The Beauty Health Company (NASDAQ:SKIN) Q3 2023 Earnings Call Transcript

The Beauty Health Company (NASDAQ:SKIN) Q3 2023 Earnings Call Transcript November 13, 2023

Operator: Good afternoon and welcome to The Beauty Health Company Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would like now to turn the conference over to [Norberto Aja], Investor Relations. Please go ahead.

Unidentified Company Representative: Thank you, operator and good afternoon, everyone. Thank you for joining us today to discuss The Beauty Health Company’s third quarter 2023 financial results, which were released this afternoon and can be found on our website at beautyhealth.com. With me today are Beauty Health’s Board Member and incoming Interim Chief Executive Officer; Marla Beck and Chief Financial Officer, Mike Monahan. Today’s call will not include a Q&A session, though management will be available afterwards for any follow-up questions you may have. Before we begin, I would like to remind you of the company’s Safe Harbor language. Management may make forward-looking statements, including guidance and underlying assumptions.

Forward-looking statements that are based on expectations that involve risks and uncertainties that could cause actual results to differ materially. Listeners are cautioned not to place undue reliance on any forward-looking statements. For a further discussion of risks related to our business, please see our filings with the SEC. This call will present non-GAAP financial measures. A reconciliation of these non-GAAP measures to the most comparable GAAP measures can be found in our earnings press release filed with the SEC today and available on our website. With that, I would now like to turn the call over to Marla. Please go ahead. Thank you, Norberto, and thank you, everyone, for joining us on the call today. Before I start, on behalf of the Board, I would like to thank Andrew for his leadership and commitment to Beauty Health.

I look forward to partnering closely with him during this transition period. I’m excited to join Beauty Health as the Interim CEO. For those of you who do not know me, I’ve spent my entire career in the beauty and wellness space, notably as CEO of Bluemercury for 22 years. I founded Bluemercury in 1999 and built the company from zero to a strategic sale to Macy’s in 2015, after which I ran Bluemercury as a division of Macy’s for six years under both Terry Lundgren and Jeff Gennette. My focus has always been on building high-growth, profitable, enduring companies with an acute focus on the customer, high-performing teams, and operational excellence. I look forward to bringing this skill set to Beauty Health and working with the team to drive revenue, profit, and build an enduring company, while delivering long-term value to our shareholders.

I’m confident my experience will serve Beauty Health well in addressing current challenges, while delivering on the many opportunities ahead of us. Since joining the Board, it has become evident that Hydrafacial’s ability to engage and attract consumers is differentiated with the anti-aesthetics place where consumers are more likely to know about generic treatments like fillers or laser rather than a specific treatment brand name. Regularly, providers report that their decision to buy a device is in part, because their clients ask for a Hydrafacial treatment by name. This represents a significant competitive advantage for Beauty Health. My focus is to protect Hydrafacial’s incredible brand equity and to address provider experience challenges with Syndeo, Hydrafacial’s newest-generation delivery system.

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Q&A Session

While we can all acknowledge that many mistakes were made with regard to Syndeo, we always put our customers first. As a result, we are taking some tough actions this quarter to do the right thing. Once we work through these, we can again go back to empowering the team to continue to drive our revenue and capitalize on our substantial growth opportunities. I am a believer in Beauty Health’s current strategy to capitalize on the blue sky potential in front of us and welcome the opportunity to execute on our vision. With that, I will turn the call over to Mike to discuss the quarter’s performance.

Michael Monahan: Thank you, Marla, and thank you, everyone, for joining us today. I also want to thank Andrew for his service. Even though we have only worked together for a short time, I came to know him as a passionate and dedicated leader and wish him the best in the future. Today, we released a significant amount of information, so I’d like to state a few things upfront. First, our recent financial performance is not acceptable. The Board and management are committed to delivering future value for our shareholders and have taken steps to position the company for long-term future success. Second, we did not take the decision to impair our earlier generation delivery systems lightly. Our long-standing provider relationships play a critical role in our continued success.

Nearly half of the devices we sold in the past nine to 11 years are still active. Providing reliable products and services is always our primary goal and the decisions we made this quarter protect our customers and the Hydrafacial brand. Third, our recent performance is largely a result of provider experience issues with Syndeo in the U.S. We have taken the learnings to avoid any similar issues in the future. We want to be very clear that the impact applies only to providers who use Syndeo 1.0 or 2.0 delivery systems. There was no impact on the safety or efficacy of the Hydrafacial treatment. We believe our latest generation; Syndeo 3.0 provides the best experience for our providers. Fourth, we believe the fundamentals of our business and future opportunity remains strong.

The issues we face are executional in nature, not strategic. On the system side, it’s important to highlight that our products are excessively priced relative to other medical devices, lowering the barrier to entry for providers. In addition, the economics of Hydrafacial to the provider are extremely compelling, with an average system payback period, of under, six months. Our business is a razor-razorblade model with our Consumables segment representing a growing predictable, long-term and high-margin recurring revenue stream. Even with the Syndeo disruption, overall consumable sales grew 17% year-over-year. As we continue to grow our delivery system installed base and put the Syndeo issues behind us, we expect to see further acceleration in our consumables business.

We have a tremendous runway to grow domestically and overseas. Despite challenges with U.S. delivery system sales this quarter, China continued its high growth at plus 79% or plus 98% year-to-date and continues to have strong average selling prices, positioning the Asia Pacific region for continued long-term profitability. In the upcoming quarters, our goal is to execute with a simpler structure to meet the high expectations of our providers, customers and shareholders. The first step in this process will be delivering on both phases of our committed strategic transformation program. Fifth, our balance sheet and liquidity remains strong. And we are positioned to make it stronger with the strategic transformation program we are undertaking. We ended the third quarter with $559 million of cash and have access to an undrawn $50 million credit facility.

As a member of the management team, I can assure you, there is a strong commitment from the Board and the management team, to deliver the best provider and customer experience, and to create value for our shareholders. With the remaining time, I will address the Syndeo program, our third quarter results, our financial guidance and the status of our strategic transformation program. Starting with the Syndeo program; as we highlighted in the press release earlier this afternoon, we incurred a $63.1 million restructuring charge this quarter due to Syndeo provider experience issues. As a result of these challenges, there was a slowdown in U.S. system placements that led to lower-than-expected overall net sales growth. To provide some background, Syndeo 1.0 launched in the U.S. in March of 2022.

The launch was met with excitement and swift provider adoption. However, after some time in the field, some providers experienced frequent treatment interruptions and issues such as distractive noises and difficult bottle insertion. Most importantly, there was an issue with low flow and clogs in the system. Simply put, Syndeo 1.0 did not meet the high standards of user experience that Hydrafacial has been known for over its 26-year history. Throughout 2022, in the first half of 2023, the company made several enhancements to Syndeo to address and remediate these issues, releasing Syndeo 2.0 into the field. Despite these efforts, many of the issues continue to persist. After rigorous testing and development, including simulating over 10 years of heavy end use – in office use, we believe we have addressed the Syndeo issues with our current Syndeo 3.0 standard implemented in July of this year.

We are very pleased with the real-world performance over the four months Syndeo 3.0 has been in the field. Additionally, Syndeo 3.0 devices coming off the production line and existing Syndeos in the field that have been enhanced to the 3.0 standard have a return rate in line with Hydrafacial’s low historical benchmark. To stand behind our commitment to our customers and protect the company’s brand reputation, we decided that with respect to Syndeo devices, we will only market and sell Syndeo 3.0. With this decision, we designated the approximately 4,300 Syndeo 1.0 and 2.0 devices in inventory as obsolete, resulting in an impairment charge of $18.8 million. Additionally, during the quarter, we incurred $12.3 million in costs associated with enhancing or replacing approximately 2,850 Syndeo 1.0 and 2.0 devices in the field.

Lastly, we accrued incremental costs of approximately $32.1 million to enhance or replace the roughly 4,500 Syndeo 1.0 and 2.0 devices yet to be addressed in the field. This decision was made after concluding it was too costly to diagnose, repair and resell return Syndeo 1.0 or 2.0 devices in inventory. In addition, by replacing the systems or enhancing currently – functioning systems in the field, we are ensuring provider satisfaction and safeguarding our brand equity. We will also extend all Syndeo warranties by one year to further support our providers. We do not believe the extended warranty will have a material impact on our financial statements. Despite these challenges, we want to reiterate that the business model remains fundamentally sound.

And the impact has been contained to a portion of our providers without spreading to the end consumer. In addition, the strength and reputation of the Hydrafacial brand and our long-term opportunity remain intact. We based this assessment on two key data points. First, our recently conducted provided survey showing our Net Promoter Score, or NPS, remains best-in-class in the aesthetic device category. As a reminder, NPS is a measure of how likely it is for a user of a brand to recommend it. Second, our passionate community of Hydrafacialists around the world or what we refer to as the Hydrafacial nation, powers our 30,000 active delivery systems globally. Our footprint within the medical aesthetics industry is unparalleled. Next, we’ll move on to Q3 results.

Net sales for the third quarter grew by 10% to $97.4 million. This came in well below the company’s expectations with underperformance in U.S. delivery systems, partially offsetting strong performances in APAC and EMEA. From a geographic perspective, Americas declined 11% year-over-year due to the Syndeo challenges we just discussed. APAC revenue grew 63% year-over-year to $24.7 million. China accounted for $16.9 million and plus 79% year-over-year growth, driven by strong delivery system placements, reflecting our success in penetrating the market and the significant potential to grow our nascent presence there. EMEA grew 37% year-over-year to $21.1 million, with the strength coming from system placements and consumables net sales, specifically in the U.K. and Germany.

Year-to-date, nearly, 45% of our net sales came from markets outside of the U.S. Moving on to net sales by product type. Our consumables business, which accounted for approximately 48% of our net sales in the quarter, saw a 17% year-over-year increase to $46.4 million. This further demonstrates our challenges are largely around delivery systems and more importantly, that the consumer continues to see high value in Hydrafacial treatments. On the system side, we saw a 4% year-over-year growth to $51 million, which was weighed down by performance in the U.S. Notably, delivery systems net sales in APAC and EMEA were plus 102% and plus 35%, respectively. During the quarter, we sold 2,140 systems at an average selling price of [$23.9000] down year-over-year, primarily due to an unfavorable mix shift towards distributor revenue.

Of the 2,140 systems, 362 were trade-ups. During the quarter, we reached a global installed base of 30,074 systems. We had a consolidated GAAP gross loss of $12.6 million, resulting in a GAAP gross margin of negative 12.9%. This was primarily driven by the Syndeo program charges of approximately $63.1 million. Additionally, this quarter, we incurred discrete charges of $6.4 million related to discontinued, excess and obsolete inventory. Normalizing for these charges, depreciation, amortization and stock-based compensation, adjusted gross profit was $60.9 million for a 62.5% adjusted gross margin. The adjusted gross margin was impacted by higher manufacturing labor costs and overhead, which we expect will subside as we continue to move portions of our manufacturing to China and sell through higher-priced inventory purchased in 2022.

Selling and marketing expense was $30.7 million or down approximately 23% year-over-year, primarily due to strategically pulling back marketing spend given the issues regarding Syndeo. The decline was further driven by lower compensation and sales commission expense, partially offset by a reversal of cash incentive accruals in the prior year. Going forward, while remaining disciplined, we plan to prioritize marketing initiatives to strengthen provider confidence and drive further awareness of our brand. Our data suggests Hydrafacial’s consumer brand has never been stronger, and our provider penetration is still low. R&D expense was $1.8 million for the quarter, relatively flat with historical trends. G&A expense was $37 million or plus 55% year-over-year, primarily driven by higher compensation, severance, share-based compensation and software expenses.

The reversal of cash incentive accruals in the prior year was also a driver. Altogether, this resulted in a net loss of $73.8 million. Normalizing for discrete charges, our adjusted EBITDA was $9.1 million, primarily due to gross margin pressures. This compares to a net loss of $0.1 million and adjusted EBITDA of $16.3 million when excluding any adjustments for discretionary cash incentives. Moving to the balance sheet. We ended the quarter with approximately $559 million of cash on hand. The cash balance reflects the repurchase of 0.8 million shares at an average price of $5.83 per share during the quarter. As of quarter end, we had approximately $95 million remaining in our existing share repurchase authorization. As of September 30, we had approximately 132.6 million shares outstanding.

We feel comfortable with our current liquidity position and together with our Board; we’ll continue to evaluate capital allocation, including liability management. Our inventory stood at approximately $74.9 million at the end of September, a decrease, compared to $109.7 million at December 31 last year, primarily as a result of the impairment charges taken during the third quarter. As of the end of the third quarter, we had approximately 1,300 trade-up elites in our inventory marked at fair market value. As we sell through these systems, there will be minimal gross profit given the trade-up accounting treatment and rules. We are estimating approximately 10% of this inventory will sell through in Q4 of 2023. Given the third quarter results, we are revising our previously stated fiscal 2023 guidance.

We now expect fiscal 2023 net sales in the range of $385 million to $400 million, and adjusted EBITDA margin of 5% to 6%, respectively. This represents approximately 7% net sales growth at the midpoint, on a year-over-year basis. Our updated 2023 outlook reflects the work that remains to be done to reaccelerate Syndeo adoption in the U.S. While we are optimistic in our ability to execute against this goal, this will take time. As a result, we are suspending our long-term 2025 financial outlook. Lastly, I want to update you on our strategic transformation program, we announced in September. This initiative is expected to have a significant impact on our financial profile. And we remain on track, to deliver over $20 million in annualized cost savings, primarily through G&A efficiencies during Q1, 2024.

We expect to incur approximately $9 million to $11 million of cost to achieve for these, Phase 1 annual savings. The cost to achieve, are primarily related to severance and consulting expenses. In parallel, we have begun work on Phase 2 of the project, which is focused on optimizing our manufacturing and supply chain footprint and continued optimization of our organizational structure. We expect Phase 2 will deliver over $15 million in annualized cost savings during Q2, 2024. We expect to provide more detail in the New Year, around the savings and any related costs to achieve. In closing, while we are disappointed in our results and recognized that there is work ahead, we are committed and confident in our ability to reaccelerate Syndeo adoption in the U.S. and to further our execution across our international businesses.

Importantly, our long-term strategy and our business fundamentals remain intact. We look forward to speaking with all of you and sharing our progress as we continue to execute against our strategy. While we will not be hosting Q&A on this call, if you have any questions, please reach out to our Investor Relations team at ir@beautyhealth.com. Thank you.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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