Ulta Beauty, Inc. (NASDAQ:ULTA) Q3 2022 Earnings Call Transcript

Ulta Beauty, Inc. (NASDAQ:ULTA) Q3 2022 Earnings Call Transcript December 1, 2022

Ulta Beauty, Inc. beats earnings expectations. Reported EPS is $5.34, expectations were $4.15.

Operator: Good afternoon, and welcome to Ulta Beauty’s Conference Call to discuss Results for the Third Quarter of Fiscal ’22. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. We ask that you please limit yourself to one question and then reenter the queue for any additional questions. As a reminder, this conference is being recorded. And it is now my pleasure to introduce Ms. Kiley Rawlins, Vice President of Investor Relations. Thank you, Ms. Rawlins, please proceed.

Kiley Rawlins: Thank you, John. Good afternoon, everyone, and thank you for joining us today for our discussion of Ulta Beauty’s results for the third quarter of fiscal 2022. Hosting our call are Dave Kimbell, Chief Executive Officer; and Scott Settersten, Chief Financial Officer. Kecia Steelman, Chief Operating Officer, will join us for the Q&A session. This afternoon, we announced our financial results for the third quarter. A copy of the press release is available in the Investor Relations section of our website. Before we begin, I’d like to remind you of the Company’s safe harbor language. The statements contained in this conference call, which are not historical facts, may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the Company’s filings with the SEC. We caution you not to place undue reliance on these forward-looking statements, which speak only as of today, December 1, 2022. We have no obligation to update or revise our forward-looking statements, except as required by law, and you should not expect us to do so. We’ll begin this afternoon with prepared remarks from Dave and Scott. Following our prepared comments, we’ll open the call for questions. To allow us to accommodate as many questions as possible during the hour scheduled for this call, we respectfully ask that you limit your time to one question and one follow-up question.

If you have additional questions, we ask that you requeue. And as always, the IR team will be available for any follow-up questions after the call. Now I’ll turn the call over to Dave. Dave?

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Dave Kimbell: Thank you, Kiley, and good afternoon, everyone. We appreciate your interest in Ulta Beauty. The Ulta Beauty team delivered outstanding performance this quarter, with strong revenue growth driving operating margin expansion and double-digit earnings growth. We accomplished these results because the Ulta Beauty teams continue to execute at a high level, and I want to thank all of our associates for their commitment to delivering great guest experiences, ensuring operational excellence, strengthening our culture and working together as one team to move our business forward as the leader in beauty. For the third quarter, net sales increased 17.2% to $2.3 billion, and comp sales increased 14.6%. Operating margin increased to 15.5% of sales and diluted EPS increased 35.5% to $5.34 per share.

Reflecting these results and our updated fourth quarter expectations, we have increased our outlook for the full year. Scott will share more details about our expectations later in the call. Our third quarter results are a testament to the resilience of the beauty category and our team’s ability to drive strong guest engagement that fueled broad-based growth across our business. All major categories exceeded our expectations, and we increased our market share in Prestige beauty versus the fiscal third quarter last year based on dollar sales according to point-of-sale data from the NPD Group. We delivered growth across our store and digital channels and achieved record loyalty membership of 39 million members. Additionally, we continue to see growth in per member across all income demographics.

Our strategic framework, anchored by the power of our differentiated model, continues to drive our ambitions and successes as we work to expand our market leadership and drive profitable growth. This afternoon, I will share an update on our progress against several of our strategic pillars. Starting with our efforts to drive disruptive growth through an expanded definition of All Things Beauty, our strategy to engage and delight beauty enthusiasts with a thoughtfully curated assortment focused on inclusivity and leading trends is delivering results. Our double-digit comp this quarter was a result of growth from our core assortment, price increases executed this year and compelling newness. Although pricing contributed more to our comp than last quarter, the majority of our third quarter comp was fueled by growth from our core assortment and newness.

Historically, sales of new products have averaged 20% to 30% of our sales, and the overall mix of newness this year has been in line with our historical experience. Turning to performance by category. Skin care, fragrance and bath, hair care and makeup all delivered double-digit comp growth against the third quarter last year. From a segment perspective, we saw double-digit sales growth across both Prestige and Mass, with Mass generally outperforming Prestige. While it’s hard to know with certainty if we are starting to see consumers trade down, as the only beauty retailer that offers a wide variety of price points from entry level Mass to high-end luxury and everything in between, Ulta Beauty is uniquely positioned to capture any consumer shifts within price points in the beauty category.

Turning to the performance of our core categories, starting with our fastest-growing category, skincare. Beauty enthusiasts are maintaining their skincare routines with a focus on science-backed and dermatologist-recommended products. Guests are engaging with newer brands, like Drunk Elephant, Supergoop and Good Molecules, while new products from established brands like the Ordinary Hero Cosmetics and the Roche Posay also contributed to sales growth. To drive discovery and support guest education, this quarter, we introduced our Skincare We Love All in all stores. This curated presentation highlights exciting brands and best-selling items across key categories. The fragrance and bath category delivered another impressive quarter as Gen Z guests engaged with the category, leveraging multiple fragrances to express themselves.

Recently launched Ulta Beauty exclusive Billie Eilish, as well as Nescens from Burberry, Gucci and Viktor&Rolf drove meaningful sales growth. While our monthly fragrance crush program drove engagement with established brands including Versace and Jimmy Choo. In addition, the category benefited from strong guest engagement with our holiday fragrance gift sets, which were available earlier this year. Haircare, our second largest category, delivered solid growth, primarily driven by newness and innovation. Key category trends include hair health, damage repair and targeted treatments. Prestige brands, including Whey and Briogeo, saw strength in treatments and core assortments, while Masstige brands, including Eva Nyc, Batiste and Kristin Ess, and professional brands such as Pureology, Redken and Kenra, continued to resonate with guests.

Within the category, strong hair product growth was offset by softer performance in hair tools as we lapped strong performance last year. Finally, our largest category, makeup, delivered double-digit comp growth, driven by newness and the strength of our key events, including 21 Days of Beauty and Fall Haul. Growth in foundation, concealers, blush and lip continue to lead the category. New brands like Fenty, R.E.M. Beauty and N°1 DE CHANEL drove sales during the quarter, while new products from a wide range of brands, including Clinique, e.l.f. and NYX also contributed to growth. In addition, the expansion of MAC, Chanel Beauté and Bobbi Brown into more stores has continued to drive Prestige sales. Now let me give you an update on our key cross-category platforms, Conscious Beauty, Black-owned and BIPOC brands and wellness.

With 290 certified brands, Conscious Beauty continues to resonate strongly with beauty enthusiasts, reflecting growing interest in products that are good for the world. This quarter, we certified 15 new brands, including NYX cosmetics, Morphe and Dime Beauty, and introduced the Conscious Beauty essentials kit, featuring minis for more than 15 brands, such as Dermalogica, Koula and our own Ulta Beauty Collection. During the quarter, we expanded our BIPOC brand assortment with four new BIPOC brands: Pebble, Bread Beauty Supply, Sugar Dough and Undefined Beauty. As another way we look to create foundational industry change, we proudly launched our MES Accelerator program to support early-stage BIPOC brands as they prepare for retail readiness.

Our inaugural class included eight BIPOC founders, with innovative brands across skin care, makeup, fragrance, haircare and wellness. In addition to financial support, each MUSE Accelerator participant took part in an intensive 10-week training program, learning from Ulta Beauty leaders, industry subject matter experts and leading BIPOC brand owners. We are honored and excited to be a part of their journey as they build their business and expand their reach. Finally, we continue to increase our presence in wellness. During the quarter, we further enhanced our assortment to reflect our guest evolving needs. And in September, we expanded our offering to include intimate wellness as the sixth online-only pillar of the wellness shop. While wellness represents a small part of our overall business today, we believe it is a significant longer-term growth opportunity given the incrementality of the purchase and the strong emotional connection consumers have with self-care.

Turning now to our efforts to evolve the omnichannel experience through a connected physical and digital ecosystem, all in your world. Store traffic trends accelerated this quarter and exceeded pre-pandemic levels for the first time, representing an important milestone in our COVID recovery. In addition to strong sales growth from stores, we continue to deliver growth in e-commerce, further reinforcing the incrementality of this important channel. The convenience of BOPIS for e-commerce orders continues to resonate with guests. During the quarter, BOPIS increased 18% to 23% of e-commerce sales, compared to 20% last year. Our services business accelerated and delivered another quarter of double-digit comp growth, primarily due to higher stylist retention, increased stylist productivity and increased capacity in our salons as we lap capacity constraints due to the pandemic.

Our targeted CRM efforts to drive awareness, trial and frequency are working, delivering increases in salon appointments from both existing and new members. Additionally, our in-store back bar events continued to drive product attachment and new guest acquisition for participating brands. As industry leaders, we’re always working to enhance guest experiences across all of our platforms. During the quarter, we introduced a new layout in about a dozen stores to showcase our categories better, improve navigation, enhance the services experience and create more opportunities for discovery. The most noticeable changes include the repositioning of skincare, an important growth category to the front of the store. All products grew by category with delineated fixtures and visuals and a flow from Prestige to Masstige to Mass.

Elevated Gondolas that showcased key iconic and service brands, new beauty bars that offer our brow and makeup services, as well as supporting in-store events, dedicated space in the front of the store to feature brand and product launches across categories, and a relocated checkout closer to the salon. We are excited to introduce this new store layout to guest. And as we’ve done in the past, we intend to introduce this new experience in new stores, remodels and relocations. At this time, we have no plans to retrofit existing stores. Stores are a critical part of our ecosystem. And while most Ulta Beauty’s transactions occur in stores, we know the guest journey often begins online. To assist guests along their journey, we offer a suite of virtual digital tools, including Glam Lab, Skin Advisor and our hairstyle tool, among others.

The latest addition is a fragrance finder designed to help guests explore fragrances by favorite brand or ingredient, launched just in time for the holiday season. Finally, we continue to be excited about the long-term opportunity with our strategic Target partnership. This touch point enables us to connect and reconnect with members. And while the partnership isn’t material yet to our overall member growth, it has contributed positively. Importantly, we are seeing members bounce back to Ulta Beauty after becoming an active member, while at the Ulta Beauty at target shop. Now, let me give you an update on some of the steps we’re taking to drive love, loyalty, and emotional connection with Ulta Beauty. Recognizing the beauty is personal. We are on a multiyear journey to create stronger, more emotional connections with our guests and bring our brand purpose to life.

Launched in September, our latest brand building campaign Beauty& is rooted in insights from cultural leaders and beauty enthusiasts. The creative content on owned and paid channels has driven broad improvement in top-of-mind awareness and is resonating with our guests, particularly Black and Latinx beauty enthusiasts. Turning to our loyalty program. Our efforts to nurture loyalty in personalized ways is driving member growth and delivering incremental value. We ended the quarter with 39 million active members, 9% higher than the third quarter last year. Overall spend per member increased driven by increased frequency and higher average ticket. While price increases are having an impact, we are encouraged to see unit growth per member. Our loyalty program is a strategic asset and an important driver of our long-term growth.

We prioritize member engagement, loyalty and retention across every Ulta Beauty touch point. The growth and strength of our loyalty program starts with ensuring that our existing guests stay engaged. Nurturing our existing members through our Member Love events and life cycle marketing strategies has enabled us to maintain healthy retention rates, which have contributed to member growth and higher spend per member. Member reactivation remains a priority, and we are leveraging CRM tools to personalize offers and reengage members in more targeted ways. And, of course, conversion of new members also contributes to overall member growth, and we continue to acquire new members in our stores, digital platforms and through our partnership with Target.

Shifting now to our plans and expectations for holiday. The holiday season is in full flow, and our teams are executing well. While predicting holiday shopping patterns this year is challenging, I am optimistic about the opportunity for Ulta Beauty this holiday season. Our engaging holiday messaging, one-of-a-kind assortment, with exceptional seasonal options and diverse touch points, all paired with our team’s unrelenting passion for delivering great guest experiences, position us well to deliver another successful holiday season. Grounded in robust consumer insights, our holiday marketing strategy positions Ulta Beauty as the place for gifting, glamming and self-care this season. Our intent is to empower guests to celebrate the season however they want.

And our integrated media plan for the holiday aims to build broad awareness of Ulta Beauty as a holiday destination, spark connection with key audiences, leverage our beauty expertise and drive consideration and purchase. Our merchandising team has built an outstanding holiday gifting assortment, whether guests want to get others or treat themselves, we have thoughtfully curated options across every category and budget, with a balanced approach to the mix of seasonal holiday items and core items that make great guests. We entered the holiday season with well-staffed stores in DCs, and our teams are excited, engaged and ready. For the first time since 2019, our store teams gathered in person to review our holiday strategies. And I know their excitement and enthusiasm for our plans will be felt in every guest interaction.

And our corporate and DC teams have worked cross-functionally to ensure Ulta Beauty is positioned to deliver for our store teams and our guests. In closing, I am incredibly proud of our year-to-date results, and I’m excited about our holiday plans. Even as consumers continue to navigate economic headwinds, we believe the beauty category will remain resilient, and we are confident that our differentiated model and growth strategy, combined with our outstanding associates, will continue to position Ulta Beauty as the preferred beauty destination. And now, I will turn the call over to Scott for a discussion of the financial results. Scott?

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Scott Settersten: Thanks, Dave, and good afternoon, everyone. Today, we reported results that were better than our initial expectations. Strong double-digit revenue growth resulted in record-setting third quarter operating margin performance. These excellent results reflect the continued focus and hard work of our store, DC and corporate teams. And I want to thank all of our Ulta Beauty associates for working together to deliver another outstanding quarter for our shareholders. Now to the financial results, starting with the income statement. Net sales for the quarter increased 17.2%, driven by comp sales growth of 14.6% and strong new store performance. In addition, other revenue increased $20 million, primarily due to credit card income growth, higher loyalty point redemptions and an increase in royalty income from our partnership with Target.

Breaking down the comp performance further, comp transactions for the quarter increased 10.7%, primarily driven by strong growth from in-store transactions. Average ticket increased 3.5% due to an increase in average selling price, partially offset by slightly lower average units per transaction. The increase in average selling price primarily reflects the impact of retail price increases executed this year. We estimate that price increases contributed about 500 basis points to the overall comp increase. While average units per transaction was slightly lower than last year, the total number of units sold increased about 10% on a comp basis. During the quarter, we opened 18 new stores, relocated one store and remodeled eight stores. For the quarter, gross margin increased 160 basis points to 41.2% of sales compared to 39.6% last year.

The increase was primarily due to the leverage of store fixed costs, other revenue growth and higher merchandise margin, partially offset by higher inventory shrink. Robust top line growth and benefits from our ongoing occupancy cost optimization efforts resulted in healthy leverage of store fixed costs. The improvement in merchandise margin was primarily due to benefits resulting from the timing of retail price changes, partially offset by brand mix. As we have discussed, we have executed a number of price increases from our brand partners this year. Generally, when the new price is effective at the shelf, we are still selling the inventory purchased at the lower cost. As a result, there’s a short-term benefit to cost of goods as we move through the lower cost inventory.

As expected, our promotional activity increased from the second quarter, but the impact to margin was not meaningful compared to last year. SG&A increased 18.6% to $597.2 million. As a percentage of sales, SG&A increased 30 basis points to 25.5% compared to 25.2% last year, primarily due to increases in store payroll and benefits and corporate overhead, partially offset by lower marketing expenses. Store payroll and benefits deleverage this quarter primarily due to increased labor hours to maintain service standards, higher average wage rates to support recruitment and retention and a timing shift of incentive compensation accruals. Corporate overhead expense deleveraged in the quarter, primarily reflecting investments related to our strategic priorities including Project SOAR and other IT capabilities, UB Media and Ulta Beauty at Target.

These headwinds were partially offset by lower marketing expense. As we have discussed on previous calls, this year, we are offsetting the incremental marketing expense of digital campaigns we manage for our brand partners, with vendor income that is a direct reimbursement for these specific costs within total marketing expense. Similar to what we saw in the first half, this resulted in about 70 basis points of favorable impact to SG&A in the quarter. Operating income for the quarter increased 27.3% to $361.9 million. As a percentage of sales, operating margin increased 130 basis points to 15.5% of sales compared to 14.2% last year. Diluted GAAP earnings per share increased 35.5% to $5.34 per share compared to $3.94 per share last year. Moving to the balance sheet and cash flow.

Total inventory increased 10.3%. In addition to the impact of 41 additional stores, the increase reflects purchases to support key brand launches and increases in inventory costs, as well as ongoing efforts to maintain strong in-stock to support expected demand. Capital expenditures in the quarter were $83.5 million compared to $51.1 million last year. The increase was primarily related to investments in new remodeled and relocated stores, IT projects and merchandising improvements. Depreciation was $58.5 million compared to $65.2 million last year, primarily due to a shift of IT investments from capital to cloud expense. We ended the quarter with $250.6 million in cash and cash equivalents. During the quarter, we repurchased 340,000 shares at a cost of $137.5 million.

At the end of the third quarter, we had $1.4 billion remaining under our current $2 billion repurchase authorization. Turning now to our outlook. We have raised our financial guidance for fiscal 2022 to reflect our strong third quarter performance and increased expectations for the fourth quarter. We now expect net sales for the year will be between $9.95 billion and $10 billion, with comp sales growth between 12.6% and 13.2%. This guidance reflects our expectation that fourth quarter comp growth will be between 6% and 8%, up from our previous expectation for low single-digit increase. Sales growth moderated in November as we lapped last year’s strong performance, but we are pleased with the sales trends we saw through the Thanksgiving holiday shopping weekend, including Cyber Monday.

We still have several important weeks left in the holiday season, and the operating environment continues to be dynamic. Our Q4 comp outlook, reflects both the expected resilience of the beauty category as well as potential risks from shifts in consumer spending, increased points of distribution for Prestige beauty and higher promotional activity. For the year, we plan to open approximately 47 net new stores and remodel or relocate 33 stores. Our new store performance continues to be strong. But like many other major retailers, we are seeing project delays resulting from external real estate and construction issues, as well as supply chain disruption for key equipment. These external factors have impacted our fiscal 2022 plans and will likely shift new stores originally planned for fiscal 2023 into 2024.

We continue to expect to open about 100 stores over the next two years, but the timing of opening between fiscal 2023 and 2024 may shift as we navigate these external challenges. The operating environment is fluid, and we will provide specific targets for fiscal 2023 when we report in March. We now expect operating margins for the year will be between 15.5% and 15.6% of sales. We expect gross margin for the year will increase with leverage of fixed costs and growth in other revenue partially offset by lower merchandise margin, higher shrink and higher supply chain costs. We continue to expect SG&A expense for the year will increase between 15% and 16% and or approximately flat as a percentage of sales, driven primarily by $60 million to $65 million of expenses related to our strategic priorities, as well as higher wage rate growth across the enterprise, partially offset by lower marketing expense.

Reflecting these assumptions, we now expect diluted earnings per share for the year will be between $22.60 and $22.90. One final update. We now expect to spend between $300 million and $350 million in CapEx in fiscal 2022, including approximately $160 million for supply chain and IT, $140 million for new stores, remodels and merchandise fixtures, and about $30 million for store maintenance and other. We expect depreciation for the year will be around $250 million. While we are not providing guidance for next year on this call, we want to share some high-level thoughts for your consideration as you model fiscal 2023. The beauty category has been stronger this year than expected. Barring a major economic event, we would expect category growth to continue in 2023, albeit at lower rates, reflecting strong consumer engagement with the category, and we remain confident we can deliver comp sales growth in fiscal 2023 within our longer-term targeted range of 3% to 5%.

In this sales scenario, we would expect operating margin deleverage versus our fiscal 2022 guidance. In addition to inflationary pressures on wage rates and other operational expenses, we expect to increase investment spending related to our strategic priorities, reflecting timing shifts from fiscal 2022 and the planned ramp-up of key IT and supply chain investments. Finally, fiscal 2023 will be a 53-week year for Ulta Beauty. We are still finalizing our budget for fiscal 2023 and plan to provide specific financial guidance, and update our longer-term growth targets, if appropriate, on our March earnings call. And now, I’ll turn the call back over to our operator to moderate the Q&A session.

Operator: Thank you. We will now be conducting a question-and-answer session. And our first question comes from the line of Steven Forbes with Guggenheim Securities. Please proceed with your question.

Steven Forbes: Dave, Scott, I wanted to focus and start with member engagement. But Dave, curious if you can expand on how member engagement trends within the recent member cohorts differ or I guess, are similar from the more mature cohorts in terms of retention, repeat behavior, the maturation of wallet share, channel preferences, really just any color that helps maybe underpin your conviction for a positive comp outlook next year?

Dave Kimbell: Great. Thanks, Steve. Yes, as I said in the remarks, our loyalty program, our membership, is vital and critical to our long-term success and one that we’re extremely proud of what we’ve built the relationship that we have with our guests. Yes, I guess, a few things that I’d call out. Naturally, our longer tenured, you get your tenured three-plus years, we see kind of a higher level of retention, higher level of engagement that tends to grow over time. Greater percentage of our guests, the longer they’re here, move into our higher levels platinum and diamond levels. So naturally, with that tenure comes greater engagement. And as I mentioned, one of the drivers of our third quarter growth, 9% growth in our total membership was healthy retention and it’s been a big focus for our entire team, our loyalty team, our store teams, our digital, everybody that participates into delivering a great experience.

So that’s key and really job one is engaging and retaining our existing guests. Our newer members that we acquire in stores, online and increasingly with our partnership with Target, play an important role. Their spend per member makes sense. It’s on average lower, and we work hard to get them into the full Ulta Beauty experience. Often they enter into one category or one experience. They might come in store. We try to move them online. They might come in to makeup, we try to move them into skincare, get them into services. We have a full suite of activities and experiences designed to engage our new members through in — and including their what we call their sophomore year, their second year with us, which is important pivot year into long-term retention.

So, we look across all spectrum, what we’re excited about now and encouraged by is we’re seeing strength across all sectors, all income demographics, all geographies. We have a healthy member base. That’s what’s driving the 9% growth in our loyalty, and of course, that, in turn, played a big role in the sales performance we had in the third quarter.

Operator: Our next question comes from the line of Ike Boruchow with Wells Fargo. Please proceed with your question.

Ike Boruchow: Congrats. Great quarter. I guess, Scott, I was going to focus on the margins with you. Merch margin is better in 3Q. It sounds like you’re off to a good start on the promotional side in 4Q as well. You’re going to end the year — I mean, it’s a good problem to have. You’re going to end the year closer to 16% margins. Your long-term target is 13% to 14%. I guess, just with merch margins as elevated as they are and as healthy as they are, are you guys starting to think more longer term about the AUR dynamics in the business and maybe that this elevated level of merch margin that you’re at might be more sustainable than maybe what you had originally thought and maybe that 13% to 14% actually can move a bit higher? I mean, it more is a high-level question, not necessarily 2023, but that’s kind of where I was coming from.