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

Good morning. This is Kate McShane from Goldman Sachs again. I am here with the Ulta Beauty team. Ulta is the largest U.S. beauty retailer with almost 1,300 stores, offering more than 25,000 products across categories: cosmetics fragrance, skin care products, hair care products and salon services. Today, we have with us, Dave Kimbell, who is the Chief Executive Officer of the company as of June this year, after previously serving many leadership roles for the company since joining in 2014. And we also have with us Scott Settersten, the Chief Financial Officer. Kiley Rawlins is on the line as well. Dave, I'm going to turn it over to you because I think you have a few opening comments.

Great. Well, thanks, Kate, and thanks, everyone, for joining today and your interest in Ulta Beauty. A few weeks ago, we did report our -- what were record second quarter results -- financial results, with sales and earnings exceeding both fiscal 2020, but also importantly, fiscal 2019 levels. So what we see is the beauty category is recovering faster than we initially expected. Investments that we've made over the last year to adapt to the marketplace disruption, to ensure that we're continuing to lead the recovery have allowed us to accelerate and strengthen our leadership position. So we're really, really encouraged by the momentum we're seeing and optimistic about our ability to continue to capitalize on the momentum, the consumer trends, the engagement that consumers are having. And as such, we increased our financial expectations for the rest of the year. However, it's clear, and you all know that the operating environment that we're all in continues to be very, very dynamic, especially as it relates to the spread of COVID-19 and the Delta variant and other potential ups and downs that are ahead of us, and the impact that can have on consumer behavior. So as a result, we've reflected that level of uncertainty in our guidance for the rest of this year. But we feel like we're emerging from this disruption as a leader. We see it in our sales trends and our market share gains and consumer sentiment and our loyalty program, and most importantly, in our culture. Our team has been through a lot this year, but it's really rallied together to continue to take care of our guests and take care of each other. So we firmly believe what we're experiencing as we lead this recovery is a real testament to the work we've done throughout the year, and through the whole 31-year history of this company to ensure we've got a great culture and a great model, so optimistic about the path ahead of us. Before we jump into the questions, I do just want to share a quick update about our Analyst Day. You may have seen that we're holding an Analyst Day in October. Given this ongoing uncertainty around Delta variant, we'd hoped to do it in person, but we've decided to move to a fully virtual event. So there's communication and information about that, but it will be webcast live on our investor website. So we're looking forward to that event, an opportunity for us to share, in more detail, the -- what we believe are exciting opportunities that are ahead of us over the next several years. So Kate, why don't we -- with that, why don't we jump right in?

That sounds great. As I was preparing questions for this, I kind of wondered how much I could ask, because I don't want to front-run the Investor Day next month because I know there's a lot of good stuff that will probably come out of that. But Dave and Scott, thank you for joining us. It's nice to see you. You talked a little bit about, just, things are moving a little bit faster than you originally expected. And I wondered if we could take a step back to see if you could walk us through the ramp-up in your business as the economy started to reopen and especially as we started to see the vaccine become more of an option. What was some of the customer feedback at the time with regards to how they felt about the category and what they needed?

Well, I'll go back through -- maybe go back even a little bit further into 2020. So obviously, what hit in March of 2020, it took us all by surprise. And so we quickly pivoted our business for the first time ever, being an e-com-only business, shutting all of our stores, and our teams really rallied to do a few things: One, to make sure we're delivering a great experience for our guests through our e-commerce. We stood up new capabilities very quickly, leveraging our buy online, pick up in store, expanding that to curbside, expanding our digital engagement tools to make sure we were serving our guests in the moment. But we were also preparing for reopening of our stores and reengagement of our guests, some of whom, through the disruption, had fallen out of the habit of shopping at Ulta. So we mobilized the team to start thinking about the recovery and what came. And so as you know, later in the year, we started -- in summer, started reopening our stores in a phased way. We kept our e-commerce business right along and -- but our stores came back still in a very disrupted time. But we were encouraged early by the level of enthusiasm and engagement we had in our stores. Traffic was still challenged, but the response to our stores being reopened, even in a disrupted environment, gave us a lot of encouragement that -- and optimism that we had a positive recovery path ahead of us. Then we moved into 2021. And as the vaccinations started rolling out, we saw strengthening traffic trends for sure as people became more comfortable broadly. What's really interesting is category had -- several categories had responded differently through this. Skin care was strong coming into it, remains strong; hair care accelerated; fragrance, which we actually thought might get hit and did at the very early stage of this, had an exceptional year and continues to be strong; makeup came into 2020 a bit weak, took a step back, but is showing signs of recovery. So as we move into this year, we saw improving -- we continue to see improving trends. Our traffic, as we've shared, in stores is still down versus last year. But our spend -- our basket size is up, and we comped positive in our stores in Q2 as guests were more and more confident to come in. And it demonstrates to us the power of the physical environment, the importance of human experience, the emotional connection our guests have to beauty. And for them, it's a real joy and a pleasure to shop for beauty. It's not a chore. At the same time, our stores were strengthening and improving, our e-commerce business, while clearly not at the level of 2021 when our stores were closed, we doubled our e-commerce business in Q2 versus Q2 of 2019. So strong continued momentum in e-commerce even as our stores are recovering. So feeling really confident in the path, the choices we made, the actions we took to ensure our stores were ready to open, and importantly, engaged in our loyalty program, build that back as we had some disruption last year, has moved us into -- down this positive path. And we think the momentum is really strong. As I mentioned, there's certainly uncertainty ahead of us as Delta plays out and other potential ups and downs. But the fundamental momentum is healthy and we really see a bright opportunity for us to continue to drive strong growth ahead of us.

And within all of the businesses makeup, obviously, as you mentioned, has had a slower ramp back up and maybe things are a little less certain in makeup, just given the Delta variant and masks being put back on. But I wonder just with regards to makeup going forward, what do you see as being the bigger driver of makeup? Is it the replacement cycle of everybody who needs to replace their expired makeup that they haven't been using? Or does newness start to come into play here? Do you see a better, deeper pipeline of newness in makeup?

Newness is critical, and it always has been across all of beauty, but arguably it's most important in makeup. There's a real clear fundamental desire to see what's new, to try new things, to adapt to new styles and looks and techniques. And so newness has been a big part of the category. We talked about this before the pandemic. It was one of the reasons we saw a slowdown in the category, is the pipeline of newness, which had been so strong for many years -- it hadn't developed new techniques as impactfully, and that was a big contributor. So we look at the business right now, as I mentioned, we're really encouraged. We didn't see, as things reopened, this sudden step change in performance in the category. It wasn't just like overnight, which suggests to us it isn't so much about restocking at home, although we know that's happening. We hear that and that -- so that's contributing. It really is this fundamental kind of reengagement in the world around -- and a continued discovery of beauty and how you want to express yourself. One of the things that even though makeup was really struggling in 2020, given all that was going on, one thing that gave us hope is there was still a huge amount of engagement and dialogue in social media about makeup. Even though people weren't going out, in the depths of the lockdown, people weren't going out, but they still were talking about it, trying new looks, just playing with makeup, which again, for them is fun, and it wasn't just a chore for our beauty enthusiasts. And that told us that makeup isn't just about going out. It's an important part of how people show up into the world, and we're seeing that play out. And then the newness pipeline is really working across the board. Mass has been stronger than prestige in this recovery. It actually is comping positive in Q2 versus last year. We actually saw some of that in Q1. And that's because mass brands tend to have a bit quicker concept to market with their innovation, and we're seeing that play out on brands like e.l.f. and NYX and L'Oreal and Maybelline and ColourPop, a number of brands that have a strong ability to connect in meaningful ways and drive growth through innovation quickly. But our prestige brands also are showing nice signs of improvement. Great innovation from MAC. Strong performance on Clinique on the makeup side. Benefit, Tarte has been a strong leader. So we're seeing innovation that's come in. And so week-over-week, really essentially, it's a steady improvement in makeup. And we think it's not just a short-term trend. It's -- we're on a path that makeup will be returned to health and be an important part of our business for a while.

Great. And are there any particular innovations around holiday that Ulta is excited about? Is it technique? Is it color? Where can we expect to see more of the innovation?

Well, I think in makeup, what we're seeing is -- we think holiday in general is going to be celebratory. It's going to be -- last year was a bit more introspective in holiday as people couldn't travel and spend time with friends and family as much. We think, this year, the current -- knowing again, there's uncertainty about exactly what's ahead of us, but what consumers are telling us is that -- and what we're seeing in the market is a celebratory mood. In the short term, makeup is really leaning into some of the drivers that we saw a few years ago that are back, bold color, glitter, bringing to life a bit more celebratory tone. And we're seeing that in social media, and we anticipate through holiday that will be a big part. And so what's cool for us is often -- and where we see this in the pipeline ahead of us, the blend of the kind of 2 sides of makeup of a return of boldness and just bright colors and as I said glitter. At the same time, there's different moments. We're embracing a more natural look at which makeup [indiscernible] used. So seeing kind of 2 sides of that. And when those 2 things go together, it actually leads to a nice engagement in the overall category.

You had mentioned earlier prestige versus mass. And I know there's been different phenomenon there in terms of market share just because of how things played out during the pandemic, who remained open, who had to be closed. And so when it comes to, I guess if we could start with mass, that seems to be a place where maybe you had lost a little bit of market share, where are we in gaining that market share back? And what do you envision for further market share gains for the mass category?

Yes, mass is an important part of our business. It's a key part of our model. And it's what -- one of the reasons our guests really love us is this idea of being able to buy mass to prestige, all things beauty, all in one place. And so mass is really important for us. We did take -- after a continued, consistent trend of share gain leading into 2021, now with our stores closed and everything we faced and the move to central retail and trip consolidation and all the other things that we know are going on, we did lose share in mass, but we're seeing that come back. Our mass business is very healthy across makeup. Skin, it's quite strong. And that's really, I'd say, a couple of things that drive that. One is just the experience, this All Things Beauty, All in One Place. Nobody does that. Our guests don't typically buy only mass or only prestige. They curate an assortment that works for them and to be able to do that in one place is -- makes sense to our guests. And so that's really important. So they're coming back to us so they can make those collective purchase decisions across the total assortment. The other thing that's really important is exclusivity or really differentiated assortment. So about half of our mass makeup assortment, for example, is either exclusive or limited distribution brands, brands like Morphe, ColourPop, Revolution, Juvia's Place, that play a really important role in our business. And then in other larger brands like e.l.f. and Maybelline and L'Oreal, we have exclusive lines within that. So we have items that you can't get in others. So all that leads to, we are -- our mass business is healthy. We see us continuing to now get back to gaining share and we're certainly doing that on the prestige side. And when both of those things work together, that's when our business is really strong.

If I could ask about the Target-Ulta relationship. I know it's still very early days. I think when you guys reported your quarter, it had only been a week or something. So now it's probably only 2 or 3 weeks since it really launched in the Target stores. And I have to say, we've been to a few of them and they look great. I just wondered if you could maybe again talk to us about what the incremental opportunity here is for Ulta. You're going to be getting some, I think, traffic that maybe you wouldn't otherwise get just because of the traffic that comes into Target. But how do you see this ultimately playing out in terms of customer acquisition?

Yes. Well, first, we are really pleased with the partnership that we have with Target. From the moment we started working together, we were committed on creating something truly unique. This isn't just take Ulta and put it in the middle of a Target. We work together to create something that's truly differentiated, that adds value to the beauty landscape and is, most importantly, really exciting. So it's a highly curated, beautiful expression. It's the best of the best assortment that is purposely and strategically designed to add incrementality to the category and add value for us, for our brand partners and for Target. And as you said, it's really early, so we can't really draw any conclusions, but we're encouraged by what we're seeing. The reason we think it's going to add value for Ulta is, first, consumers love it. So if you're delighting consumers, you're off to a great start. And consumer response has been overwhelmingly positive from the moment we announced the idea of bringing together Target and Ulta is really exciting. And the initial in-market response has been equally encouraging, so consumers really love it. And so when we know we delight our consumers, we typically win. But what we see is really this overall experience. We now see Target, this Ulta Beauty at Target as a third big pillar in our omni-channel strategy. At the heart is our core stand-alone stores, 1,300 stores. It's the biggest part of our business. It's what brings all of Ulta Beauty to life through the human experience, the physical experience, the brand discovery. So that's our -- we are hyper-invested and focused on our e-commerce business and all things digital because we know that's a key part, not just the commerce, but the way it drives across the business -- the total business. And now this third pillar of engaging our guests in a really convenient way in about 100 Targets this year and hundreds more to come. And so we see it as a third pillar. And what we've historically seen is any time we add value to our guests, anytime we get a guest to take more advantage of what Ulta offers, we get rewarded. So a store guest that has been only-store that starts shopping on our e-commerce business, their spend goes up almost 2.5x. They continue to shop in-store, but they now are giving us a greater share of their wallet. Even among our best guests, we don't have 100% share of their wallet. Beauty enthusiasts love beauty and they do buy across a variety of locations. And so we see -- when we get them more engaged in a new channel, they give us greater share of wallet, we get greater loyalty. That's what we believe is going to work here. And all the research suggests, all our analytics suggest that as consumers start to get either discovered, we acquire a new guest at Target, and then they come and experience all that Ulta has to offer, which is much more than what's delivered just in Target or we'd have an existing guest that goes to buy something at Target, over time, we see -- we believe we'll see their engagement across the total channel and total experience rise. So it starts with great customer enthusiasm and this idea that if we delight our guests, they will reward us. And so far, that's been true in everything we've offered, and we're quite confident it will be true in this. And as I mentioned, again, just a few weeks in, but feeling good about the results so far.

Scott, I wondered if I could throw a question to you, just with regards to the inflationary environment. One thing that we've been hearing quite a bit over the last day or so of this conference is just all the consternation in the supply chain. I don't think, necessarily, this is affecting Ulta in a meaningful way. But I wondered if you could maybe address for us just what you're seeing within the supply chain. And then second to that, just with the amount of inflation that seems to be coming across on the transportation side and on the wage side as well, just how Ulta is managing their margins.

Sure. Thanks, Kate. Yes. So we're not immune. Ulta plays in the same arena, again, over a large swath of the U.S. economy right now, struggling with a lot of different things on the supply chain side. So we are planning for higher costs in the supply chain for the second half of the year. Partly, we're adding more shifts in our distribution centers. So there's more hours going to be expended here, incurred in the second half of the year, partly because of social distancing requirements that are still -- exist out there in all locations we do business in the stores and in our DCs. And so we're adding extra capacity there, but also because of the increased volumes that were, again, largely unexpected. So more hours. Wage rate growth, again, inflation there. We're experiencing it like many others, so we're taking action where we think it's appropriate. And then on the transportation side, with fuel and driver shortage issues and shipping surcharges. So again, our team does a great job with the analytics there and trying to look ahead down the road, and we think we have that appropriately built into our forecast for the second half of the year. So the teams are working diligently. I called it earlier today, I call it good old-fashioned elbow grease, like, really working more closely with our partners, whether it's on the transportation side or vendor partners and just doing a better job there, staying connected, I'd say, on the product vendor side. We did mention on the call that we expect inventories to be higher than our growth rate here at the end of the third quarter. So just being strategic and pulling some of those key items ahead in the supply chain network so that we can flow them out to a store -- to our store fleet in a more optimal kind of manner maybe than we would typically would do so that we stay ahead of the curve as best we can. So we're very proud of the team. They're doing a fantastic job. Again, the resiliency and adaptability that the team has demonstrated here over the last 18 months and continues to do, and we know this is not over by a long shot. So the team is doing a great job. And we feel like we're confident, we're optimistic in how the second half of the year will play out and how we will compete during the holiday period. We think we're as well positioned as we possibly can be to make sure we make the most of it.

That's great. I guess, Scott, if I can ask you one more question. Part of, I think, what has weighed on margins over time is just the mix shifts more to digital away from brick-and-mortar. Just how are you thinking about digital versus brick-and-mortar sales as we enter into 2022? And how could that mix impact gross margins? Do you feel like e-commerce will get to a place where it can be more profitable over time?

Yes. So I would say the first general statement is we really look at it as an omni-channel model. That's what we are. So we don't control how the consumer or our guest wants to shop. We are focused on making sure we present the best shopping experience, whether it's in the store or online. So again, I think we've made a lot of progress on the digital side with investments in recent years, both on the augmented AR piece of the business, the AI piece of the business and upgrading our app and our website experience. So we're very proud of all the accomplishments we made there. So as we're thinking -- so again, the profit -- the margin profile is obviously important, and we're focused on that. So we've done a lot of things within that channel itself to try to improve the overall profile. So part of it would be ship from store capabilities that we stood up last year. Part of it would be the BOPIS and curbside capabilities that we stood up late in 2019 and now we're starting to see the benefits of in that business. Part of it is the EFG initiatives that we started a number of years ago. And now we're starting to see the fruits of our labors here, especially as the sales momentum continues. So with that, we talked about it with some of the promotional discounting kinds of things. Again, that's more indexed in the digital space for a variety of reasons. It's logistics. The AI capability and getting more personalized with our offers to our guests is something that we're seeing make a bigger, more meaningful impact to margins overall. And then there's things we're doing outside of the digital channel around fixed store costs with lease renegotiations to help drive benefits there. There's things in the SG&A bucket that we've done here with some overhead cost earlier this year. So there's a variety of things we're doing both in the channel and outside the channel to help give us confidence and optimism that we can expand operating margins over the longer term. So very optimistic about our ability to do that.

I just want to remind the audience that we will be taking some questions at the end of the session. There's a little bit of a delay in when I get the questions. So if you want to send them in now, we'll be able to ask them in the next few minutes. We have been asking, Dave and Scott, every company, 4 common questions -- all the companies I've been presenting at the conference -- multiple choice type questions just to get a lay of the land in terms of your view going into the back half in 2022. So the first question we had was just with regards to consumer demand. As we move into the back half, do you see it accelerating, decelerating or staying the same versus what you saw in the first half?

Well, I'd say for our business, while we're encouraged by the overall results, we see uncertainty. So you see in our guidance, we've got -- we have that uncertainty reflected. And so compared to 2019, perhaps not as strong. Having said that, there's a lot of momentum on our business, and we're seeing strength across categories. So as we look over longer-range view, feeling, really, the recovery is healthy. Our business model is working, and we're leading that recovery and feel really strong about that.

The second question we've been asking is about digital penetration. You definitely saw an uptick in 2020. 2021, maybe it's taken a little bit of a step back as people come more into the stores. But for 2022, how should we think about digital penetration relative to this year?

Well, you mentioned it at the beginning, that is one of the topics that we are going to share in more detail at our analyst call in October. But I will say our e-commerce is a critical part of our business. I mentioned a few minutes ago, we're investing heavily in both the commerce component of it as well as everything that surrounds our digital footprint. So we see continued growth there, and it will play an important part and a growing part of our total business. But for us, it's the balance that really works. We don't want -- penetration of e-comm isn't the goal if that means stores are struggling. And in our case right now, all boats are rising, which is what we want to have continuing, and that's our focus going forward.

Our third question is about promotions in 2022, if you expect them to be higher, lower or the same versus 2021?

Yes. That's a bit tricky to really think through right now. We have been able to pull back strategically. This is something that we actually started prepandemic to focus on our strategic promotional things that really add value to our brand and our brand partners, and we've been successful in accelerating that next year. So our goal is not to accelerate in promotional activity, but we'll also see where the landscape goes and make sure that we're continuing to gain share. But we won't be leading promotional activity. Our intent is to remain focused on the most strategic elements of it going forward.

And then our last question is -- and Scott, I think you did mention this, but how do you -- what do you expect for inventories in the back half of the year? Should they grow faster or slower than sales?

Yes. So for us, specifically, they'll grow faster than sales. Again, that -- we're just taking a very pragmatic approach there, making sure we catch up on our existing, what I call, day-to-day business and making sure in-stocks are strong, especially on key items. And then thinking ahead about holiday and demand forecasting there and just making sure it's well positioned as it can be. So they'll be higher in the third quarter. And then as we look out towards the end of the year, they will be higher than 2020. I mean 2020, we ended the year in a pretty lean position. And again, '22, the outlook is going to be stronger than it was going into 2021. So yes, we would expect it to be moderately higher.

We have a couple of questions from the audience that have come in. The first one is asking, where are you seeing opportunities to renegotiate leases? And how large is this opportunity for you?

Yes. So that's something that we started as part of our EFG initiatives multiple years ago. So again, that's -- our store fleet is a significant strategic asset for us. We look at that as an opportunity. Again, COVID kind of caused a lot of disruption there with centers and co-tenant issues and things like that. So again, we -- it's -- we're thinking about it as more of a long-term opportunity for us. So again, we've got a great healthy fleet of stores out there now. We will continue to add new stores. We've got 44 new stores going online this year. We still think the 1,500 to 1,700 range that we've been guiding to now for a while, we're still confident that's a good target for us over the longer term. And as we play it forward here, again, this -- we're about to enter what I'd call kind of a step-up in the number of renegotiations for stores. So the 100-store-a-year kind of cycle started roughly 10 years ago. And so we're going to have 100 leases per year coming up for the next 8 to 10 years. So plenty of opportunity for us to optimize our footprint. So possibly moving into different centers or relocating within existing centers into a better position. So definitely an opportunity for us over the longer term. We've seen great results from our real estate team, renegotiating leases, existing leases. And we think, again, this is going to be a good leverage point for us that will create kind of a waterfall benefit for many years to come.

I'm going to try and ask this next question. I don't -- I will ask it. How are Q3 quarter-to-date top line trends running? And are they running ahead of your second half implied guidance?

We're very happy with the spectacular first half results, and we were happy with the start out-of-the-gate for third quarter. All that was baked into our guidance. Again, I think I mentioned supply chain is going to weigh heavier in the second half than it did the first half. We don't expect sales growth to be quite at the same levels in the second half as we saw in the first. Again, that was a huge surprise to all of us. Again, a pleasant surprise. So we don't expect that to continue at that rate in the second half. There's wage pressures out in the stores as well for our field team, so that's baked in. We've got some investments we're going to accelerate for future growth levers for the business that weren't anticipated earlier in the year. So that'll be baked into the second half. And then we're going to step up our marketing cadence in the back half of the year as well to make sure we take advantage, again, of the strong financial results and market share opportunities that we think are there for us to capture. So all that's baked in. If results are better than what we're forecasting or what our outlook includes now, obviously, the results will be better and we'll take advantage of that as best we can.

And it doesn't look like we have any other questions. But since we have just a couple more minutes, I thought I could slide in one more of my own, which didn't come up yet today, which was your loyalty program. And I know you saw a very nice tick up with the member count last quarter and members are now above 2019 levels. Can you just talk about the composition of those sign-ups? How much was from re-joiners versus brand-new members? And what is the overall read-through, in your opinion, from this tick up in loyalty members at this time?

Well, we're really proud and pleased with that. I mentioned, as soon as this started breaking out last spring, we mobilized our team, a loyalty team, our data analytics team, to really understand what was happening with our guests. So we stayed really close to them. And as I mentioned, obviously, in 2020, we took a step back for the first time in, really, the history of the program. And so it was really important for us to, as we entered into '21, to make sure that we were reengaging with those guests. So through our all efforts, really, everybody in the company owns loyalty because everyone touches the guest experience, and that's ultimately what drives loyalty. But certainly through our personalization and data analytics, to make sure we are pinpointing those that maybe had stepped away, to get them back in, and then continuing to delight those that had stuck through all of the disruption with us. So as we look specifically at Q2, the fact that we got to a new high in the program as quickly as we did just I think, demonstrates the hard work and the great effort across the whole organization to make sure we're doing that. Reengagement made up an important element of that growth. We added, in total, 2.3 million members, which was a new quarterly record for us in 1 single quarter to have that much growth. And it was a nice blend of both reengagement, so those that had stepped away, but we also added a large group of new members. And that's happening both in store and online. Our stores continue to convert at a high rate, if we get a nonmember in and we're getting quite a few nonmembers coming in for the first time as our stores are reengaging guests and they're converting them. And importantly, we're still attracting a lot of new guests in our digital channels. So it's a healthy balance between new guest acquisition and reengagement. We're seeing both contribute to our growth. And for us, it's just -- that's been a key part of our strategy for a long time and a key part of our success. And the fact that we're already ahead of 2019, we think, bodes well as we look out over the next 18, 24 months because we've got a great pool of customers to continue to engage with and we're attracting new ones every day. So it's -- we're pleased with the results, and I'm just proud of the team of -- pulling together to get us back to where we are.

Great. And with that, I think we'll wrap up the fireside chat. Scott and Dave, thank you so much for being with us today.

Thanks, Kate.

You're welcome. Thank you.

Yes. Thanks for joining, everyone.