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

Thank you, everyone, for being here. My name is Dylan Carden. I'm the specialty retail analyst here at William Blair. We're pleased today to have David Kimbell, CEO; and Paula Oyibo, CFO of Ulta Beauty. So thank you.

And we're just going to kind of kick it off here and we spoke to this. But I guess there's -- there are a lot of headwinds in your business that you've called out. You've got the sort of just the general beauty cyclicality. You've got a fuzzy macro outlook. You've got competition, and you've got your own success over the last 2 years, right? You kind of had outsized growth relative to your model. So a lot of people are focused on the competitive aspect of it, but you got a bucket and even just sort of rank kind of those pressures on your business as you see them today?

Yes. Well, first of all, thanks for having us. Thanks for your interest in Ulta Beauty, and thanks for holding this in our hometown of Chicago. We were started here 34 years ago. So it's nice to be here in our home city. Yes. When we look at our business right now, there's -- there are a lot of factors going on. And overall, we feel very confident and optimistic about the future of our company and how we're performing today despite some of the pressures and the challenges. So to take some of the things you highlighted of, I look more broadly about the consumer landscape, the macro environment. I think you all are watching it as closely as we are. And it is a uncertain environment right now. There's a lot of anxiety with consumers, and that's true across all categories that influences all categories. Consumer confidence is pressured despite there's some obvious positives in the economic environment, but there's other concerns and challenges that are putting pressure on consumers. And then we're seeing that show up and just then be more thoughtful and more aware of how they're making choices and spending money. And then you layer in the election environment and other dynamics going on in our cultural and society. The consumer is in a, I guess, I'd say, an uncertain place. And so that certainly influences all of consumer behavior. When I look at the beauty category, specifically within that context, beauty category is healthy and has been for a long time has been historically, it's performed very well, a very consistent growth category because of the importance it plays in consumers' lives. Beauty is emotionally connected to consumers. It's so important in how they take care of themselves, how they show up in the world, how they think about self-care and wellness and self-expression. So historically, beauty has been a strong growth category. And coming out of the pandemic, it's been exceptionally strong, double-digit growth really in '21, '22, '23, the category and really stronger than really anybody expected coming up. It is still healthy this year but moderating as we expected and anticipated. So going from very strong growth to moving down more towards historical levels of growth, still a little bit ahead of that. So a bit of a headwind in the sense that it's not growing as fast as it was last year, but still healthy overall. And then the other thing, I guess, that I'd highlight is we're also -- because of the strength of the category and the overall attractiveness of beauty, it's growth history, its margin profile, it's always been competitive. And the competitive intensity right now is more than -- I've been with the company 10 years. First started working in beauty in the '90s at Procter & Gamble many years ago. It's an intensely competitive environment right now because of the attractiveness and the opportunity that so many see. And so we can talk more about what that means, but that's certainly an environment. Having said all that, as we look at our business right now, while our growth has moderated, we see so many positive signs, good growth overall. Our members up 6%, our brand, brand love, reached all-time high, our brand awareness. We have reached all-time high, good growth in stores, good growth in e-com. We're seeing so many factors across our business. We held share in total beauty. We gained share in e-comm prestige. And so when we look across our business, a lot of positives that give us confidence, and then we're navigating some of the pressures in the short term.

We'd touch on all of that hopefully today. I mean, maybe start from a competitive standpoint, it's been sort of a newer phenomena, maybe fourth quarter, but sort of first quarter as far as sort of your comments around that you might be losing share in some parts of your business. I guess, where are you losing share? But I'm also curious sort of how your competitors are taking share and maybe how you think you sort of counteract that further into the year?

Yes. So for the first quarter, and it was true into last year for the fiscal year 2023, we held share in total beauty. So if you think of beauty across all categories, haircare, skincare, fragrance, makeup, and then all price points. As you probably know, the beauty historically segmented in from mass products to prestige products, luxury products. We play in all of them. We're really the only scaled beauty player that has presence across all price points. So when you look at total beauty held share, historically, we've gained a lot of share. So we're accustomed to gaining share, but held share in Q1 and for 2023, we gained share in prestige e-com, as I mentioned. So our e-com business gaining share where we were pressured is prestige overall, driven by pressure on the store side, the brick-and-mortar part of our business, in particular, makeup and hair care. So you go total beauty holding share, where you get down to make up, haircare, prestige in our brick-and-mortar business. That's where we're feeling the most pressure. What's going on in the category is there are over 1,000 new points of physical distribution in the last 2 years, really unprecedented in beauty. I've been trying to figure out if it's happened in retail at all that you have a direct competitor open up 1,000 new point and we have 1,400. It's a meaningful change in the category. It is by no means in any way, a long-term kind of dynamic that we feel like we won't be able to manage through to gain share to drive our business forward. We're already -- we've seen historically when stores -- competitive stores open up to ours. We're able to absorb a short-term dynamic, but then be able to grow in that location over time, and we're confident we'll do that. But we're facing that right now. So again, feel good in the sense that we're holding on to our total share despite the elevated competitive pressures and clear about where we're facing some challenges, and we're taking actions across our business to protect and drive share for the long term.

Can we talk about that? And so is it simply just then a cannibalizing impact when a new store opens up in close proximity. You mentioned that you've kind of seen that video before, how that plays out over time. And then yes, just sort of how you claw back some of that share in the physical channel.

Well, I mean, yes, there's definitely that dynamic. I don't want to say there aren't -- there's other factors going on as there always are in this industry. I mean, it has always been a very competitive industry because it's been attractive. So there -- again, I've been here 10 years. We're used to have got multiple fronts of competitive, both opportunity and challenge and threat, and we react and we've been able to gain. We have gained meaningful share. Since the pandemic, we are up over -- our total connection with our guests is over 200 basis points in share in our business. And so we feel very confident in our ability over the long term to continue to grow share. What is really unique? And yes, when I say we got experience with stores opening up near our stores in any given year, that might be 20, 30, maybe 50, not 1,000 over 2 years. And so that's unprecedented. Again, we -- as we look at it, we're -- the fact that we're continuing to grow hold share, hits all the positives, I said, about brand love and brand connection and traffic to us signals our guests are very confident in our business. They love what we're doing. We're navigating this. And over the long term, we'll -- we're confident we'll be gaining share as we've done for a long, long time.

Engagement and one stat I find interesting about you guys is you've actually -- the growth in your loyalty program has doubled that of your store expansion. So it's sort of an efficient way, right? And it seems to me that there's an embedded sort of competitive advantage in the loyalty programs. I'm just wondering if you could touch on engagement, particularly in the online channel. That's part of the initiative this year, right, sort of more relevant engagement in online. How you think about fostering that asset, particularly as it relates to the dynamic competitive landscape?

Yes. Our loyalty program is one of our greatest assets. We've got over 43 -- nearing 44 million members in our loyalty program, the largest beauty focused loyalty program in the country to have, again, nearly 44 million beauty enthusiasts connected to our business, active members, which we define that means they've shopped with us at least once in the last 12 months. So 44 million people. It gives us such great connection to both understand beauty trends and what's important to them to be able to connect and communicate over 95% of our sales go through our loyalty program. So almost every individual item that we sell, we track back to an individual to understand behaviors. And then provide more value and relevance. We've been on a journey for a long time to increase our personalization to understand Paula's unique ways to engage with the category, communicate directly to her add more value through the experience that we deliver, and we've been doing that, and that's what's been driving the loyalty and connection. When I tie it back to share, I'd like to kind of make the point the importance of our loyalty program to our long-term share is critical because of the connection and the relationship that we've built. And when I look at share growth opportunity, a big focus for us is, one, continuing to grow total members for sure. And we are up 6% as we reported in the first quarter, and we'll continue to -- and we see a runway to continue to grow that. But also increase share of wallet. What we -- and the opportunity within them. And so that is less focused on any one individual competitor, but us providing experiences that delight our guests in a way that they concentrate more and more of their spend at Ulta Beauty. So almost everything we do is designed to add value to our loyalty. So if we get a store guest that's shopping only in store, if we get them to start shopping us online, they increased 2.5x. If they get their credit card, they're increasing significantly. If they move from our base program to our platinum or diamond program and our loyalty program, their spend engagement and share of wallet increases. If they use our services, if they try us at Target, if they download our app, all the things that we do, if they are makeup shopper and we can get them to start shopping haircare, all these things are designed to get share of wallet, which translates to share of market.

Yes. And related to that, I'm curious about sort of the term you used in sort of addressing your strategic initiatives this year, relevance online. How it's sort of, I think, related to this, how do you view your relevance. And I think relevance of the online space, you just kind of stopped giving the online sales number. But how do you see -- it was actually a bright spot in the quarter as far as growth and market share is concerned. So how do you see the online channel from a penetration standpoint, from a growth standpoint, progress from here? And how does that sort of factor into your own business?

Yes. What I would say, Dylan, is we were really happy with the performance of our online and our digital e-commerce business. In Q1, we had high single-digit comp growth and really strong traffic across all of our digital touch points, our app as well as our website. It represents about 20% of our total sales at this point, and we expect continued growth, growth at a level that will outpace our store growth. But as we take a step back, we really think about our business through an omnichannel lens. And we think both our digital as well as our brick-and-mortar business has a really important role in working together and driving growth. We see that when a guest engages with us across multiple touch points, whether it is in our stores or online and our app or on our site as well as [ Juvia ] target. They engage more. They're more loyal and they spend more. And so what we have seen is that omnichannel guest, they spend 2.5 to 3x more than our brick and only, brick motor -- brick-and-mortar only guests. And so again, we see a lot of growth still to come from an e-commerce perspective, but really think about how those 2 channels play well together.

Because the category lends itself more from a sort of a symbiotic relationship or harmonious relationship between the 2 channels, right? I mean, it's still very much a try-on influence, right? So I would think that -- would you expect this to be a category that would overpenetrate line in any sort of point in the future? Or is something that you would expect to kind of remain at a relatively stable level?

Well -- and Dave can add on here, but what we know is that trial is really important for this category. And so guests, they enjoy newness. They enjoy having the opportunity to come in our stores and play and trial. The digital channel also plays an important role with product discovery. And so oftentimes, we could see a guest come into our store and they may be looking on our app to look and discover and then shop in stores. And so I think those 2 really, really play well together.

Excellent. And it somewhat merges into the question around by the end of this year, you'll be kind of within spitting distance of your lower bound of your long-term store target, call it, about 1,500 stores. How do you think about retail expansion or growth from there as the online channel pick up more of the lift, how -- prepare people for kind of riding, so to speak.

Yes. You mentioned we had previously shared our confidence in having store growth in the range of 1,500 to 1,700 freestanding Ulta Beauty locations. We're still confident in our ability to see that at the top end of the range. What I would say is we also see a lot of opportunity. We had shared that we started to open small format stores. And we've been pleased with the results that we've seen with that and we see that, that creates an additional opportunity -- potential opportunity for us from a growth -- store growth perspective above that range. We also at the -- we have -- we are expecting 800 Ulta Beauty at Target locations, which is another point of presence for us. And then as you know, we announced our entry into Mexico. And so we are excited about the opportunity that UB Mexico will provide for us with additional store growth.

Let's talk about all of those. As you approach 1,700, call it, the stores that you're opening up now versus the stores you were opening pre-pandemic, any sort of comparison that you can make between those for the newer larger format, the core Ulta stores as far as performance ramp, profitability?

Yes, what I would say is we're really pleased with the performance of our fleet. I mean our store productivity is one of the most productive parts of our business, and it is more productive now than it was pre-pandemic.

And small format, where are those? Are those tertiary markets? Is that Des Moines? Or is that something there was an infill opportunity? Or maybe there's a more unique neighborhood aspect to it? What do those look like?

Yes. Those were -- it's not Des Moines because Des Moines, that's a great market for us. But it does have -- we're talking about smaller communities with fewer households than a city like De Moines. Del Rio, Texas. I don't know if you vacation there, spend much time. But it's a really cool town in Texas. And Texas, of course, is growth, but it's a small -- and it's -- I think it's at least 30 miles or maybe even 50 miles from the closest Ulta. It's an isolated smaller number of households than we've traditionally gone into, and it's performing very well. The cool thing about this category and the power of social media is you can live anywhere and be as connected, as intuned, as excited about everything that's going on in beauty and you want access to it. And in these markets, there is no -- there really is not any other place, particularly on the prestige side to get it. So we're excited about those opportunities. We've opened many of them across the country, and we'll continue to penetrate those markets.

Is there a population range that you've given just sort of how to think about that opportunity if you...

I don't think we talked specifically about a number...

[ Can you tell me about Texas? ]

Yes, if you want to check it out, that's a good market in there. Yes, we're doing that really across. We've got to spread out across the country.

And we don't talk about Target a lot. I mean can you kind of remind us the strategy there, how that partnership is evolving, who that customer is and sort of the success you've seen in transforming them maybe into a core customer or maybe you don't need to transfer them into a core customer.

Well, that is the focus to get them connected to the total Ulta Beauty ecosystem. I mentioned earlier about this strategy that we have of surrounding our guests with touch points. And again, the more they get engaged and try new experiences from us the more they love us and the more share of wallet we get and Target is a big part of that. So the strategy behind Target is to give an incremental experience to our guests and to provide another touch point or opportunity to reach new guests, 30 million people walk through a Target every week. Many of them are Ulta guests, a lot are not. And so they might discover Ulta and start shopping with Ulta for the first time there then we want to get them connected to the total experience. What's different about Target is it's not -- if you had an opportunity to see it, you'll notice pretty quickly, it is not in a full Ulta experience. A full Ulta experience comes to life in a physical way and 10,000 square feet, about 600 brands, 25,000 SKUs, several people working salon experience. Target was very purposefully designed in that environment. It's about 1,000 square feet, 60 prestige only brands that we bring to life. So it is a taste of Ulta that complements what Target does in other parts of beauty and it is designed to, again, reach new guests, delight our existing guests, grow our loyalty program and provide another touch point that [Technical Difficulty ]. We've been out for a few years now. Paula mentioned, we're opening together with Target, about 100 new locations this year, and we're excited about the long-term potential of it.

So the fact that you're opening up 100, I mean, the read then would be that you are seeing success in that transformation and taking a target the brand carries when they sort of discover you in that channel?

Yes, it's -- and it's great for Target because it's an incremental experience. It's great for our brands. And if you go in there, you'll see brands like Clinique and Mac, and Venti and many others because it gives them in a specialized way an opportunity to grow their business, reach new guests. We curate say, Clinique to have the best of Clinique. But then we also, by getting loyalty, that's a key part of this loyalty programs, if you buy that there, you get benefits both through Target circle and Ulta Beauty Rewards. And then by getting into our loyalty program, we know if you shop there, you bought Clinique, maybe for the first time, we can communicate, you want the full Clinique experience. You can get it at the closest Ulta Beauty and get it online. And so it's a cycle that we think is working and our guests, but one of the coolest things of it, the moment we announced it, guests just even before they even saw it, love the idea. Ulta, Target together, it's like I can get my Starbucks, I can get Target and I can shop for Ulta all in one place, like everything comes together, and it's pretty cool.

Yes. The concentric circle of that customer.

Yes.

And international, I mean, you had thought about -- sorry, Canada at one point, now we're in Mexico, you're in Mexico. How can the international landscape evolve in Europe? What are the other sort of parts of the map that might make sense here and who's there, I guess, who are you kind of up against in Mexico? Who are you going to come up against in Canada? Is it easy to get, I guess, my question.

Well, yes, I mean nothing comes easy. I guess, you got to work hard for everything in this category in this world, I guess. Yes, Canada, we're moving, I guess, I'd call that maybe a COVID casualty. We were well down the path and then COVID hit and we made the strategic choice, which was the right choice to make to [ staff ] that effort just opening up stores in that environment was -- so Canada is a potential long term, but nothing immediate in our plans. We are very excited about Mexico. And the reason we chose Mexico is it's a very strong growth -- a beauty growth category. The economy is performing well, largely driven by -- there's a lot of, I guess, near shoring, many [ maturing ] being built. The economy is doing well. Mexican's over-index. Latin ex-consumers, Hispanic consumers in general way over-index in beauty. So it's a very healthy, strong beauty market. And we start in Mexico with good brand awareness. I mean we don't have any stores there. But because of the traffic back and forth from Mexico into the U.S., our border stores along Mexico or some of our strongest stores. So we enter into that market with good awareness of Ulta Beauty to begin with. Many Mexicans have already shopped there when they visit the U.S. are certainly heard about us. So good brand awareness, strong category, and we saw a clear opportunity to bring our unique All Things Beauty, mass to prestige, to luxury, makeup, skincare, haircare, our unique model does not exist in Mexico. We've got great competitors there that from department stores to other beauty specialty to mass and drug. So there's an environment there, but we're confident and we're excited to roll out our -- open up our first stores next year. Beyond that, nothing specific that we've announced other than to say we do see long-term potential. It's not everywhere. We're not going to go just open up stores because every market is a little different, the competitive environment, the cost of doing business, the dynamics. So we've been very thoughtful, but Mexico is our first step, and we're very excited to do it.

And then maybe people are going to be mad that we're not going to give this topic as much time, but there's a breakout margin. The guide for the year assumes a little bit of deleverage on sort of a decelerating top line, some anxiety about how margins trend over the next couple of years. I guess, how do you think about the guide on margins, particularly back half weighted aspect to it? And sort of the line of sight there. But also you've got the ERP and projects sort of kind of rolling out now. Minutes left. How does that support sort of the efficiency of the model leverage point and give you more confidence in being able to sort of guide like that?

Yes. So particularly, what I would say on gross margin because I think that is the question that was on a lot of people's mind. We guided gross margin to be flat to modestly down. And really, that is driven by lower merchandise margin, which lower merchandise margins, some fixed cost leverage, deleverage and then that is being offset by growth in other revenue and lower transportation costs from our supply chain efforts. As you mentioned, we -- in the second half, we're expecting a bit of an inflection point from first half with regards to gross margin. That's primarily due to better merchandise margin. We see that in the second half will largely be past the price increase benefit that we had in 2023 and the first half once we get into the second half. So that will help improve merchandise margin. We also will see the ramp of the transportation -- lower transportation costs, which will serve to offset the higher promos -- the promos and the pressure that we are seeing from a fixed cost -- a store fixed cost leverage perspective. When I think about -- if you think about from an SG&A perspective, you are right, we are expecting growth in SG&A to moderate in the second half from low double-digit growth in the first half to low to mid-single-digit growth in the second half. And a large part of that is due to the fact that we are nearing completion of some of our big transformational efforts with digital store of the future. Our digital transformation will be largely done in the first half as well as our store ERP transformation will be near completion as well. And so that gives us a bit more comfort in kind of the margin profile for the second half because we're largely past some of those big drivers.

Two questions emerge on that. For one, on the promotion side of it and sort of the gross margin with this sort of increase in 1,000 points of distribution, are you seeing irrational behavior from a promotional standpoint to sort of capture...

We came into 2024, knowing that the promotional environment would be more higher than 2023, but still rational. And so we afforded for increased promotion in our guide. I mean as we think about it, we think that there is a role that promotions play in this category. As we've talked about, strengthening our top line, we will use promotions as one of many levers in order to strengthen our top line. But we don't see the -- us or the environment getting back to 2019 levels per se, but we do expect higher promotions in the category.

But not irrationalize relates to sort of specifically that...

No.

Okay. The incremental competition. And then on the ERP replatforming some of these systems, is that a benefit to margin simply that you're not spending to stand them up? Or is it more that you're sort of gaining efficiencies from?

I think it's a -- it will be a bit of both in the near term. It is that we will no longer be spending on those. And then over time, we'll see the benefits of those investments come into the P&L.

Got it. And then we've got final minute here. You guys are holding an Analyst Day in October and that's always an interesting part in the company's history. You guys don't hold them a lot. But just -- I'm not obviously going to ask you to sort of highlight anything or steal the headline, but just the context that you find the company and sort of preparing for that. Maybe you just sort of set that up for people. I know it's far away, but...

Right. Well, yes, here's the -- yes, as we look at the context, it's certainly communicating, clarifying what's updated dynamics in the category, consumer, starting with the consumer, where we see consumer going. One of the greatest things about this category is the level of engagement that consumers have with beauty. I touched on it earlier. And what's cool about it, we didn't get into it, but it's just every generation of consumers from millennials, older millennials, younger millennials, Gen Z, now Gen A each has been progressively more engaged in the category, which is great for the future of the category. So we'll lay out what we see in the category, how we think about the consumer opportunity, obviously, talk about the competitive environment. But we spend most of our time laying out what we see over the next 3 years is the opportunity for us to continue to lead the category. We started 2 founders here in Chicago, 34 years ago, set out with a vision to disrupt the beauty category to change how consumers engage in this category to give them an environment where they can engage with beauty on their own terms, discovered all the wonderful aspects, bringing what we say, bringing their own possibilities to life. We'll share what we're thinking about what comes ahead as we continue to evolve, disrupt and grow our business for the long term.

Excellent. Thank you.

Great. Thank you.

Thank you.

Thank you, everyone. There's a breakout in Adler on the second floor.