Yum! Brands Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 8, 2024

There are 8 speakers on the call.

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 and A. At this time, I'd like to turn the conference over to Maria Lycouris, Investor Relations for Audity. Thank you. You may begin.

Speaker 1

Thank you, operator. I'm joined by Eran Holtzman, Audity's Co Founder and CEO Lindsay Drucker Mann, Audity's Global CFO and Doctor. Evan Zhao, Audity'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 Audi's business strategy, market opportunity, future financial performance and potential long term success.

Speaker 1

Forward looking statements involve risks and uncertainties and actual results could differ materially due to a variety of factors. These factors are 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.

Speaker 1

I'll now hand the call over to Eran.

Speaker 2

Thanks, everyone, for joining us today. The Q1 was once again another record breaking quarter for us. We achieved massive scale online, growing revenue 28 percent to $212,000,000 and we did it very profitably with 23% adjusted EBITDA margin generating $79,000,000 of free cash flow, a massive record cash generation quarter. We continue to deliver above our plan, beating our guidance for the Q1 on every metric. This is what we have done every single quarter since we went public and every quarter even before that as a private company.

Speaker 2

During our IPO last summer, many investors told us that they had concerns that we would not be able to lock our Innovus revenue performance in Q1 2023, where we grew more than 80%. And we try 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 another proof that the demand online for beauty is very high and that our platform allow us to capture this demand and enable profitable growth. I will provide a few data points that shows the demand and the strength of our platform.

Speaker 2

Q1, 2024 revenue is more than double our revenue for the Q1, 2 years ago. In Q1, twenty twenty four, with $212,000,000 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 power our business up and down on a dime, a huge advantage for us and something almost no other business can do. We are in full control of our growth base.

Speaker 2

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.

Speaker 2

Over the last couple of months, we have heard some of our competitors talk about their business slowing. I want to be clear, we don't see any signs of slowing down in 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 product. This is a transformation that Audity is leading and investing a lot behind it. To win in both, we believe our investment will allow us to continue winning for the long term.

Speaker 2

Our data and massive investments in our future gives us high confidence in our long term financial targets of more than 20% revenue growth and 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 4 d growth algorithm is among the best that exists in consumer and tech businesses and it's a function of 3 powerful drivers. First, we are competing in a massive global TAM with great joint economics that work online, while still being dominated by offline incumbents.

Speaker 2

2nd, our huge technology advantage over incumbents while behind the curve allow 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. 3rd, we have proven again and again that our platform is a scaling machine. It's the power of our more than 50,000,000 users and over 2,000,000,000 data points that we already acquired in the past 5 years. This combination of data, technology and category with high online events has enabled us to consistently win across the board. It only took us a few years to scale in Makayashi to be what we believe is the largest online beauty brand in North America.

Speaker 2

We scaled our second brand spoil child to be the most successful D2C brand launch of all time, crossing $100,000,000 in revenue, profitably in less than 2 years. Also in just 2 years, we scaled HilmaCare's 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 25% of a massive base due to our existing color business. Our powerhouse brands, Ilmakias and Spoelchial both had very strong results in the Q1 and both are on track to my goal, which is $1,000,000,000 for each brand. We will scale new brands and new categories in our future.

Speaker 2

Brands 34 are being built in 2 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 D2C model. As we all have seen from most D2C businesses, the more the scale, the harder and more expensive it is for them to grow. But for us, it's the opposite.

Speaker 2

The more we scale, the easier growth becomes for us. This is for 2 main reasons. One, because we are going with so much repeat and that repeat compounds, repeat was over half of our sales last year and it will be even a greater portion of our sales this year. 2, 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 scales means more data, means better conversion and greater share of wallet.

Speaker 2

Let me give you one example of this for Kila Macias. 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 offering multiple products into the same user base while leveraging the data and a clear example of how our platform allow us to gain share of wallet. This is why we deliver one of the best margin profiles across all D2C even as we continue to scale and invest in future growth. So while many other D2C businesses rely on external capital to grow, we do the opposite.

Speaker 2

We have a cash balance of $252,000,000 which we generated 0 debt. We did 23 percent of EBITDA margin and generated almost $80,000,000 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 is our future. We do not rest and enjoy the massive margin and high growth.

Speaker 2

We are executing a long term plan with huge investments across current and new brands, technology, vision and of course, Audity Lab, 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.

Speaker 3

Thanks, Aran. Let's turn to our Q1 2024 results, which I will refer to on an adjusted basis. You can find the full reconciliation to GAAP in our press release. Oddity delivered a record breaking Q1 across the board. We grew net revenue by 28% to $212,000,000 This strength was driven by both IlmaQiyage and Spoiled Child across a wide range of product categories.

Speaker 3

Last year, we talked at length about the huge preparations our teams were making to ensure we have many ways to grow in 2024, 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.

Speaker 3

Just a few examples from the Q1 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 a number of our KPIs. Our expanded product portfolio, which Aron mentioned, it 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 and L, gross margin of 73.8 percent expanded 284 basis points in the quarter.

Speaker 3

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 $48,000,000 for the quarter. Adjusted EBITDA margin of 22.7% expanded 559 basis points from the prior year, driven by gross margin expansion and a higher mix of repeat, offset by increased investment 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 $79,000,000 in the quarter powered by our asset light model and very strong returns on capital.

Speaker 3

And we exited the quarter with $252,000,000 of cash equivalents and investments on our balance sheet and 0 debt. Turning to our outlook. We remain committed to our targets of 20% plus 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 6.26 $1,000,000 $635,000,000 which represents 23% to 25% year over year growth.

Speaker 3

We expect to deliver 71% gross margin for the full year and we expect to deliver adjusted EBITDA between $139,000,000 $143,000,000 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 Q2 where EBITDA margin is expected to expand. We expect full year adjusted diluted earnings per share will be between $1.57 1 point $2 Turning to the Q2, the strong business results we saw in the Q1 continued into April and so far in May. We're very pleased with the complexion 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.

Speaker 3

Given the very strong start, we expect Q2 net sales will be between $185,000,000 $189,000,000 or 22% to 25% revenue growth. You can find more details on our Q2 outlook in the press release. And with that, operator, we're ready to take questions. We also have Doctor. Evan Zhao on the line to answer

Operator

Our first question is from Dara Mohsenian with Morgan Stanley.

Speaker 4

Hi, guys. Can you give

Speaker 5

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 34 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.

Speaker 2

Sure. Hi, Dara, Oren Altman. Thanks for the question. For those who don't remember, OIT Labs use the same technology being deployed in pharma to develop higher efficacy molecules. I view the opportunity as endless.

Speaker 2

This is why we spend so much time around it. We are building system. We grow the teams. We invest a lot in the infrastructure. It takes more time than I initially projected.

Speaker 2

It is really hard, but also building the tech in Israel at 6 years ago was really tough for us, and but we made it. It will continue to be an investment in the next 3 years and we will never launch a single product from lab range of categories, including skin, especially for brand color and hair and many other things that we are working on now. We are 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 this is what we do as we speak. To achieve this goal, we are focusing on 2 things.

Speaker 2

Number 1 is massive recruitment and number 2 is building a full operating system with process and control. In terms of recruitment, bioengineering and chemistry team are where we spend most of our recruitment focus. Those are the teams that are doing the research and running the actual lab work as the development in vitro molecule screening to develop the molecules. We plan to grow the team to 75 to 100 people, mostly PhDs in the next 12 months. 2nd area where we focus a lot is building methodology and solidization, a complete system to ensure we remain the highest standards and quality as we scale.

Speaker 2

We are adding protocols. We are building something again very deep to make sure that we can scale it up, but at the same time, we are not letting quality be secondary. We are adding a lot of systems there, my sister and I there almost every month. And it's not easy. I fully believe in it, but it requires a lot of work and to build it properly.

Speaker 2

But like we never tried to do something that was easy. We never followed any playbook. And when we started to build the tech team and the data usage in Tel Aviv, we didn't have any playbook there and we started from scratch. The beginning before start, it's the same here, but we already have products that are ready to go. Since we don't need the growth in like in this quarter, we are improving again and again and using them as use cases to shape the system and to build something that actually works at high scale.

Speaker 2

So I'm very pleased with where we are today. Again, it takes more time. I feel very confident that we'll make it. But thank God, as I said in the previous calls, like it will be our number one focus, but it's what we don't need it for the near term growth. And second question is Brand 3 and Brand 4.

Speaker 2

Brand 3, as a reminder, is a medical grade skin and body brand. It should 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 solution. In my view, the user experience out there is really bad. With Brand 3, we are building an end to end solution that position us to win in my view. This includes platform that uses data, machine learning, computer vision to deliver diagnosis and a precise treatment and coaching to ensure compliance and success.

Speaker 2

As well we are today, the team is being built. We have a strong CEO for Brand 3, Tom Amsterdam, who's already has a large team. We completed Brand 3 branding process and with defined identity and brand name not like that is already on track. Physical product line development of wide range of product across OTCM and prescription product is in place. In terms of vision technology for the diagnosis and treatment tracking, we are working on that front for the past 2 years and building a machine learning vision capabilities for accident diagnosis including severity and localization and classification.

Speaker 2

We have already built algorithm that can classify severity with 86% accuracy we are currently improving the Legend localization accuracy from 77% to 90%. Again, it's another domain that doesn't exist in the market. We are building something from scratch. When we started 2 years ago, build like working on those machine learning, like it was really tough. It was very hard to get like to get a read, But we already have machines in place ready to go with very high accuracy.

Speaker 2

So those things take time, but we believe that Brent will be massive. As for timeline, no change, still plan to launch it next year.

Speaker 5

Great. That's helpful. 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 the Il Bakiage versus Spoiled Child or Skin versus Color, however you break it out? And was the upside more existing customer upside or new customers?

Speaker 5

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? Thanks.

Speaker 3

Great. Thanks, Sarah. So as, Arun talked about in his prepared remarks and 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. And we actually saw that very visibly when we started the year.

Speaker 3

So 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 4Q run rate, and then we also very quickly started tracking ahead of our plan. And after that, we started to slow the business down again, and 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 are things that we feel with very high conviction that we'll be able to achieve on, and that feel bulletproof to us. And so we felt strong confidence we'd be able to hit the targets of the 23% to 25%.

Speaker 3

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, huge beats, outsized beats the way we delivered last year. We want to really, really land the plane. And so we're thrilled with the outcome in the Q1.

Speaker 3

And based on how 2Q has already started and we're through a lot of it already, 2Q 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. Spoiled Child also had a really strong quarter.

Speaker 3

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 outcome.

Speaker 5

Great. Thank you.

Operator

Our next question is from Andrew Boone with JMP Securities.

Speaker 4

Good morning and thanks so much for taking the questions. One for Lindsay and one for Ron, please. Lindsay, guidance suggests an expansion in 2Q EBITDA margins and then an investment in the back half of 'twenty four. 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, Ron, you talked earlier about a greater penetration of repeat rates for 2024.

Speaker 4

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? Thanks so much.

Speaker 3

I'll start with the first one. So yes, we have some really nice EBITDA margin expansion. We had it in the Q1. We'll have it again in the Q2. 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, Arun talked about.

Speaker 3

In terms of the Q2 in particular and the Q1, we have so much increase in repeat, which is 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's 3 big buckets for us. First of all, there's new brand development.

Speaker 3

So we're doing a lot to invest behind both Brands 3 and Brands 4. We already have teams in place, product development, trials with consumers to make sure we have the product absolutely right, pre funding as much of the launch as we possibly can in a way that's really thoughtful where we know we'll get a strong return. The second, Aran 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 Aran and Sharon.

Speaker 3

And right now, all that you're seeing is truly the expense portion of it impacting our P and L, but we believe the profit upside will be huge for us. And this is, again, another massive competitive moat that we're building today alongside what we do 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.

Speaker 3

We have to make sure we preserve our competitive advantage and develop new products that will increase all of our KPIs or conversion or satisfaction and allow more categories to work online. So those are really the 3 primary areas of investment.

Speaker 2

Hey, 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 business 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.

Speaker 2

Currently, 12 months net revenue repeat rate is around 100%. This compares to less than 50% 2 years ago and still getting better every cohort. What are driving it is like 3 main things. Number 1, more repeat for the same product. Number 2, expanding wallet share with new products.

Speaker 2

And number 3, now that we are getting cross selling from Ilmakias to spoil child in the future new brands. Where it will go? Again, 100% today, it's already the best that I've seen in Energy to see and this is why we are profitable, but I didn't see any ceiling for that. We continue to improve the cohorts. More products and more brands that people love means higher repeat as we use the same user base and same customer base.

Speaker 2

And basically, we are taking more share from others under the same user base. That's it. Lastly, I would say about repeat again, very hard to grow against that quarter last year with having still more than 50% coming from repeat. And this is what we saw, and that's why we could grow again this quarter with such strong profitability. Thank you.

Operator

Our next question comes from Youssef Squali with JUWIS Securities.

Speaker 4

Hi, thank you. Good morning. Two questions here, please. Lindsay, can you please talk about return rates in the quarter and kind of what's how do you see those kind of progressing in Q2? And then, Oren, maybe going back to the Audity Labs topic.

Speaker 4

So just trying to get a sense of when do we get when do we start seeing new products coming out of that? Should we be thinking that brand number 3 will be kind of the official kind of launch of the new pipeline coming out of Audity Labs? Or have you already started kind of infusing existing products within the 2 brands with some of the Audity Labs innovation so far? And if so, is it in skin, is it in color, is it in hair? Thanks.

Speaker 3

Charles, starting the repeat rate. So we don't disclose repeat rates specifically by quarter. We were really pleased with the return rate. We were very return rate that we saw in Q1. As you know, last year in fiscal 2023, return rates were lower on a year over year basis.

Speaker 3

I would actually expect them to be a touch lower again this year. However, we have no 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, a way 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 actually are seeing on a for like basis with vision, improvement in return rates for the same products. And there's we're still very early days here.

Speaker 3

But for example, for the first time, we can use multimodal data sets for our machine models that includes vision, reviews, data around purchase rates, etcetera. And 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 things are allowing us to improve on our return rates.

Speaker 2

I will touch one thing regarding the return rate. Look, I never view it as 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 say like I need to be wrong. I need to send the wrong product to the wrong person and then and that's the way that we train the machine.

Speaker 2

So if I decide to invest now in building more machine learning for new products, it means that I will have higher return rate, but like that's like we are prepared for it and this is not an outcome. That's like it was our decision. And so that's why like just like pay attention to the return rate doesn't represent anything about the business. As for Odyssey Labs, for sure you will see it in Brand 3. We will start to do things even before that when we need.

Speaker 2

Just to be clear, if we wanted or needed products out there in the market, they would have been ready. V1 in some projects and even V2 already, but we are already pacing the growth without it. So I didn't need to do it. I don't for new products, I don't need 50 or 100 PhDs in Boston. And I don't need to spend my time there or insurance time there.

Speaker 2

We build labs to build something that never existed before. We build labs to take the business 5 or 10x. And therefore, another year, another quarter, if I don't need it, like I'm not putting pressure. I do put a lot of pressure around way higher efficacy in terms of products and very high sales through protocols. So if we need before we will launch it, probably we will start launching product to see the reaction, but a meaningful wave should come with the Brantree.

Speaker 4

All right. Thank you. Thank you, both.

Operator

Our next question is from Lauren Lieberman with Barclays. Ms. Lieberman, your line is live in conference. Our next question is from Lorraine Hutchinson with Bank of America.

Speaker 6

Hi, this is Melanie on for Lorraine. Thanks for taking our question. I wanted to talk about the marketing strategy that you guys implemented in 1Q. Just how that looked versus prior years and that it drove such a strong start to the quarter that you ended up pulling back a bit? Just any context on that strategy?

Speaker 2

Thanks. Same strategy. We've put a lot of attention in Q1 for new user acquisition. That's how we did historically. Acquisition environment was very favorable for us.

Speaker 2

And you can see that in the strong margin that we just printed, again, we grew with new users and without damaging improving them and the EBITDA margin went from 17% to 23% from Q1 to Q1. We are we have very different approach from other companies, which make us more efficient. We use a lot of data. We're acquiring users. We're not acquiring customers.

Speaker 2

And therefore, when we hear a lot of like problems around acquisition with other companies, we still continue to acquire at very high scale new users at very strong metrics. Next question please.

Operator

Our next question comes from Javier Escalante with Evercore.

Speaker 7

Hi, good morning, everyone. Oren, Lindsay, how are you? I'm kind of new, so would like to explore your business model a little bit better. It's proving it's quite idiosyncratic. It's proving advantage.

Speaker 7

In our neck of the world, dollars 200,000,000 per quarter is quite a scale and you did it very rapidly. So two part for me. I guess, Lindsay, if you could give us some more color on the repeats, if you have it. Was it particularly in Il Maquias, whether it was it led by new product launches or repurchase of so called hero products or your best sellers? And then I have a follow-up to Orin.

Speaker 3

Sure. Repeat rates continue to be very strong. We talked about last year it was more than 50% of our revenue and in 2024 it will be even higher. In terms of 12 month net revenue repeat rate, we've talked about this 100%. So in other words, for a year ago, all of our first customers spent $100 Over the next 12 months, they spent an additional $100 And as far as we know, this is by far the highest repeat rate, 12 month net revenue repeat rate of any DTC certainly that we've seen.

Speaker 3

We have no specific plans to increase that higher because it's a huge rate, but we haven't yet found a ceiling. And of course, as we continue to add new brands and new products to the mix and we're gaining more share of wallet from the same user base, that will grow. Iran had a really important data point that we disclosed for the first time on this call, which is what happens when we add skin to Il Makiage. So as you know, we had no skin business a couple of years ago, and now it's 20% of our revenue as of 2023, and it's on track to be 25% for 2024. And Javier, I know based on the industry you cover that you understand how hard it is for a beauty brand to actually expand into skin.

Speaker 3

And when we started, everyone told us it wasn't possible. And yet here we are with a huge color business and now skin on track to be 25%. What Aran talked about was for our customers who came into us through color, they were previously color purchasers, but then they try skin, over the next 12 months, they're shopping with twice as much frequency and they're spending twice as much as our other customers. And it just goes to show you the power of the ability to know who our user is, use that data to create products that she wants, have the machine models based on that data to put them in front of her to drive transaction, drive frequency. Obviously, with the retreat, we get a lot of profitability at very high incremental margins.

Speaker 3

So we certainly saw great trends again for Il Makiage. And for Spoiled Child, that portfolio is set up to be a great repeat business. And so on a standalone basis, we're seeing very strong repeat behavior at Spoiled Child again. And then at the oddity level, it all compounds together to lead to overall better repeat.

Speaker 2

Because it's the same user, same user, same customer. We started with offering them color, few products in color for him a few eyes, then we added more color products, then we added skin, then we added spoil child, building this brand for her. So that's why it's compound that's why it continued to grow. By the way, it grows both for quality level, but also for image and for spoilage turnaround business.

Speaker 7

Now yes, this is all very impressive, and I like the fact that you kind of like link it back to the business model that is so unique. But Oren, more strategically and in the context of your business model and your solid repeat and new users at a time when traditional companies spoke of a market deceleration. So going forward, there is going to be changes in digital marketing. So do you expect your business model to prove as advantage or even more advantage relative to your beauty peers if and when programmatic advertising or cookies go away as people there is this rumor? Thank you.

Speaker 2

Thank you, Javier, and welcome. Look, I cannot answer it. The only thing that I can say that when iOS 14 took place, most of my competitors had really like bad quarters trying to navigate and we didn't see any problem. I think the main reason is because we use data and the main reason and the second main reason because we are not acquiring customers. Actually, I'm not acquiring revenue, okay?

Speaker 2

I'm acquiring users, then I'm enriching the data, then I'm building products and I'm converting them based on what I believe is the best thing for them. And the biggest question if people continue to use like social media and search, and I believe it's going to grow. Every year, we have more people on those platforms. So as long as they are there, I don't see any problem.

Speaker 7

So conceptually, you are basically personalizing beauty products to your existing user base? That's kind of like the secret sauce, if you will.

Speaker 2

Learning a lot about them, trying to understand what is missing in their routine, building machine learning models that actually can work to send the right product for them and then matching it with the right physical product to send them because at the end of the day, you can have all the technology in the world, but if you don't have very strong beauty products that matches them and they are happy with, and then they will return and the repeat will not be high. So continue to increase our machine learning capabilities, but at the same time continue to add more and more products for those users who did not convert 3 or 4 years ago. That's why the business continued to be so strong because we have such strong and large user base from that we built in the past 5, 6 years. One last thing that I would say, building a business like this today would be way harder because every day market is getting more expensive and to acquire 50,000,000 users today would cost 4th gen and like again, this is an advantage that we had as a first mover. Good stuff.

Speaker 2

Thank you so much. Thanks a lot Javier.

Operator

Our next question is from Lauren Lieberman with Barclays.

Speaker 3

Hey, thanks. Sorry about this before. My phone was on mute. Ora notwithstanding what you said earlier about return rates in certain respects part of the process, I was just curious, if you're seeing any tick up in return activity as we're kind of in a tougher consumer environment, an environment where consumers are reallocating their spending and making different decisions. So any uptick in that type of, if you will, return rate?

Speaker 3

And then also any change in the mix in terms of demographics of your consumers? That was my first section of questions.

Speaker 2

Sure. Hi, Ryan. Look, I almost think that people want me to say that we see softness, but the answer is no. Look, like we were trying to get as much data as we can internally, learning the corporate, learning the return at behavior, learning the repeat and we didn't see softness. We see the same metric.

Speaker 2

In terms of acquisition, we didn't see any problem acquiring new users at the high scale this year again, although the consumer is a bit more challenged based on what we hear from others. So no, the answer is no. So far so good.

Speaker 3

Okay. Let me 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 2, our demo is expansive, okay? So if you look at on a state basis across the United States, we are almost evenly perfectly aligned with that distribution.

Speaker 3

We have a big portion of our customers that are under 30, a big portion that are over 50, a big portion that are right in the middle. We service upper, middle and lower income. We see people trading in from luxury brands into our categories. We see them trading from CoverGirl and Maybelline. And it's important to remember like 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.

Speaker 3

So you really wouldn't see it here, I guess is the punch line.

Speaker 2

One last thing. Q1 2024 compared to Q1 2023, return rates was better this year. So again, to your question, we don't see it.

Speaker 3

Okay, great. And then second thing was just on the decision and timing on new launch activity. And Elan, it's very consistent what you said this quarter is what you said last about 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, let alone versus what you've already got in the market, why wouldn't you be looking to launch, right, to raise the profile? Like Lindsay said, you're tiny, but like raise the profile, raise the word-of-mouth that exists around some of your products.

Speaker 3

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?

Speaker 2

Because I want to be sure 100% that it's way better than others. Okay? That's my honest answer. I want to make sure that we have a system that is very strong. We build protocols.

Speaker 2

We make sure 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 way better and it takes time.

Speaker 3

Okay. I appreciate that. Thank you so much guys.

Speaker 2

Thank you.

Operator

Our next question is a follow-up from Dara Mohsenian with Morgan Stanley.

Speaker 5

Hey. So Lindsay, we're more focused on the top line side, but gross margins are really notable in Q1 at record levels. It looks like you're expecting a solid Q2, but that implies the back half will decelerate sequentially and on a year over year basis. So just trying to understand that implied guidance for the back half, perhaps it's just conservatism, but help us understand the pacing of gross margins as we go through the year. And I'm just wondering if that has implications for the out years, the back half or how we should think about that?

Speaker 5

Thanks.

Speaker 3

Sure. Thanks for the question, Dara. So just as a reminder in terms of how we build our brands and our product launches, we really focus on gross margins last. We're going to make sure, number 1, we have the absolute best performing product. We're going to make sure that we're building, an experience that's going to drive the right kind of customer satisfaction, the right kind of return rates that we're going to sort of optimize for all our KPIs.

Speaker 3

We're then going to see if it scales, if we can scale it and it's only after we achieve those that we go back to solve for gross margins. We know that there's a threshold gross margin level achieved, but in the beginning, we're not at all focused on delivering it. So for example, the spoiled child early on, we were air freighting everything. And now obviously we're much, much better at inventory planning and we're much more scaled, so we're able to extract cost efficiencies. And the same thing goes for Il Makhij.

Speaker 3

The team has done an awesome job going back across the supply chain and picking low hanging fruit candidly that we had in order to and it's delivered more gross margin improvement than we expected. The truth is though that as an organization, we are not focused O'Cros margin is not a KPI that we are focused on. We are focused on contribution margin. And so if we're making a trade off where gross margins are lower, but frequency and repeat are higher, we're very happy to make that trade off as long as we're meeting our contribution margin and EBITDA margin targets. We're already several quarters into the kind of cost optimization that you saw that drove us for the last few quarters in terms of gross margin.

Speaker 3

We start to lap that benefit. And again, we always want to make sure we're delivering targets that we're not ever going to miss. We feel very confident in the gross margin targets that we've laid out. Remember, certain products for ours have lower gross margin profile than others. And if we opt to mix more into those, you're going to see gross margins the complexion of gross margin change.

Speaker 3

And so we've laid out as targets that we believe are achievable. We feel very confident in them. And we're sort of towards the end of that big tailwind from cost optimization you saw earlier.

Speaker 5

Great. That makes sense. Thanks.

Operator

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

Speaker 2

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

Operator

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

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Earnings Conference Call
Yum! Brands Q1 2024
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