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

Okay. I think we'll get started. Thank you, everyone, for joining. I'm Mark Altschwager, Baird's senior research analyst covering fashion and wellness. And I'm excited to welcome back to Baird's consumer tech and service conferences, Ulta Beauty. Ulta Beauty is the largest specialty beauty retailer in the U.S., with over $10 billion in revenue, healthy mid-teens operating margins and a track record of consistent market share gains. Joining us on stage, CEO, Dave Kimbell; and CFO, Scott Settersten. Great to see each of you.

Good morning.

Thanks for having us, Mark.

So to -- maybe starting off here, higher level, Dave, beauty and wellness have been very strong categories within the consumer landscape over the past couple of years. Ulta's been delivering double-digit or near double-digit comps for 9 straight quarters. This has softened a bit recently. So it would be great to hear how you think about the macro factors that are at play here relative to maybe category-specific dynamics that are leading to some of this moderation.

Great. Well, again, thanks for having us, and thanks, everybody, for joining. I appreciate your interest in Ulta Beauty. If I -- I'll just start with kind of zooming back a bit and just thinking about the beauty category over an extended period of time. And one of the things that excites us about being in the beauty category is historically, it's been a consistent growth story. You look at over an extended period of time in the 2% to 5% growth rate year after year. So despite there are some exceptions to that, but so consistently, and it's resistant, not immune to economic changes, and it's because of the importance it plays in consumers' lives. It's about how our guests -- how consumers in general and certainly the Ulta Beauty guest expresses themselves to the world. And you mentioned wellness, it's a big shift. It's always been part of the category. The pandemic really awakened the connection between beauty and wellness and the way consumers think about overall self-care and the role that beauty, makeup and skincare and haircare and fragrance can play in their wellness routine. So we believe in the future of the category, we -- I think it's proven over time to have a path to continually being connected to consumers to continue to innovate, to find new ways to engage in guest lives, and this connection to wellness will be a big part of it. As far as the moderation, it has moderated some, but it's still a very strong, healthy category. And -- but we knew coming into this year, and it's why we laid out guidance that had our comp in the 4% to 5% range. We anticipated that the category would moderate some, still again, strong growth, high level of engagement, a lot of consumer excitement about the category. But after a couple of years of mid-teens growth. We knew that given this mature category in the history, that wasn't going to be sustainable. So that, we're excited about what we see. We see strong innovation across all parts of the business. We see categories like skincare and fragrance continue to be very healthy and have been throughout the pandemic. So confident in the future of the category and focused on our role is finding ways to gain share as category evolves.

And maybe zeroing in specifically on the cosmetics category. That was a little bit challenged heading into the pandemic. It has now come out and been a remarkable growth story. How durable is that recovery? Was this a big replenishment cycle that's now moderating versus innovation? Maybe talk a little bit about that.

Yes. Well, you're right. The makeup -- of our 4 biggest categories, makeup, skincare, haircare and fragrance, makeup was the most challenged coming into the pandemic, 2019 after years, a few years have just tremendous growth and excitement in the category was pressured in 2019 and was the most challenged in the pandemic for obvious reasons, people not going out and all the dynamics. It has come back in a very strong way. There is no doubt some level of replenishment in that, some activities as people were like out with the old and with the new and cleaning out their makeup bag and getting excited about going out, back to work and back to -- well, maybe not excited about going back to work, but excited about going out to events and activities and all those things. So that was part of the story. But we're also seeing a high level of engagement, social media engagement in makeup is very high. TikTok being the biggest, but Instagram, also playing an important role. So we see a lot of trends coming up, a lot of like discovery, Gen Z, discovery, makeup and new trends and really interested in exciting ways. A lot of demonstrations and show me how kind of type videos and activities in social media. There are important trends driving makeup right now. This combination of big, bold looks and colors that are reminiscent to maybe even 2015, or going back in time to earlier phases of innovation in the category. But at the same time, dewy, glowy, healthy, moisturizing kind of looks within makeup are also on trend right now. So we see good trends. We see a lot of innovation. We see brands like e.l.f. really tapping into all aspects of that, and we're leaning in to make up and excited about the path ahead.

Sticking with some of the trends here for a moment. You called out last quarter that the mass categories, the lower price points are outperforming prestige, is that a function of consumers trading down? Is that an indication of maybe some consumer stress? Or are there any interesting dynamics happening within the consumer basket, the customer's basket that you would call out?

Yes. Well, I'd remind everybody that Ulta Beauty is the only retailer in the U.S. that has assortment across all price points. From entry-level mass to high-end luxury and everything in between. So what's -- and we think that's a real strategic advantage. It gives us the opportunity to flex and to lean in where consumers are excited. And yes, mass in the first quarter grew faster than prestige. What's difficult for us is to fully tease apart how much of that is driven by economic concerns that our guests may have versus innovation and excitement and enthusiasm for brands mass side. Probably -- we do a lot of research. We -- there's perhaps some of our 41 million members are making economic choices. But most indicators say that, that is not the primary reason why mass is driving. We see strong growth across all income levels. We have consistent growth across all income levels and a high level of engagement across mass, but also we've expanded our luxury and that's working well. What we do know for sure is brands like e.l.f and Nick and survey and Ordinary and others in mass side of the business are really hitting the mark right now in their marketing and in their innovation, their products. And so those are driving outside growth. And so that's what we think is probably the primary driver. But we have been able to, over time, flex and adapt to consumers, and that's what we're here to do, and we'll continue to do that as the consumer shakes out.

Sticking with the innovation theme, and you called out earlier, just the impact of social media and what that does for the category. With TikTok, it seems like micro trends can pop up in an instant. Can you maybe talk about Ulta's capabilities to respond to that quickly? And how do you pick and choose where you want to lean in there?

Scott watches TikTok most of the day. And so he's always ahead of that for us. Now we have a whole -- I mean, we are focused on making sure we're staying close to our guests. And so that's a big area like we are -- we've got teams that are like that's what they do every day is to understand consumer behavior to see what's happening and TikTok has been a really positive beneficial part of the category. Social media over time has really been part of the growth story of beauty since the early part of, I guess, the last decade as YouTube and Instagram started to take off. So you're right though, what's happening now and has been for a while is trends, products will unexpectedly hit the mark. It just takes a little bit of traction and all of a sudden something can explode. So we're continuing to build the capability to make sure that we've got the inventory and the products. We get them in the right space. We've got great relationships with our brand partners. It's obviously in their interest to make sure that they're reacting and pushing if they see something take off. It is hard for them or us to always anticipate and predict. But we've kind of have done now the playbook of, hey, we get something that's unexpected, takes off, actually being sold out for a short period of time is sometimes not a bad thing because it kind of helps build the buzz and then we try to address that and get inventory and working with our brand partners to do it. And so it's an exciting part of the business right now. That's for sure.

That's great. Switching gears a bit. Last year, your e-commerce business was up year-over-year, but there was a mix shift back to stores. How are you thinking about stores versus e-commerce today? Maybe touch on the key investment priorities for each channel? And then, Scott, maybe to more directly address you. Maybe talk about the margin differential by channel. I think 2019, you were still catching up with a lot of investments. I know that was called out as a headwind in the last couple of years. Where are we today?

Yes. So I'd say, overall, we're still continue to be focused on delivering great guest experiences, both in-store and online. And over the long term, we expect to grow sales in both channels as well. We've seen over time that people that are -- guests that are involved and touch us in multiple different ways across the whole omnichannel flywheel, whether it be services or credit card or now our new Ulta Beauty at Target activities. Over time, that strengthens the loyalty connection that we have with that guest and drive share of wallet. So e-commerce, our digital platform plays right into that as well. We've done a lot of good things over the last couple of years to the margin profile part of your question there, Mark. So introducing new capabilities like BOPIS, ship from store, new efficiencies gained in our distribution centers and across our supply chain network have helped us improve the margin profile of our e-commerce sale. So again, while there's still a bit of a gap, stores are still slightly better. We've narrowed the gap significantly over the last couple of years, and the teams continue to do a great job with that. I would say, just a reminder, fiscal 2022, store traffic drove was the primary driver of the comp over performance. And so that's a little different. In 2023, we expect e-commerce comp growth to outpace our stores. So just keep that in mind.

And Ulta has been chasing demand throughout the recovery here. As trends moderate to more normal growth rates, maybe talk about the opportunities you see to drive some cost efficiencies or perhaps realize more cost efficiencies as we see more moderate growth.

Yes. So back to Dave's point, we planned the year, we plan moderation. So for us, this is not a surprise. So the full year, we've got comp guidance of 4% to 5%. So we planned the business appropriately to match up with that more moderate growth environment. The company is in a much healthier position. The margin profile of this business is much stronger than it was pre-pandemic. There's been a lot of drivers to that. I know there's a lot of focus on promotion and now we're talking a little bit more about shrink as is all of retail these days. And so those are definitely headwinds for our business. But the amount of fixed cost leverage we've been able to drive on the stepped-up increase in sales over the last few years, new capabilities. We've been able to introduce, I just mentioned a couple around BOPIS and ship from store kinds of things to help our margin profile and new things that we have in the hopper now. So some of our strategic initiatives, investments in ERP platforms like SOAR, our digital store platform upgrade, new business models like UB Media, new capabilities like continuous improvement are all things that give us confidence that we're going to be able to maintain our margins on a 3% to 5% comp here in the near term to deliver 14% to 15% operating margins, but also over the long term, we continue to leverage that.

And Scott, sticking with the cost topic for a moment. There have been a number of questions regarding your SG&A growth guidance commentary from the recent call. I look for Q2 and sort of the shape of the year. So could you clarify how you're planning SG&A growth?

Sure. So the first thing I'd say is SG&A was actually a bit better than we had planned for the first quarter from our internal forecast. So I think there's 2 elements at play here, maybe a little disconnect with some of the modeling that was done by the Street. So the first one is around investments in our strategic initiatives. And the second piece of that would be store labor. So on the investments, so in 2022, we called out around $50 million to $55 million of incremental investment around digital store projects or getting out the UB Media up and off the ground and a few other things in the IT area. And so that ended up. Again, you got to put yourself back a year ago, right? Things were kind of coming out of COVID, staffing, infrastructure, third-party assistance kinds of things. So we got off to a little bit slower start than we were hoping to last year. So most of that -- 2/3 of that 50 to 55 was kind of back half loaded in 2022. So this year, again, 60 to 70 incremental this year is what we're thinking around the investments, and that is -- should be more evenly spread quarter-to-quarter, right? So that will cycle itself out. There's kind of a similar dynamic going on with store labor. So again, last year at this time, we were kind of chasing sales. I'd say we weren't as staffed up in the stores as we would have liked to have been. And then we also had some wage rate increases going to affect midyear last year to kind of address some of the pressure we were seeing across the landscape. So both of those things kind of working in unison in 2023. So we do expect to see some SG&A leverage. More of an impact in the first half of the year and kind of moderate it as we get deeper into the second half.

That's very helpful. Hitting on promotions, you called out a little bit earlier. In Q1, on the call, the company said that you're seeing promotions pick back up within the sector, you're prepared to defend your share. So maybe on a scale of 1 to 10, with 10 being 2019 levels of promotional intensity, 1 being where we were last year. Where are we today? Maybe give us a bit more perspective on the promotional backdrop.

Well, yes, I don't think I'm going to get exactly on your scale. But what I would say is -- what's happening in the promotional environment is we do see and we believe through this year as things kind of normalize coming out of the pandemic, and the category gets into its more historic growth rate that promotional activity will tick up, and that's what we said we saw in the first quarter. Both within our business and in the competitive environment. Our strategy around promotional activity is to not lead the category. We don't think we need to. We've got a differentiated model that's really working in a lot of strategic assets that are driving our business assortment, our loyalty program, our guest experience, our omnichannel capabilities. We lean into those and continue to build our brand and differentiate. But we know promotion plays an important role. And so we will make sure that we're competitive and not ceding share solely on promotional activity. We focus on our strategic promotional levers, programs like our -- what we call our tent pole events, 21 Days of Beauty, our hair and skin events throughout the year, programs that are designed to not only drive volume in the short term, but have a long-term strategic benefit. 21 Days of Beauty, if you don't know that program is a prestige focus of highlighting individual items for a single day at a 50% discount for 1 day. And we've been doing it for years. What it does is not only, of course, drive volume that day, but we see it introduces our guests to that item, that brand or in many cases, prestige for the first time. And that means to greater baskets over time, greater loyalty to Ulta. We also have advanced strategic CRM capabilities, our ability through our 41 million members in our loyalty program. We have more capability and capacity than we did in 2019 or at any time before that, to understand consumer behavior and be more efficient in our promotional activity. So while we've seen a tick up, we do not believe it's going to get back to 2019 levels because of our focus on the strategic elements that I talked about. So we're closer to what we've been experiencing in '21 and '22 than we are to 2019, and we think it's going to stay to that for a while.

And you didn't like my 1 to 10, so this is probably hitting my head against a wall here. But -- so if the industry does get back to a 10, given the tools, the personalization capabilities of CRM, if the industry gets back to a 10, where would Ulta be on that scale?

Yes. So I would just say we just need to keep in mind, Mark, it's not all about promotion. I know we kind of get conk up on that terminology. And it's not black and white. There's a lot of different levels of promotion in our business, right? I think people just don't appreciate that enough. It's not just marketing promotes with x% off your purchase, but it's merchandising things, it's loyalty things. There's a lot of different elements and levers across the business that we have to push and pull to optimize that. And then again, it's not all about the discount in the gross margin. There's a lot of other things we've done with our business over the last 3 to 4 years. Whether it be optimizing in our real estate portfolio to drive fixed cost leverage, new capabilities like BOPIS and ship from store that helped change the margin profile for an e-commerce sale and other things we've done in SG&A as well coupled with things we are queuing up for the future, which will help take some pressure off our margins by helping drive efficiencies like Project SOAR, continuous improvement kinds of activities and then new business models like UB Media, which is a margin accretive part of our business that really is just getting out of the starting gate point in time. So we're confident we can hold the line, by and large, regardless of what the promotional environment brings to us here in the near term.

That's great. And I do want to touch on a few of those items in a moment. But before we go there, I want to hit on shrink another really important topic, theft, organized retail crime. It's been a growing issue with the retail industry. Beauty, a highly targeted category. You're planning shrink to be a headwind this year. You updated your guidance a few weeks ago and incorporated a bigger headwind than you assumed at the start of the year. What gives you confidence that you've planned this conservatively enough and this isn't going to be something that continually, I guess, surprises to the upside?

Yes. Well, that's a question for all of us. Again, you said it well, Mark. The shrink and the ORC issues is something that's affecting not only Ulta, but all retailers at this point in time. And it's a serious situation, I would say. So for 2023, I just want to clarify for people, I know there are some issues or some questions around this. So we plan for a slight moderation, a slight improvement for the full year and that was based on some puts and takes. So we're making some significant investments in our business around fixturing to try to mitigate some of the shrink challenges. But also investments in our people and other activities and infrastructure in the business. So we did expect some slight moderation in 2023, but the trends now in the first quarter have proven that, that was a misestimate on our part and we just have to get more realistic around what we see playing out here for the rest of the year. So we're still doing a lot of -- there's all hands on deck. This is a real challenge for us. So the fixtures we tested them last year. We saw good results because not only do the SKUs, the product itself get restrained, but we're also investing in labor in those stores to make sure that there's assistance there for guests when they shop the category, all right? So that's one. They training, the things we're doing with the industry, organizations like RILA and NRF, and working with local law enforcement across the country to try to get a better handle on this. So we're doing everything we can. We think we have a realistic expectation for how we see the rest of the year playing out, and we'll just work hard with our industry partners to try to do what we can to help course correct this.

A couple of questions that are coming in from the room here. First to shrink, which you just addressed. Second, I guess it's not lost on the room that there are 3 guys up here talking about makeup.

We got help.

Yes. The question is what percent of your senior positions are women and maybe talk about the makeup of the Board as well?

Okay. Well, 91% of our company are women of our -- 10 members of our executive team, 7 are women. Vast majority of our leadership. So having said that, yes, it is incumbent on all of us regardless of who we are to understand our business and be ready to drive it. So while you don't see me wearing a lot of makeup, all of us try to make sure we understand the category. And more broadly, DEI is a really important part of our business. Yes, for sure, we are -- vast majority, over 90% women company. And that's great. There's a lot of opportunity for women to grow their careers and expand across our stores, our distribution centers, our corporate office. But also more broadly, our DEI is an important part of the category in general because inherently, beauty is about diversity, it's about how every individual brings themselves to -- expresses themselves to the world. And we have been focused on that, both externally and communicating that, and provide an environment to our guests externally, but also internally as we think of our team and how we continue to grow and expand.

That's great. Switching gears a bit and maybe going back to couple of things you brought up...

I'm sorry. Just you did ask specifically about the Board? The Board is 60% women as well, majority women as well. Yes, I should have mentioned that.

All detail laid out in our ESG report which you can find on our website.

That's exactly right.

There we go. Okay. Switching gears, maybe going back and hitting on some of the good guys with respect to margins, some of the longer-term initiatives for the company. Target is one, UB Media is another. Maybe starting with Target and your partnership there. Any new learnings that you're willing to share here today?

I'd just reinforce that we're excited about this partnership. It really was designed to be new to the world, something completely different, both obviously for us, for Target and for our brand partners, an opportunity for the collective, the 3 of us, brands, Target, Ulta come together to create an experience that delights the shared consumer that we have. And we're really excited about what it's doing. We're adding new members. We're delighting our existing members and our brands are finding a new way to drive growth in a really dynamic shifting environment, particularly on the prestige side of the business. So yes, we're confident in the business going forward. The one thing I'd emphasize is a big part of the strategy is part of an overall effort on Ulta -- for Ulta, to make sure that we are providing a multitude of touch points and opportunities for our guests to engage in Ulta. We have seen again and again and again, the more we get our guests engaged in different experiences, the deeper the loyalty and the greater the spend per member, the greater share of wallet. We got a store-only guest to start shopping us online. Their spend goes up over 2.5x with us. If they use our salon, it's 3x more with us. If they get our credit card, if they download our app, if they join our loyalty program, they become a diamond member. If they shop at Target, if they use our BOPIS experience, all these experiences collectively get greater loyalty and they reward us with a higher share of wallet, and we're excited with what we're seeing in Target, and really every touch point we have.

Great. And UB Media, Ulta's retail media network. What inning are you in here? And what are the key initiatives we should be watching in 2023?

Yes. So I'd say we're in the early innings. So this was something that we had done prior to 2021 in a very small select way. 2021 got out of the starting gate, I would say. 2022 now we're trying -- we are accelerating that business. Again, it's a margin-accretive add to the overall P&L. So I'd say right now, we're still trying to match demand. Supply is still a little bit short as we bring on focused sales teams to work with our vendor partners and to gear up on our technology, the behind the scenes to make all this stuff work in an efficient manner. So we're very optimistic about the long-term impacts on this on our P&L.

So these are relatively small revenue streams today, so you're not breaking it out in the financials. So hard to really discern what's happening there, but very, very high margins. So maybe just higher level, I mean, can these high-margin revenue streams scale fast enough to offset some of the factors like shrink and promotions that are -- might be headwinds? Or maybe just talk us through the short term versus the longer-term margin implications of these initiatives.

Yes. Well, again, you plan for multiple scenarios. So we plan the year, more moderate growth, the 4% to 5% comp. That's how we plan our business for this year. If things get tougher, which they could, we've got levers and dials at our disposal. That's what management does. We adjust and we formulate new plans. So there's things we would -- actions we would take to try to moderate headwinds, the shrink and the promotion thing if it got tougher than we are now expecting. But I just, again, remind people we're in the midst of a huge transformation of our business. Again, around ERP systems, digital store of the future systems, our supply chain transformation. So there's a lot of things going on right now that are going to provide benefits for the company for shareholders for the long term. So we're committed to those kinds of things. So we would work around, again, the edges to try to optimize both the short and the long-term financial performance of the business.

Great. We are out of time. So I think we're going to have to wrap it there. But if anybody has further questions, Ulta will be available for a breakout session just around the corner. So please stop by and join. Please join me in thanking Dave and Scott for a great presentation.

Thank you.