Earnings Call Transcript - ELF Q3 2022

Melinda Fried, Head of Corporate Communications

Thank you for joining us to discuss e.l.f. Beauty's Third Quarter Fiscal 2022 Results. I'm Melinda Fried, Head of Corporate Communications. With me 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 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, CEO

Thank you, Melinda. And good afternoon everyone. Today, we will discuss the drivers of our Q3 results and our raised fiscal 2022 guidance. I am proud of the e.l.f. Beauty team for achieving our 12th consecutive quarter of net sales growth. We delivered Q3 net sales of $98 million, up 11% versus a year ago, and 20% on a two-year stack basis. Adjusted EBITDA of $22 million was up 18% versus prior year. We delivered these results with a significantly smaller holiday program. As a reminder, we proactively scaled back our holiday program to prioritize container capacity for our core products, which continue to be in high demand. With our continued momentum, we're raising our full-year guidance, which Mandy will discuss. Our innovation, digitally led strategy, core value proposition, and ability to adapt at e.l.f. speed, continue to fuel our performance. In Q3 e.l.f. had 5.7% market share, up 86 basis points on a two-year stack. For calendar year 2021, we were the only top-5 color cosmetics brand to grow share above pre-pandemic levels by a wide margin. Our relentless focus on our five strategic imperatives is driving results across our brand portfolio. Let me provide a few highlights from the quarter. Our first strategic imperative is to drive brand demand. We continue to find innovative ways to engage and entertain our community moving beyond traditional beauty boundaries. This approach has driven strong ROI and business momentum. This quarter, we created our first-ever TikTok native movie to celebrate the holiday season. BIG MOOD, BIG E.L.F.ING CITY, recaps some of the biggest TikTok trends of the year with an innovative twist. The movie garnered 400 million press impressions, over 32 million campaign views, and built upon our engagement on the platform. We also joined forces with Enthusiast Gaming to find the next gaming superstar. The competition called Rising Stars seeks up and coming creators from colleges across North America, and e.l.f. is the first brand to co-create the series. This builds upon our track record while also supporting our mission of empowering others to reach for the stars. Our brand building efforts continue to gain recognition. TikTok recently named e.l.f. to their culture drivers list for 2021 for our Gamers Got Talent campaign. We're among 14 other brands that TikTok highlights as doing the best, most engaging, and entertaining work on the platform. Building upon our entertainment chops, we recently teamed up with TikTok and American Idol creator Simon Fuller to find the next big music group. Together, we launched a search culminating in the creation of a first of its kind pop group called The Future X. We're working side-by-side with TikTok's vibrant creator universe via a hashtag challenge in search for makeup artists who'll work with the group. This collaboration represents another moment where e.l.f is leading to bring together two things our community loves, beauty and music. Keys Soulcare, our groundbreaking lifestyle beauty brand with Alicia Keys, garnered 7 billion global press impressions this quarter. In November, Alicia dropped her much anticipated 8th album 'Keys'. Keys Soulcare product offerings were prominently featured as Alicia promoted the album and held special one-night-only concert events. We celebrated the album by having it available to download on keyssoulcare.com. The buzz was timely as we recently celebrated the one-year anniversary of keyssoulcare.com. We're incredibly proud of what we're building with this brand, which has been recognized across the industry with over 20 awards this past year. Our second strategic imperative is a major step up in digital. Our digitally led strategy continues to serve us well with our digital consumption trends up triple digits on a two-year stack. We continue to see a channel shift between digital and brick-and-mortar in Q3 in line with our expectations, digital channels drove 14% of our business in Q3 as compared to 16% a year ago, and 10% two years ago. Our follower base across social and digital platforms is now over 12 million, helping to fuel our growth. On elfcosmetics.com, approximately 50% of our shoppers in Q3 were new consumers. Our Beauty Squad Loyalty Program now has over 2.7 million members, up over 20% year-over-year. Beauty Squad is an integral source of first party data, and we'll continue to look for ways to enhance the consumer experience. Our Keys Soulcare loyalty program called Soulcare Rewards continues to grow. The loyalty members made up 45% of sales this quarter on keyssoulcare.com. We also developed a new first and beauty digital gifting experience on the site for the holidays. Gift givers were able to create and send a personalized video to their loved ones while gifting them Keys Soulcare offerings. Our third strategic imperative is to lead innovation. Our superpowers centered on our ability to deliver 100% cruelty free, premium quality beauty products at accessible price points with broad appeal continue to resonate with consumers. e.l.f. Cosmetics saw ongoing success in our core segments: brushes, primers, concealers, brows, and sponges, which make up approximately half our sales. We have the number one or two position in all five segments and continue to drive sales growth in each. We're proud of our newest holy grail innovations which launched online at the end of Q3 and will be hitting retailer shelves in the coming weeks. Our Power Grip primer builds upon our strength in the primer category. It's jaw-dropping value of $10 versus the prestige equivalent at $34 has already propelled it to become the number one selling product on elfcosmetics.com and a viral sensation across social media. We continue to build upon the success of our Camo franchise. We recently launched the Camo Powder Foundation in 30 shades, packaged in a sleek compact with a mirror and sponge, and priced at $11 versus a prestige equivalent, $38. The powder foundation is on its way to becoming a top selling holy grail. Building upon our strength in brows and tools, we recently launched brow lift and an accompanying brow lift applicator priced at $6 versus a procedure equivalent at $23. The brow lift features an extreme hold, clear wax formula that sculpts brows for a feathered effect. This item quickly sold out online and over 15,000 e.l.f. fans signed up for Notify Me anxiously awaiting its return. Our newest lip products are attracting consumers looking for a color moment. Our new Glossy Lip Stains are priced at just $6 versus the prestige equivalent at $38. They feature a unique glossy to stain finish that is long wearing and won't transfer. We remain bullish on the color category. These four holy grail launches are generating incredible buzz across social platforms even before being widely available at our retailers. Skincare remains a major focus across our brand portfolio. In Q3, e.l.f. Skin consumption was up 29% compared to a category that was up 9%, propelling e.l.f. Skin into the top 20 for the first time ever. Our recently launched Pure Skin line is a three-part regimen designed to meet our consumers' daily needs. Dermatologist developed, clean, vegan, and cruelty-free, Pure Skin nurtures the skin with ingredients like oat milk and niacinamide. The Pure Skin line initially sold out on elfcosmetics.com. We also launched our W3LL PEOPLE skincare collection online this quarter. Skincare is the largest category in Clean Beauty, and we're excited to start with five plant-powered, derm-developed Clean skincare products. The line will also be available in Ulta Beauty and Target stores this spring. We're proud of the progress we're making with W3LL PEOPLE in color as well, with our top-selling products now available in more inclusive shade ranges. Our Bio Tint moisturizers and Bios Stick Foundations both now extend to 14 shades, and our Bio Concealers are available in 20 shades. We plan to further extend the W3LL PEOPLE shade ranges to bring plant-powered, high performance, clean products to a wider audience. Turning to Keys Soulcare, we innovated further in the body category with three new offerings: Melting Body Balm, Mind Clearing Body Polish, and Energizing Dry Body Brush. Our core body care products continue to be named to coveted beauty award lists. This quarter we were recognized by Pop Sugar and Refinery29. Awards included Best in Celebrity Beauty for our Rich Nourishing Body Cream and Beauty Innovator award for our Sacred Body Oil. Our fourth strategic imperative is driving productivity and space expansion with our retail partners. Productivity was strong this quarter with consumption ahead of our expectations. Consumers bought more of our core products during the holiday season in lieu of our traditional holiday kits. We're also quite pleased with our spring resets, which we're rolling out in the coming weeks. We believe our innovation is strong and our visual merchandising is more impactful than ever. We continue to see shelf space opportunities. As previously reported, we're pleased with the space expansion we've secured with CVS in the fall of 2021, and Walmart in spring 2022 in a subset of their doors. Internationally, we're expanding our shelf space with Boots and Superdrug in the U.K. this spring. International represents major whitespace at just 11% of our business today. Our performance in the U.K. gives us confidence for further geographic expansion. The latest Nielsen data ranks e.l.f. at number 8, up from number 12 last year, and continues to be the only top 10 brand to post growth. We continue to drive differentiation with our retail partners inspired by the success of last year's Mint Melt collection. And after polling our community for what they wanted next, we launched Cookies and Dreams. This is an indulgent limited edition 13-piece collection featuring cosmetics and skincare products. Cookies and Dreams will be available exclusively at Walmart in the US, at Superdrug in the UK, and in selected Douglas markets in Europe. Keys Soulcare is elevating and accelerating our global retail strategy. We've launched the brand in 10 countries to date with four major retail partners: in the US with Ulta Beauty, in the UK with Cult Beauty and H Beauty, and in eight countries across Western Europe with Douglas. We're excited to announce our newest retail partner, Sephora. We'll be launching Keys Soulcare in Sephora Canada online and in stores this spring. This marks e.l.f. Beauty's first brand entry into Sephora. We're also pleased that W3LL PEOPLE will gain its first in-line placement in a subset of Ulta Beauty stores in spring 2022. Our fifth strategic imperative is delivering cost savings to help fuel brand investments. As we spoke about in recent quarters, and like many other companies, we're facing a global container imbalance and port congestion, which is slowing shipments and increasing our transportation costs. I'm proud of the e.l.f. Beauty team for how we've navigated these challenges. Our operations team has executed with excellence, managing SKUs at the store level to sustain in-stock rates around 95%. Given the uncertainty around how long the supply chain challenges will persist and the inflationary environment, we made the decision to increase prices on the majority of our portfolio, effective mid-March. These price increases will impact approximately two-thirds of the e.l.f. Cosmetics SKUs, as well as certain items within Keys Soulcare and W3LL PEOPLE. We balanced our approach between offsetting elevated costs and maintaining our value proposition with consumers. While this round of pricing is broader than previous rounds, our opening price points on e.l.f remain unchanged, enabling us to continue to deliver high-quality products at an extraordinary value. Before I turn the call over to Mandy, I want to give an update on our clean and sustainability efforts. Both W3LL PEOPLE and Keys Soulcare were launched as clean and sustainably-minded brands. Over the past several months, our team reformulated over 350 SKUs on the e.l.f. brand. There are now over 1,650 ingredients on our do not use list. While it will take a number of months for these new formulations to roll out, we're excited to add clean to our existing superpowers. With e.l.f., consumers can have premium quality beauty products at accessible price points that are clean, vegan, and cruelty-free. On the sustainability front, we reached another milestone this quarter with Project Unicorn, eliminating more than 1 million pounds of packaging materials since launch. Project Unicorn is streamlined packaging for 500 SKUs across multiple categories. We're evolving Project Unicorn to Project Green Unicorn with a focus to eliminate even more packaging, adopt friendlier environmental practices, and explore sustainable materials. Project Green Unicorn is a long-term initiative. Our clean and sustainable practices will continue to rise in importance, and I'm glad that we're positioning e.l.f. Beauty to excel in this area. I will now turn the call over to Mandy.

Mandy Fields, CFO

Thank you, Tarang. I'm pleased to share the highlights of our strong third quarter results and raised fiscal 2022 guidance. We delivered Q3 net sales of $98 million, up 11% versus prior year, and up 20% on a two-year stack, driven by strength in our national and international retailers. Consumption was strong this quarter as well, up 17% year-over-year and up 15% on a two-year stack basis. This exceeded our expectations and is an encouraging trend as we head into the fourth quarter. Gross margin of 66% was up approximately 100 basis points compared to prior year. We saw gross margin benefits from cost savings and margin accretive mix, specifically from consumers switching away from holiday kits into higher margin core products. We also benefited from the price increases we implemented on a subset of our SKUs in May. These gross margin benefits were partially offset by foreign exchange and elevated transportation costs, which flowed through the P&L at a lesser rate than previously expected. Given the rate of flow-through on these freight costs and the overall favorable mix, we now expect gross margin for the back half to come in flat to last year. On an adjusted basis, SG&A as a percentage of sales was 50%, up approximately 70 basis points versus prior year. The increase was mainly driven by investments in marketing and digital. Marketing and digital investment for the quarter was approximately 15% of net sales, slightly ahead of Q3 last year. We continue to expect marketing and digital to come in at 15% to 17% of net sales for the year. Q3 adjusted EBITDA was $22 million, and adjusted EBITDA margin was approximately 22% of net sales. Adjusted net income was $13 million or $0.24 per diluted share compared to $12 million or $0.22 per diluted share a year ago. Our liquidity remains strong with the combination of our cash balance and access to our revolving credit facility, sitting at approximately $130 million. We ended the quarter with $33 million in cash on hand compared to a cash balance of $35 million a year ago. Our current cash balance reflects a complete pay down of our revolving credit facility, reducing our overall debt by $13 million in the quarter. Our ending inventory balance was $85 million in line with our expectations as compared to $69 million a year ago. As a reminder, last quarter, we spoke about carrying higher inventory levels due to the combination of longer lead times, higher transportation costs, the addition of Keys Soulcare and W3LL PEOPLE, and our continued business momentum. We expect our cash priorities to remain on investing behind our five strategic imperatives and supporting strategic extensions. Now let's turn to our fiscal 2022 guidance. We now expect net sales growth of approximately 17% to 19% versus fiscal 2021, up from 14% to 16% previously. We expect adjusted EBITDA between $70 million and $72 million, adjusted net income between $40 million and $42 million and adjusted EPS of $0.73 to $0.76 per diluted share. We still expect a fully diluted share count of approximately 55 million shares. And our fiscal 2022 adjusted tax rate to be approximately 22% to 23%. Our raised top-line guidance largely reflects our outperformance in Q3 relative to our expectations and an improved outlook for Q4. As Tarang mentioned, our business momentum remained strong throughout Q3, up 20% on a two-year stack basis. Despite not having most of our holiday program, we expect Q4 to look similar to Q3 on a two-year stack basis at approximately 23% growth. As a reminder, in Q4 and into Q1 of next fiscal year, we will be lapping the largest round of stimulus-related spending we've seen to date. This has implications on our net sales, as I just noted, as well as what you'll see in the Nielsen data. In the four weeks ending March and April of 2021, we posted 40% and 52% growth respectively in tracked channels, and we expect cycling those numbers to cause volatility in Nielsen data during those periods. Therefore, we're anchoring on a two-year stack comparison to better capture trends. We remain mindful of the industry-wide container imbalance and the continued elevation in cost as a result. We're proud of how our team has navigated these logistics to date, and it remains a dynamic environment. That said, given our sales momentum, we are raising our adjusted EBITDA expectations to $70 million to $72 million, up 15% to 18% year-over-year. As we discussed earlier in the call, we're taking pricing actions next month to mitigate the impact of elevated shipping costs and inflationary pressures on our financial performance, which we believe will help us as we enter fiscal 2023. We plan to provide more color on the expected impact of these pricing actions when we provide our fiscal 2023 guidance in May. This should allow time for us to better assess consumer response as it will take a few weeks for our retailers to reflect pricing in the market. Overall, we're very pleased with our Q3 results and are excited about the opportunities ahead in fiscal 2023. Our performance over the last 12 quarters, both on an absolute basis and relative to the category, demonstrates how our five strategic imperatives are driving results, and we remain confident in the long-term growth potential for our portfolio of brands. With that, operator, you may open the call to questions.

Operator, Operator

Begin the question-and-answer session. At this time, we will pause momentarily to assemble our roster. Our first question is from Andrea Teixeira with JPMorgan. Please, go ahead.

Andrea Teixeira, Analyst

Thank you. Good afternoon and congrats on your quarter both on innovation and distribution. I have a question for Tarang and another one for Mandy. First to Tarang, on the Keys Soulcare entrance in Sephora Canada, again, congrats on that. Is there a plan to expand into the US and Europe, given obviously, Alicia's strong international following? And then for Mandy, it's great to see you've raised guidance for the top line, but it doesn't flow inside the diluted EPS. We all appreciate what's happening with cost pressures and labor and distribution. Is this a function of these costs, or is it about the timing of marketing, or just being more conservative given the moving pieces ahead of you? Thank you.

Tarang Amin, CEO

Good afternoon, Andrea. On your question about Keys Soulcare, we're really pleased with the progress on the brand, including entering Sephora Canada. We have high hopes for our launch in Sephora Canada, and we definitely see Sephora US as a potential future partner. As a reminder, we are still in the exclusivity period with Ulta Beauty in the US, so we're starting with Sephora Canada. I think the prospects of additional distribution for Keys are quite bright, particularly given the level of engagement we're seeing with that brand.

Mandy Fields, CFO

To answer your question, did you have a follow-up on Keys?

Andrea Teixeira, Analyst

No. I was just saying that I will follow up if I may. Thank you, Mandy. On in-trend, how is the W3LL PEOPLE entrance on Ulta? Is that a separate shelf from e.l.f.? I'm assuming it's because it's mostly skin and it's going to be side-by-side to e.l.f. itself or is it going to be a separate display?

Tarang Amin, CEO

The Ulta distribution of W3LL PEOPLE is incremental to e.l.f. and in a different part of their store. W3LL PEOPLE have been part of the Conscious Beauty program within Ulta as a separate dedicated merchandising vehicle. This is our first in-line placement within a subset of the Ulta doors. Again, we're quite excited about that as well, given the momentum that we have on W3LL PEOPLE after our rebranding as well as the innovation program we have on that brand.

Andrea Teixeira, Analyst

Perfect. Thank you.

Mandy Fields, CFO

On the raised guidance and the flow-through on EBITDA and EPS. Essentially, we've taken our guidance up from 14% to 16% on the top line up to 17% to 19%. This amounts to roughly $9 million incremental on the top line. As for EBITDA, we've raised our guidance from $66.5 million to $68 million, up to $70 million to $72 million, thus representing a $4 million increase on the top end on EBITDA. Q3 beat was roughly $4.55 million, and so we are flowing through most of that to the full year. We feel really great about our EBITDA guidance. This translates to 15% to 18% growth on the year, even with the cost headwinds that we're seeing, so I'm really proud of that EBITDA expectations.

Andrea Teixeira, Analyst

And then regarding the Ulta exclusive, when it expires, will that exclusivity end at any time?

Tarang Amin, CEO

It will run out at a certain point. Obviously, we continue to discuss Keys Soulcare with Ulta. They've been a terrific partner and supporter as we launched the brand in the US with Ulta Beauty. I think there will be ongoing conversation. But at some point, that exclusivity will run out and we'll evaluate whether we extend or continue to expand distribution on Keys Soulcare.

Andrea Teixeira, Analyst

Okay. That's perfect. Thank you both. I'll pass it on.

Operator, Operator

The next question is from Steph Wissink with Jefferies. Please go ahead.

Steph Wissink, Analyst

Thank you. Good afternoon, everyone. We had two follow-up questions as well. The first is about pricing. Tarang, could you share your thoughts on maintaining the price gaps to prestige even with the planned price update in mid-March? Additionally, regarding space gains, could you quantify the benefits in the domestic market with CVS and Walmart, as well as internationally? I'm interested in how much these gains might contribute to the 2022 calendar year. Thank you.

Tarang Amin, CEO

Hi, Steph. On the pricing actions, we're using a very similar approach to what we used in 2019, which proved quite successful. We've gone SKU by SKU and really taken a look at those where we have the most pricing power. When you look at a lot of our range, the comparable product is a prestige product. For example, our Power Grip Primer, which I mentioned on the call, is priced at $10 while the comparable prestige item is $34. There's a significant gap there, as are many of our other core products. Our strategy involves taking many of those products up $1 each in price, while keeping our opening price point items at their current prices. We believe this focused approach allows us to maintain our strong value equation while capitalizing on pricing power. We always proceed cautiously with pricing due to our committed consumer value proposition but feel we are well-positioned for the mid-March price increase. As for the space gains, we're not quantifying the percent space gains just yet, but I can tell you that with CVS, for example, we've increased our space from a 3-foot end cap gondola to 6 and 10-foot sections. We've been pleased with the productivity of that increased space, which bodes well for future gains within CVS. Walmart is currently being set in a subset of their doors as part of their spring resets, where many of those sets will now feature 8 feet of space. Both Superdrug and Boots have also been expanding their space, so we're excited about those opportunities.

Steph Wissink, Analyst

Thank you. Very helpful.

Operator, Operator

The next question is from Dara Mohsenian from Morgan Stanley. Please go ahead.

Dara Mohsenian, Analyst

Hey, guys. Good afternoon.

Tarang Amin, CEO

Good afternoon.

Dara Mohsenian, Analyst

So, Tarang, can you spend some time discussing cosmetics category growth trends in calendar Q4? Also, I'd like an update on category growth so far this fiscal year. Any thoughts around potential risks to category growth from weaker consumer spending as fiscal support and stimulus benefits fade? And also, how might this impact e.l.f. if we do see weaker consumer spending?

Tarang Amin, CEO

I remain very bullish on the category. In Q4, I saw mixed results, where we had six weeks above pre-pandemic levels, and six weeks below. Overall, the trajectory for the category is positive, and consumer behavior reflects this. We're seeing strength across our core segments. As I mentioned, our skincare consumption for e.l.f. Skin for the quarter was up 29% versus a category that was up 9%. I believe we are well-positioned regardless of the inflationary environment, having proven our growth over the last 12 consecutive quarters regardless of category performance. My confidence is bolstered by our diverse portfolio, including e.l.f. Skin, W3LL PEOPLE, and Keys Soulcare, which provide considerable whitespace opportunities for us.

Dara Mohsenian, Analyst

Great. And then on supply chain, can you give us an update on your ability to meet demand this quarter and any forward thoughts on maintaining supply in light of high consumer demand?

Tarang Amin, CEO

I'm very pleased with our performance in the quarter. We maintained a 95% in-stock rate. Many proactive decisions earlier in the year, including scaling back our holiday kits, allowed us to focus on core items, which proved beneficial. We've raised our inventory levels to tackle longer lead times, so I feel more confident than ever about our supply situation. We are aware of the ongoing impacts of longer lead times and volatility, but I believe we can meet the strong demand we are experiencing.

Dara Mohsenian, Analyst

Great. Thanks.

Operator, Operator

The next question is from Olivia Tong with Raymond James. Please go ahead.

Olivia Tong, Analyst

Great. Thank you. First question is just around helping us understand if you can give a finer point on what drove the revenue upside this quarter and the sustainability of that over the next few quarters. Could you provide a range of the planned price increases, and have you seen any impact from Omicron on January sales or on cost and efficiencies? Thanks.

Mandy Fields, CFO

I'll start, Olivia. The revenue upside in Q3 surpassed expectations on the consumption side, with consumers shifting from our holiday kits to core products. This core business momentum has anticipatory potential for Q4. So we're optimistic regarding Q4 projections on a two-year stack basis. The price increase we'll implement in March spans about two-thirds of our portfolio, including portions of Keys and W3LL PEOPLE as well. We aim to keep our opening price points steady to preserve value for our consumers. Regarding Omicron, parsing out its effects is challenging considering various variables, but we felt its earlier impact with Delta compared to the current trend.

Tarang Amin, CEO

Moreover, our confidence stems from our strong spring innovation, notably the Power Grip Primer and the expanding Camo Foundations. Lip products are on the rise as well, particularly with our Glossy Lip Stains offering excellent value compared to prestige equivalents. While Nielsen data may show volatility due to prior stimulus-driven purchasing periods, our overall consumption trends are trending better than expected.

Olivia Tong, Analyst

Thanks. That's helpful. Given the strength of the December quarter, does this in any way shift your longer-term perspective on managing holidays in future years and the extent and nature of promotions?

Tarang Amin, CEO

We are pleased with Q3's results. This will influence our future holiday programs. While we intend to maintain some holiday kits due to consumer interest, our primary focus will be on core products. They deliver better gross margins and attract consumer interest. This will most likely be our strategy moving forward – prioritizing core products while selectively leveraging holiday kits to maintain consumer engagement.

Olivia Tong, Analyst

Great. Thank you.

Operator, Operator

The next question is from Bill Chappell, with Truist Securities. Please go ahead.

Bill Chappell, Analyst

Thanks. Good afternoon.

Tarang Amin, CEO

Good afternoon.

Mandy Fields, CFO

Hi, Bill.

Bill Chappell, Analyst

First question about W3LL PEOPLE. We've been two years into that deal, and I'm trying to understand your learnings, future expansion, and plans for future M&A. Will you focus on brands of similar size, or might you consider larger platforms? Just reflecting on these past 24 months.

Tarang Amin, CEO

We're very pleased with our acquisition of W3LL PEOPLE, a pioneer in plant-powered, clean beauty. We saw an opportunity to bring value to that brand through innovation, distribution, and marketing. We executed well, completing a rebranding and energizing the product development cycle. We've seen strong momentum since, including in clean beauty due to our expertise with W3LL PEOPLE. Regarding future acquisitions, while we're open to interest, we'd prioritize acquiring brands that complement our portfolio. We remain disciplined and selective during the evaluation process. The intention with W3LL PEOPLE was to keep it small, but future acquisitions may involve larger brands with robust potential for top and bottom line growth.

Bill Chappell, Analyst

Thanks for that insight. On supply chain, since the holidays are over and you predominantly source from Asia, do you feel that most of the supply chain risks have been mitigated? Or is there still potential for bumps over the next few months?

Tarang Amin, CEO

We're pleased with our supply chain risk management. Over the last months, we've been successful in securing container shipments. While they may come in at elevated costs, our capacity and product availability allow us to meet demand efficiently. We've worked to stabilize our supply situation to match consumer needs.

Bill Chappell, Analyst

Great. Thanks so much.

Operator, Operator

The next question is from Linda Bolton-Weiser with D.A. Davidson. Please go ahead.

Linda Bolton-Weiser, Analyst

Hi. I want more detail or quantification on the gross margin, as it was a strong performance. Can you break down what contributed to that stronger performance and whether this new level is sustainable?

Mandy Fields, CFO

Hi, Linda. In Q3, the gross margin improvement can be attributed to two key factors. Firstly, the shift from holiday products, which are lower-margin, to core products improved our year-over-year margins. Secondly, we're generally mixing better than anticipated despite the higher freight costs, not impacting the P&L as we initially expected. For the second half, we've indicated that we expect gross margins to come in flat compared to last year, which indicates slight declines in Q4 due to the absence of holiday benefits. Our outlook has improved based on favorable mix trends. As for pricing affecting gross margin, we will provide more details when presenting our fiscal '23 guidance in May.

Linda Bolton-Weiser, Analyst

Thanks! Can I ask about the top-line performance? According to your guidance, you are anticipating softer year-over-year growth in Q4 against tough comparisons. How should we generally assess this, especially considering the increased challenges in the first half of FY '23?

Mandy Fields, CFO

Focusing on Q4, we're anchoring on a two-year stack number. While it implies minor negatives for Q4, it remains robust at a 23% two-year stack. The full fiscal '22 year is expected to show strong performance with over 30% growth on a two-year stack. We will provide further insights for fiscal '23 in May, but I can state we feel optimistic about our spring innovation, especially with positive consumption signals from top-selling items.

Linda Bolton-Weiser, Analyst

Okay, thank you very much.

Mandy Fields, CFO

Thanks, Linda.

Operator, Operator

The next question is from Oliver Chen with Cowen. Please go ahead.

Joanne Manno, Analyst

Hi. Thank you for taking our questions. Just curious, e.l.f. Skin care seems to be gaining momentum. How do you balance the shelf space between skin care and cosmetics at different retailers? Also, with your expectation for marketing spend ranging from 15% to 17% for Keys Soulcare this year, do you think this is the right level going forward as you lap the Keys Soulcare launch?

Tarang Amin, CEO

We are seeing great momentum in our skincare segment. This quarter marked e.l.f. Skin's entry into the top 20 skincare brands. We manage shelf space differently per retailer – in essence, seeking greater allocations to showcase our skincare offerings. Our most developed skincare presence is with Target, wherein we’ve secured a larger footprint. As Target grants us more space, our skincare assortment expands. Incremental space has been allowed at Ulta for skincare, so we can expect more integration with our existing e.l.f. offerings.

Mandy Fields, CFO

Regarding marketing spend, we are comfortable with maintaining our 15% to 17% range. We are implementing several high ROI activations. Balancing investment in marketing and digital with EBITDA growth remains our key focus.

Joanne Manno, Analyst

Got it. Thank you!

Operator, Operator

The next question is from Jon Andersen with William Blair. Please go ahead.

Jon Andersen, Analyst

Thanks. Hi, Tarang. Hi, Mandy. Congrats on the quarter. My first question is about the elfcosmetics.com business. You mentioned that your Beauty Squad membership is up around 20% year-over-year, nearing 3 million members. Tarang, could you elaborate on how you utilize that first-party data to enhance targeting and conversion efforts?

Tarang Amin, CEO

Beauty Squad is critical for our brand. The program has grown to 2.7 million members, who account for 70% of sales on our website. The insights derived from their behaviors inform our marketing strategies – from product collaborations, such as our partnerships with Chipotle and Simon Fuller, to hashtag challenges that resonate with our audience. The engagement facilitates core brand insights to keep refining our offerings while enhancing the entire customer experience.

Jon Andersen, Analyst

That's helpful! In terms of your digital shift, I recall the digital share of your business fell to 14%, down from 16% a year ago. Are there any margin implications from this shift?

Mandy Fields, CFO

The shift to digital indeed contributes positively to gross margins. However, marketing and warehousing costs normalize that margin impact to neutral once we consider operating margins. The shift presents mostly a gross margin benefit.

Jon Andersen, Analyst

Great. That's helpful. Lastly, regarding portfolio management, how do you foresee capital allocation for brand extensions versus investments in strategic initiatives across your existing brands? Should we expect opportunistic acquisitions, or are there specific targets you intend to pursue?

Mandy Fields, CFO

Our priority remains on supporting our strategic imperatives and extensions. We've considered recent acquisition targets and will look for suitable brands to complement our portfolio. While we maintain strong organic growth across our current brands, we aren't rushing into acquisitions. Discipline is key in our evaluation process; our first priority will always be enhancing our existing capabilities.

Jon Andersen, Analyst

Well said, thank you for the clarity.

Mandy Fields, CFO

Thanks, Jon.

Operator, Operator

The next question is from Wendy Nicholson with Citi. Please go ahead.

Wendy Nicholson, Analyst

Hi. I wanted to follow up on M&A. While maintaining discipline is important, could you clarify on managerial bandwidth? Your acquisitions require management involvement. W3LL PEOPLE has taken time to ramp up; does M&A become a more central part of your strategy, or do you prefer to keep the focus on your core business to avoid losing sight?

Tarang Amin, CEO

Our core business is foremost at e.l.f. with our focus on e.l.f. Cosmetics and e.l.f. Skin. We maintain managerial attention on both. The strategic extensions require distinct brand managers, but we leverage our operational support system to manage them without losing our primary focus. W3LL PEOPLE succeeded due to supportive marketing and innovative development, and we will apply those learnings to future acquisitions while keeping e.l.f. as our priority.

Wendy Nicholson, Analyst

That makes sense. Thank you. Moving on to pricing, many years ago, you positioned your products around $3. With the brand gaining significant recognition, what flexibility do you see in adjusting prices, and if needed, how readily can you respond to maintain market share?

Tarang Amin, CEO

We maintain agility with pricing. Referring back to our 2019 price increase, we found certain items received a price hike that was too steep, and we rolled back those adjustments swiftly. This brand holds pricing power, and our strategy employs regular monitoring of consumer responses. If a SKU's price point seems excessive, we can adjust it effectively, allowing us to also keep our market share while maintaining our value perception.

Wendy Nicholson, Analyst

Thank you very much.

Operator, Operator

The next question is from Mark Astrachan with Stifel. Please go ahead.

Mark Astrachan, Analyst

Thanks, everyone. Two questions. First, could you clarify reported sales in relation to track versus un-tracked growth? Prior quarters saw your growth above scanner data, but this was below expectation even when accounting for the holiday dynamics. Can you explain the slower growth compared to scanner data this quarter?

Mandy Fields, CFO

The difference this quarter stems from last year’s positive 10% revenue growth alongside a consumption decline of 2%. Thus, anchoring on a two-year basis this quarter showed a growth of 20% concerning forecasted consumption, which was at 15%. We expect shipping and consumption to eventually align, but fluctuations between quarters occur.

Mark Astrachan, Analyst

Noted. Moving to international, is relative growth similar to what you observed last quarter?

Mandy Fields, CFO

Yes. We witnessed strong growth internationally in Q3, continuing the trend in those markets and with our customer relationships.

Mark Astrachan, Analyst

In closing, do you anticipate any sales pull forward from the pricing changes? Is that accounted for in next quarter’s guidance?

Mandy Fields, CFO

We generally don't anticipate significant pull forward from our customers, so no, we're not banking on that.

Operator, Operator

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, CEO

Thank you, everyone, for joining us today. Again, I'm so grateful to the incredible team we have at e.l.f. Beauty for delivering outstanding results. We look forward to seeing some of you at upcoming investor meetings and speaking with you in May when we'll talk about our fourth-quarter results and fiscal 2023 outlook. Thanks everyone, and take care.

Operator, Operator

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