Ulta Beauty (NASDAQ:ULTA) just wrapped up a fiscal year that included strong sales growth and another big step toward management's long-term goal of building a 1,700-store base. The retailer's fourth-quarter report contained signs of profitability struggles, though, thanks to price-based competition in the makeup industry.

CEO Mary Dillon held a conference call with Wall Street analysts to put those market share challenges in perspective and explain why management isn't worried about another profit margin drop in 2018. Below are a few highlights from that presentation (all quotes are Dillon's).

A woman purchasing hair products from a woman cashier

Image source: Getty Images.

Sales performance

[Comparable-store] sales grew 8.8%, on top of 16.6% comps in the fourth quarter of 2016, driven by positive traffic and ticket growth, a strong January, and continued great momentum in e-commerce.

Sales growth fell within the range that management had predicted back in early December. However, the 9% comps improvement marked the third straight quarter of decelerating revenue gains.

Executives said the slowdown came from weakening trends in the core makeup segment, which made the holiday quarter "a bit more challenging than expected."


Ulta.com grew 50.4% on a comp basis in the fourth quarter, maintaining a strong momentum and representing 12.8% of total company sales. E-commerce contributed 460 basis points of our total company comp, driven by transaction growth.

Ulta Beauty's digital sales are growing faster than expected and have quickly become a major part of the business. Up 50% over the holiday quarter, the channel was responsible for more than half of the retailer's overall 8.8% comps figure.

As a result, digital sales reached 13% of the broader business and charged past the 10% target executives had planned -- a full two years ahead of schedule. The success had a mixed impact on the business by speeding sales growth up at the expense of profitability.

Profits going forward

It's clear that for the long-term health of the business, it no longer makes sense to drive toward the 15% operating margin target on the timetable we set several years ago ... managing the business to attain that target would require underinvestment in areas that we believe will drive robust, sustainable, long-term growth.

A woman applying facial cream.

Image source: Getty Images.

Ulta Beauty is scratching plans to steadily push operating profit margin up to 15% of sales after the metric dipped slightly to 13.3% in 2017.

A few big factors are combining to lower that medium-term profitability potential, including the faster shift toward online sales, higher labor costs, and pricing pressures as rivals compete for business in a slowing industry.

As a result, executives are projecting operating margin will dip by less than a percentage point again in 2018, down to just below 13% of sales. They still believe that metric will expand over the long term, but challenging industry dynamics mean that rebound won't start until at least 2019. 

Reinvesting the tax benefits

We're planning to invest a portion of the roughly $100 million tax rate benefit expected in 2018 in a variety of projects designed to further enhance our differentiated positioning and elevate our overall guest experience.

Dillon and her team said the recent tax law reform "changes the game" by unlocking funds that management can direct toward investing in growth. Their spending plans prioritize increased labor investments, in addition to data capabilities that should allow for more personalized offers targeted to its loyalty members.

Ulta plans to make upgrades to its e-commerce business and optimize its supply chain, too. The company is optimistic that the investments will keep Ulta's multiyear streak of market share gains going even as industry pressures delay plans for increased profitability.

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