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

Good morning, everyone. My name is Rupesh Parikh. I'm the Senior Food, Grocery and Consumer Products Analyst at Oppenheimer. I'm happy to introduce our next presenting company, Ulta Beauty. We're excited to have joining us today, Dave Kimbell, CEO; and Scott Settersten, CFO. So over the past several years, the Ulta management team has delivered significant shareholder value. Since January 2014, Ulta shares have increased roughly 300%, outperforming a gain of approximately 100% in the S&P 500 and an over 30% increase in the XRT ETF. Ulta remains a top pick for us, and we still see double-digit upside from here. We believe the market continues to underappreciate the underlying strength of Ulta's unique beauty offering and a strong and consistent execution of the management team. So format of today's session will be a fireside chat going through a number of questions I prepared, and then we'll move -- then we'll take audience questions. So if you do have any questions, please put them in the chat under the video.

So let's get started. So Dave and Scott, thank you so much for joining us today. I'm going to kick it off with a macro question as that remains top of mind in our investor conversations. So I'm going to start with your views on the U.S. consumer. You had another super strong delivery in Q1 with an 18% comp increase on top of a very difficult comparison. It doesn't seem like there are any major sizeable weakness out there, especially within the Ulta box. Would love to hear your thoughts on the consumer today and why you have built in more subdued top line expectations as the year progresses?

Great. Well, first of all, thanks, Rupesh, for having us. Great to see you, and thanks, everybody, for joining today and your interest in Ulta Beauty. We're glad to be here. Great place to start our discussion when we think about the consumer and the landscape ahead. And I'll start, Rupesh, by just saying we are really pleased with the performance we're seeing on our business. As you mentioned, it's broad-based strength across our portfolio, across categories, across our channels, across geographies, within our loyalty program across ages and other demographics. Broad-based strength in our business, which we think is a reflection of both our strength in the overall beauty category and the power of our model and the uniqueness that we bring, the unique experience that we bring, differentiated experience that we bring, allowing us to continue to gain share even as the category is performing well. So we are very pleased and proud and optimistic based on the underlying trends in our business. But as you alluded to, the world around us is incredibly dynamic -- and consumer behavior is particularly difficult to predict and anticipate as we look forward. I suppose it's always challenging. But with all the factors coming at all of us as just people and then consumers and beauty enthusiasts as we study them in particular, there's a lot coming at both economic uncertainty, the impact of inflation and how that will play out over the rest of this year and into 2023, whether it's inflation, unemployment, savings, interest rates, all the other factors that are influencing on an economic level. So far, we haven't seen a dramatic change in our business based on those, but we know that's top of mind, of course, for most people across most of our guests and most beauty enthusiasts as well as everybody else, I suppose. But then you layer in all of the other uncertainties in anxiety that's going on in the world around us, whether it's global issues, the war in Ukraine in Europe, the domestic challenges with some of the social issues, the election coming up, there's a lot coming at consumers right now that's creating -- despite some of the underlying things that maybe are positive, like low unemployment, a lot of anxiety. And I know I'm not telling you anything you don't know, et cetera. But we look at all of that, and that kind of combination of factors give us some concern about where consumers are going. We believe and are confident in the underlying power of beauty and the importance that it plays in our consumers' lives, and we look back over history, and we see that beauty is largely resilient. But we've never faced the combination of factors, coming out of the pandemic and everything else that I just mentioned, that we're facing right now. So there's a lot of uncertainty. Some of that is reflected in our outlook as we look forward. But having said that, I'll just go back to -- we remain really optimistic. We're operating at a high level. So far, we haven't seen -- certainly, the economic dynamics impacting our business in a big way. We're getting a high level of traffic in our stores online. Spend per member is growing. So our model is working, but we are working hard also to look ahead, anticipate, be prepared and adapt to whatever changes come our way over the balance of this year.

Okay. Great. So tying into my first question. We continue to get many questions on the guide. So it seems to me that you essentially pass through the Q1, raise Q2 guidance and then built in additional cost pressures in the back half. Is that the correct way to think about it? And is there any color you can provide always now built in the guidance for the balance of the year and key upside opportunities and downside risk as you see them from here?

Yes. So you're directionally you're right on point. That's generally what -- how I would describe it. So -- we're very happy with the strong start of the year. Obviously, the first quarter results were much stronger than what we had expected initially, carried through to a large extent, into the early part of the second quarter. And so all that was included in our updated sales and revenue guidance for the full year. But due to a lot of the things that Dave just described, the uncertainty, the volatility, macro, U.S. concerns here. We didn't think it was prudent to carry those trends into the back half of the year. So we've kind of maintained our initial outlook for 2022 at those levels. We think that's a smart and prudent thing to do. On the cost side, so operating margins, I mean, we are seeing increased cost pressures across the business. It's generally more acute right now in supply chain. It was in the first quarter. To some extent, that was camouflaged a little bit by the extraordinary top line performance for the first quarter. But we do see cost increases starting to be more meaningful not just with fuel costs, which have been elevated and we expect will not moderate in the near term. But we've got wage pressures and other travel costs And kind of everywhere you look, we're seeing increased costs being passed along to us. And so we're reacting accordingly, mitigating where we can, but we are baking in more pressure into the second half of the year. So cost increases coming through to us. And we're also seeing some of our investment cadence kind of go a little bit slower than what we had initially planned for, for 2022. So some of those costs have shifted primarily from the second quarter back into the third quarter. So that adds a little more pressure to the back half of the year. So collectively, when I think about the P&L, kind of what's changed from our initial outlook for '22 versus this -- our updated outlook on the top line. so we got revenues up at $300 million to $400 million on a continuum there. So stronger comp rules in the first quarter. Early second quarter is included there. And then the other revenue benefit that we pointed out in the first quarter, we think that will continue to a certain degree the rest of the way. On the gross margin line, fixed cost leverage over delivered in the first quarter. We expect that to continue now with a more robust sales trend the rest of the way. Other revenue will continue as we get further down the path in the year, and that will be offset by increased supply chain cost pressure on the gross margin line. On the SG&A line, we're going to get more leverage than we originally thought because of the higher sales and revenue levels for the year. Marketing costs, we saw some of that leverage come through, UB Media benefit there in the first quarter. That will continue as we go further down the path in 2022. And that will be offset by higher wage, people cost pressures in the second half of the year. And then some of those other more, I'd call administrative overhead kinds of things like travel cost, supply cost, material cost across the business. And then there'll be the incentive comp. We won't get as much leverage there year-over-year as we had originally planned for, for 2022. So collectively, you get better operating margins than we were thinking early part of the year. And so that's good news. And so a little better on the gross margin line than we originally thought, but roughly the same or maybe slightly worse on the SG&A line net-net. So overall, in a great position, happy with the strong start of the year, and we'll do our best to navigate through and try to optimize full year results.

Okay. Great. That's helpful color. So now moving on to the makeup category. So a 3-part question. So first, we saw a nice pickup in your makeup category in Q1 with sales finally above pre-pandemic levels. Going forward, what do you see as a bigger opportunities in the makeup category?

Well, yes. So we did for sure see a nice recovery in makeup. And makeup, as you know, refresh has been struggling even before the pandemic. After years of just extraordinary growth in 2014 through mid -- and through even 2017, it kind of came into the pandemic challenge, still selling a huge amount of makeup, still our largest category. But not showing the growth that it had, and then pandemic it the hardest. So when we look forward, we're excited about what we're seeing. And obviously, it's an important part of our business, representing roughly 45% of our sales now. And so seeing growth in that category, seeing it ahead of 2019 for the first time in the pandemic, seeing prestige makeup come back. Mass makeup had been doing fairly well. So it's nice both sides of the equation are performing well. When we look forward, we think a combination of a number of things are coming together to drive makeup. One is this getting out in the world being out and about and all the events and work and weddings and graduations and all types of activities that we haven't been doing as much of, and that's -- we all are experiencing that in our own lives. More and more of that's happening. That drives usage. You combine that with a desire in that environment to make sure you've got the most current products and freshness and refreshing your personal stash at home, getting rid of COVID related things and then moving on to kind of freshing your stash. So that's contributing. And that continues because there's always newness in driving that. Newness is working in makeup, which we're excited about, after a gap in time where there hadn't been as much, we saw that come back some last year, performed really well. We're also adding new brands into -- specifically into the Ulta environment, brands like Venti, REM Beauty by Ariana Grande, Chanel, No 1, Traceluce, a LatinX founded business, many others. So we're seeing broad-based brands that are adding value to our guests that they're excited about, that will continue to drive engagement. And then perhaps even maybe most important, the fundamental underlying engagement with makeup is strong and healthy. And we see it in social media. We see it in TikTok and Instagram and YouTube and other forums that there's a lot of dialogue and discussion about beauty, and that's leading to engagement in new trends. Big, bold, bright looks, eye colors, glitter kind of driven in part, many people kind of call that the euphoria look that's driving a lot of trend this summer as we head into festival season and concerts and music. It's the -- that is reminiscent of some of the things we saw -- seen in 2016. There's trends around long wear lip. There's trends around brow and different kind of brow treatment and innovation that's going on across brands. There's a combination that many consumers have between a more natural muted look and big bold bright looks that's driving. We see young consumers discovering things like contouring for the first time. So a lot of underlying trends that we think is driving engagement. It's hard to know exactly where it's going to go. But for the first time in a while, we're seeing growth versus 2019, and we're encouraged by the underlying trends on that part of the business. Last thing I'd say though is -- it's important to know that our performance in Q1 was not a makeup only story that contributed, but it was strength every category contributed in a meaningful way. Great to have our largest category back to a positive contributor, but we're seeing strength across the portfolio.

Okay. Great. Second part of the question for you. So, fragrances and skincare are more than recovered since before the pandemic. The makeup sales in Q1 '19 were only 12% above Q1 -- I'm sorry, in Q1 were only 12% above Q1 '19 versus total company sales are now 35% above Q1 '19. Where do you think we are now in the makeup renaissance as some of your key suppliers are calling it? When could we see this gap between makeup and total company sales close?

Give us a little bit of a break, Rupesh. Yes. We're trying -- yes, we're excited about the 12% growth in makeup. Scott, we haven't seen that for a while, right? So we actually have that positive, that's step 1. And so -- because like I said, we had a bit of bank getting better in Q1. We're hoping it will come back, and we're doing everything to try that. So to be positive on the positive side, even if it isn't keeping up, it hasn't caught up with the growth we're seeing in other categories, it's encouraging. It takes time to kind of get back. We have an outlook that it's hard to know exactly what -- given all the uncertainty that we've already talked about today, exactly what will play out. But we anticipate a sustained engagement in the category. But what's really encouraging to us is as makeup has come back and is now growing, 12% growth is, we believe, a nice healthy growth rate even if it's below some of the other categories. We haven't seen it come out of skincare or haircare or fragrance. And then particularly with skincare that's been a historical kind of the dynamic that maybe is make up stronger, skin goes down and vice versa, we believe we're going to be in an environment for a while that both categories will grow because of the elevated engagement in makeup. But at the same time, the strengthening that happened over the pandemic about the importance of skincare in routines and taking care of themselves and self-care. So far, we're seeing it that as makeup is getting better, the other categories are holding on, and that's a good thing for our business, and we're doing everything we can to kind of maintain the healthy balance we're seeing across all categories.

Okay. Great. That's -- so Dave, that's a great segue into my next area that I want to cover. It's just the skincare category. So your team has had significant success in recent years. I know you decided to -- recently added the Drunk Elephant brand. So what do you see as a bigger opportunities going forward in the skincare category?

Well, I think it's a number of factors that have been driving it that we think will continue. There are opportunities to continue to expand and evolve our assortment, both through new brands and innovation. We're seeing great innovation across both mass and prestige in a number of key areas like eye and serums and mask and other areas that are adding real meaningful efficacious innovation that this -- that's so important in this category and consumers are noticing. So that will continue. And I think this overall connection that consumers that strengthened over the pandemic between beauty and self-care, the importance that even younger consumers now, even Gen Z are seeing in the long-term effect of taking care of their skin and the need to start early on that. Those behaviors we don't think are going to go away or going to be forgotten even as we get out in the world more, we think they'll sustain. And in fact, deeper recognition that great makeup, great looks for makeup start with healthy well taken care of skin through skincare. So a lot of factors that has come together. So we think through a combination of innovation, new brands, underlying consumer trends and then the unique way that we execute with education and training and store tools online. We launched, for example, a Skin Advisor online that's performing really well. So we're hitting it on all -- at all touch points and in multiple ways. Engagement's high, innovation is working, and so we anticipate skincare to continue to be an important contributor to our business going forward.

Okay. Great. So switching gears to another area I want to cover is UB Media. So Ulta launched UB Media a few weeks ago. At launch, I believe the network offers advertising access via offsite display, video, social and influencers as well as on-site sponsored products. So on the grocery retail side, we've seen program Walmart more aggressively with driving alternative revenue streams with success. How do you see the ramp of the media offering over time? And would you expect this to become another material driver of profitability in the coming years?

Yes. So this is a new capability that we've introduced, as you pointed out, Rupesh, to help our vendor partners develop winning digital strategies, right, to engage with consumers in a more efficient, profitable way overall. And we believe that Ulta Beauty is uniquely positioned to deliver this because no one knows beauty like Ulta does, right? We're this unique mix of the breadth of the categories that we carry, the number of brands that we partner with and, of course, the different price points, right, all the different products that we carry in our assortment. So we're happy to have officially launched this just within the last couple of weeks. Again, as a reminder, this isn't -- we've done this a little bit on a smaller scale over the course of the last year, 1.5 years or so. But now we've put a stake in the ground, and we've added internal resources and capabilities there to help us scale this up to a much larger piece of our business over the coming years. So this is a way, a methodology capability for us to play the middleman. Again, part of the unique proposition here is 37.7 million loyalty members, right? So first-party data, understanding purchasing results from those consumers over a long, long period of time. And so again, the magic of this is our ability to help focus the advertising to consumers and then measure the results of that by way of our data and analytical capabilities. So it's a win-win situation for both the vendor partners and for us. The vendor gets better insight into who's watching, who's engaging with this medium, then we can measure what the result is, what the sales result is and then we provide enhanced reporting, right, and feedback on the overall results of the campaigns, let's say. So we're looking forward to this. Again, it's going to be -- it's a relatively small part of the business now. We're just kind of getting out of the starting gate in a much bigger way, but we expect this to be a much bigger part of our business over the longer term, and it will be margin accretive to us overall. So very excited to get this kicked off and looking forward to seeing how we can build it over the long term.

And then just given all the changes out there with Apple on the privacy front, Google changes that are coming, it seems that the launch is extremely well timed. So I'm also curious, is there anything you can share in terms of the reception of the offering so far from beauty suppliers to date?

Yes. So overall, vendors -- again, I mentioned we've been doing this on a smaller scale now for a little bit of time. And vendors are very excited. There's great demand for this insight. And again, to have a more efficient marketing investment right on their end of the equation here is something that gets them very interested. So feedback has been great, and we're confident that we're going to be able to work together to grow this, again, to a much more meaningful part of our business over the long term.

Okay. Great. I'm going to pause for 1 audience question here. So cosmetics sales versus Q1 '19, this question is just regarding the growth rate you saw in Q1. As we look out for the balance of the year, do you have confidence to say cosmetics is definitely on a growth trajectory versus 2019 as you look to Q2, Q3 and Q4?

Well, what I'd say, I mean, like I definite on anything other than -- like, I'd reinforce the optimism that we have and those underlying strengths that I kind of went through whether the kind of consumer behavior going out, innovation, new brands, underlying trends, whether kind of the usage occasions and trends. So a lot of positivities. We're -- it's been -- it's -- Q1 was the first quarter that we comped positively to 2019 throughout the pandemic. So -- we're encouraged by that, we know, but we know it's an uncertain environment. So it's certainly our intent, and we're working hard with both, within our model and with our brand partners, to continue to drive engagement in this important category. So we're encouraged by what we're seeing, but we know we've had some ups and downs over these last even couple of years, both pre and during the pandemic. And -- but we're confident in our efforts to continue to drive this important part of our business.

Okay. Great. So another area I wanted to cover is contributions from new brands. So Ulta has added Venti Beauty, OLAPLEX, Drunk Elephant and other key brands lately. We would love to hear about how these brands are performing versus your expectations. And are they also helping to bring a new customer to Ulta?

Well, Rupesh, you know well that newness as long -- has always been an important part of our model and the entire category. It is a -- beauty enthusiasts love to try new products and explore new brands and new items, whether new to the world or in some cases new, to Ulta, brands. And so that's long been the lifeblood of this category, and it certainly was in Q1. You mentioned a couple of big ones that we have launched brands like Venti and OLAPLEX in particular, that launched this year that were very well-established, well-loved brands in the marketplace. And our guests were thrilled to get access to them at Ulta Beauty. So they've been performing well. Newness was an important contributor. We had an 18 comp in the first quarter, and it contributed. It was not majority of our growth. For sure, the majority came from broad-based strength across all categories, all price points, existing brands driving high level of engagement, but it was a meaningful contributor to our first quarter results. And we always have newness in every single quarter. We happened to have some particularly strong newness in the first quarter. So very pleased with the results and encouraged by what we're seeing. And to your question about do they drive in new members, new consumers? Yes. Yes, when you launch a brand like Venti or OLAPLEX or Drunk Elephant that have strong established brand recognition and engagement, we both here and social -- [indiscernible] and social media when we announced, "Oh my gosh, I'm so excited that Ulta has Venti or OLAPLEX and now I'm going to try them," and then we see it for sure. So they contribute to new member growth. And they were part -- there are many things that came together, but part of the reason that we grew our loyalty program 17% in the first quarter to 37.7 million members. So newness plays an important role, and we're thrilled with what our merchants have delivered in the first quarter. It's making a difference on our business, both today and well in the future.

Okay. Great. So the next area I want to cover is services. So as we look at the service recovery, where are we with the recovery in this Salon customer? And what are the bigger opportunities going forward for the service recovery?

Yes. We're really excited about our Services business delivering double-digit growth in the quarter. It's another like a bit like the makeup story that, that got hit pretty hard, too. I mean we had shut our services down. They were actually closed longer than our stores were due to the kind of safety requirements in that environment. So -- we had more of a hill to climb to kind of get that business back, but it is back, it's growing. And I'd argue better than ever, I mean -- our leadership team has worked very closely across the enterprise to ensure that we -- this is a people-driven business. It is one-on-one human connections, great stylists, taking care of our guests in really meaningful ways. And so we really count on having the best of the best and across our business and our team has worked hard to take care of our stylists through the pandemic and the challenges of that phase and ensure that we've got highly trained, highly capable stylists and brow experts and makeup artists and skin care in those stores that have that delivering a high level of experience and engagement. So it's working. We're glad that -- we're excited to see. As you know, it's not a massive part of our total sales, but it's important to be growing, and it's an important part of the overall experience to be able to we talk a lot about human connections. There's no more human connection than we have in our store. When a guest allows one of our associates to take care of them to touch their hair, to cut it, to color it, to style it, to take care of their brows, to do their makeup, that's a one-on-one, very personal connection that means a ton to us. High level of loyalty, high level of engagement creates an environment of just beauty engagement even if you're not there to get a service. So services working to have been part of our model from day 1. We'll continue to be and we're just thrilled with the work that our team across the country is doing to take care of our guests, and it's shown up in our results.

Okay. That's great to hear. So there's 2 last topics I was hoping to cover. So first, we've been asking all our companies just about a recessionary backdrop. So Ulta comps held up amazingly well in the last financial downturn with only 3 negative comp quarters. Where has your team historically seen a weaker environment?

Yes. So we recognize that there's a lot of pressure on the consumer right now and inflationary costs, the compounding effect of that we believe will impact our business as well as all retail businesses here as we get further down the path. Again, we're not in the business of trying to predict our word or when things will necessarily impact us, but we're keeping a very close eye on that. We believe the beauty category is more resilient, again, just the nature of, we call it, affordable luxury and things like that. To your point, during the last recession, we saw a few down quarters. Again, relative to the rest of the retail space, we held up much -- in a much stronger position than most. So we're happy to have those strengths behind us. our model, very flexible. Again, all the price points, the categories that we carry out as part of our assortment, it's a very healthy margin business. So again, when things would get potentially much tougher. There's certainly a space for us to invest, right? Margin rate to help drive traffic, both online and in our stores, again, as a retailer, we believe. The traffic is the lifeblood of any good, healthy retail operation. So I guess I'd close it up by saying we know there's going to be challenges. We're anticipating that. I mean, some of that's baked into our outlook when we think about upward pressure on cost of doing business here, but we think beauty is well positioned to weather the storm and Ulta Beauty specifically positioned to win over the long term.

Okay. Great. The other area I want to cover is just the Target partnership. So commentary thus far is very positive from your team, from your suppliers like Estee Lauder. Have there been any surprises when you say versus your initial expectations that you can share at this point?

Yes, we are really pleased. Target has been just an exceptional partner. And most importantly, consumer engagement has been very high. From the moment we -- well, even going back to when we were researching this possibility of this partnership, we heard loud and clear in that research that makes so much sense. We love the idea of these 2 great brands coming together, Ulta Beauty and Target. And the idea of making it easier to engage in Ulta Beauty, it was clearly exciting. We saw it when we announced it in social media, just that love that both of our brands have. And then we've seen it as we've opened now -- we've got about 130 locations open. And obviously open a whole lot more this year. So very encouraged by the engagement. We see it as an opportunity to attract both new members. They -- a lot of people, 30 million people, walk through Target every week, and many of them are not Ulta Beauty guests or loyalty members, so we can attract new members. But equally important, we can make it easier for our guests to engage in Ulta and history shows that when we do that, when we get a store shopper to shop online or to download our app or to use our services or to take our credit card or to engage with us in any way, we get rewarded by higher loyalty, higher share of wallet, and we're encouraged by what we're seeing. Any surprises -- probably not surprises, nothing kind of came totally out of left field that we didn't see coming. I will say we're continuing -- we're really encouraged by what we're seeing. You mentioned our brand partners, they like the productivity, they like the opportunity to reach a new guest in a disrupted prestige retail environment. And we're just focused on anything that you kind of new to the world like this so much is working, but we're -- always we have a continuous improvement mindset on everything that we do. And so we're continuing to find ways to improve the experience to make sure the associates working in those stores are highly trained and knowledgeable on the brand. We were attracting new members and converting at a high level that we're engaging our existing members. We're evolving the assortment. So -- we're on a continuous improvement ride. But -- yes, I wouldn't say there's anything that surprised us, but we are pleased with the -- here we are, I don't know, 9, 10 months into it and encouraged by what we're seeing and excited to be continuing to expand the partnership.

Great. Thank you. So thanks, Dave and Scott for joining us today.

Great. Thank you, Rupesh. Thank you. Really enjoyed our conversation, and thanks, everybody, for tuning in today and your interest in Ulta Beauty.

Thank you.