Earnings Call Transcript - ODD Q1 2024

Operator, Operator

Good morning, and welcome to ODDITY's First Quarter 2024 Earnings Conference Call. Today's call is being recorded, and we have allocated time for prepared remarks and Q&A. At this time, I'd like to turn the conference over to Maria Lycouris, Investor Relations for ODDITY. Thank you. You may begin.

Maria Lycouris, Investor Relations

Thank you, operator. I'm joined by Oran Holtzman, ODDITY's Co-Founder and CEO; Lindsay Drucker Mann, ODDITY's Global CFO; and Dr. Evan Zhao, ODDITY's Chief Science Officer. As a reminder, management's remarks on this call that do not concern past events are forward-looking statements. These may include predictions, expectations, or estimates, including statements about ODDITY's business strategy, market opportunity, future financial performance, and potential long-term success. Forward-looking statements involve risks and uncertainties, and actual results could differ materially due to a variety of factors. These factors are described under forward-looking statements in our earnings press release issued yesterday and in our annual report on Form 20-F filed with the Securities and Exchange Commission on March 6, 2024. We do not undertake any obligation to update forward-looking statements, which speak only as of today. Finally, during this call, we will discuss certain non-GAAP financial measures, which we believe are useful supplemental measures for understanding our business. Additional information about these non-GAAP financial measures, including their definitions, are included in our earnings press release, which we issued yesterday. I'll now hand the call over to Oran.

Oran Holtzman, CEO

Thanks, everyone, for joining us today. The first quarter was once again another record-breaking quarter for us. We achieved massive scale online, growing revenue 28% to $212 million, and we did it very profitably with a 23% adjusted EBITDA margin, generating $79 million of free cash flow, a massive record cash generation quarter. We continue to deliver above our plan, beating our guidance for the first quarter on every metric. This is what we have done every single quarter since we went public and every single quarter even before that as a private company. During our IPO last summer, many investors told us that they had concerns that we would not be able to lock our enormous revenue performance in Q1 2023, where we grew more than 80%. And we tried to explain why we had full confidence in our ability to continue to grow on top of it. Now we are here today after growing 28% against that quarter, and we achieved it with record profit margin. It is further proof that the demand online for beauty is very high and that our platform allows us to capture this demand and enable profitable growth. I will provide a few data points that show the demand and the strength of our platform. Q1 2024 revenue is more than double our revenue for the first quarter two years ago. In Q1 2024, with $212 million of revenue, we delivered almost the same amount of revenue that we delivered for the full year of 2021. And Q1 2024 is more than double our revenue from Q4 2023, just a quarter before it. We have shown once again that we can manage our business up and down on a $0.10, a huge advantage for us and something almost no other business can do. We are in full control of our growth phase. This efficiency is what makes our model so attractive and profitable. And even with this growth, we don't see a ceiling. In my view, we didn't even come close to reaching our limit, and this is our strategy to ensure very strong profitable cash flow growth for many years to come. With the huge success of Q1 and the great results we have already seen in Q2 so far, we are even more confident in our outlook for the full year and raising guidance on revenue, profit, and earnings per share for 2024. I would like to take a moment to touch on our industry. Over the last couple of months, we have heard some of our competitors talk about their business slowing down. I want to be clear. We don't see any signs of slowing down on our platform, not in new users and not in existing user behavior. What we do see is that the industry is transforming, moving online and moving to science-backed products. This is a transformation that ODDITY's leading and investing a lot behind. To win in both, we believe our investment will allow us to continue winning for the long term. Our data and massive investments in our future give us high confidence in our long-term financial targets of more than 20% revenue growth and a 20% adjusted EBITDA margin. Our results in 2024 will be even stronger than this, and Lindsay will explain soon. This makes ODDITY a real outlier in our industry, growing 3 to 4 times faster than our main competitors, which means we are taking market share and strengthening our competitive advantage every day. Our rule of 40 growth algorithm is among the best at existing consumer and tech businesses, and it's a function of three powerful drivers. First, we are competing in a massive global TAM with great economics that work online while still being dominated by offering combined. Second, our huge technology advantage over incumbents or behind the curve allows us to win in the online arena, which we believe is the most important channel of the future and will make up at least 50% of the market. Third, we have proven again and again that our platform is a scaling machine; it is the power of our more than 50 million users and over 2 billion data points that we have already acquired in the past 5 years. This combination of data, technology, and category with high online demand has enabled us to consistently win across the board. It only took us a few years to scale IL MAKIAGE to be what we believe is the largest online beauty brand in North America. We scaled our second brand SpoiledChild to be the most successful DTC brand launch of all time, crossing $100 million in revenue profitability in less than 2 years. Also, in just 2 years, we scaled IL MAKIAGE SKIN to be 20% of the brand revenue in 2023, and we expect it to scale further to be 25% of the brand revenue in 2024. It is a large percentage of a massive base due to our existing color business. Our powerhouse brands, IL MAKIAGE and SpoiledChild, both had very strong results in the first quarter, and both are on track to my goal, which is $1 billion for each brand. We will scale new brands and new categories in our future. Brands 3 and 4 are being built in two large categories in beauty and wellness. We believe the opportunity is massive for each of them, and we are spending a lot of time and focus to make sure we'll capture this massive opportunity. After addressing the current trends in beauty, I want to touch on a point that many people are worried about, which is the viability of the DTC model. As we all have seen, for most DTC businesses, the more the scale, the harder and more expensive it is for them to grow. But for us, it's the opposite. The more we scale, the easier growth becomes for us. This is for two main reasons. One, because we are going with so much repeat, and the repeat compounds; repeat was over half of our sales last year, and it will be an even greater portion of our sales this year. Two, because we know so much about our users, we are able to build brands and products that we know they want and build the machine learning models to put those new brands and products in front of those users. Higher scale means more data, better conversion, and greater share of wallet. Let me give you an example of this for IL MAKIAGE. Our customers who started with us in color, but then they try skin, shop more than twice as frequently and spend more than twice as much with us over the next 12 months. This is the magic of offering multiple products into the same user base while leveraging the data and a clear example of our platform allowing us to gain a share of quality. This is why we deliver one of the best margin profiles across all DTC, even as we continue to scale and invest in future growth. So while many other DTC businesses rely on external capital to grow, we do the opposite. We have a cash balance of $252 million, which we generated with zero debt. We did 23% EBITDA margin and generated almost $80 million of free cash flow in Q1 alone. So to summarize, we are very pleased with how we delivered in Q1 and have total confidence in achieving our plans for the full year. But as I've said many times previously, what is most important for our future is not to rest and enjoy domestic margin and high growth; we are executing a long-term plan with huge investments across current and new brands, technology, vision, and of course, ODDITY LABS, where we are growing the teams massively as we speak and other domains to ensure we continue to win and build a large-cap company. With that, I will hand it to Lindsay.

Lindsay Mann, CFO

Thanks, Oran. Let's turn to our Q1 '24 results, which I will refer to on an adjusted basis. You can find a full reconciliation to GAAP in our press release. ODDITY delivered a record-breaking first quarter across the board. We grew net revenue by 28% to $212 million. This strength was driven by both IL MAKIAGE and SpoiledChild across a wide range of product categories. Last year, we talked at length about the huge preparations our teams were making to ensure we have many ways to grow in 2024, with many different levers to pull, everything tested and ready to go, and we immediately saw the benefit from this preparation as we entered the year. We quickly began to deliver results ahead of our plan. This very strong start to the quarter allowed us to once again slow the business down with full control in order to pace our growth. As is always the case for us, there were no single drivers of our strength, but a combination of so many improvements across our entire business. Just a few examples from the first quarter include getting even better in our acquisition and retention using data and our tech to segment customers, deliver personalized marketing campaigns, and curated experiences to drive several of our KPIs. Our expanded product portfolio, which Oran mentioned, allowed us to do an even better job meeting user demand at very attractive contribution margins and continued integration of computer vision into product matching and recommendation models. These are just to name a few examples. Moving down the P&L, gross margin of 73.8% expanded 284 basis points in the quarter. The gross margin beat versus our guidance was driven by specific supply chain and logistics efficiency initiatives at both brands. We delivered adjusted EBITDA of $48 million for the quarter. Adjusted EBITDA margin of 22.7% expanded 559 basis points from the prior year, driven by gross margin expansion and higher mix of repeat offset by increased investments in future growth drivers. Adjusted diluted earnings per share was $0.61 and reported diluted earnings per share was $0.53 in the period. We delivered very strong free cash generation of $79 million in the quarter, powered by our asset-light model and very strong returns on capital. And we exited the quarter with $252 million of cash, equivalents, and investments on our balance sheet with zero debt. Turning to our outlook, we remain committed to our target of over 20% revenue growth at a 20% adjusted EBITDA margin over the long term. In 2024, specifically, with our very strong start to the year, we expect to do even better than these long-term targets. We expect net revenue growth between $626 million and $635 million, which represents 23% to 25% year-over-year growth. We expect to deliver a 71% gross margin for the full year, and we expect to deliver adjusted EBITDA between $139 million and $143 million, including a significant step-up in growth investments such as LABS and our new brands. We now expect the timing of these growth investments to have a greater negative impact on EBITDA margin in the back half of the year versus the second quarter, where EBITDA margin is expected to expand. We expect full year adjusted diluted earnings per share will be between $1.57 and $1.62. Turning to the second quarter, the strong business results we saw in the first quarter continued into April, and so far in May. We're very pleased with the complexity of our growth across both brands, multiple categories, and with first orders and repeat. We continue to be very disciplined in managing our rate of growth and are proactively slowing our business down so that we do not over-deliver on our revenue and profit objectives. Given the very strong start, we expect Q2 net sales will be between $185 million and $189 million or 22% to 25% revenue growth. You can find more details on our second-quarter outlook in the press release.

Operator, Operator

Our first question is from Dara Mohsenian with Morgan Stanley.

Dara Mohsenian, Analyst

Can you give us an update on the LAB side and molecule development and what you're expecting in terms of commercialization in the rest of this year? And then looking out to next year? And then also, just a couple of months later after the last earnings call, can you give us an update on any plans for Brands 3 and 4? And any more insight you can give us there? Has anything changed on that front? And then I'll come back with one more question if that's okay.

Evan Zhao, Chief Science Officer

For those who don't remember, ODDITY LABS uses the same technology being deployed in pharma to develop higher efficacy molecules. I view the opportunity as endless, and this is why we spent so much time around it. We are building a system. We have the teams. We invest a lot in the infrastructure. It takes more time than I initially projected. It is really hard, but also building the tech in Israel six years ago was really tough for us, but we made it. It will continue to be an investment in the next three years, and we will never launch a single product from the lab without being 100% sure about its efficacy and safety. In terms of the product range of categories, they are growing in skin, especially for Brand 3, color, and hair and many other things that we are working on now. We're working with the team to ensure we have the capacity to support our pipeline and to ensure we are delivering the highest efficacy product. It means we need to transition from a research lab to a factory output model, and that is what we are doing as we speak. To achieve this goal, we are focusing on two things. Number one is massive recruitment. And number two is building a full operating system with processes and control. In terms of recruitment, our bioengineering and chemistry teams are where we spend most of our recruitment focus. Those are the teams that are doing the research and running the actual work as the development in bit-molecule screening to develop the molecules. We plan to grow the team to 75 to 100 people, mostly PhDs in the next 12 months. The second area where we focus a lot is building methodology and solidifying a complete system to ensure we maintain the highest standards in quality as we scale. We are adding protocols. We are building something very deep to ensure that we can scale it up. But at the same time, we are not letting quality take a backseat. We're adding a lot of systems nearly every month, and it is not easy. I fully believe in it, but it requires a lot of work to build it properly. But like we never tried to do something that was easy. We never follow any playbook. When we started to build the tech team and use data in Tel Aviv, we didn't have any playbook then; we started from scratch at the beginning of our journey. It's the same here. But we already have products that are ready to go. And since we don't need the growth in this quarter, we are improving again and again and using them as use cases to shape the system and build something that actually works at high scale. So I'm very pleased with where we are today. Again, it takes more time. I feel very confident that we will make it. But again, as I said in previous calls, it will be our number one focus, but it's what we don't need it for near-term growth. Second question is Brand 3 and Brand 4. Brand 3, as a reminder, is a medical-grade skin and body brand, issues like acne, eczema, and other skin issues are huge pain points for our users, and the majority of them tell us they are unsatisfied with the current solutions. In my view, the user experience out there is really poor. With Brand 3, we are building an end-to-end solution that positions us to win, in my view. This includes tools that use data, machine learning, and computer vision to deliver diagnosis and precise treatment and coaching to ensure compliance and success. As for where we are today, the team is being built. We have a strong CEO for Brand 3; Tom Amsterdam who already has a large team in place. We have completed a Brand 3 branding process and defined the identity and brand name, and that is already on track. The physical product client development of a wide range of products across OTC and prescription is in place. In terms of vision technology for diagnosis and treatment tracking, we have been working on that front for the past two years, building machine learning vision capabilities for acne diagnosis, including severity, localization, and classification. We have already built algorithms that can classify severity with 86% accuracy, and we are currently improving lesion localization accuracy from 77% to 90%. Again, this is another domain that doesn't exist in the market. We are building something from scratch. When we started two years ago working on those machine learning models, it was really tough. It was very hard to get a read. But we already have machines in place ready to go with a high degree of accuracy. So those things take time, but we believe that brand will be massive. As for the timeline, no change; still the plan is to launch it next year.

Dara Mohsenian, Analyst

And then, Lindsay, can you just give us a little more insight on the revenue upside in the quarter? Where did you come in better than expected at the brand level in terms of IL MAKIAGE versus SpoiledChild or skin versus color? How do you break it out? And was the upside more existing customer upside or new customers? Just basically looking for a bit more insight under the hood there and then implications in terms of the way you think about the business and balance of the year after that Q1 upside from a revenue perspective.

Lindsay Mann, CFO

As Oran talked about in his prepared remarks and as I mentioned as well, we're running the business well below its actual potential based on the demand we see and the strong returns we're able to get on our spending. And as a result, we're delivering very strong revenue growth, but we could be growing more than that. We actually saw that very visibly when we started the year. We basically went from no investment in new user acquisition to in January, the team came out swinging really strong. We very quickly started to see our revenue pace increase relative to the Q4 run rate, and then we also really quickly started tracking ahead of our plan. After that, we started to slow the business down again; you guys are used to us doing that by now. But we always want to make sure we're delivering guidance objectives that we know we feel with very high conviction that we'll be able to achieve and that feel bulletproof to us. So we felt strong confidence we'd be able to hit the targets of 23% to 25%. We came in a touch above. We talked about last quarter that our plan was to really land the plane on what we were delivering versus our guidance. You would not see big beats outside the beats the way we delivered last year. We want to really land the plane. And so we're thrilled with the outcome in the first quarter. And based on how Q2 has already started, and we're through a lot of it already, Q2 is going to be another great outcome for us. In terms of where the strength was, both brands did great; IL MAKIAGE had an awesome quarter; color and skin were very strong. SpoiledChild also had a really strong quarter. It was across a number of product categories. New acquisition was great. Repeat, again, very strong; our repeat is on track to be even higher as a percentage of our sales this year versus last year again. So just all around very strong outcomes.

Operator, Operator

Our next question is from Andrew Boone with JMP Securities.

Andrew Boone, Analyst

One for Lindsay and one for Oran, please. When the guidance suggests an expansion in Q2 EBITDA margins and then investment in the back half of '24, can you talk about where you're spending those dollars in the back half of the year and how we should think about that? And then, Oran, you talked earlier about a greater penetration of repeat rates for 2024. Can you help us understand the drivers of that comment? And then what you're seeing maybe at a cohort level in terms of repeat rates?

Lindsay Mann, CFO

I'll start with the first one. So yes, we have some really nice EBITDA margin expansion we had in the first quarter, we'll have it again in the second quarter. And as we talked about before, Andrew, the underlying profitability of the business is much higher than what we are printing because we want to reinvest a lot of that profitability upside into all the future growth opportunities that Oran talked about. In terms of the second quarter, in particular, in the first quarter, we have so much increase in repeat, which is a very profitable business for us. So that's really the primary driver of the EBITDA margin expansion. We're also getting great gross margin behavior on top of that as well. In terms of where we're investing, there are three big buckets for us. First of all, there's new brand development. So we're doing a lot to invest behind both Brands 3 and 4. We already have teams in place, product development trials with consumers to make sure we have the product absolutely right, prefunding as much as the launch as we possibly can in a way that's really thoughtful where we know we'll get a strong return. The second, I talked a bit about ODDITY LABS. That's a huge focus of investment for us. The teams, the infrastructure; it's a huge focus for Oran and Zhao. Right now, all that you're seeing is truly the expense portion of it impacting our P&L, but we believe the profit upside will be huge for us. This is again another massive competitive moat that we're building today alongside what we did with technology. So we think that's a great use of our capital. And then the last is technology. It continues to be the largest team in the company. We have to make sure we preserve our competitive advantage and develop new products that will increase all of our KPIs or conversion rates, satisfaction, and allow more categories to work online. So those are really the three primary areas of investment.

Oran Holtzman, CEO

As for repeat, as I mentioned before, like most D2C companies, we generate most of our revenue from repeat, and this is although we grew 28% in Q1 2024, comparing to 80% growth last year in Q1. This is why the beat is so profitable, and we continue to see the repeat percentage of revenue grow consistently. There is nothing more impactful and meaningful to the business strength than this. And, by the way, this is why you will see Q2 guidance for EBITDA margin so strong because we enjoy a lot of repeat coming from new users for Q1. Currently, the 12-month net revenue repeat rate is around 100%. This compares to less than 30% two years ago and is still getting better with every cohort. What is driving it is like three main things: number one, more repeat for the same product; number two, expanding wallet share with new products; and number three, now that we are getting cross-selling from IL MAKIAGE to SpoiledChild and into our future new brands. And where it will go, again, 100% today is already the best that I've seen in any D2C, and this is why we are profitable, but I don’t see any ceiling for that. We continue to improve the cohorts. More products and more brands that people love mean higher repeat as we use the same user base and same customer base. Ultimately, we are taking more share from others among the same user base. That's it. Lastly, I would say on repeat again, it's very hard to grow against that quarter last year while maintaining more than 30% coming from repeat, and this is what we saw. And that's why we could grow again this quarter with such strong profitability.

Operator, Operator

Our next question comes from Youssef Squali with Truist Securities.

Youssef Squali, Analyst

Two questions here, please. Lindsay, can you please talk about return rates in the quarter? And how do you see those progressing in Q2? And then Oran, maybe going back to the ODDITY LAB topic. So just trying to get a sense of when do we start seeing new products coming out of that? Should we be thinking that Brand 3 will be the official launch of the new pipeline coming out of ODDITY LABS, or have you already started infusing existing products within the two brands with some of the ODDITY LABS innovations so far? And if so, is it with the skin and color and hair?

Lindsay Mann, CFO

I'll start with the repeat rate. So we don't disclose repeat rates specifically by quarter. We were pleased with the return rates that we saw in Q1. As you know, last year in fiscal '23, return rates were lower on a year-over-year basis, and we actually expect them to be a touch lower again this year. However, in our model, we don't project return rates to continue to decline as a percentage of gross revenue, mostly because we think that's a really important investment that we have, the acquisition investment we have to push new products and expand into new categories where you'll just naturally have some threshold level of return rate. But for us, we're managing towards a contribution margin, which is most important. I will say, and I talked about in the prepared remarks how we are incorporating vision more into our matching engines, and we are actually seeing, on a like-for-like basis with vision, an improvement in return rates for the same products. And we're still in very early days here. But for example, for the first time, we can use multimodal data sets for our machine models that include vision, reviews, data around purchase rates, etc., and by putting all those things together, we can lead to an improved training set, which is now driving better models. We can also use vision during the matching process itself for the first time. Again, it's still very early days, but these improvements are allowing us to enhance our return rates.

Oran Holtzman, CEO

I will touch one thing regarding the return rate. Look, I never view it as an improvement because don't forget how we work. When I want to launch a new product or a new category, I start to train the machine learning. In order to train the machine learning, I need to see like I need to send the wrong product to the wrong person, and that’s the way that we train the machine. So if I decide to invest now in building more machine learning for new products, it means that I will have a higher return rate. But we are prepared for it, and this is not an outcome that we view negatively; that was a decision we made. So that's why paying attention to the return rates doesn't represent anything about the business. As for ODDITY LABS, for sure, you will see it in Brand 3; we will start to do things even before that when we need to. Just to be clear, if we wanted or needed products out there in the market, they would have been ready for B1, and in some projects even B2 already. But we are already pacing the growth without it; so I didn't need to launch it. For new products, I don't need 50 or 100 paid days in Boston, and I don't need to spend my time or my team's time there. We build ODDITY LABS to create something that never existed before, and we want to take the business 5 or 10 times larger. Therefore, if we don't need it, I am not putting any pressure on it; but I do put a lot of pressure on higher efficacy in terms of products and very high protocols. So if we need products beforehand, we will start launching them to see the reactions, but a meaningful wave should come with Brand 3.

Operator, Operator

Our next question is from Lauren Lieberman with Barclays.

Lauren Lieberman, Analyst

Notwithstanding what you said earlier about return rates and the service as part of the process. I was just curious if you're seeing any pickup in return activity as we're in a tougher consumer environment, where consumers are reallocating their spending and making different decisions. So any uptick in that type of return rate? And then also any change in the mix in terms of demographics of your consumers. That was my first section of questions.

Oran Holtzman, CEO

Look, I almost think that people want me to say that we see softness. But the answer is no. It looks like we were trying to collect as much data as we can internally, learning the core, running them and analyzing their return behavior, learning the repeat, and we didn't see softness; we see the same metrics, and in terms of acquisition, we didn't see any problem acquiring new users at a high scale this year, again, although the consumer is a bit more challenging based on what we heard from others. So no, the answer is no. So far, so good.

Lindsay Mann, CFO

I'll just add on to that, Lauren. So I think it's really important to remember that, first of all, we are tiny in a huge market. And number two, our demographic is expansive, okay? So if you look at our customer base across the United States, we are almost evenly aligned with that distribution. We have a big portion of our customers that are under 30, a significant portion that are over 50, and another big portion in between. We service upper, middle, and lower-income brackets. We see people trading in from luxury brands into our categories. We see them trading from competitors, enabling. And it's important to remember that we are dominating what we believe is the most important and will be the largest channel in beauty, and we're really alone in acquiring customers at scale in this channel. So you really wouldn't see it here; I guess, is the punchline.

Oran Holtzman, CEO

One that Q1 '24 comparing to Q1 '23, return rates were better this year. So again, to your question, we don't see it.

Lauren Lieberman, Analyst

And then second thing was just on the decision and timing on new launch activity, and around very consistent what you said this quarter is what you said last about the timeline for launching products from LABS. But one of my questions was if some of these products have such demonstrable efficacy and improved quality versus anything in the market, why wouldn't you be looking to launch, to raise the profile, like Lindsay said, you're tiny, but raise the profile, raise the word of mouth that exists around some of your products. So if you've got things that work better than anything else, why wouldn't you want those in the market sooner rather than later?

Oran Holtzman, CEO

Because I want to be sure 100% that it is way better than others. That's my honest answer. I want to make sure that we have a system that is very strong. We built protocols. We ensure that, again, we are doing it for the first time. I don't want to go to market when I don't need it with something that is better but slightly better. I want to go with products that are significantly better, and it takes time.

Operator, Operator

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to Oran Holtzman for closing remarks.

Oran Holtzman, CEO

Thank you very much, guys. See you next quarter. Have a good day.

Operator, Operator

Thank you. This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.