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

Good morning, everyone. Thank you for attending Oppenheimer's 23rd Annual Consumer Conference. My name is Rupesh Parikh. I'm the Senior Food, Grocery and Consumer Products Analyst here at Oppenheimer. I'm very excited to introduce our next presenting company, Ulta Beauty. We're excited to have joining us today Kecia Steelman COO; and Scott Settersten, CFO. Even with the recent pullback in Ulta shares, the management team has delivered significant shareholder value over the years. This is in large part due to the company's efforts in developing a powerful omnichannel model and continue to step up brand assortments and the in-store experience. Since our fireside chat with Scott in the middle of 2015 for the first time, Ulta share is up more than 170%, meaningfully outpacing gains of around 100% in S&P 500 and just 20% in the XRT ETF. So the format of the session will be a fireside chat going through a number of questions I prepared. And if time allows, we will take audience questions at the end. If you have a question, please enter them into the question panel below the video.

Let's get started. So Kecia and Scott, thank you so much for joining us today. So with continued concerns out there on the consumer macro backdrops, I would love to get your thoughts on the health of your consumer today. You've talked about mass outperforming prestige and units per transaction slowing, but it's hard to tell what's trade down versus compelling mass innovation and what is a more selective consumer versus category normalization. So I think it would be helpful if you can walk us through some of the puts and takes as you see them on the consumer front.

Yes. Thanks, Rupesh, and thank you so much for having Scott and I and Ulta Beauty today. I'll start with that first question. And what we're seeing is that engagement is still really strong. Behaviors did start to shift in Q1. And it's kind of given us some mixed results actually and mixed understanding of what the consumer's behavior is. I'll start with income levels. So what we're seeing is that by income levels, the cohorts, the growth rates are still healthy and strong, but we did see them start to moderate through the quarter. Traffic in ticket. So traffic remains really healthy and strong. Average spend per member is still growing and increasing. But the average ticket has declined a little bit because of the fewer units per transaction. Promotional activity, the guest is responding really well to promotional activities. However, we introduced luxury also this quarter and luxury has gotten out of the gates really strong and there's limited promotional activity, no promotion activity really within luxury. And then you asked about mass versus prestige. So mass did outperform prestige, but prestige was still healthy. What we're seeing is that in social media with TikTok, e.l.f. was really coming out with some great marketing campaigns, influencer campaigns along with like La Roche-Posay, The Ordinary also. So we don't know that it's necessarily a trade down, but it's more of the newness, the engagement with the consumer right now is a little bit heavy weighted on the mass categories. What I would say about Ulta Beauty is that we're in this great position because we offer mass to masstige, to prestige and luxury now, so we can take that member's dollar, no matter where they want to spend it, they can come to Ulta Beauty to spend their dollars with us. So we're really leaning into what the consumer trends are, what the consumer is saying, and making sure that we're keeping them engaged with Ulta Beauty.

Okay. Great. And then going back to your latest report, Q1 results were in line with expectations versus a meaningful upside that investors have become accustomed to in recent quarters. what do you think contributed to top line results being more in line versus significant upside we've seen from Ulta in prior quarters? What categories have slowed faster than you expected?

Yes. So we are very happy with delivering a good, solid first quarter result overall. Again, it came in line with our internal expectations, by and large. And I think we need to keep in mind that we're cycling over some spectacular performance over the last 2 years, specifically where we delivered far above what our initial expectations were in each year, '21 and 2022. Overall, the category, the economy in general is very dynamic, right? So we're doing the best job that we can to stay focused on the consumer, our guest in our stores, the category overall, feeling very confident. Our sales expectations for 2023 are unchanged. So again, we delivered just north of a 9% comp in the first quarter. We guided first half of the year to high single digits. And back half of the year to low single digits, which get us in that 4% to 5% comp for the full year. We're still very confident we can deliver that in light of all facts and circumstances. The first quarter, we saw, again, to Kecia's point, it was a little bit of some mixed themes going on there, but we are looking at the strength of the store traffic, both -- well, store and digital. Specialty services still being very strong. We saw good performance to your category piece of your question there. Fragrance continues to outperform. Skincare is still very strong. I mean we did see mass outperform prestige in the quarter, but prestige is still growing at very healthy rates over all. So we're feeling good about the category. We're feeling good about our positioning in the beauty space, and we're still very confident that we're going to deliver a good solid result for 2023.

So just going back to the category. So as the category growth continues to normalize, does your team believe industry growth could still be at the higher end of the 2% to 5% range this year?

You know, beauty is an emotional category, and it's an emotional connection to our consumer. The pre-COVID growth rates from 2011 to 2019 were right around in the industry [ over ] 4%. We really think after 2 years of unprecedented double-digit growth, strong growth here at Ulta Beauty, that it's going to moderate a bit. And we feel like we're still on top of those incredible numbers and growth of over $1 billion in our business last year, that will moderate more towards that 4%. That's why we gave the guidance of the 4% to 5%. We really do think that beauty is in a category that's going to still remain relatively important to the consumer, they're going to spend to choose to spend their dollars with us, but we remain focused on really capitalizing on that loyalty that we have. 95% of our guests through our loyalty program are shopping with us on a consistent basis, and we'll just stay connected with them.

Okay. Great. So diving deeper into specific categories. So first, on skincare. So skincare had strong double-digit growth again in Q1 on top of difficult lapse. So what are the key efforts to further drive share gains and sustain this momentum going forward?

Yes. Skincare is one of our best-performing categories and it was one of our strongest categories in Q1. I think that strong double-digit growth is really coming from a couple of different areas. #1, newness, new brands. So new brands like Bubble, Beautycounter, these are really relevant with Gen Z. They're clean brands, which is incredible to add to our assortment. There was also a lot of newness that was happening within some of our existing brands, some of our hero [ product categories ], Drunk Elephant, the [ bronze ] is hot right now. So to see this newness and innovation, not only with brands coming in, but with the existing brands is really important. Social media also was a big play with skin, La Roche-Posay, a lot of social media activity on TikTok, The Ordinary, Drunk Elephant, that really resonates with our guests too. The regimens have continued to stick. That happened through COVID, and we see the self-care, taking care of yourself is still really relevant and important, and that's great. So whether you're talking about a dermatologist -- dermatologically recommended brand, SPF, eye products, that's really important to the consumer and they're really engaged. We're also under-indexed in skin currently today. So that just says that we've got a lot more space to continue to grow. So we're continuing to lean in on skin and make sure that our associates are really educated because skin can be a little tough to purchase. So we are working on really demystifying skin as the consumer is coming in to purchase with us.

Okay. Great. And then just on makeup, makeup has continued like skincare Ulta. So what is the bigger opportunities from here in the makeup category? And I guess is there still reopening tailwinds in makeup that should continue for the rest of the year?

Yes. Engagement continues to be really strong in makeup. We had high single-digit comps in makeup as a whole. Newness is still really important. 21 Days of Beauty or Temple events to get new consumers into the brand, really, really important to Ulta Beauty. Spring Haul, how we're getting even that mass consumer to come into our stores, really resonates across all price points, which is we are not just targeting one price point. Our luxury strategy is also really important. So adding in prestige brands like Hourglass, NATASHA DENONA, BLEU de CHANEL, Dior was a huge one, MAC continuing to expand. We -- I talked earlier about some of the social media brands around NYX and e.l.f., it's just that we are hitting on all cylinders there. And makeup is really important to us at Ulta Beauty to continue to focus on and making sure that we're enabling the guests to continue to meet their beauty needs. The outdoor activities, people going back into the office. A lot of travel, travel is starting to really pick up. So -- and what we're seeing is that the regimens with skin care, as I mentioned earlier, are sticking, but they're also buying makeup. The looks and the trends right now also we're really liking because it's from the no makeup, makeup look, which does take a lot of makeup, to the bold makeups, and I refer to it as the 80s and 90s, probably my era where it was the bold looks of your eye and lip. And it's the same customer that's doing both. So that's really nice that we're seeing that there's still trends that are emerging, innovation that's happening, and we are confident in what's going to happen in make up going forward.

Okay. And then the last category I want to touch on just fragrances. So fragrances are really -- been booming for years, even during the pandemic, which at least for me, it's been obviously very surprising. Momentum again continued into Q1. So what has Ulta been doing in this category? And what opportunities does your team see from here? And would you expect the momentum to persist in the category?

Yes. You wouldn't think that there could be makeup [indiscernible] or trends in fragrance, but there are trends that are happening in fragrance right now. And I'd say one of them is around layering. So not just wearing one scent but wearing multiple scents at a time. So we really -- I mean, that's great for the category because it means there's more purchases than just one item. And now the other thing that we're hearing is wardrobing, where it's not -- you used to have your signature scent, that was the one scent everybody knew that was your scent. That's not the case anymore. It's scents that are based on how you're feeling in the moment. And I think that really resonated during COVID. People were really purchasing fragrance, and that's stuck. So they're now wanting to have that same scent that they're wearing today. I know I myself, you can poke in my drawer, and I have probably 40-plus, embarrassingly so. But there's also great growth in categories like Carolina Herrera. Ariana Grande is an exclusive to us. So she continues to have new launches, which is really exciting to bring new guests into the category and into Ulta Beauty. But we expect that to moderate a little bit because we're just coming off of such strong, strong numbers over the last couple of years, but we still think that it's a growth category for us.

Okay. That's a great overview. And then on the brand side. So over the past several years, we've seen Ulta continue to elevate brand and store, especially on the prestige side with brands such as Fenty Beauty, Chanel, and Drunk Elephant. How do you feel about your pipeline of brand additions?

Well, we feel like the merchants are doing a fantastic job. They're always looking for new entrepreneurial leaders and that's what's great about this makeup category in and of itself is there's always newness. Like, Fenty, 5 years ago, we never even heard of it. And now it's such a big cosmetic brand today. We feel great about our newness pipeline. But we're going to get some really strong newness from last year. So we had -- and arguably, the strongest categories of hair makeup and skin. We had Drunk Elephant in skin, OLAPLEX in hair, and Fenty in cosmetics. We're cycling over those big launches that we had last year. But we have some newness that's sprinkled in throughout this year, and we've even got some newness that we're already focused on for 2024. And but they're probably not to the same degree as the ones that we had because I'd call them the perfect trifecta that we were able to expand last year that we're cycling up against right now. But newness is really important. We're continuing to lean into it. The merchants do a fantastic job. And there might be a product or a category that we're talking about that weren't -- that's not even in existence today that could be in the next couple of years here. So we're leaning in and we're making sure that we're front and center of having those brands when it come to us at Ulta Beauty.

Okay. Great. And then switching gears to your new store design. So last year, your team introduced a new store layout with the repositioning of skincare to the front of the store being one of the more notable changes. So I did have a chance to visit one of your locations outside Disneyland back in March. So how are these new layout stores performing versus your expectations? Anything surprising that you've learned from them so far?

Yes. Well, I want to start first by that -- we always keep a consumer lens, and any time that we're going to be changing anything in the company and the store specifically. And we listened to them over the last 1.5 years on what were they wanting to see differently in our store prototype. And one of the big changes that we made was we used to have mass on one side of the store, prestige on the other. And that's not really the way that the beauty basket is built and how the consumer is really shopping. So -- like you said, we actually reflowed and we led with our prestige, going to masstige into mass in both makeup and skin care specifically. And then we also have luxury, more towards the middle on our luxury doors. We have about 200 luxury doors right now. One of the things that we learned that we listened to the guest on is that they did not like the register being located more towards the back of the store. So initially, in the first rollouts, we had the register at the back. We are now moving forward with moving the register back up front. The associates like it better upfront. They can really engage with the guests as they're walking in the door. Also from a BOPIS perspective. So buy online, pick up in store, it's a lot easier to pick it up right at the front at the register versus having to go all the way into the store. So we listen to the consumer. But overall, the guest NPS is really strong in these new locations. We also like what we're seeing from the units per transaction in these stores. While it's still a little bit early to read because we've only got about 50 stores through Q1. The checkout formation in the grab-and-go area, so as you're checking out, the new configuration of that is -- we're really seeing some nice add-on purchases because you get in that line, and there's items that are right there for you that you just got to grab before you check out. So we're continuing to lean in on that also with this prototype going forward. And again, just as a reminder, we're not going back in a big way to the whole fleet. We're only retrofitting on our remodels that we've got currently in the plan. And then also new stores going forward. But -- yes, it's great. I'm glad you were able to go into a store by Disney.

Yes. And I agree with that feedback from your customers. And what are some of the other opportunities you see to further enhance the in-store experience?

I just think that continuing to make sure that we have great guest experience and that we're looking at activations. So we did -- in this last quarter, we did over 2,500 events in-store. So the more you can have this experiential shopping, I think that takes it to a new level from just going into a store to buy products, actually having engagement and interaction and education. So that's what we're really leaning into. And you can really feel that, especially in this new layout and prototype because the experiential pieces are right more towards the center of the store, so it's kind of the hub, it's the center hub. So there's always some kind of activation going on, which our guests love coming into the store and learning something new. I know I learn new things every time I go into a store.

Great. And then the luxury opportunity, so I had time to spend at your Michigan Avenue store a few weeks ago. Could you just remind us of your launch of luxury at Ulta Beauty? I think it's in 200 stores now. Can you just remind us how you're thinking about the luxury opportunity for the chain? And then should we expect to see the offering added to more stores over time?

Yes. We're currently in 200 stores. And with that, we have an elevated fixture, but it's more linear in sites. So it's not those big boutiques that you may have seen in the past, which is great from us being able to use our dollars per square foot very wisely. The Gen Z population is really what the consumer is really leaning into luxury. They love luxury. So that was a little bit of a white space for us that we felt like we could lean into and improve our overall assortment. It's very thoughtfully curated. The merchants have done a fantastic job. We're listening to the consumer and what they're asking for in regards to brands. We've got many of them that I mentioned earlier, but there's a few that are still on our radar that will hopefully be adding to the assortment very, very soon. But from both cosmetics and also fragrance, it's really important to us. So some of the fragrances I didn't call out earlier, YSL, Tom Ford, Viktor&Rolf, Gucci, Tiffany, those are the brands that the consumers are really looking for, and it's great that we're able to offer them now into our assortment, and continue to drive share.

Okay. Great. So switching gears to your loyalty offering. So we continue to see different promotions in the program. Do you see additional opportunities to add more benefit to new tiers, et cetera? Just wanted to better understand the opportunities to further enhance member benefit from here, especially in increasing competitive beauty landscape.

Yes. So our loyalty platform is one of our most important assets at Ulta Beauty. Again, you've heard us describe it that way for many, many years. So 41 million-plus members, active members, purchased within the last year, contributing 95% of our sales. So it's a critical element of our business model. So I'd say it's an evolution. Again, lots of good things going on. It's things that we've been able -- capabilities we've been able to build over time. So you've heard us talk about our CRM platform. Our tools have improved, our insights, our data analytical analysis and insight capabilities have been improved over time. So I wouldn't say it's -- there's a number of different types of promotional drivers we have, what we call our tent pole events like 21 Days of Beauty and Love Your Hair and all those kinds of things, which are very specifically identified, and we do for strategic purposes, right? Like, 21 Days of Beauty is intended and has demonstrated over time to move people from mass to prestige as we get them to engage with those brands and those products. So that's one element. There's other reasons and issues, strategies, why we promote -- to build a basket, for example, would be another one, or get people to engage in different categories within our store, right? They buy -- we've seen them with a propensity to buy makeup over time. Why aren't they buying hair care with us as well, right? So we do things along those lines. We do things with reengaging people with the brand, people that have fallen off outside that 1-year active shopper window. And most times, we find it's not because they had a bad experience with Ulta Beauty. It's because they relocated or somehow they lost touch with the brand. And so when we have an opportunity to reengage with them. We've seen really good results from that as well. So I would say, overall, the team, we've got a great loyalty team that are always looking for ways to innovate and improve our loyalty offering to our guests and to keep them retained with us. So it's going to be an evolution over time. And we still -- there's plenty of opportunities there for us to continue to capitalize on that.

Okay. Great. Now switching to a few financial questions. So starting with gross margins. Can you walk us through the key puts and takes on the gross margin line for the year, including your expectations for a shrink and how that compares to the 70 basis points headwind you experienced last year.

Yes. So gross margin in the first quarter, I mean we expect to deleverage for the year-end gross margin as we cycle over the price increased benefits that we got in 2022, which were a major tailwind last year. There will be a headwind this year. And then we also discussed the fact that we expect the promotional environment to kind of ramp back up a bit here as we get back into more of a normal kind of competitive environment and after cycling over 2 years of spectacular sales growth. So those were at play. Of course, there's some benefits, right? There's the other revenue, some of the things we've been talking about with our credit card, new store, non-comp performance continues to be strong. But we did see shrink tick up here a bit. So that was in our plan for the year. We expected maybe a slight improvement in shrink versus the 70 bps that you called out for 2022. And that was based on investments we're making to help mitigate some of the shrink risk in our stores along with some incremental brands that we were bringing to the assortment that we knew they were going to be a high focus for some of the bad actors. So that was built into the plan. So again, for the year, we thought maybe we'd see a slight improvement. That wasn't the case in the first quarter. We saw the trends again, the 70 bps from last year, it accelerated as we got through the year. So it was tougher in the back half than it was the front half, and we saw that continue into the first quarter, especially in places where we didn't have our new fragrance fixture in place. Again, we've got those installed in roughly 500 stores at the end of the first quarter, but we'll have expanded to about 70% of the chain by the time we get to the end of the year. So we think that's -- again, we've seen that be effective. We've seen a decreased shrink and increased sales as the labor that we've invested alongside those fixtures has helped enhance the guest experience and make sure that we're in stock when the guest comes to shop fragrance with us. So again, we see the year playing out the total comp, we're still comfortable with our 4% to 5% top line guide, and we think this -- the operating margin adjustment now gets us into a comfortable place that we feel optimistic and confident that we're going to deliver the year as we laid out here at the end of the first quarter.

Okay. Great. And then switching gears to a few SG&A questions, and we still get a lot of questions on that topic. So I believe your team continues to expect SG&A deleverage this year. Can you remind us of the key puts and takes driving that expectation? And is there anything else we should be thinking about on the SG&A front?

Yes. So that's right. SG&A deleverage for the full year, I think maybe there was a little bit of a surprise in the first quarter with some of the models out there because we have 2 -- really 2 issues kind of at play in the first quarter specifically. So #1 is around our strategic initiatives and the second piece is around store labor. So in the first -- so 2022, our strategic initiatives, again, projects or our ERP replatforming, our Digital Store of the Future, we got Ulta Beauty Media ramp-up and play there as well as a number of other IT initiatives underway. So last year, we called out $50 million to $55 million of incremental P&L headwinds in 2022. Those ended up being mostly back half loaded. So 2/3 of that kind of hit the second half of 2022. Switch over to 2023, all these projects now are ramped up. They're in full swing. And so the $60 million to $70 million that we called out for 2023 is kind of equally spread over the quarters. So there's a bit of a lapping issue there, I guess, in the first quarter that was unexpected. And similarly, with store labor. So in 2022, we had some wage rate adjustments upwards to maintain our competitiveness out there, really store labor. It was effective in the DCs as well, but this is at the SG&A line that we're talking about. And then last year, you may have recall that we were, I'd call chasing sales maybe a bit in the first quarter. The year got off and well, the whole year way overperformed what our initial expectations were. And so there was a bit of an issue with ramping up labor coverage in our stores, especially in the first quarter. And so now first quarter this year, we've got it right sized and we're back in equilibrium, I would say. So you got the impact of the incremental hours in the stores, coupled...

Did I freeze or operator -- or that's Scott. Operator, did I freeze? [Technical Difficulty] We apologize for the technical difficulty. So we'll continue on the SG&A questions. So Scott, my next question on SG&A is on the labor front, have you seen improved worker availability? Are we starting to move closer to pre-pandemic conditions on the availability front?

Yes, I'd say overall, we feel like we're in really good shape on the labor side of things. So we took some actions last year, you may recall, to adjust wage rates up. And that -- I think we had really good reaction from...

I think -- Scott, you're on mute again, I believe. Or operator, can you unmute Scott?

Hello?

Yes, Scott, we can hear you. Go on.

You can hear me? Okay. So...

I can hear you. Go on.

Sorry to -- maybe I got cut off. I'd say overall, we feel like we're in a good position on the labor front. We took some actions last year on...

Unfortunately, Scott, you're getting cut off. [Technical Difficulty] Okay. Sorry for the technical difficulties. Kecia is back, so we're going to wrap up with a few questions for her. So just on omnichannel. So your team has talked about the omnichannel shoppers spending 2.5x more than an in-store-only guest. What are key things you're doing to increase that penetration of omnichannel shoppers? And with what efforts are you seeing the most success in transitioning a single-channel shopper to an omnichannel shopper?

Yes. The guest journey is no longer linear. They want to shop at all different touch points from physical to digital to social. So a couple of things that we're doing is really doubling down our efforts of buy anywhere, fill anywhere. So BOPIS, we talked about earlier, same-day delivery. We're in 18 markets right now, about 500-ish stores. We're really continuing to focus on personalized, convenient services that the guest is really wanting. Expanded pay also is something that we're really leaning into. So Afterpay, that really resonates with the Gen Z consumer. In Apple Pay, we take both forms of payment now in store. We've worked on POS upgrades and you wouldn't think about POS as being part of that digital omni journey. But at the register now, the ship to store door capability is right at the register. So if there's an out of stock or we don't carry that item in the store, right at the register, we can make that as part of the overall transaction. So we're really, really pleased with that. And then virtual assistance. So using our digital technologies to engage in virtual interactions with the guests. We've done some tests with some of our key brand partners, and the guests love participating in a different way in a digital way.

Okay. Great. And then just on services. So your salon services business had a really strong quarter of double-digit comp growth again. What are the bigger opportunities for the salon business going forward?

Yes. I would say that's one of our unique propositions that we have, a salon in almost all of our stores. We had double-digit growth, as you mentioned last quarter. We're really focused on training and education. And I think about our product and services is our stylist. So really working on retention of our stylists, highlighting and recruiting a high level of stylists that bring their big book of business. You talked earlier about the omnichannel as 2.5 to 3x the services customer that is engaging with us is 3x plus because of the frequency that they're coming in to get their hair done. We're also leaning into product attachment. So these back bar events that we've been working on where we're engaging with our primary backbar partner, Redken, but where we can bring in new brands that you not only give the stylist the knowledge base of how these products are working in the guest's hair, but also give the guests the ability to try some new products. And when we've done these activities and these activations. During that week that we were doing the trial, 90% of those guests are first time into that brand. So that's a pretty incredible number. If we can get the guest trying with their stylist in an educated way, we definitely see attachment of product sales. So that's really what we're leaning into this whole 360 of having the right stylist, taking care of the [indiscernible] guests, and putting more products in front of them while they're in the chair. And wrapping that all with loyalty because we want to always get them into our loyalty program because they get to earn their points, whether they're getting their hair done, which is a nice ticket for us.

Okay, great. We're going to wrap up with one question from the audience. Just in terms of your target initiative, how is the target initiative been working and plans to increase the presence there?

Yes. So our overall goal is to be at around 800 stores when we're at full scale. Part of the partnership was that we felt like there was this great way that our guests for a fill in or a trial, they could have an experience at Ulta Beauty at Target. The partnership is going well. We now have a field team that is dedicated to just Ulta Beauty at Target. We're making sure that we're working on the education, the in-stocks, the overall experience, really leaning into loyalty. So the ability for us to get in front of new guests that's shopping at Target into our loyalty program, or to engage potentially a lapsed loyalty member that hasn't shopped with us in a year to get them back into the loyalty program, and bring them back into both the -- back into Ulta Beauty is really where the magic starts to happen with this. And this also gives our brand another point of presence out there in the marketplace. So -- we're really excited about what we're seeing, and we look forward to the continued growth in this partnership going forward.

Okay. Great. Well, thanks, Kecia and Scott for joining us today. And to the audience, we apologize for the technical difficulties.

Yes. Thank you so much, Rupesh. It was great to spend some time with you today, and thank you, everyone, for your interest in Ulta Beauty.