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

All right. Great. Thanks, everybody, for joining. I'm Mark Altschwager, senior research analyst at Baird, and I'm very pleased to welcome management from Ulta Beauty. Ulta is the largest beauty retailer in the U.S. Joining us on stage are CEO, Dave Kimbell; COO, Kecia Steelman; and CFO, Scott Settersten. The company is coming off a very strong Q1 report, including healthy demand across its product portfolio and really highlighted by a return to growth in Prestige makeup for the first time since the onset of the pandemic. Thank you all for being here.

Thanks for having us, Mark. Glad to be here.

Great. So Dave, I do want to start on bigger picture. Investors who have followed Ulta for a long time and know you all as part of the leadership team really since 2014. The company went through a very thoughtful leadership trend -- leadership succession over the past couple of years with you officially taking the reins last June. So for investors who are newer to the story or revisiting the story, could you just speak to your broader vision for Ulta Beauty and the biggest opportunities you see ahead for the company over the next several years?

Absolutely. Well, again, thank you for having us, and thank you all for your interest in Ulta Beauty. Glad to be here with all of you. So Ulta is a little over 30 years old, 32 years old. And it was started with an idea to change the way consumers engage in beauty to create a beauty experience that really reflects the way most consumers -- most beauty consumers, beauty enthusiasts want to engage in beauty. And that's the model and the journey that we've been on for the last more than 30 years, and we see so much opportunity to continue to drive that. But the elements that make Ulta Beauty unique have been true from the beginning and continue to drive our business today. We look at it across our core strategy we define as this idea of All Things Beauty, All In Your World, at the heart of the beauty community, and all of those aspects come together. So just quickly, All Things Beauty is an assortment that is unique in the United States and really, frankly, around the world to have all price points from mass to Prestige, all categories, makeup, haircare, skincare, bath, fragrance, wellness across categories and to have an assortment that really reflects the way consumers buy products is really unique and one of the key drivers. So All Things Beauty, All In Your World is an idea that continually meeting our guests wherever they want to engage in beauty. That starts with our stores. We have a unique and we think really powerful and engaging store experience that again reflects the way consumers want to engage in the category. So over 1,300 stores all across the country in large cities, right here in Manhattan to smaller towns and everything in between. We reach consumers, our guests, our beauty enthusiasts with exciting, engaging, fun, welcoming, diverse store experiences that really allow them to discover beauty in ways that are exciting and again, reflect the way they want to engage in beauty, but also touching them in every other touch point. We have a massive e-com business, but importantly, the intersection between physical and digital is key to our success. And then the third piece at the heart of the beauty community is so critical and always has been because beauty is an emotional category. Beauty is a category that is about self expression, bringing what makes you unique to life, and we play a role with our guests to allow them to discover their own possibilities to bring to life what makes them special to express them way -- themselves in whatever way they want to. And so the emotional connection we have with guests is so important. This isn't a transactional business. We aren't a place just to go get a bottle of shampoo, we are a destination for our guests, over 37 million -- 37.7 million members. We are a destination to help them on their journey to express themselves to the world. And so all of those things come together, I think, in a really powerful way that give us a lot of optimism and excitement. Have delivered results for over 30 years, but I think this category is healthy, and it's one that we're excited about going forward.

Great. And as we sit here today, I think Ulta is benefiting from the consumers return to social activities, the return to office, return to in-person events. What is your view of the state of the U.S. consumer? And how do you think about the resiliency of the broader beauty category in a recession scenario?

Well, certainly, there is a lot of turmoil, a lot of disruption, a lot of uncertainty that we're all aware of in the macro environment around us. What -- so we're watching that carefully, and we're trying to anticipate what's ahead and some of that uncertainty is reflected in our outlook for the balance of this year. But what I will say, within beauty -- and we saw this in our results, beauty is strong. The category is healthy. It's holding up we think very well in this uncertainty because of the emotional importance, the connection it has and people expressing themselves to the world. So we've seen -- we haven't seen an impact of inflationary pressures or trade down in our business. Consumers are very much engaged in that category. And again, because of our model, all price points, all categories, a welcoming destination that reaches our guests in so many ways, we're able to adjust and adapt to meet their evolving needs. So I have no more insight into kind of what the broader consumer market is going to look like than probably anybody in this room, but what we are confident in is, beauty will be able to adapt. Certainly, Ulta model is set up to serve our guests with whatever circumstances are happening around and the importance of our category historically has allowed us to weather any disruptions that are ahead of us. And so we're confident in the path forward, but preparing in multiple ways to adapt to whatever comes.

And sticking with the category transfer for a moment, you mentioned in the opening that the highlight of the Q1 report was Prestige makeup exceeding the pre-pandemic levels for the first time. I'm often asked, is this pent-up demand? Or is this the beginning of a new multiyear cycle within the makeup category? Would be great to hear your views there. And then just generally how you're thinking about the interplay between category trends in the medium.

We have that in common because I'm often asked that as well because it is an important question. I'm going to start with just saying -- and I'll get to makeup. We're excited about makeup. What we're really excited about and gives us confidence going forward is, we're seeing strength across the portfolio. The performance that we had in Q1 was not solely a makeup story, it was broad-based strength across channels. Stores being a real highlight with people traffic coming back. Transactions up meaningfully up in our stores, so store story. But e-com continuing to deliver. Salon coming together all our omnichannel. So, broad-based in channels and broad-based in categories. So again, I'll talk about makeup. We saw continued strength in skincare, in haircare, in bath and fragrance, the expansion we have into wellness, in hair tools. So what gives us a lot of, again, optimism about how to go ahead is, this isn't just a one channel or one category that's driving, it's a broad-based strength. Again, it's a reflection of the importance of beauty, and it's a reflection of the connection that we have in our guests. But makeup is our biggest category, and it's one for those of you that have been following Ulta Beauty for a little while, you know a little bit about the makeup story. After years of strong growth in, call it, 2014 through 2016 into 2017, the category came into the pandemic a bit challenged. We just -- consumers had -- there wasn't innovation, whether marketing or product or trend that was driving enough growth -- incremental growth to the category and then the pandemic hit it the hardest of any of the categories. So we're excited to see it come back, and it is a reflection of a few things. One, the makeup -- the emergence of going out and getting back out in the world, whether it's work or events or weddings or social activity or concerts all that is driving more usage occasions and more different types of usage. You might use one look in the day and a different look at night. That behavior hasn't happened as much over the last couple of years. So that certainly opening up story is part of the story. But we're also seeing innovation that we hadn't seen in the category for a while, and it's resonating with our guests and it's across price points, brands like NYX and Mass to MAC and Prestige and many others are bringing relevant innovation that is exciting. Social media is really strong. There's important trends happening across all age groups. Teens, in particular, are excited about many of the things that are happening at TikTok, which are leading to bolder looks and brighter colors, which is great for the category. And then specifically, at Ulta, we continue to evolve our assortment. We've added a lot of innovation. We're expanding our partnership with MAC, which is really important. We've established a leadership position with Clinique, and we launched some big brands like Fenty early in the quarter. We launched Chanel No 1, on the Prestige -- on the luxury side, Ariana Grande's REM beauty. So we've had a lot of innovation within our store as well and all those things are coming together to deliver results.

And speaking of partnerships, you also have some new partnerships on the distribution front with Target. Maybe give us an update there. And then what have been your key learnings so far? How do you see the target relationship evolving?

Yes. We're really excited about the partnership with Target. And what I would say is, in the first quarter, we opened 127 stores. We're over 140 plus now. This is a whole new way to engage with new guests. You look at the traffic that comes into a target store. We're front and center in a premier location. We like what we're seeing thus far. It's still early in the partnership. However, some of the things that we've collaboratively worked on between Target and Ulta Beauty are, we just came out of our 21 Days of Beauty event, and we kind of co-created what that would look like in the Target store, the Ulta Beauty at Target concept. And we liked what we saw with the results for both organizations, really strong consumer engagement. The guests responded really well, and it was like our first foray into doing this together from a marketing perspective. The other thing that we're working really collaboratively on is our loyalty program. So this is a way for us to engage with the new guest and bring them into the Ulta Beauty ecosystem through our Ultamate Rewards program. So what we're seeing in the early phases is that when a guest comes into the Ulta Beauty at Target location and they become part of our ecosystem with the Ultamate Rewards membership, they are coming back into the Ulta Beauty store, and they're behaving very similar to our existing average Ultamate Rewards member. So again, this is a way we can engage with the new guest and get them into our entire ecosystem. More to come, but like I said, through the first part of this year, we'll continue to learn more, and we're working really collaboratively together. From a financial impact perspective, it's immaterial because it's so small at this point in time. And just as a reminder, this is a royalty agreement. So they own the inventory. They own the sales. We really work collaboratively with the brand partnerships and what the assortment looks like, but they own the inventory and the sales.

And sticking with distribution for a moment, I guess more generally, Target is really just part of an evolution that we're seeing within Prestige Beauty distribution. Kohl's is investing heavily behind its Sephora partnership. Walmart's been adding brands, brand websites. Amazon continue to push forward. What does all of that mean for Ulta's ability to continue to capture share the way it has in the past?

Well, beauty is an attractive category for a lot of reasons, and I've highlighted a few of those today, and it's good margin category. So it's been competitive for a long time. I first started working in beauty in 1995 and -- at Procter & Gamble and have been -- so it's been a competitive category for a long, long time because it's so attractive. So that's not new, but you're right, there's -- I think there have been multiple changes over the category, and we are seeing some distribution changes, including our partnership at Target, which we're really, really excited about. At the same time, we're continuing to open up our own stores. We're expanding our digital presence. So we're going to continue to drive. So there is competitive activity. We have a lot of respect for our competitors. There are some great competitors in the marketplace. Our focus, though, is doing what Ulta Beauty does best. Nobody does what Ulta Beauty does. Our experience is truly unique, and it's really connecting with our guests, and it's connecting in guests in so many ways that when we think about the competitive environment, yes, we're aware. We watch it all the time and we understand and we're thinking about implications on our business. But our first instinct and our first goal and our primary focus is play offense. We know our business model. We know what works. We know where there's opportunities to evolve and expand. One example of that is the launch of our UB Media as an incremental driver of our business. So we continue to innovate both in the core aspects of our model and then adding incremental drivers that will provide -- contribute to profitable growth over long term. So been competitive for a long time, but we've been gaining share. We gained share in the first quarter, even with a few hundred new location -- competitive locations. So I think it's a reflection that our model is resonating and we're going to continue to drive that going forward.

And with that connection to your consumer, I think the Ultamate Rewards program is really part of the secret sauce there, one of the best loyalty programs in the retail space, over 37 million members, I think, up 17% year-over-year in Q1. What capabilities do you have today that you didn't have several years ago when it relates to really leveraging the power of the data that you're capturing through that program?

It is one of our greatest assets is the strength of our loyalty program, 37.7 million members, up 17%, as Mark said, 95% of our sales go through our loyalty program. So almost every item that we sell or service that we deliver, we can track back to an individual, and that gives us a ton of insights and data, arguably the best data and insights on purchase level behavior in the country because of the scale of the program and the depth and the breadth across categories. Because of our data and insights on purchase level behavior in the country because of the scale of the program and the depth and the breadth across categories because of our assortment and the experience we deliver, nobody really has that broad range Mass to Prestige across category insight. We have been building capabilities for a while, and we'll continue this journey around leveraging the power of that data through personalization. A couple of years ago, 2018, I think it was, Scott. We brought Q1 Scientific, which was an advanced analytics firm based out of San Francisco, really specifically to accelerate our efforts around personalization, and we've been on that journey for multiple years. So the capabilities we have today are a step change better than they were even just a couple of years ago that allow us to more specifically understand certainly groups of consumers and increasing the individual consumers and point and tail. I'll give you one example of the area that's been particularly relevant for us. Through the pandemic, we saw consumers not because they had a bad experience at Ulta, but because of the pandemic and our stores closed, fall out of our active member list of -- and so we knew who they were, but they were no longer in the last 12 months hadn't shopped with us. We have new tools to be able to point and identify and test to see what's going to motivate Mark to get back into Ulta, and we can test and learn and iterate and drive that and be able to pinpoint those capabilities. It allows us to be more efficient with our promotional spend and be more effective with the tools. So we're excited about our capabilities, and we'll continue to build them as we move forward.

Kecia, it's been really exciting to see Ulta stores return to and really exceed pre-pandemic productivity so quickly. There's been a lot of discussion about the accelerating structural shift to digital over the past few years, but I think it seems clear that, that beauty enthusiast really craves the in-store experience. So hoping you could talk about the role of stores and how it's changing, and then really Ulta's initiatives to keep those stores productive and engaging for consumers?

Yes, you could see coming out of Q1 stores do matter to our guests, and they're coming back, which is exciting to see our proprietary insights through our loyalty members that they tell us loud and clear that, that human interaction, the engagement with our associates, the experiential shopping, and it's fun to shop beauty. They want to be in store. It's just such a critical component to our overall ecosystem and our success. And I'm really proud of our store field team leaders that have engaged and continue to engage with the guests when they come into the stores. They do matter, and it's part of the entire ecosystem. And when you look at our investments in our digital engagement and our tools, so like the skin analysis tool or the GLAMlab, it's how do you invest in your digital innovation to improve that human interaction or to give the guest even more knowledge of how -- what they want to buy and how they want to shop when they come into the stores. So it's a critical component. We like what we're seeing with the traffic. And again, I think that's what makes our segment so different is that it's not viewed as a chore to shop at Ulta Beauty. It's fun, and it's experiential. We've relaunched our makeup services in the back half of the first quarter. So that's another engagement way to offer the beauty services -- makeup services as a benefit and then also our relaunching of our in-store events. So these activations -- when you come into the store, there's something going on along with our services component. So it's a humanistic connectivity, human wellness. We're seeing that be really strong coming out of COVID and continues to remain a strength for us going forward.

And on the digital front, you talked about some of the ways where you've invested in the experience there. I think the company often refers to its digital store as the future where you're continuing to invest. Maybe speak to what that all entails?

Yes. It's -- digital is so important, certainly. Obviously, before the commerce component of it, and we've seen a huge amount of growth over many years, pandemic accelerated that growth. But I'd say, perhaps even more importantly, just across the purchase cycle, the journey of engaging in beauty, it influences nearly every sale we have even if those sales are happening in our stores or our salons through research, engagement, social media. And so we're on a multi-pronged approach to continue to advance and elevate that a digital store of the future to evolve the platform and the experience you have when you engage with us on the app, on your phone, on a desktop, both again for commerce, but also for engagement. And that capability, that new platform will give us more flexibility to adapt and adjust, be able to leverage through the cloud more of our insights and data that we have. We bring in new experiences. We also bought a company a couple of years ago, Glam Street, that powers and fuels our virtual try-on capability. We continue to invest and expand in that. We've added new capabilities to that experience as one example. So we look across all of our digital experiences through both a commerce component, but again, more importantly, through engaging our guests the way they want to be experienced. And it's a powerful tool for Beauty to be able to try things on to have a community to learn from each other to share ideas, to learn from Ulta Beauty and for us to learn from our guests, and we'll continue to invest in that space.

Scott, I didn't forget about you, I promise. I wanted to talk about margins. Operating margins, EBIT margins for Ulta were in the 12% to 13% range pre-COVID. You're now guiding to 13% to 14% longer term, and I think you're on pace to be over 14% this year even with e-commerce penetration higher, which has been somewhat margin dilutive. So walk us through what has structurally changed in the business relative to 2019? And then sort of secondarily, just given the strength that you're seeing, speak to your level of confidence that you could sustain something at the upper end or even above that 13% to 14% that you outlined last year.

Yes. So I know it seems like a long time ago now, 2019, but we only take back to the pre-pandemic environment. So besides the e-commerce mix challenge that we were navigating, we also had a pretty significant deceleration in the makeup category occurring about mid-year 2019. So that was kind of a stair-step change for us and a very important part of our assortment mix and pretty high margins relative to the rest of the box. Those 2 things on top of wage pressures that we saw across the business and some high fixed cost because some of the investments we were making for the future. So all that collectively was putting pretty significant pressure on our operating margin pre-pandemic. So our team has done a great job over the course of the last few years by way of our efficiencies for growth initiatives and other actions across the business to put us in a much better position now. And our business is in a much healthier overall spot than it was pre-pandemic. So first of all, on the merchandise margin piece of our business. So just better analytical capabilities across the platform and better insight, better process, better discipline around our assortment choices, which is leading to much better economic outcomes overall. E-commerce, while it's about twice as large as it was pre-pandemic, it's actually more profitable for us now than it was back in 2019 by way of new capabilities like BOPIS, ship from store and increasing efficiencies in our distribution centers. Our real estate portfolio is super healthy, and we're getting better economics there overall by using leverage of our brand and just working with our landlords to improve overall economic outcomes and optimizing our store portfolio. CRM capabilities, Dave mentioned, we're a lot more capable now than we were 3 years ago, and we're leveraging our data even better today than we did then, which is allowing us to be more focused, personalized with our offers to our guests and that allows us to decrease the amount of broad-based kind of promotional things that you have to do to drive sales today. And then finally, we rightsized our corporate overhead. So we took action there early in 2021, and we've hit the pause button on our international aspirations for the time being. So again, collectively, we've made a lot of progress. We talked about it at our Analyst Day. We still think there's plenty of opportunity there as we look out over the next couple of years. Again, efficiencies for growth and our continuous improvement initiatives, which makes us super comfortable with our 13% to 14% operating margin targets, a much more moderate comps than what we've seen historically from our business. So I'm confident thinking about other opportunities. I know this year, we're a bit ahead. Again, our updated outlook reflects that we're going to be above our long-term algorithm. Again, with all the uncertainty, consumer macro backdrop, we think it's prudent to take a more conservative view here, and we're not going to update our long-term guidance at this time. We're not anticipating that here in the near term. We think it's smart to kind of see how '22 plays out with all the different variables at play here, and we'll get through 2022 and put our 2023 plan together. And at that point, we'll kind of assess longer-term.

Makes sense. We only have a couple of minutes left. Maybe I'll pause to see if there are any questions in the room here.

On the Target relationship. I appreciate you said it's not a major component right then. But is Target giving you an exclusive, in that, are they selling beauty products elsewhere in the store, elsewhere in the franchise and online? Or is everything sort of going through the Ulta [indiscernible]?

Yes. Our agreement is that anything that's sold in the Ulta Beauty target component is only sold at the Ulta Beauty at Target. So it's not going to be outside of the store within a store concept. They do offer what we have in the concept online also, but it's only those items that are online that are in the concept right now.

And that's Prestige focused.

Yes, Prestige.

They have a mass business, which we carry many of the same brands. So we'll compete with them on that, but then we're exclusive on the Prestige side. Yes.

So what market share or what wallet share of the Target beauty customers [indiscernible]?

It's too early to kind of say, and we don't -- we're not sharing a ton of like detailed consumer data on that because we're still relatively early, just a little over 100 stores less than a year into this. So -- but what we're -- the strategic rationale, one, creating a great guest experience, and that's definitely evident. Kecia talked about that. Given an opportunity for brands, Prestige brands to reach new guests, brands are excited about the productivity and experience. And then for us to reach new consumers that -- they have 30 million people that walk through Target every week. So it's a lot of untapped potential for us to grow members that then engage in the total Ulta Beauty ecosystem. So excited about the path and encouraged by what we're seeing.

Well, I think that just about puts us at our time. So we'll have to leave it there. But everybody, please help me in thanking the Ulta team for a great presentation.