Ulta Beauty (NASDAQ:ULTA) investors have been concerned with the company's slowing sales gains lately, which are combining with rising e-commerce spending to hurt the retailer's profitability.

Coming into this week's earnings report, shareholders had grown cautiously optimistic that the beauty products specialist might soon return to its past head-turning growth trends. Its announcement instead suggests that Ulta Beauty will continue posting moderate, but still significant, sales gains even as profit margins slip.

Here's a look at how the headline results compare with the prior-year period:

 Metric

Q1 2018

Q1 2017

Year-Over-Year Change

Revenue

$1.54 billion

$1.31 billion

17%

Net income

$164 million

$128 million

28%

EPS

$2.70

$2.05

32%

Data source: Ulta Beauty's financial filings. EPS = earnings per share.

What happened this quarter?

Sales growth edged past management's targets, and profitability worsened as the company's sales mix shifted aggressively toward the digital sales channel.

A woman applies makeup.

Image source: Getty Images.

Here are the key highlights of the quarter.

  • Comparable-store sales, or sales at existing locations, slowed for the fourth straight quarter, with comps improving by 8% compared to 9% last quarter. CEO Mary Dillon and her team had forecast slightly slower growth of between 6% and 7%. The increase included a healthy 5% boost in customer traffic and 3% higher average spending.
  • The e-commerce business shot up by 48% and was responsible for 3.4 percentage points, or about 40%, of Ulta Beauty's comps growth.
  • Gross profit margin held steady at 36% of sales after falling for several quarters. Inventory levels were healthy, dipping slightly on a per-store basis.
  • Selling expenses ticked up by nearly a full percentage point to 22.4% of sales as the retailer spent more on labor and on building out its digital sales channel. That, plus slightly higher store-opening expenses, combined to push operating profit margin down to 13.6% of sales from 14.3% a year ago.
  • The company added 34 new stores to its footprint to reach 1,107 locations around the country.
  • Ulta Beauty's tax rate plummeted due to the recent tax law changes. As a result, net income jumped and bottom-line profitability improved to 10.6% of sales from 9.8%.

What management had to say

Dillon said the results "represent a solid start to 2018, with better than expected sales and earnings growth." The performance "reflects our highly differentiated business model," management explained, "that continues to drive healthy retail comparable store sales, excellent new store productivity, and continued strength of our e-commerce business."

Looking forward

Despite the sales growth outperformance, executives left their full-year forecast in place. It calls for gains between 6% and 8%, compared to an 11% spike last year and a 16% gain in 2016. Operating profitability is still expected to fall for the second straight year as the company invests more heavily in its e-commerce infrastructure. That sales channel is set to pass 15% of the business this year and could soon account for over half of Ulta Beauty's overall comps revenue growth.

The strong customer traffic trends, meanwhile, have management feeling confident that they can continue expanding the retailer's square footage at a double-digit rate. Ulta Beauty aims to add 100 stores to its base this year, which should allow overall sales to rise between 12% and 15%. Over the long term, the company targets as many as 1,700 locations across the U.S., compared to 1,100 in operation today.

Meanwhile, tax-law changes and share-repurchase spending are helping to create a slightly better earnings increase than expected this year. Ulta Beauty now sees profits rising in the low-20% range in 2018, up from the prior 20% target increase.

Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends Ulta Beauty. The Motley Fool has a disclosure policy.