Ulta Beauty, Inc. (ULTA) Earnings Call Transcript & Summary

Good afternoon, everyone. Thank you for joining us for the last session of the day. It's Ulta Beauty, and it's a perfect time for this presentation. We're very happy to be hosting the management team from Ulta at our fireside chat. Ulta is the largest U.S. beauty retailer, offering more than 25,000 products across cosmetics, fragrance, skin care products, hair care products and salon services. They operate over 1,200 stores across the U.S. and generate a revenue of around $7 billion. Today, we're very happy to have Mary Dillon, who's Chief Executive Officer of Ulta and has been in a leadership role since June 2013, and we also have with us Scott Settersten, Chief Financial Officer, Treasurer and Assistant Secretary at Ulta. And I also welcome Dave Kimbell, President at Ulta Beauty. He was previously Chief Merchandising and Marketing Officer. Mary, Scott and Dave, thank you so much for joining us today. Mary, I'll turn it over to you for some prepared comments.

Thank you, Kate. It's great to be here. Last but not least, here we go, Ulta Beauty. I just wanted to just make a couple of comments before we start and then obviously open it up to the Q&A. But I guess, just to give you an overview -- everybody an overview of how we're looking at things today. So obviously, we just reported our second quarter results recently. And frankly, we're pretty proud of the progress that we're making. So although comp sales were down 27% for the quarter, the trend did improve significantly as we reopened stores. And as we said on the earnings call, sales trends continue to improve. In fact, in August, the first 3 weeks, 3 weeks of August, comps were down in the mid-single-digit range. So we're not providing more of a business update today, but I just want to reiterate, we're encouraged by those trends and that positive demand signals that we've been seeing from our guests. That said, we do remain, I guess, I'd say, cautious about demand for the second half as a lot of things to navigate, a lot of uncertainties. So whether it's virus resurgence, economic uncertainty, ongoing other social, political issues that are happening in the country, we think that means there's some uncertainty about demand. So we're sort of planning for that. I'd say, in addition, we also plan to continue to refine our promotional strategy. I talked about this a bit on our call, that we're using this opportunity to look at eliminating or reducing promotions that have lower returns, but increase our focus on more targeted and strategic events. So our goal then on that is to improve overall profitability and just ensure that we're well positioned for growth in 2021. But as our store fleets are opening, our trends are improving, we've certainly been also putting our attention on how do we strengthen our business in this new normal and setting a foundation for profitable growth in '21 and beyond. And so there's 5 strategic priorities I talked about on the call that I'll reiterate at a high level. But think of them as sort of an evolution of strategic priorities we already have, but a honing in, given the new context that we're operating in with the COVID situation. So first of all, obviously, it's going to be an increasingly omnichannel world. And so we're working on strategies to make sure that we win as an omnichannel retailer. Secondly, experience and discovery, critical to the beauty category. We already were reimagining and of course, now reimagining that more aggressively in this environment. Third, accelerating our efforts in the fastest-growing categories like skincare, hair care and wellness. Fourth, leveraging insights from our ultimate rewards program to deepen our guest engagement, to drive increased spend per member and drive new guests into the program. And in fitness, we continue to adjust to new cost pressures like channel mix and PPE. We're looking at how we can drive holistic cost optimization but also continue to invest in capabilities and opportunities that are required for us to drive future success. So I would just say at a high level, near-term environment, a little dynamic, a little fluid, right? But I'm really confident that our team will continue to navigate the challenges successfully. And I should reiterate, we also feel very confident about longer term, the growth opportunity for the beauty category and for Ulta Beauty. We have a strongly differentiated business model, and we're actively investing to expand our brand leadership, and I remain really confident that we're going to be able to continue to innovate and invest in the ways that will drive market share growth and drive profitable growth. So with that, Kate, I'll turn it over to you for questions. Thank you.

Great. Thanks so much, Mary. The first question, Mary, I'll direct your way. You touched upon it briefly in your prepared comments, but we wondered if you could discuss a little bit more your same-store sales expectations for the back half. Just given that Q3 is starting at -- or running at negative mid-single digits, do you think there's any conservatism built in your expectations for the double-digit comp declines that you've guided for the back half of the year?

Well, we'll see, I guess. I mean, we're trying to call it as best we can. As I mentioned, I think being cautious probably makes sense right now. As I said on the earnings call, feel positive. We do feel positive about the signals that we're seeing from guests, particularly in July and August. Beauty enthusiasts have remained engaged in the category. And as more stores reopen, we're seeing people feel more comfortable returning to retail environments. And now that all of our stores, mostly all of our stores are open, we're going back to more normal operational processes like merchandise resets, assortments, newness introductions. August was our member appreciation month, which is a marketing event that was designed to bring new members or bring -- welcome our members back. But despite that, I'd say we think it's going to take time to fully return to pre-COVID levels given just the likely disruptions in everyday life. And so it's not any signs of concern that we don't see any signs that are concerning us in our business. It's more about how does anybody predict in a pandemic, historic time, what the macroeconomic environment will be and what impact that has on consumer behavior. So yes, I'd also say that the signals and demand's strong. We like that. But you certainly could see, we saw week-to-week disruptions or market to market disruptions where there are flare-ups in the virus and whatnot. So I think it's smart to just say, "Okay, be measured and somewhat cautious about it," because things are a little bit unpredictable. In addition, the holiday season is going to be quite different. And so we know that, for example, we're not going to be open on Thanksgiving Day. We know that there's not going to be long lines of people waiting, coming into stores or outside of stores, right? So we have to think about how do we set up holiday differently as well. I'm confident that we've got the right strategies in place to do that. But I would say all those would kind of say to us, let's plan for the best -- let's plan to be cautious but also have the opportunity to really make sure that we drive the market share growth and strong results that we hope to. The other thing I'd say, I said this up front is that, we do have an opportunity to be less promotional, and I think we're leading the thinking on that as well. That's a smaller part of, I guess, the way we think about the comps for the second half. We've got a lot of tools in our toolkit, but I think using this time to kind of be more strategic about how we use those tools, but also aggressive at holiday. So again, let me be clear. We're going to -- we think we have planned holiday really well, but just expect consumer behavior to be somewhat different even though we'll continue to be a great holiday gift-giving kind of a retailer in category. So I guess that's sort of the way that we think about it, is nobody can really exactly plan what's going to happen here. But as each week goes by and as we get through each quarter, we'll continue to update our view of that.

Okay. I wondered if we could switch gears a little bit to innovation. That was something pre-pandemic that I think was on people's minds, just given some of the malaise that we were seeing in the makeup category. But you've seen a lot of innovation in skincare and haircare during that time. So I wondered if, Dave, you could talk a little bit about areas where you are seeing newness. Is it only in product? Or are you seeing newness in innovation, in price points and digital capabilities? And what are your conversations with vendors currently suggesting?

Yes. Thanks, Kate. Innovation, as you suggested, is a really important part of our category. Newness has historically been a key driver in growth and a key aspect of our beauty enthusiast delight about the beauty category, discovering and exploring new products, finding new ways and new solutions. And so it does play a really critical role and 2020 has been disrupted. And in many cases, brands, particularly makeup, but across the board, brands, just as they saw what was unfolding earlier this year, decided to push back some key innovation into 2021, which I think was the smart thing for their business and gives them a chance to get things more stabilized and drive innovation. So we do see some things coming in 2021. Having said that, there is innovation. This is not like we're totally devoid of innovation this year. There's been some really good innovation across the portfolio, and we're excited about it. I think, yes, you mentioned skincare, haircare. In both of those categories, we've been seeing innovation across different forms and functions within that, whether it's in retinol or serums or vitamin C or mask aids, we're seeing that, but also several new brands have entered into the Ulta assortment, most recently, Beekman 1802, L'Occitane, GLAMGLOW. Ordinary is performing very well. On the mass side, you have a question about price points. e.l.f. has expanded into skin care, and that's a strong addition. So across all price points and different segments of skin, we're seeing strong innovation that's connecting with our guests. Hair, equally, I think, as strong in many ways. In particular, our textured hair business, Pattern by Tracee Ellis Ross was a brand we added late last year. We brought in styling into that this year. That's been a big success. So textured hair innovation, also Kreyol Essence is another brand and others, in expanding in the textured hair space has been a big role for innovation. Fragrance, interestingly enough, took -- was slow at the beginning of the shutdown but is actually strengthening. We've seen some nice innovation in that from big established brands like YSL but also Newness from Ariana Grande and others to drive business. Makeup, though, has -- that's where we probably saw the most shifting around in timing. But where we have seen innovation has been both new brands. We just launched KVD Vegan Beauty, which is the first brand in the Kendall portfolio that we'll be launching at Ulta, that has launched at Ulta, and we're early in that, but off to a good performance there, Laura Mercier, Thrive, Pixi, others, new brands are driving new engagement. And then specific innovation in subcategories of makeup, in particular around eye, so mascara, brow, some cool innovation that's leaning into where consumers are today and where they're focused on their makeup looks. So makeup innovation was absolutely disrupted, but we've seen some good pockets that give us encouragement about consumers' engagement, and then we're anticipating even more innovation coming through, some through the rest of this year, but certainly as we get into next year as our brands' plans get stabilized and rolled out.

Great. I wondered if we could talk a little bit more about skincare and haircare since they have been very strong, and then during the pandemic, I think they've gotten even stronger. I wondered if you could discuss your efforts in terms of balancing the portfolio between makeup and these 2 other categories. How should we think about the productivity of the box with enhanced focus on these categories? And the last question within this is we've always understood gross margin dollars were lower for these categories than makeup. So how do you balance some of the pressure that may come along with the stronger haircare and skincare categories?

Yes. Really important question and one that we're spending a lot of time thinking about is just how we manage our portfolio. One of the great, great strengths of Ulta Beauty has been from the very beginning, 30 years ago, this idea of all things beauty all in one place, which means across all price points from [indiscernible] to prestige and strengthen in all categories. Strong, growing share in makeup and skincare and haircare and fragrance and bath and accessories and tools. Really strength across the entire portfolio allows us to flex as consumer trends evolve, whether it's across price points or across categories or both. And so we have that ability, and we have been flexing to your suggestion. Having said that, first, I'd start with just saying that makeup, we still have a lot of confidence in the future of makeup as much as it's been challenged for a little while now. And COVID certainly added more complexity to that. As we look out over the next few years, we think makeup has a good future. And so it's not like we see a long term -- or we're giving up on makeup. We see a lot of opportunity and we'll continue to emphasize and bring newness and new brands and try to maximize that opportunity and prepare for what we believe will be a turnaround in the trend on that business going forward. But in the now, in the current moment, we are seeing strength in skincare. And so we're flexing all aspects of that business -- of our go-to-market strategy from our marketing to our flex space in stores, promo tables and added chairs and in-caps to the actual space as we bring in some of the new brands that I just mentioned, our digital assets and -- are emphasizing skincare and haircare. So we are already emphasizing -- have been, pre-COVID are certainly doing more, emphasizing skin care more and imagine doing more of that into next year, including more space to make room for more brands and more emphasis throughout our -- all aspects of our go-to-market strategy, including store space. Specifically about margin, I guess, what I'd say is you think about our 3 biggest categories, makeup, skincare and hair. Hair has been our strongest, highest margin category for quite a while. And so that, as we see that growth, that certainly is accretive to the total store and has been that way. Historically, skincare has been a little bit less than from a margin rate standpoint, than makeup. But as we've seen this trend coming over the last couple of years, our merchant team has been working hard to close that gap to renegotiate, bring in new brands, restructure terms and reimagine the assortment. And actually, we have closed that gap. So today, when we look at margin rate across makeup and skincare, they're essentially the same. And certainly, there's fluctuation within brands and subsegments, but in totality, makeup and skin care. So the shift to skincare is actually not -- there's not a margin, that headwind associated with that. Actually, those have turned in to be about the same. So it gives us the flexibility to not have to try to manage a margin risk. At the same time, we're maximizing the opportunity with consumers.

Mary, I'm going to skip over to the market share gain question that we have since we just talked a little bit about the makeup cycle with Dave. As we think about the evolution of the competitive landscape in the aftermath of the pandemic, can you discuss your thoughts on potential market share gains, especially considering the challenges the department stores are going through and other large prestige vendors talking about closing their freestanding stores? On the other hand, you have -- we've had Target at the conference today. We had Costco at the conference today, both who discussed trends and strength in beauty. So if you could maybe walk us through how you're thinking about walking that tightrope over the next few months and year might be helpful.

Yes. Well, it's not a new tightrope, and I'd say it's one that actually, we've proven we can walk pretty well. And it's really about just understanding who we are and what differentiates us in our business model by continuing to understand the competitive tailwinds and headwinds and flex as we need. So I'm confident we're going to -- we position ourselves as a leader in the industry. We still really actually have a very small share of this very large fragmented beauty category. We're continuing to gain share through the pandemic in prestige. And I believe we're going to continue to be ultimately a share gainer. We know we can do that. So I'd say stepping back, we've always competed with everybody who plays in beauty and there's -- everybody plays in beauty, right? So we compete with department stores, with the mass players, even grocery stores, direct-to-consumers, e-commerce only, other specialty retailers. So we've long had a very aggressive, I'd say, and diverse competitive set. Our strength is that we do things that nobody else does. We bring together all the categories of beauty, all the price points in one place. We add services on top of that. Our real estate positioning is stronger, our e-commerce capability, and now omni-channel capability, we think is quite strong, and our loyalty program kind of really brings it all together in a way that incents our guests to spend their net dollars with us versus fragmented -- fragment those dollars. And lastly, I'd say we've built a brand around the Ulta Beauty retail brand that is known and loved. I mean, we're the #1 brand with teens, not just the brand name, but shopping at Ulta Beauty. And teams are obviously an important part of the cohort. We're very strong with the Latinx community, which is also a large and growing share of the beauty market. And so I think we've positioned ourselves well. So as I said, we will continue to gain share. We've been gaining share in prestige throughout the pandemic. So that's good. And I think we've positioned ourselves well to understand how to take advantage of what's happening in the department store world. Certainly, for some period of time, our mass competitors were open and our stores were closed. So that makes logical sense that they probably had some share gain, but we see that coming back. We've got a lot of exclusive brands that only are sold at Ulta Beauty in that space, which is terrific. And I would just say that when you think about it from a digital perspective, and our brand partners, they certainly are rethinking the ways that they sell for sure. And we are a very important portion, I think, of their future growth. And so continuing to partner with us on all things digital and physical is a place that we know we're going to continue to partner well and drive market share gains. The last thing I'll say is that the Ulta Beauty enthusiast, which is the largest segment of the beauty market, that shopper, they don't really just go one place to shop. They really -- they don't buy just one brand. They love the assortment and the plethora of options that they have in Ulta Beauty. And so for our brand partners, being part of that digital ecosystem, as well as our physical ecosystem will be important as well. So I think we're well positioned to continue to find market share gains even in this changing environment.

Okay. Scott, if I could throw a question your way on real estate. I wondered if you could discuss your view on unit growth opportunity in a post-COVID world. You reiterated recently that 1,500 to 1,700 store target is still the target but that you're deciding where within that target is right for Ulta. Do you see more opportunity or better opportunity as you see some of the disruption happening in real estate? And given the fact that maybe a good amount of capacity is likely to be available, could that 1,500 to 1,700 store number be bigger?

Yes. So while the e-commerce digital channel is capturing all the headlines these days, and I guess rightly so under the circumstances, we have, for a long time, and continue to believe, that brick-and-mortar is going to continue to play a really critical role, especially in light of an omnichannel shopping environment, right, which is what most consumers expect these days, to get a great guest experience, whether it's in-store or online, and that's what we've been focused on for a long period of time. Our loyalty data tell us clearly that even our best omni-channel shoppers, I mean, primarily, the majority of their transactions are in the store, right? The brick-and-mortar fleet is still a very important part of our overall growth strategy. We mentioned to investors earlier this year that while we've always been careful and thoughtful about square footage growth and where we're placing stores and trying to make sure that we navigate that line between the overbuild and underbuild as thoughtfully as we can that we did undertake kind of a whiteboard exercise earlier this year, again, seeing what happened with the e-commerce penetration and believing, a lot of that's going to be sticky, right? And while we've been planning for some of that for some time now, the scale, right, the step-up is more significant than we would have anticipated at this point in time. So the team has been doing great work, and it's not a completed project. I mean, this is something that we're going to have to analyze and go deep on the data probably for years to come, right, to continue to monitor and manage this. But based on what the work that's been done so far, we still feel very confident in that range, 1,500 to 1,700 stores. Again, it's purposely kind of a wide range, right? We don't know the crystal ball, and any one number in that range is any better than any other at this point in time, but still feel good with the range overall. So having said that, there's a lot of disruption, right, right now out there on the retail landscape, in the retail universe. So we think it's smart to be cautious in the foreseeable future. So we have toggled back on the number of new stores this year. It's 30 for 2020, is our target. And again, we said for next year, it's probably going to be at least that many, maybe a few more, but we think it's smart to go slow, be careful. There's a lot of stores going dark. So there's co-tenancy issues and centers where we're already located that present a risk. Potentially, there's going to be centers, good strong centers that we haven't been able to get into in the past for one reason or another, right? Our retailers aren't in a hurry to exit the strongest centers. So we see opportunity there, of course, to continue to build out our fleet and plan to have even stronger stores and better centers over the longer term while also taking advantage of situations now with the disruption to go back and look at economic terms with our landlords, right, and make sure. Again, it's not us versus them kind of situation. We needed to put together because we want our stores to be in productive centers. So it doesn't necessarily do us any good to have a rock bottom rental rate if the rest of the center is struggling, right? So I think we have the right strategy in place, and we're navigating through that in a very thoughtful, planful manner and are very optimistic about the opportunities on both sides, but having stronger stores and better centers and being able to improve the economics over the long term.

And along with that, you mentioned e-commerce, I know you've had a lot of success in leveraging your digital presence while your stores were closed. And it seems like that might be an opportunity that you can lean into a little bit more in the future. This question has come up with you, Scott, before, in terms of the channel shift implications for gross margin. And I think historically, you've noted a range, but now that's been thrown out the window, I think, just with the strength of the channel. So when it comes to the pressure on the gross margin from being more digital, how do you mitigate some of these margin headwinds?

Yes. So it's important, again, to remind everyone, it's not an either/or kind of decision tree here that we're dealing with, right? This is an omnichannel model. And so e-commerce plays an important role, along with the brick-and-mortar fleet of stores that we have. So again, we've made no secret of the fact that the e-commerce channel on a gross margin line, it's a tougher business for us, right? And it's primarily driven by -- it's naturally a more promotional part of the business. It just -- it's not the number of promotions we offer to those guests versus the store guests. They're the same. We offer the same promotion to everybody when we do it. It's just that it tends to overindex online, right? It's easier. You've got an e-mail delivered that motivated you to shop with us on the app or on our website. And so you can see what the offer is, and it's just easier for people to engage with that or go out some place and find a coupon on another website. I mean, we all know what they are. Where to use loyalty points, right? Again, as you're checking out, we serve up all that information to our guests directly. So it just naturally kind of fits into that profile. So what are we doing for self-help, there's a lot we can do there. And part of it, part of it is things we've already taken actions on, like the focus offering in our store, which was live only late last year, to remind folks. And then we quickly pivoted to the curbside offering, right? And we've said, those transactions are less dilutive on the margin line than a typical to the front door kind of delivery order because of the shipping costs, right, the third-party shipping costs. And again, I'm sure most people are aware of upward cost pressure there, right, that are being passed on to all retailers, not just [indiscernible] So we're thinking about how do we leverage to bulk this curbside offering to make sure -- mitigate those headwinds as best we can, along with expanding our capabilities, so ship from store, something else we tested last year. And now we were going to expand later in 2020. And again, that's part and parcel of getting closer to the end customer and taking some of that third-party last mile delivery part out of the equation. Our fast fulfillment center strategy is another piece of this. So these are investments we're making upfront. But the Jacksonville fast fulfillment center, again, we pulled it up into 2020, partly for capacity considerations, right? Again, e-commerce is kind of off the charts growth. Holiday is going to be different. It's going to be a heavier lift there. So we need that capacity in place. But again, that's strategically put into a marketplace, a geography in the U.S., that's super important, tons of customers for us there in Florida and the Southeast U.S. So that's going to help mitigate some of those shipping headwinds as well. So those are a couple of things that we're doing in what I would call, in the digital e-commerce channel specifically, but we're thinking broader than that, right? So there's other places for us to look to help try to mitigate some of those headwinds in the SG&A line. Again, some of those we've already discussed with investors around rethinking some of our services' management structure in the store that we think is an efficiency, and will deliver a better guest experience over the longer term, thinking about how we bring back our store associates, right, and matching them up with the sales volumes now, we think is a lever. Again, in the short term, that will be helpful to us. But we're also thinking broader terms. So the discounting promotion thing we talked about earlier, that's an element we've been focused on for a long time and one where we've seen, even in the midst of the COVID crisis, we've made some good inroads in, right, just being more methodical and disciplined around the level and amount of promotion that we do in the business. We've seen some good results there earlier this year. And we think that's a lever for the future as well that can help. SG&A is always a focus area for all investors. And so again, for us, in Mary's opening remarks, she used the word holistic. So again, this is something we've been thinking about for a couple of years now, right? Under our EFG initiative, efficiencies for growth, thinking about what kind of cost we can take over the business to help support some of the investments we think we need to make for the future. The COVID crisis just brought a new sense of urgency, I would say, to that. And so we've cut a lot of costs, a lot of overhead costs out of the business during the course of 2020, and that will continue the rest of the way into the second half of the year. And it just brings to light other opportunities that maybe we didn't look hard enough at in the past. And so we're looking at everything with a fresh set of eyes as we think about 2021 and the years following that, seeing how this ladders out. So there'll be more to share. There's more decisions to make as we frame up 2021, and we'll be there to talk more about that, provide more color as we get further down the path here this year. I'm here. Is Kate here?

Sorry for the interruption. Kate will be right back.

Maybe while we've got a little period here, we can go into the Q&A, the standard Q&A that Kate -- oh, there, she's back.

I'm back. I'm so sorry. Leave it to the end presentation for me to just bow out in the middle of your answer, I'm sorry. So...