e.l.f. Beauty, Inc. (NYSE:ELF) Q3 2023 Earnings Call Transcript

e.l.f. Beauty, Inc. (NYSE:ELF) Q3 2023 Earnings Call Transcript February 1, 2023

KC Katten: Thank you for joining us today to discuss e.l.f. Beauty’s third quarter fiscal ’23 results. I’m KC Katten, Vice President of Corporate Development and Investor Relations. With me today are Tarang Amin, Chairman and Chief Executive Officer; and Mandy Fields, Senior Vice President and Chief Financial Officer. We encourage you to tune into our webcast presentation for the best viewing experience, which you can access on our website at investor.elfbeauty.com. Since many of our remarks today contain forward-looking statements, please refer to our earnings release and reports filed with the SEC, where you’ll find factors that could cause actual results to differ materially from these forward-looking statements. In addition, the company’s presentation today includes information presented on a non-GAAP basis.

Our earnings release contains reconciliations of the differences between the non-GAAP presentation and the most directly comparable GAAP measure. With that, let me turn the webcast over to Tarang.

Tarang Amin: Thank you, KC, and good afternoon, everyone. Today, we will discuss the drivers of our Q3 results and our raised outlook for fiscal ’23. We delivered Q3 results well ahead of our expectations. We grew net sales by 49%, increased gross margin by 180 basis points and delivered $37 million in adjusted EBITDA, up 69%. Q3 marked our 16th consecutive quarter of net sales growth. Given our momentum, we’re raising our full year guidance. We are encouraged by the continued strength we are seeing across the color cosmetics category. In Q3, category trends grew 8% versus a year ago. e.l.f. Cosmetics continued to significantly outperform the category, growing 36% in tracked channels. We grew our market share by 150 basis points and increased our rank to the #4 brand as compared to #5 a year ago.

We continue to be the fastest-growing top five brand by a wide margin. In skin care, Q3 category trends grew 6% versus a year ago. e.l.f. SKIN also significantly outperformed the category, growing 34% in tracked channels. Before diving into our key growth drivers, I want to share a few highlights. In the last year, e.l.f. has been celebrated for the power of our company, brands and disruptive marketing engine. We are humbled by the recognition we continue to receive. In Q3, we were named Beauty Brand of the Year in the mass category by Womenswear Daily and recognized on Forbes’ annual list of America’s Best Midsized Companies. We continue to be recognized for our purpose and values as we strive to create a different kind of beauty company, one that is both purpose-led and results driven.

With the appointment of Gal Tate to our Board of Directors, we are proud to be one of only four public companies out of nearly 4,200 with a Board that’s at least two-thirds women and one-third diverse, underscoring our commitment to diversity and inclusion. The fundamental drivers of our business continue to fuel our results, our value proposition, powerhouse innovation and a disruptive marketing engine. Let me explain how each of these drivers underpinned our strength in Q3. First, we’re known for our value proposition. We make the best of beauty accessible to every eye, lip, face and skin concern. We take inspiration from our community and the best products in prestige to deliver high-quality holy grails at extraordinary prices. We often get questions whether our growth can be attributed to trade down from prestige or trade within from mass.

While we see benefits of each, we believe the more fundamental point is that our value proposition creates accessibility, driving category expansion. We have many examples where the accessibility of our holy grail innovation significantly expanded the number of consumers who participate in a particular category. I’ll start with primers. A few years ago, a prestige brand introduced a new primer format at a $52 price point that quickly became a top primer in prestige. We took inspiration from this item, added our own unique e.l.f. Twist and launched Putty Primer. Our price point of $8 invited a much wider range of consumers into the space, significantly expanding the entire Putty Primer category. In fact, looking at data over the last year, we’ve sold over nine times the units of the Prestige primer and both e.l.f. and the Prestige item have continued to grow units at a double-digit pace.

It’s not just in primers where we see the benefits of e.l.f.’s ability to make the best of beauty accessible, we also expanded the concealer category with the launch of our CamoConcealer of $7, compared to the Prestige comparison at $31. Over the last year, we’ve sold nearly double the units of the Prestige comparison with both our Camo Concealers and the Prestige product growing units at a double-digit pace. In both cases, e.l.f. expanded the category by attracting new consumers who are looking for high-quality products at a great value. By making the best of beauty accessible, we are both expanding our share of the category and making the whole category bigger. The second driver of our performance is that we are in an innovation powerhouse.

Our innovation engine has built category leadership over time. Our largest segments brushes, primers, setting sprays, brows, eye shadow, concealers and sponges collectively make up over half of e.l.f. Cosmetics sales. We continue to gain share in all seven segments while maintaining the #1 or #2 position within each. We know how to build winning franchises across categories. Our growing Putty Primer and Camo franchises are great examples of how our multiyear innovation is driving our share leadership in key segments. Our Power Grip franchise is a more recent example. We launched our recent Power Grip primer in late 2021 at an incredible value of $10, compared to the prestige item at $36. In 2022, Power group was our top selling SKU and the #2 SKU across the entire U.S. mass cosmetics market according to Nielsen.

e.l.f.’s cosmetics Power Grip is also the #1 face primer SKU across the entire U.S. prestige market according to the NPD Group, coupled with our multi-year innovation in primers. e.l.f. now holds the #1 position in the face primer category in both the mass and prestige markets. We are building upon the success with our recent launch of our Power Grip Primer with 4% niacinamide. At the same $10 price point, this hybrid product delivers on our community’s desire for makeup with skin care benefits. The sticky texture grips make up for a long-lasting wear while the 4% niacinamide helps even out in brighten skin. This item has proven to be highly incremental, further expanding our Power Group franchise. We are also innovating in areas where we currently under-index on share.

Our spring 2023 launches include a few great examples. In mascara, we launched lash and roll Mascara, a mega curling mascara with a unique double-sided and cursed silicon brush to lift and separate lashes for an eye-opening effect. In lip, we launched our O Face Satin Lipstick that delivers a bold satiny color with a creamy long-lasting finish and is infused with hydrating squalane and jojoba esters for a super comfortable next to nothing feel. Skin Care, we launched our Youth Boosting Advanced Night Retinoid Serum, a powerful retinoid that reduces the appearance of fine lines and wrinkles over time to reveal rejuvenated, smooth and radiant skin. In skin care, we also launched our Suntouchable Whoa Glow SPF 30, a lightweight face sunscreen that doubles the makeup primer and leaves skin with a glowing finish.

As compared to the approximately 7% share we have across the cosmetics category, we have a 1% share in mascara, lip and skin care. For context, mascara is a $900 million category and the largest segment within cosmetics, lip color is nearly $0.5 billion category and skin care is over a $5 billion category within mass. We have significant white space in these large segments of beauty and the innovation engine to conquest them. The third driver of our performance is our ability to attract and engage consumers with our disruptive marketing. We kicked off the holidays with a first-of-its-kind digital campaign informed by the insights from the weather channel and brought to life with Grammy award-winning Megan Trainer. Megan delivered a special Radiance report across social channels to break the news of an e.l.f.ing glow storm, celebrating the restock of our viral sensation Halo Glow Liquid Filter.

Photo by Element5 Digital on Unsplash

The trifecta of e.l.f., the Weather Channel and Megan Trainer help us reach new audience and entertain our community. The campaign generated over five billion press impressions, exceeding last year’s holiday campaign by a wide margin. Over the past three years, we’ve increased our marketing investment from 7% of net sales to 16% and continue to expect marketing near the high end of our17% to 19% range for fiscal ’23. We recently completed our annual Nielsen marketing mix analysis and again saw exceptional ROI results, giving us further confidence that our marketing and digital initiatives are driving brand demand and delivering profitable growth. We expect these three drivers of our performance, our value proposition, powerhouse innovation and disruptive marketing engine to continue to fuel our results.

Looking beyond fiscal ’23, we believe we are still in the early innings of unlocking the full potential we see for the e.l.f. brand. Taking category share as one KPI, we see a lot of runway for growth. Nationally, we’re the #4cosmetics brand with a 7% share. In Target, our longest-standing national retail partner, we’re the #2 brand with a 13% share. The significance of our position and share at Target is that we entered Target in 2008, a number of years ahead of our other national retailers. We believe that our position at other major retailers could mirror that at target over time. And even at Target, we believe we still have opportunities to continue to take share and become the #1 brand. On our Q2 call, we discussed the space expansion we’ve earned with Target for spring 2023.

As we continue to drive productivity and expand our footprint across customers, we see a significant opportunity for growth. We also see considerable white space internationally. We’ve recently expanded space at Shopper’s Drug Mart in Canada and Superdrug in the UK. and there still is more room to grow. International represented approximately 13% of our e.l.f. Beauty sales in Q3, with the business growing nearly 80% year-over-year. We’re seeing strong results behind our disciplined expansion strategy in Canada and the UK. As compared to our #4 position in the U.S., we’re the #7 brand in Canada and the #8 brand in the UK. We recently hired a new GM of International and plan to build out that team to further penetrate international markets. Before I turn the call over to Mandy, I want to discuss our brand superpowers, which set the foundation for overall competitive advantage.

With e.l.f., consumers can have premium quality beauty products at accessible price points with broad appeal that are cruelty free, vegan, clean and fair trade certified. While other beauty brands can try to replicate any one of these, we believe the unique combination of our expanding superpowers forms our competitive moat and fuels our ability to win in fiscal ’23 and beyond. I’ll now turn the call over to Mandy.

Mandy Fields: Thank you, Tarang. Our third quarter results were outstanding. Q3 net sales grew 49% year-over-year, driven by broad-based strength across national and international retailers, as well as digital commerce. Shipments exceeded consumption trends this quarter due to pipeline shipments related to our spring 2023 space gains in Walmart, Target, CVS and Shoppers Drug Mart, as well as increased shipments for the restock of our viral sensation Halo Glow Liquid Filter. Our digitally-led strategy continues to serve us well. Q3 digital consumption trends were up over 75% year-over-year. Digital channels drove 17% of our total consumption in Q3, as compared to 14% a year ago. We see opportunity to increase our digital penetration, particularly as we’re able to further enhance our Beauty Squad loyalty program.

Beauty Squad now has nearly 3.5 million members with enrollment growing over 25% year-over-year. Our loyalty members drive almost 70% of our sales on elfcosmetics.com have higher average order values, purchase more frequently, have stronger retention rates and are a rich source of first-party data. Gross margin of 67% was up approximately 180 basis points, compared to prior year. We saw gross margin benefits from the price increases implemented last March, margin accretive mix and cost savings. These gross margin benefits more than offset the impact of costs associated with space expansion and inventory adjustments realized in the quarter. On an adjusted basis, SG&A as a percentage of sales was 47%, compared to 50% last year. We drove leverage in our non-marketing SG&A expenses as a result of our better-than-expected top-line trends.

Marketing and digital investment for the quarter was approximately 17% of net sales, as compared to 15% in Q3 last year. We continue to expect marketing and digital investment for the full year to be at the high end of our 17% to 19% range with Q4 expected well above that range. Q3 adjusted EBITDA was $37 million, up 69% versus last year and adjusted EBITDA margin was approximately 25% of net sales. Adjusted net income was $27 million or $0.48 per diluted share, compared to $13 million or $0.24 per diluted share a year ago. Moving to the balance sheet and cash flow. Our balance sheet remains strong and we believe positions us well to execute our long-term growth plans. We ended the quarter with $87 million in cash on hand compared to a cash balance of $33 million a year ago.

Our ending inventory balance was $81 million, compared to $85million a year ago. Our average customer in-stock rates were over 95% in Q3 and we remain confident in our ability to meet the strong consumer demand we’re seeing. I’m also pleased with the strong free cash flow generation we’ve seen year-to-date of approximately $67 million. As we previewed last quarter, we paid down approximately $25 million of our outstanding debt in Q3 in response to the rising interest rate environment. Given our strong cash position, we ended the quarter with less than 1x leverage on a net debt basis. We expect our cash priorities for the year to remain on investing behind our growth initiatives and supporting strategic extensions. Now let’s turn to our raised outlook for fiscal ’23.

For the full year, we now expect net sales growth of approximately 38% to 39% versus prior year, up from 22% to 24% previously. We expect adjusted EBITDA between $110.5 million to $112 million, up from $93.5 million to $95 million previously. We expect adjusted net income between $75.5 million to $77 million, up from $59 million to $60.5 million previously and adjusted EPS of $1.37 to $1.40 per diluted share, up from $1.07 to $1.10 previously. We expect our fiscal ’23 adjusted tax rate to be approximately 19% as compared to 22% to 23% previously. Lastly, we continue to expect a fully diluted share count of approximately 56 million shares at year-end. Let me provide you with additional color on our planning assumptions for fiscal ’23. Starting with top line, our raised outlook reflects our strong Q3 performance and ongoing business momentum.

In Q4, our outlook implies approximately 42% to 46% net sales growth, reflecting the strong consumption trends we’re seeing. Turning to gross margin. We now expect our gross margin to be up approximately 200 basis points year-over-year, as compared to our previous expectation for up 175 basis points. This is largely a result of our outperformance in Q3. In terms of the key puts and takes for the year, we expect gross margin improvement from the price increases implemented in March of last year, margin accretive mix and cost savings to more than offset the impact of higher transportation costs and cost associated with space gains relative to prior year. Turning now to adjusted EBITDA. Our outlook implies adjusted EBITDA growth of approximately 48% to 50% versus prior year, up from approximately 25% to 27% previously and on top of the strong 22% growth in fiscal’22.

We expect our marketing and digital spend to be at the top end of our 17% to 19% range, up from 16% a year ago. Even with that increased investment, our outlook implies adjusted EBITDA margin leverage of approximately 150 basis points year-over-year as compared to approximately 50 basis points previously. The improved outlook is supported by the combination of our strong sales growth, gross margin expansion and leverage in our non-marketing SG&A expenses. Overall, we are quite pleased to be in a position to meaningfully raise both our sales and profitability outlook in what continues to be a dynamic environment. In summary, we’re pleased with our outstanding Q3 results and remain upbeat on our long-term growth potential. As Tarang discussed, we continue to see significant white space across cosmetics and skin care, both domestically and internationally to support our expected top-line growth.

The easing cost environment gives me further confidence in our ability to continue to expand our adjusted EBITDA margins. Finally, we believe our solid balance sheet, low leverage and strong cash flow generation can continue to drive shareholder returns and support our overall growth. With that, operator, you may open the call to questions.

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Q&A Session

Operator: Our first question comes from Dara Mohsenian with Morgan Stanley. Please go ahead.

Dara Mohsenian: Hey guys. Good afternoon.

Tarang Amin: Good afternoon.

Dara Mohsenian: So clearly, very strong top-line growth in the quarter, which accelerated sequentially and your implied forward fiscal Q4 revenue growth guidance is also very robust, even though you’re normally very conservative with forward guidance. So, I guess, can you just give us an update on what’s driving the confidence in the much higher revenue growth range short term? And then longer term, similar question, obviously, very strong market share results. Can you just run through what you think the key drivers are there? And how sustainable they are as you look out the next year or two, maybe particularly focusing on e-com, which was obviously very strong in the quarter? Thanks.

Mandy Fields: Sure. All right. So I’ll start with your first question on the strong top-line growth and what gives us there. As we have gotten into now giving an outlook for the last quarter of the year, certainly, want to reflect the momentum that we’re seeing. And as we talked on the call, the category has performed better, our innovation continues to resonate with our consumers and then just our ability to really engage our consumers. We talked about the activation that we did with Megan Trainer and Halo Glow and just really that combination of our innovation and marketing give us confidence as we head into Q4. And then on the longer term what gives us confidence, we talked about a number of white space opportunities ahead of us.

I’ll start with the example that Tarang gave with comparing our market share today broadly versus that €“ where we have a target and the opportunity that we have with our existing retailers to get them to that level. We also talked about international being a big white space opportunity for us. It was 13% of our sales in this quarter, but we know that there is much more potential than that on the road ahead. And then I would say, across the subcategories that we called out mascara, lips, skin care as a big opportunity as we talk about e.l.f. SKIN on the road ahead. So there is a number of things that give us confidence on the road ahead.

Tarang Amin: And I’d add to that, to your question on digital, Dara. We’re seeing real momentum in our digital business. It was up over 75% for the quarter, now 17% penetration relative to 14% last year and a lot of the investments we’ve been making in our digital business are definitely paying off. Our investment in Beauty Squad Loyalty Program now with 3.5 million members over 20% year-over-year really drives a lot of our e-commerce results as have a lot of our investments penetrating other digital channels. We have a very strong business with Amazon. We see real strength at retailer.com and so our hope is to continue to drive that digital penetration even further.

Dara Mohsenian: Great. Thanks.

Operator: Our next question comes from Olivia Tong with Raymond James. Please go ahead.