e.l.f. Beauty - Q3 2023

Transcript

KC Katten (VP of Corporate Development and Investor Relations)

Thank you for joining us today to discuss e.l.f. Beauty's Q3 fiscal 2023 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. Let me turn the webcast over to Tarang.

Tarang Amin (Chairman and CEO)

Thank you, KC, good afternoon, everyone. Today, we will discuss the drivers of our Q3 results and our raised outlook for fiscal 2023. 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're encouraged by the continued strength we're seeing across the color cosmetics category. In Q3, category trends grew 8% versus 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 number 4 brand as compared to number 5 a year ago.

We continue to be the fastest growing top 5 brand by a wide margin. In skincare, Q3 category trends grew 6% versus 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're humbled by the recognition we continue to receive. In Q3, we were named Beauty Brand of the Year in the mass category by Women's Wear Daily, and recognized on Forbes annual list of America's best mid-sized companies. We continue to be recognized for our purpose and values as we strive to create a different kind of beauty company, 1 that is both purpose-led and results-driven.

With the appointment of Gayle Tait to our board of directors, we are proud to be 1 of only 4 public companies out of nearly 4,200 with a board that's at least 2/3 women and 1/3 diverse, underscoring our commitment to diversity and inclusion. 3 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. 1st, 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 Poreless 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 9 times the units of the prestige primer, and both e.l.f.

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 Camo Concealer at $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're both expanding our share of the category and making the whole category bigger. The 2nd driver of our performance is that we're 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 7 segments while maintaining the number 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 multi-year innovation is driving our share leadership in key segments. Our Power Grip franchise is a more recent example. We launched our original Power Grip Primer in late 2021 at an incredible value of $10 compared to the prestige item at $36. In 2022, Power Grip was our top-selling SKU and the number 2 SKU across the entire U.S. mass cosmetics market, according to Nielsen. e.l.f.

Cosmetics Power Grip was also the number 1 face primer SKU across the entire U.S. prestige beauty market, according to the NPD Group. Coupled with our multi-year innovation in primers, e.l.f. now holds the number 1 position in the face primer category in both the mass and prestige markets. We're building upon this 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 skincare benefits. The sticky texture grips makeup for a long-lasting wear, while the 4% niacinamide helps even out and brighten skin. This item is proven to be highly incremental, further expanding our Power Grip 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 'N Roll Mascara, a mega curling mascara with a unique double-sided and curved silicone 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. Skincare, 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 skincare, we also launched our Suntouchable Whoa Glow SPF 30, a lightweight face sunscreen that doubles as a 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 skincare.

For context, mascara is a $900 million category and the largest segment within cosmetics. Lip color is nearly a $500 million category, and skincare 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 3rd driver of our performance is our ability to attract and engage consumers with our disruptive marketing. We kicked off the holidays with a 1st of its kind digital campaign informed by the insights from The Weather Channel and brought to life with Grammy Award-winning Meghan Trainor. Meghan 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.

The trifecta of e.l.f., The Weather Channel, and Meghan Trainor helped us reach new audiences and entertain our community. The campaign generated over 5 billion press impressions, exceeding last year's holiday campaign by a wide margin. Over the past 3 years, we've increased our marketing investment from 7% of net sales to 16% and continue to expect marketing near the high end of our 17%-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 3 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 1 KPI, we see a lot of runway for growth. Nationally, we're the number 4 cosmetics brand with a 7% share. In Target, our longest-standing national retail partner, we're the number 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. Even at Target, we believe we still have opportunities to continue to take share and become the number 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 Shoppers Drug Mart in Canada and Superdrug in the UK. 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. Compared to our number 4 position in the US, we're the number 7 brand in Canada and the number 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 1 of these, we believe the unique combination of our expanding superpowers forms our competitive moat and fuels our ability to win in fiscal 2023 and beyond. I'll now turn the call over to Mandy.

Mandy Fields (SVP and CFO)

Thank you, Tarang. Our Q3 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%-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 $85 million a year ago. Our average customer in-stock rates were over 95% in Q3. 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. Let's turn to our raised outlook for fiscal 23. For the full year, we now expect net sales growth of approximately 38%-39% versus prior year, up from 22%-24% previously. We expect adjusted EBITDA between $110.5 million-$112 million, up from $93.5 million-$95 million previously. We expect adjusted net income between $75.5 million-$77 million, up from $59 million-$60.5 million previously, adjusted EPS of $1.37-$1.40 per diluted share, up from $1.07-$1.10 previously.

We expect our fiscal 23 adjusted tax rate to be approximately 19% as compared to 22%-23% previously. 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%-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 costs associated with space gains relative to prior year. Turning now to adjusted EBITDA. Our outlook implies adjusted EBITDA growth of approximately 48%-50% versus prior year, up from approximately 25%-27% previously and on top of the strong 22% growth in fiscal 2022. We expect our marketing and digital spend to be at the top end of our 17%-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. 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. 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 skincare, 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. We believe our solid balance sheet, low leverage, and strong cash flow generation can continue to drive shareholder returns and support our overall growth. Operator, you may open the call to questions.

Operator (participant)

Thank you. We will now begin the question and answer session. To ask a question, you may press * then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the key. To withdraw from the question queue, please press * then 2. At this time, we will pause momentarily to assemble our roster. Our 1st question comes from Dara Mohsenian with Morgan Stanley. Please go ahead.

Dara Mohsenian (Managing Director and Senior Equity Analyst)

Hey, guys. Good afternoon.

Mandy Fields (SVP and CFO)

Good afternoon.

Dara Mohsenian (Managing Director and Senior Equity Analyst)

Clearly very strong top-line growth in the quarter, which accelerated sequentially. Your implied, you know, forward fiscal Q4 revenue growth guidance is also very robust, even though you're normally very conservative with forward guidance. I guess, can you just give us an update on what's driving the confidence in the much higher revenue growth range, short term? 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 2? Maybe particularly focusing on e-com, which was obviously very strong in the quarter. Thanks.

Mandy Fields (SVP and CFO)

Sure. All right, I'll start with your 1st question on the strong top-line growth and what gives us confidence there. You know, 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. As we talked on the call, you know, the category has performed better. Our innovation continues to resonate with our consumers, just our ability to really engage our consumers. We talked about the activation that we did with Meghan Trainor and Halo Glow, just really that combination of our innovation and marketing, give us confidence as we head into Q4. On the longer term, what gives us confidence, you know, 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 at 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's much more potential than that on the road ahead. Then I would say across the subcategories that we called out mascara, lip, skincare as a big opportunity as we talk about e.l.f. SKIN on the road ahead. There's a number of things that give us confidence on the road ahead.

Tarang Amin (Chairman and CEO)

I would 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. 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 with our retailer dot coms. So our hope is to continue to drive that digital penetration even further.

Dara Mohsenian (Managing Director and Senior Equity Analyst)

Great. Thanks.

Operator (participant)

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

Olivia Tong (Managing Director of Beauty, Personal Care, and Household Products)

Great. Thanks. 1st, congrats on a great quarter and outlook. You know, you've obviously had a significant number of distribution wins of late, so my question is around how you have to run the business differently to support that. You know, does it require more lead times? To what extent did stocking the shelves help you this quarter? Maybe if you could help us bridge the gap between your sales and scanner. Then any early insights you have on, you know, discussions around incremental shelf space later this year. If I could just sneak 1 more in.

You know, given the torrid pace of growth, my question is around production and ability to keep up especially since much of your production is based in China, and obviously, you know, the COVID infection rates that we're seeing just have to be somewhat of a challenge. What you're doing to sort of stay ahead of that as well. Thanks so much.

Tarang Amin (Chairman and CEO)

Sure. Hi, Olivia. It's Tarang. What I'd say is we've had a pretty good and consistent track record of being able to pick up more space. If I take a look at the contribution of space gains over the last few years, it's been pretty consistent. I'm highly confident of our ability to continue to not only pick up more space, but also optimize that space. Our first and foremost focus is always going to be on the productivity, whether somebody gives us more space or not. That's been the key driver of our business, and I think we have really good cadence in terms of how we're being able to do that. We have quite a few customers taking up space in the spring reset.

Those are just starting now, we'll have a better view of how those resets are doing when we have our May call. Between Target, Walmart, CVS, Shoppers Drug, there's a lot that our team is executing right now. I've got a lot of confidence in our team's ability to execute that. In terms of incremental space opportunities, you know, I think given the productivity of our brand, the innovation we have, the consumer profile, I think there'll be other opportunities. We'll highlight those as we're able to achieve them into the future. Again, I feel really good about our track record over time, particularly in more recent years, our ability to optimize that space as we get it. In terms of your production question, that's 1 area I'm particularly proud of the team.

Our operations team has done a phenomenal job. If I go back all the way to the pandemic, all the supply chain disruptions, even lockdowns in China, we've been able to meet the strong consumer demand we've seen in the last quarter. Our in-stock levels remained above 95%, which I think speaks to, you know, even a 49% growth quarter, our ability to meet that demand. I feel really good about our overall production and capacity. There will be some out-of-stocks on certain viral sensations. We spent a lot of time this last year kind of chasing the success of Halo Glow. Seemed like every time we took that forecast up, we saw even greater sales. We talked about our Power Grip Primer, which is not only our number 1 SKU, but the number 2 SKU across the entire category.

Important to note, it's not only the number 1 primer in mass, but it's also the number 1 primer in prestige. That's an item that I think we're going to also be chasing. They will have some periodic new items that we'll be looking to chase, but overall, we remain highly confident in terms of our ability to meet the demand that we're seeing.

Operator (participant)

Our next question comes from Andrea Teixeira with JPMorgan. Please go ahead.

Andrea Teixeira (Executive Director)

Thank you. My question, Tarang, was exactly what you just described and how you were able to keep up with Power Grip and Halo Glow and even Poreless Putty Primer in the past. So in terms of like just perhaps giving us a little bit more of details on how the execution and your ability to have in-stocks going forward. Related to that, you have a lot of white space, not only as you pointed out, the 3 subcategories, lip and mascaras and skin. Wondering like the cadence of that set up, can you give us an idea if most of these new shelf resets will carry those new products and how the cadence as we go into fiscal 2024 will shape?

Thank you, and congrats again on the numbers.

Tarang Amin (Chairman and CEO)

Thanks, Andrea. I'd say on the first one, in terms of a bit more detail on how we are able to maintain such high in-stock levels. Again, it's a credit to our team and the penetration we have with each of our national retailers' supply chains. Our ability to plan with them, to highlight items that we feel are going to be taking off, and then be able to take a stronger inventory position on those items. It was a couple of years ago that we did take our inventory levels up in anticipation of some of the container imbalances, and that strategy served us well. We have quite a bit of credibility with our customers in terms of when they place orders for us to tell them really almost down to the store level and SKU level, what they should be carrying.

I feel good about our ability to manage that. As I said, there will always be periods where we have, given the viral nature of this brand, items that we're chasing. Overall, I feel good about and overall production plans feel really great about our ability to continue to execute upon those. In terms of the white space, I would say, I feel really good about the innovation we have in each of those white space categories. We mentioned in mascara, our Lash 'N Roll Mascara, which is off to a great start. In lip, our O FACE Satin Lipstick is this phenomenal product at a great value. In skincare, already our Suntouchable! Whoa Glow SPF 30, I think, is already our 2nd best-selling skincare SKU just a few months out of the gate.

As I look forward, I also see quite a bit in our pipeline against not only our leadership segments, but also those categories we're conquesting. Very high hopes about our innovation continuing to be able to not only drive leadership in the segments we have, but also conquest these new categories.

Andrea Teixeira (Executive Director)

If I can explore, this is super helpful. Some of the data that you have in the Beauty Squad in particular, because I understand that those would be 70% growth, I think I understood from your presentation. Is there any metric you can say, listen, we are not only recruiting and keeping those consumers really engaged, and I think Kory had said that many times, but also recruiting new customers, right? Especially with these new premium products, you just immediately recruit people who are not even in the e.l.f. category.

Is there any metric you can help us understand if there is a new cohort that you're getting with the Beauty Squad or even your direct-to-consumer e-commerce platform that can inform us on the potential for additional customers in your base?

Tarang Amin (Chairman and CEO)

Sure. On Beauty Squad, we continue to expand the base on Beauty Squad. I talked about the 20% growth in Beauty Squad members, and we see that growth coming obviously from new consumers. Probably the biggest magnet we have to attract new consumers is a combination of our innovation and our marketing engine. On our innovation, all of those core innovations I just talked about, Halo Glow, Liquid Filter, Power Grip, all of the new ones that I just talked about, all attract a significant number of new consumers to the franchise. I think they see the viral buzz, they see other people talking about this prestige quality, these great prices, and particularly these days with platforms like TikTok, we get consumers kind of doing their own demonstrations and comparisons. It's been a great source.

The metric we specifically look at there is what % behind each product are we pulling in new users, and it's often more than 50%. The composition of those consumers, it's a combination of our strength amongst Gen Z, but increasingly also amongst millennials and Gen X as well. I think the quality of these products at the prices we have and our ability to engage them really are attracting even more consumers to our franchise.

Andrea Teixeira (Executive Director)

Thank you. I'll pass it on.

Operator (participant)

Our next question comes from Linda Bolton Weiser with D.A. Davidson. Please go ahead.

Linda Bolton-Weiser (Managing Director)

Hi. Thank you. Can you maybe just talk about your other brands, Alicia Keys and W3LL PEOPLE, and how their share progress is coming in their respective areas?

Tarang Amin (Chairman and CEO)

Sure. Hi, Linda. We feel good about our progress on both W3ll PEOPLE and Keys Soulcare. As a reminder, they're both relatively new in our portfolio. Keys Soulcare we only created 2 years ago. W3ll PEOPLE we acquired a little less than 4 years ago, and our main focus is really building up the awareness and trial of both of these brands. During the quarter, we had a great hit on Keys Soulcare with our Multi-Benefit Peptide Serum. It's actually already out of stock. It's another item that we're chasing to get more stock in. Our consistent focus is building these brands for the long term, and I feel good about the progress there.

Linda Bolton-Weiser (Managing Director)

Thanks. Can I just ask, I was a little surprised to hear that transportation costs are still up year-over-year. Can you just talk about kind of the cadence of how those comparisons flow in the next few quarters and when we'll start to see roughly the transportation cost being down year-over-year?

Mandy Fields (SVP and CFO)

Sure. Linda, we did start to see transportation costs ease within the quarter. We're really pleased with that and sure hoping that that holds. As you know, it takes some time for our inventory to turn through those lower costs since we capitalize the freight with the inventory. As we think about, you know, the coming quarters, it certainly should be a tailwind for us as we think about cost and gross margin.

Linda Bolton-Weiser (Managing Director)

Okay, thank you very much.

Operator (participant)

Our next question comes from Anna Lizzul with Bank of America. Please go ahead.

Anna Lizzul (VP and Equity Research Analyst)

Hi, thank you, and congratulations on the great results. Just given the benefits driven by price increases and product mix, I was wondering if you could share how much of the growth was driven by the expansion of e.l.f. SKIN with your added shelf space at major retailers. Then are you seeing an increase in older demographics purchasing e.l.f. SKIN outside of your more typical consumer in the Millennial and Gen Z cohorts? Just overall, in terms of the growth that you're seeing, how much of the benefit would you allocate to innovation in your products? Thanks.

Mandy Fields (SVP and CFO)

Yes. Hi, Anna. First on the price increases and mix, you know, we have talked about the price increases that we took last March and the benefit that that's had to our overall top line. It's about high single-digit impact. That's kinda how you can size up the specific price increases that we took. Mix is playing a role in that, right? We've launched some innovation this year that is at that $10 or $12 range that is also playing a role. You'll see in our commentary in the Q, how price and volume, price mix and volume break out across both net sales and gross margin. I would say this quarter, pretty healthy mix of both, which we are very pleased to see.

From a skincare standpoint, you know, we talked on the call about skincare being up 34% for us in Q3, skincare consumption versus a category up 6%. On the color side, seeing cosmetics up 36% versus a category up 8%. Very pleased with how our skincare is performing as well, and certainly an opportunity for growth. Tarang just talked about our Whoa Glow. That will be a part of our shelf resets and a continued focus on making sure that skincare is a part of that shelf expansion as we go in. We're very pleased with that. Then if I think about innovation overall, innovation is a healthy contributor to our sales growth and has been pretty consistent over these last several years. We feel great about the innovation that's coming.

We highlighted the innovation in mascara and lips and in skincare that we're really excited about. As we think about balance of growth, really seeing it across all vectors. You know, from a channel standpoint, we talked about digital, we've talked about international, and really pleased with the balance that we're seeing as well across kind of core products and innovation.

Anna Lizzul (VP and Equity Research Analyst)

Great. Thanks very much.

Operator (participant)

Our next question comes from Susan Anderson with Canaccord Genuity. Please go ahead.

Susan Anderson (Managing Director and Senior Analyst)

Hi. Thanks for taking my question. Great job on the quarter. I wanted to ask a little bit about marketing. I'm curious if there's any thoughts or color you can give around just the increase in marketing and how much you think that has helped to drive the accelerated sales growth. Also, I'm curious if you had any early thoughts about how you're thinking about marketing for 2023, if this is gonna be the new base level, or do you think you'll increase it again? Thanks.

Mandy Fields (SVP and CFO)

Okay.

Tarang Amin (Chairman and CEO)

Hi, Susan, this is Tarang. We're not ready yet to give FY 2024 guidance on marketing, but what I would tell you is we're highly comfortable with the 17%-19% range we have this year. What gives us comfort there is we recently got our Nielsen annual marketing ROI analysis back, and it shows exceptionally high marketing ROI. I've been in the consumer space for 30 years. Typically, when you increase your marketing levels, you see a diminished returns. In our case, we've now had 3 consecutive years where we've taken our marketing levels up and have actually seen the marketing ROI go up. I think it really speaks to the strength of the marketing engine that we do have.

The support we have is not only effective, but it allows us to broaden the audiences by which we go after and test on new platforms and new things, like the collaboration we talked about between The Weather Channel, Meghan Trainor, and us. I feel really great about where we're at in marketing, and it's definitely driving profitable sales for us, from our own analyses and what gives us confidence for this year.

Susan Anderson (Managing Director and Senior Analyst)

Great. If I could maybe just ask about the inventory. It looks pretty lean at the end of the quarter, down 5. I guess, how are you thinking about just replenishing as we go throughout the quarter? Would you expect that to be up higher at the end of the year? Thanks.

Mandy Fields (SVP and CFO)

Yes, Susan. Inventory for this quarter, a little bit lighter than we probably would have wanted, just given the outperformance that we saw. We feel great about our ability to service our customers. We talked about having over 95% in-stock levels, even with that inventory. As we get towards year-end, we do expect that inventory level to go up and be higher as we seek to support the growth that we're seeing. Feeling great about where we are right now. To Tarang's point, we may have onesie-twosie out of stocks on those items that really take off on innovation. Also, on the other hand, you know, lead times have improved, and we're able to get behind and get product here faster than we have previously.

Again, feeling great about where we are on an inventory standpoint.

Susan Anderson (Managing Director and Senior Analyst)

Great. That sounds good. Thanks for the color.

Mandy Fields (SVP and CFO)

Yep.

Operator (participant)

Our next question comes from Jon Andersen with William Blair. Please go ahead.

Jon Andersen (Consumer Research Analyst)

Hi, good afternoon, everybody, and, congrats on the terrific quarter.

Mandy Fields (SVP and CFO)

Thank you.

Tarang Amin (Chairman and CEO)

Thank you.

Jon Andersen (Consumer Research Analyst)

A couple quick ones. The guidance I think implies somewhat of a just sequential decline in gross margin in the Q4, 200-300 basis points perhaps. Is that? Am I thinking about that the right way and what might be some of the drivers of that?

Mandy Fields (SVP and CFO)

Yeah. I'm really pleased with how our gross margin is positioned overall. We are outlooking gross margin up 200 basis points year-over-year in a rising cost environment, which is really fantastic to see. As we look out to Q4, what you're observing is a little bit of natural seasonality that we see from Q3 into Q4 of a lower gross margin. I would say, the other thing layered on there are cost related, one-time costs really related to space gains that will flow through in Q4 as well. We picked up a little bit of that in Q3, but we'll have some in Q4 as well. That also is impacting gross margin.

Overall, I feel great about where gross margin is positioned, even in Q4, still above last year, is what's implied in our outlook. Again, 200 basis points higher on the year.

Jon Andersen (Consumer Research Analyst)

That makes sense. Very helpful. Thanks, Mandy. Then again, I'm gonna take a shot at this. I know you're not ready to talk about fiscal 2024 guidance, but I'm just kind of thinking back to the long-term algorithm you've kind of communicated in the past, mid to upper single-digit revenue growth. Obviously, that's gonna be different from year to year. You know, when you put it all together and you think about the color category tailwinds and the share gains for the e.l.f. brand and what seems like significant new shelf space, this spring, a very robust innovation pipeline, high digital and marketing spending, any thoughts on maybe kind of triangulating, you know, the 24 kind of drivers relative to kind of that long-term algorithm?

It just feels like it could be another very strong year, above kind of algorithmic growth.

Mandy Fields (SVP and CFO)

You're right, Jon. We're not giving fiscal 24 guidance today. You have to stay tuned for May for that. You know, we feel great about the white space that's ahead of us and the opportunities that still lie before us. You called out a number of them. You know, certainly would love to see growth continue at this level. But, you know, I've always taken a balanced approach with guidance, as you know. So you'll have to wait until May, but we're feeling pretty good about where we're at right now.

Jon Andersen (Consumer Research Analyst)

Thanks so much. Appreciate it. Congrats again.

Mandy Fields (SVP and CFO)

Thank you.

Operator (participant)

Our next question comes from Ashley Helgans with Jefferies. Please go ahead.

Speaker 13

Hi, this is Sydney on for Ashley. Congrats on the quarter. Thank you for taking my question. I just wanted to ask first about that kind of higher price tier of products. Are you seeing any difference in customer demographics between those who are shopping the more entry-level lower price point or versus, like, the higher price point products in your mix?

Tarang Amin (Chairman and CEO)

Hi, Sydney, this is Tarang. We do see some difference. I would say, you know, our strength is Gen Z into Millennials and some Gen X, and so we certainly do pick up more consumers from different age cohorts. The biggest thing, because I often get asked this question, "Are you seeing trade down? Are you seeing trade within mass?" As we talked in our prepared remarks, I think the real secret sauce of e.l.f. is with these Holy Grail products, some of these higher price tier products. We're able to expand the entire category. I gave the example on Poreless Putty Primer. It had an inspiration of a prestige item that was $52. By introducing Poreless Putty Primer, we've grown. I think we sell 9 times more units of that prestige item, and that prestige item is still growing.

We've seen the same thing when it comes to our concealer business, where we've more than doubled the units on a pretty iconic set of prestige concealers. We definitely do pick up more new consumers, and because of that, you will see a broader range in terms of ages and their demographics. I think the bigger concept and what really propels us is our ability to expand that entire category, where it's no longer accessible just to a few who could afford a $50 item, but you can really bring anyone in when it's $8 or $10 bucks.

Speaker 13

Yeah. That's helpful. My next question is a bit more long term and actually kind of about that next upcoming generation from Gen Z, Gen Alpha. It feels like they're kind of beginning to rise as the new buzzy generation. Because of your price point and high level of innovation and you're always on trend, I think it seems like you guys make a great entry skincare or color cosmetics brand. I was just curious if you're beginning to see any of those younger shoppers or if you have any thoughts on kind of beginning to consider them in your, in your marketing approach.

Tarang Amin (Chairman and CEO)

Sydney, absolutely. We're definitely seeing early signs of resonance with Gen Alpha. There's a lot of our marketing activities that frankly appeal to Gen Alpha just as much as they do to Gen Z, particularly if you look at the different platforms that we're on and the types of things that we're doing. More to come on that, but, you know, you'll continue to see us be at the forefront on some of these new consumer demographics and introducing them to the best of beauty and making it accessible.

Speaker 13

Got it. Just 1 last one, just to dig in a little bit more on that marketing ROI. It's great to hear that that keeps expanding, the more you invest. I'm curious, are there any new channels or platforms that you're seeing especially strong traction on?

Tarang Amin (Chairman and CEO)

You know, that's the great thing about our marketing ROIs. We see strengths across vehicles and channels. Certainly, you know, we tend to look at our paid media, our owned, and then also our earned media. We're seeing strength across all 3 of them. By vehicle, we see very strong ROIs on our digital advertising. We see strong ROIs on our influencer work, on our PR is really off the charts. It's really almost every 1 of those buckets. I'd say the other thing about us is we're not afraid to test and learn on new platforms. When we were 1 of the first beauty brands on TikTok. In the early days, it was hard to get attribution on TikTok.

We now can see almost immediately when something goes viral on TikTok, the impact it has on our business and our ability to be able to track that. You'll continue to see that good balance between things that we have that are definitely proven and other things that we are testing for the future, and we've got a great cadence going there.

Speaker 13

That's great. Thank you so much.

Operator (participant)

Our next question comes from Rupesh Parikh with Oppenheimer. Please go ahead.

Rupesh Parikh (Managing Director and Senior Analyst)

Good afternoon. Thanks for taking my question. Also congrats on a great quarter. I guess I wanted to ask just on the trends. Anything you can share in terms of the cadence of trends during the quarter, and then maybe if you as well provide some color into January.

Mandy Fields (SVP and CFO)

Yeah. You know, really strong trends throughout the quarter. I would say that, you know, we had a really strong Cyber Monday with our e-commerce business, and we saw trends really strengthen as we got closer to the holiday period. It was great to see. Right now, what we're seeing in track channel is, you know, a continuation acceleration of that year-over-year growth. I think from about, you know, end of December through mid-February, you will see those indices continue to be really strong. Given that in the base there is the Omicron that we're cycling in the base. That suppressed some of our numbers last year, and has really accelerated what you're seeing in track channels right now. That doesn't diminish, you know, our bullishness on our performance.

You know, I take you back to our guidance of 46% on the top end for the quarter, really demonstrates how strongly we believe our business can perform right now.

Rupesh Parikh (Managing Director and Senior Analyst)

Okay, great. Then, you know, gross margins this year, you expect to expand around 200 basis points. What are the bigger opportunities you see going forward to further expand margins in the coming years?

Mandy Fields (SVP and CFO)

We talked a little bit about transportation costs easing, and that, if those should sustain, would be a tailwind for us as we head into fiscal 2024. The other thing that we're looking at is on the FX side. You know, we source the majority of our products from China, and as we've seen favorability there, that could be a tailwind for us as well from a gross margin standpoint.

Rupesh Parikh (Managing Director and Senior Analyst)

Great. Maybe 1 last question. You know, as we look to the next fiscal year, and I know you're not providing much guidance today, but is there anything you guys would caution us in terms of modeling for next year, just from a comparison perspective?

Tarang Amin (Chairman and CEO)

I mean, it's hard for us to say right now because we're not providing FY 24 guidance. I think you've seen from this call a general bullishness on the business. Mandy said it well. She always takes a very balanced view. I think we'll better be able to talk about that. I don't see any big red flags at this moment in terms of the things that we're particularly worried about. We're always going to be balanced. I think, again, it served us well in terms of taking into consideration all factors.

Rupesh Parikh (Managing Director and Senior Analyst)

Okay, great. Thank you.

Operator (participant)

Our next question comes from Oliver Chen with TD Cowen. Please go ahead.

Speaker 14

Hi, thanks for taking my call. It's Tom on for Oliver. A question on pricing. How should we think about the potential for price increases, you know, going forward this year and the demand elasticity in that regard? Additionally, have you seen any slowdown in demand? If so, where might those pressure points be?

Mandy Fields (SVP and CFO)

Yeah. I'll take the question on pricing. You know, we have used pricing very judiciously over the last several years. We really have only taken 2 major price increases, 1 back in 2019 related to tariffs, where we touched about 1/3 of our portfolio from a pricing standpoint. Last March, in response to the inflationary environment that we're all operating in, where we took pricing on about 2/3 of our portfolio. Right now, pricing is not on the docket for us to take again. You know, we take very seriously, you know, our ability to provide our consumers with an extraordinary value, with exceptional quality, and we'll continue to do that. Right now, pricing, not on the docket for us. Oh, go ahead. On your 2nd question on-

Tarang Amin (Chairman and CEO)

On the slowdown in demand.

Mandy Fields (SVP and CFO)

Yes. I'll pass it to Tarang Amin.

Tarang Amin (Chairman and CEO)

Yeah, no, we've not seen any slowdown in demand. I know there's a lot of concerns out there on recessionary environment. You know, what I'd tell you is, historically, mass color cosmetics, mass skincare has fared really well in inflationary environments, or recessionary environments. Even more importantly, you know, we've long been bullish on the category, this is a category that really did suffer during the pandemic when people were restricted from their normal behavior. I've long felt there's a lot of pent-up consumer demand for the categories in which we compete, and we very much are seeing that. I mean, for the quarter, as we said, overall mass color cosmetics was up 8%. In track channels, mass skincare was up 6% and are both even stronger.

We're seeing an acceleration of consumer demand, not any slowdown. I feel, again, very bullish in terms of how the category shapes up as we continue to go forward.

Great. Thanks. A quick follow-up on skincare. Can you just add some color on the main drivers of the recent success there and where you might be taking share?

Yeah. Well, I mean, we're still small in skincare, so I think less about where we're taking share and more about the fundamental drivers. The fundamental drivers are very similar to the fundamental drivers we have on the color business. We have an incredible value proposition, prestige quality at accessible price points. We have meaningful innovation that's resonating with the consumer. If I look at our Halo whole hydration franchise, I look at our recent global launch. We know how to engage and attract consumers. It was only a couple quarters ago that we've put our first dedicated support on skincare, and we've seen good returns from there.

We're gonna follow a similar formula in a different category with more education and more dedicated focus there, but I like the momentum we have in there, and that momentum's now, you know, sustained for a number of quarters here, and I feel like we have a huge opportunity there.

Operator (participant)

Our next question comes from Mark Astrachan with Stifel. Please go ahead.

Mark Astrachan (VP)

Yeah. Thanks. Afternoon, everyone. 1 just a follow-up question, 1 more broad question. In thinking about how to model the top line, if you back away international, back away digital, you know, the sales are sort of directionally in line with the scanner data, so obviously then a lot of what we're not seeing is what you referenced in terms of the strong digital and international growth. Anything there from, you know, and not just a quarter standpoint because you've obviously given us Q4, but anything that we should be thinking about both positives and negatives there in terms of how the business has fared over the last couple of quarters here, that we should be modeling or thinking about as we model?

Tarang Amin (Chairman and CEO)

You know, you hit on it, Mark. I mean, our digital and international growth and just growth in our untracked channels has been very strong this year. I think that if you parse out what you're seeing in tracked channel and then kind of take forward what you're seeing from an untracked standpoint, you probably get to the right place from a modeling view.

Mark Astrachan (VP)

Got it. Basically keep the trend in Q4, and that's sorta how we bridge the gap. Okay. More just category related and somewhat following the last question. Any thoughts, you know, not specific to your guidance, but how you think about category performance, talking more broad beauty trends, if you have thoughts on 2023 and even just on the cycle, you know, Tarang, your comment on coming out of the pandemic. You know, the last time the beauty category had a cycle makeup in particular, it lasted, I think, 5+ years. Are we kinda year 2 in a longer-term cycle? You know, how are you thinking about all of that?

Tarang Amin (Chairman and CEO)

I mean, we're always gonna be balanced. I'm hopeful that we're in the start of a really good cycle here, both the comments I made on the broader economy, more importantly, consumers wanting to express themselves. We're also seeing good things from a competitive standpoint. I've long been a believer that I actually wish really well for our larger global competitors, 'cause the more they do to bring interest to the category, either through innovation or their own investment levels, I think it's good for the category, which in turn is really good for e.l.f., 'cause our value proposition comes shining through. You know, I've been bullish for maybe times when I shouldn't have been bullish on the category, but if it's bullish then, I'm certainly bullish now in terms of how the category continues to gain momentum.

Mark Astrachan (VP)

Any thoughts about performance kind of nearer term versus longer term in the category?

Tarang Amin (Chairman and CEO)

Well, I mean, I think if you look longer term, when I look at long arcs of this category, looking over the last 30, 40 years, you know, it is the category that in the mass side was a consistent grower and kinda called this low to mid-single digits. We're obviously seeing outsized growth right now in Q3. I would expect to see outsized growth. Part of it in Q4 will be related to the compares to Omicron and the suppressed volume we saw there. You know, I'm hopeful for, you know, at least back to historical ranges, if not a little bit higher in the coming year.

Mark Astrachan (VP)

Great. Thank you.

Operator (participant)

Our next question is a follow-up from Olivia Tong with Raymond James. Please go ahead.

Olivia Tong (Managing Director of Beauty, Personal Care, and Household Products)

Apologies. My question's been answered. Thank you so much.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to Tarang Amin for any closing remarks.

Tarang Amin (Chairman and CEO)

Well, thank you for joining us today. As you can tell, I'm so proud of our incredible team at e.l.f. Beauty for delivering yet another quarter of outstanding results. We look forward to seeing some of you at our upcoming investor meetings and speaking with you in May when we'll discuss our Q4 and guidance for FY 2024. Thank you, and be well.

Operator (participant)

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.