analyst

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

Scott Settersten, Chief Financial Officer

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

David Kimbell, Chief Executive Officer

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

Operator, Operator

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