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

All right. Well, thanks, everyone, for coming back. We've got Ulta Beauty with us. Really excited to have Scott and Dave here again; Scott Settersten, CFO; Dave Kimbell, Chief Merchandising and Marketing Officer. I feel like, Dave and Scott, a year ago, as we sat here, although we were in Laguna Beach, which was nice. The category had just started to crack a bit. I think there were a lot of questions about how you've managed that. On one hand, I think you guys have actually managed that pretty well. But on the flip side, I think the overall environment couldn't be any less certain than it is right now. So just -- it's an interesting time.

I guess my first question, high level, I'll kick it up to both of you guys. Just -- what is COVID doing to you guys from a strategic standpoint in terms of how are you managing the multiyear strategy of the business, just anything big picture that if COVID hadn't happened, maybe you guys wouldn't be talking about when you're sitting around the desk with all the executives?

Yes. First of all, thanks for having us, Ike. Great to see you at least virtually. And hopefully, we get back to more attractive surroundings for our next meeting together. But yes, -- so of course, this has been for everybody a wildly disrupted time. So we have spent a lot of time over these last several months, both managing the -- in the moment of crisis, of which there's been a lot of twists and turns like there have been for every company. But also thinking about what our strategic path is going forward and how we can take the strengths that we had coming into this and position ourselves to really accelerate coming out of that. And overall, we're really optimistic about that path forward for us. The way I'd summarize how we're thinking about the path forward is, while a lot of the specific opportunities have evolved and shifted, the fundamental strategic direction that we saw for our business pre-COVID still remains. Key aspects of it, like the -- first, the belief and confidence we have in the beauty category itself. We think while there's been some up and down -- ups and downs and some challenges in segments over time, we believe through all of our research and just looking back over time, the role that beauty plays in our consumers' lives, the opportunity for us to continue to be a leader in connecting with our guests and helping them express themselves to the world and bring to life everything that they want to through the way they look and feel, it's such an emotional category. It's such an innovation-driven category. And as a leader in it, we're really confident about the future path of the category itself. So that's one. And that hasn't changed. In fact, in some ways, this is called some evolution, but we think even new ways and more important ways, beauty category will play a big role going forward. And then our position coming into it. The things that have driven our company for really the history of it. I mean we're 30 years old and some of the core aspects of our business, we think that have driven our success will continue to drive our success. One of the biggest differentiating features, one of the elements that makes us really unique and special in the marketplace is our assortment, this idea of All Things Beauty, All in One Place, mass to prestige, all price points, all categories, haircare, skincare, bath, fragrance, makeup, every category across all price points and brands allows us to flex, and that's worked well for us pre-COVID and certainly is working well for us right now. And so some of the fundamental building blocks of the company, we think will still drive our business going forward. Having said that, we think there's 5, and I'll go through them really quickly, but there's probably -- there's 5 key areas that we were thinking about before COVID and this crisis has evolved our thinking, not the importance of each one of these, but how we might go execute. First, we are an omnichannel retailer. We were before this crisis, we're even more so now as our e-commerce business, like every -- like most other retailers or e-commerce business has really strengthened. Ours is -- and we think that's a really good thing because we have more people that have experienced both our in-store and our online experience than we did just a few months ago, and history suggests that's a really positive result in driving greater share of wallet in connection. So we're going to be thinking even more omnichannel, more ways to engage our guests across both channels, the role of stores, expanding stores, the role of e-commerce and building the best-in-class e-commerce experience that omnichannel work was underway, and we're accelerating that. Guest experience is number two, across all touch points. And there's key aspects of that, that stay the same. But there are some elements that we think evolve. Trial and discovery is a big part of this category. And the way people will discover new items, we think will shift. Right now, testers, as one example, are not available for most products in our stores. We think we'll get back to that, but we know the way our guests will discover products will look different. So we're evolving our focus in that. And so the whole guest experience we're accelerating and thinking about how in a post-COVID world that could look different. The third is assortment. And that's, as I said, has played a big part in our success for our whole history. We're leaning into categories that we were strong before, but we think we'll be even stronger coming out of this wellness, self-care, categories like skin and bath and hair, fragrance. So we're adjusting our assortment and leading into those. The fifth is around loyalty, and that's been a big part of our business. We are proud to have what we believe is one of the best loyalty programs, and we're going to continue to innovate and drive connection through that because we know there's power in that, there's data and insights in that. And that got disrupted through this, but we're going to lean into that and drive even more. And then the last thing that's kind of the foundation in many ways is continuing to work hard on the cost structure of our business and the capabilities we have to succeed going forward. So we've had success over the last couple of years in some key initiatives to pull cost out of the business. We're doubling down on that. At the same time, we're making sure we have the capabilities to deliver those other 4 examples. So we're excited about the future. We're managing through this crisis, we think, the best we can, but we're also preparing ourselves to be the leader that we were coming into this and accelerate out of it going forward.

Great. And I want to touch on some of those omni and e-com details in a minute with Scott. But let me ask another question much more near-term. Just -- you talked about big improvements in the comp trend, July to August. What exactly drove that sequential improvement? And then is there -- was there anything unique in August that would have created a much better comp run rate relative to what you've been seeing?

Well, yes, what I'd say is early in Q2 with our stores closed, of course, our comp was much more challenged with stores closed. As stores started to reopen in late May, June, we started opening them by July. We had all of our -- pretty much all of our stores open, then that's when we really saw kind of full engagement across the fleet across all markets. So I'd say a big factor was just getting our stores back open and getting our guests reengaged in the omnichannel experience. A lot of our guests that were previous store-only shoppers came online as our stores were closed, but some didn't. And so getting them back into store was a key focus for us. That started happening in July, all of our stores were ramping up and then strengthened as we moved into Q3. We also had -- we did -- in order to reengage our guests, we had what we call the member appreciation month throughout the month of August, which was very purposeful in pinpointing those guests that all our data suggest should have shopped with us over the second quarter. But we think largely because our stores were closed and other disruption factors, getting them back in through, engaging in the loyalty program, points offers, special programs with key brand partners. So that really worked and helped reengaged our members. All of that is very purposeful in setting ourselves up to kind of rebuild and recover those guests that were disrupted by the store closures and everything else going on in the world around us. So August was a month to kind of get that -- kick start that. We're in the middle right now of 21 Days of Beauty, which you know is one of our biggest promotional and traffic-driving events of the year, and we're pleased with the overall direction. And we're just taking steps then and then we go into holiday at the end of the year and gearing up to hopefully get back in where our guests are -- it won't be normal by any stretch, but we're at least getting our guests back engaged. So that's why we're seeing some of the strength, and we're very purposefully trying to reengage and get our guests back into the Ulta fold.

Got it. And then just -- I think you mentioned -- we talked about promotion. I mean, why exactly are you guys holding back on promotion right now? It seems like driving traffic has got to be such an important thing. So how do you kind of balance promotion and traffic? And what is embedded in your outlook right now for the second half?

Yes, yes. Well, first, I'd just say, we are still going to leverage promotional activities to do what you suggested, attract traffic to get customers engaged. But also more importantly to focus on those events and activities that have long-term equity building impact on our business. So I mentioned briefly 21 Days of Beauty, which we're in right now, we're -- there's only a few days left, Ike, so make sure you get in by the end of this week. But it's a great example of a strategic promotion. Yes, there's a discount related to it, but the purpose of this promotion is to do what we call mass migration, to get those that are only shopping in mass to, in many cases, try a prestige brand for the first time. And we've done it for many years, and we have lots of history and analytics that demonstrate that is the behavior, not just in the moment, like I'm buying this discounted item. But I come back and engage in those items and the entire brand, and there's equity build for us as we get more greater share of their wallet, we're introducing them, we're moving them up and the brands. So that is a promotion with real strategic purpose. Where we've been trying to pull back and optimize is those that are maybe not as strategic, not as equity building over time or have a very purposeful consumer-driven other than just discounting. So 2 examples in Q2 that we talked about. We've had a big leader event, which is just a deep discount across a bunch of our large-sized shampoo and conditioner -- professional shampoo and conditioner. Yes, it drove volume, but it really didn't have a sustained impact on our business and cannibalized core business and over time was not a equity building and long-term sustainable type promotional activity. Similarly, we pulled back with this broad scale, 20% off coupon. And we'll still do some of those occasionally. But those just served in the moment to drive traffic, but don't lead to long-term loyalty and connection to either Ulta or the brands that we carry. So we're shifting that focus to strategic initiatives. Loyalty, there's a lot -- well, those are big, big things that everybody sees. We're trying to eliminate some of those. What's harder to see is all the pinpointed loyalty personalized promotions, identifying segments of guests that we think we'll be really excited about the newest launch we have in makeup and directing pinpointed, high-value, high ROI promotions towards them. So it's not a total cutback on promotion as much as it is a shift to those higher-value strategic ones. And so far, we think it's working.

Great. So I'm going to shift over to omni. I'm going to talk to Scott for a little bit on this. I mean, Scott, we couldn't get a fireside chat without talking about channel margins. So on the e-com side, Scott, I don't know if you had a chance to see, but we put out a pretty detailed note on you guys last week discussing your margins by channel. I guess, can you update us on how best to think about profitability by channel today in terms of what you're able to share with us?

Yes. So yes, we did -- we're aware that you published a report last week, and it was very well done, very thoughtful, very thorough. And we're not going to be able to comment specifically on any of your assumptions, right? But...

Fair enough. Fair enough.

Just important to remind everyone, right, that this is an omnichannel business, right? It's brick-and-mortar, and the digital e-commerce kind of working well together. We know that our most engaged omnichannel shoppers spend 3x what a normal brick-and-mortar only shopper spends over the course of a year. We also know over a long period of time that when we open up a new store, we get incremental e-commerce shoppers that come along with that, right? So again, it makes sense to us, right, that people get closer to the brand and more engaged with us and this notion of newness and the beauty enthusiasts' shopping behaviors, they worked equally well, whether it's in the store or online. Just remind people, when we talk about omnichannel, there's 5 different ways that people engage with us, right, either through stores directly, what you call the DTC, right, through the website or the app and through our distribution network right through the front door. They come into a store and we're out of stock, we can ship it to them, right, through our e-commerce capability to their home. We have BOPIS, right, in curbside service, right? BOPIS was rolled out late last year. So we're really just beginning to see kind of the power of what that can bring to the mix overall. And then finally, we tested some ship from store capability last year. We're going to do more of that this year. We're ramping up in the fourth quarter to have, hopefully, maybe 100 stores capable of doing that around the country in key markets to get us closer to the end customer, right, which provides some good cost benefit for us on the final mile kind of shipping equation. So we're not going to get -- be able to get specific around actual margin, basis points headwinds or tailwinds. Suffice it to say, when we think about the sales channels, it's holistic. And we think the same way around cost mitigation strategies, right? So it's not just what can we do on the e-commerce cylinder, let's call it. So BOPIS is a way to mitigate some of that, FFCs and ship from store is a way to mitigate some of that. But there's also other elements in the SG&A line, right, that can be pulled as well. We mentioned some of that around some of the store service manager tweaks we're making to help take some cost out and to optimize our business, but there's a lengthy of other things, fixed store cost and rent leverage and other SG&A opportunities as well that would mitigate some of those, what I'd call natural headwinds that are part and parcel of the direct-to-consumer or what people commonly call the e-commerce business.

So we're not going to talk about the absolute margin until I understand that. But at a higher level, let's talk about the channel. So in e-com, I guess my question would be, wherever those margins are, can they move higher? I mean, you talked about curb side and BOPIS mixing up. We know Jacksonville is launching soon. It seems like the mix headwinds in the second quarter got much better than the first quarter. So it seems like there's some potential there to move the margins within the channel higher over time. Can you kind of just speak to that at a high level?

Sure. So while it's unlikely that if you compare an e-commerce direct to the front door sale versus a brick-and-mortar sale or some amalgamation of those other 3 methods we have of engaging with our guests, it's never going to be on parity, right? Or it's never going to be richer, I would say, than some of the other avenues we have, the sales avenues we have. So again, that's kind of a given, I would say, on the front end. And then the question becomes, what can you do to mitigate that, right? And again, it's more than just an e-commerce challenge or a gross margin challenge, it's overall operating margin. That's kind of how we think about it. Again, longer term, we need to be agnostic on where the sale originates and how we complete the sale, right? I mean, that's what true omnichannel means. And so we mentioned -- I mentioned here a second ago, so BOPIS and curb side, it's clear to us that, that's a better margin profile sale overall than a direct to the front door sale, all right? Things around the FFC, so Jacksonville moved up this year, right? It was planned and had gotten deferred to 2021, moved up. That's going to get us closer to end customers in a very key market for us in the Southeast especially the Florida market, which is key for us. Getting closer to your customer is better on the cost equation side of things. Ship from store is another element of that, right? So again, in key markets across the country, how do we get closer to the end customer to try to mitigate some of those shipping costs and surcharges, other things that we're grappling with as all retailers are at this point in time. And then when we shift to, okay, what else is there outside the e-commerce cylinder that you guys can influence? I mentioned service, labor, right, in the store. So in the SG&A line, store labor and benefits is the biggest driver of SG&A for our company. And we've been making significant investments there over the years, part of it's the boutique strategy, part of it, engagement with guests in the store. So a lot of things going on behind the scenes. But there's obviously, again, in light of COVID in the changing environment, there's definitely ways for us to optimize those costs. There's things around rent. I know we might talk a little bit about landlords and real estate and what's going on there. But our EFG efforts, remember, there's 4 major buckets there, and one of them is around our real estate strategy, and what we can do to optimize our rent structures in our stores. There's a lot of work going on behind the scenes. We think that's a major lever that will help us mitigate some of the e-commerce channel headwinds we have in the future. And then, lastly, just SG&A as a total bucket, right? Again, in light of what we've seen there with disruption and assuming sales are going to be tougher, right, in the near term, there's definitely other areas of the business we're looking at across the enterprise to optimize the cost structure for the business. So again, we think there's a lot of opportunity over the longer term. And the one thing in your report I was appreciative of, that I will comment on, is we both agree that double-digit EBIT margin is something that Ulta can deliver over the longer term, we're very confident on that.

Got it. Well, that was my last question on margin actually. I mean, it's kind of you talk about each channel in and of itself and on the e-com side, there are initiatives to push it up on the store side. It sounds like there's labor and occupancy and some other levers that you're working with in a lower productivity -- potential lower productivity environment going forward because of e-com. I guess, I don't know, your operating margins peaked at 13.5% to 14%. Based on the conversations we have, some people don't think you'll ever get back to 10%. I mean, you guys seem pretty confident that double digit is very much on the table. I mean, can you elaborate a little bit on what you just kind of offered in terms of 10%? And how do you think about margins long term?

Yes. So I mean I would tend to agree that, that mid-teens operating margin, that's going to be tough, right? Just in light of what we've seen with color cosmetics and the digital shift that we have in our business and again, some of the inherent headwinds that come with that. I would just remind people that we've said this, call it, 400 basis points that we've seen of headwind in 2020, right, when our stores were closed and you become just a solely a direct-to-consumer kind of business, that's not going to last forever, right? That's extraordinary. We've already seen sequential improvement. You alluded to that second quarter over first quarter, and we've seen that continue to moderate as we get into the rest of the year. Again, the good news is, I think Dave said this is as the stores reopen, it's obvious that consumers, our guests want to come back into the store environment, right? That's a key part of the equation here. And so again, the strength, what gives us confidence is coming out of the second quarter and the early part of the third quarter, again, those comps, right? Again, net-net, in light of everything that's going on, that's a pretty good place to be. And we're just working on how do we continue to optimize the total model, right? What can we do to mitigate some of the rate headwinds and make sure we continue to invest for the future, right? Because there's just things we need to continue to work on to help elevate the guest experience for the long term, and that's what we're focused on.