The Beauty Health Company

Good afternoon and welcome to the Beauty Health Company third quarter 2023 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. Please note, this event is being recorded. I would like now to turn the conference over to Norberto Aja, Investor Relations. Please go ahead.

Thank you, operator, and good afternoon, everyone. Thank you for joining us today to discuss the Beauty Health Company's third quarter 2023 financial results, which we released this afternoon and can be found on our website at beautyhealth.com. With me today are Beauty Health's board member and incoming interim chief executive officer, Marla Beck, and our chief financial officer, Mike Monahan. Today's call will not include a Q&A session. though management will be available afterwards for any follow-up questions you may have. Before we begin, I would like to remind you of the company's safe harbor language. Management may make forward-looking statements including guidance and underlying assumptions, forward-looking statements that are based on expectations that involve risk and uncertainties that could cause actual results to defer materially. Listeners are cautioned not to place undue reliance on any forward-looking statements. For further discussion of risks related to our business, please see our filings with the SEC. This call will present non-GAAP financial measures. A reconciliation of these non-GAAP measures to the most comparable GAAP measures can be found in our earnings press release filed with the SEC today and available on our website. With that, I would now like to turn the call over to Marla. Please go ahead.

Thank you, Norberto, and thank you everyone for joining us on the call today. Before I start, on behalf of the board, I would like to thank Andrew for his leadership and commitment to beauty health. I look forward to partnering closely with him during this transition period. I'm excited to join beauty health as the interim CEO. For those of you who do not know me, I've spent my entire career in the beauty and wellness space. notably as CEO of Blue Mercury for 22 years. I founded Blue Mercury in 1999 and built the company from zero to a strategic sale to Macy's in 2015, after which I ran Blue Mercury as a division of Macy's for six years under both Terry Lundgren and Jeff Gannett. My focus has always been on building high growth, profitable, enduring companies with an acute focus on the customer, high-performing teams, and operational excellence. I look forward to bringing this skill set to Beauty Health and working with the team to drive revenue, profit, and build an enduring company while delivering long-term value to our shareholders. I'm confident my experience will serve Beauty Health well in addressing current challenges while delivering on the many opportunities ahead of us. Since joining the board, it has become evident that Hydrofacial's ability to engage and attract consumers is differentiated within the aesthetics place, where consumers are more likely to know about generic treatments like fillers or laser rather than a specific treatment brand name. Regularly, providers report that their decision to buy a device is in part because their clients ask for a Hydrofacial treatment by name. This represents a significant competitive advantage for beauty health. My focus is to protect Hydrofacial's incredible brand equity and to address provider experience challenges with Sundeo, Hydrofacial's newest generation delivery system. While we can all acknowledge that many mistakes were made with regard to Sundeo, we always put our customers first. As a result, we are taking some tough actions this quarter to do the right thing. Once we work through these, we can again go back to empowering the team to continue to drive our revenue and capitalize on our substantial growth opportunities. I am a believer in beauty health's current strategy to capitalize on the blue sky potential in front of us and welcome the opportunity to execute on our vision. With that, I will turn the call over to Mike to discuss the quarter's performance.

Thank you, Marla. And thank you everyone for joining us today. I also want to thank Andrew for his service. Even though we have only worked together for a short time, I came to know him as a passionate and dedicated leader and wish him the best in the future. Today we released a significant amount of information, so I'd like to state a few things up front. First, our recent financial performance is not acceptable. The board and management are committed to delivering future value for our shareholders and have taken steps to position the company for long-term future success. Second, we did not take the decision to impair our earlier generation delivery systems lightly. Our longstanding provider relationships play a critical role in our continued success. Nearly half of the devices we sold in the past nine to 11 years are still active. Providing reliable products and services is always our primary goal. and the decisions we made this quarter protect our customers and the Hydrafacial brand. Third, our recent performance is largely a result of provider experience issues with Sundeo in the U.S. We have taken the learnings to avoid any similar issues in the future. We want to be very clear that the impact applies only to providers who use Sundeo 1.0 or 2.0 delivery systems. there was no impact on the safety or efficacy of the hydrafacial treatment. We believe our latest generation, Sundeo 3.0, provides the best experience for our providers. Fourth, we believe the fundamentals of our business and future opportunity remain strong. The issues we face are executional in nature, not strategic. On the system side, it's important to highlight that our products are accessibly priced relative to other medical devices lowering the barrier to entry for providers. In addition, the economics of hydrafacial to the provider are extremely compelling, with an average system payback period of under six months. Our business is a razor, razor blade model, with our consumable segment representing a growing, predictable, long-term, and high-margin recurring revenue stream. Even with the Sandeo disruption, overall consumable sales grew 17% year over year. As we continue to grow our delivery system install base and put the Zendaya issues behind us, we expect to see further acceleration in our consumables business. We have a tremendous runway to grow domestically and overseas. Despite challenges with U.S. delivery system sales this quarter, China continued its high growth at plus 79% or plus 98% year to date and continues to have strong average selling prices positioning the Asia-Pacific region for continued long-term profitability. In the upcoming quarters, our goal is to execute with a simpler structure to meet the high expectations of our providers, customers, and shareholders. The first step in this process will be delivering on both phases of our committed strategic transformation program. Fifth, Our balance sheet and liquidity remains strong, and we are positioned to make it stronger with the strategic transformation program we are undertaking. We ended the third quarter with $559 million of cash and have access to an undrawn $50 million credit facility. As a member of the management team, I can assure you there is a strong commitment from the board and the management team to deliver the best provider and customer experience and to create value for our shareholders. With the remaining time, I will address the Cindeo program, our third quarter results, our financial guidance, and the status of our strategic transformation program. Starting with the Cindeo program, as we highlighted in the press release earlier this afternoon, we incurred a $63.1 million restructuring charge this quarter due to Cindeo provider experience issues. As a result of these challenges, there was a slowdown in U.S. system placements that led to lower-than-expected overall net sales growth. To provide some background, Cindea 1.0 launched in the U.S. in March of 2022. The launch was met with excitement and swift provider adoption. However, after some time in the field, some providers experienced frequent treatment interruptions and issues such as distractive noises and difficult bottle insertion. Most importantly, there was an issue with low flow and clogs in the system. Simply put, Sundeo 1.0 did not meet the high standards of user experience that Hydrafacial has been known for over its 26-year history. Throughout 2022 and the first half of 2023, the company made several enhancements to Sundeo to address and remediate these issues, releasing Sundeo 2.0 into the field. Despite these efforts, many of the issues continue to persist. After rigorous testing and development, including simulating over 10 years of heavy in-office use, we believe we have addressed the Sundeo issues with our current Sundeo 3.0 standard implemented in July of this year. We are very pleased with the real-world performance over the four months Sundeo 3.0 has been in the field. Additionally, Sundeo 3.0 devices coming off the production line and existing Sundeos in the field that have been enhanced to the 3.0 standard have a return rate in line with Hydrafacial's low historical benchmark. To stand behind our commitment to our customers and protect the company's brand reputation, we decided that, with respect to Sundeo devices, we will only market and sell Sundeo 3.0. With this decision, we designated the approximately 4,300 Sandeo 1.0 and 2.0 devices in inventory as obsolete, resulting in an impairment charge of $18.8 million. Additionally, during the quarter, we incurred $12.3 million in costs associated with enhancing or replacing approximately 2,850 Sandeo 1.0 and 2.0 devices in the field. Lastly, we accrued incremental costs of approximately $32.1 million to enhance or replace the roughly 4,500 Sundeo 1.0 and 2.0 devices yet to be addressed in the field. This decision was made after concluding it was too costly to diagnose, repair, and resell returned Sundeo 1.0 or 2.0 devices in inventory. In addition, by replacing the systems or enhancing currently functioning systems in the field, we are ensuring provider satisfaction and safeguarding our brand equity. We will also extend all Sundeo warranties by one year to further support our providers. We do not believe the extended warranty will have a material impact on our financial statements. Despite these challenges, we want to reiterate that the business model remains fundamentally sound and the impact has been contained to a portion of our providers without spreading to the end consumer. In addition, the strength and reputation of the Hydrafacial brand and our long-term opportunity remain intact. We base this assessment on two key data points. First, our recently conducted provider survey showing our Net Promoter Score, or NPS, remains best in class in the aesthetic device category. As a reminder, NPS is a measure of how likely it is for a user of a brand to recommend it. Second, our passionate community of hydrafacialists around the world, or what we refer to as the Hydrafacial Nation, powers our 30,000 active delivery systems globally. Our footprint within the medical aesthetics industry is unparalleled. Next, we'll move on to Q3 results. Net sales for the third quarter grew by 10% to $97.4 million. This came in well below the company's expectations, with underperformance in U.S. delivery systems partially offsetting strong performances in APAC and EMEA. From a geographic perspective, America has declined 11% year-over-year due to the Sandeo challenges we just discussed. APAC revenue grew 63% year-over-year to $24.7 million. China accounted for 16.9 million and plus 79% year-over-year growth, driven by strong delivery system placements, reflecting our success in penetrating the market and the significant potential to grow our nascent presence there. EMEA grew 37% year-over-year to 21.1 million, with the strength coming from system placements and consumables net sales, specifically in the UK and Germany. Year to date, nearly 45% of our net sales came from markets outside of the US. Moving on to net sales by product type. Our consumables business, which accounted for approximately 48% of our net sales in the quarter, saw a 17% year-over-year increase to $46.4 million. This further demonstrates our challenges are largely around delivery systems, and more importantly, that the consumer continues to see high value in hydrafacial treatments. On the system side, we saw 4 percent year-over-year growth to 51 million, which was weighed down by performance in the U.S. Notably, delivery systems net sales in APAC and EMEA were plus 102 percent and plus 35 percent, respectively. During the quarter, we sold 2,140 systems at an average selling price of 23.9 thousand, down year over year, primarily due to an unfavorable mixed shift towards distributor revenue. Of the 2,140 systems, 362 were trade-ups. During the quarter, we reached a global install base of 30,074 systems. We had a consolidated GAAP gross loss of $12.6 million, resulting in a GAAP gross margin of negative 12.9%. This was primarily driven by the Cindeo Program charges of approximately $63.1 million. Additionally, this quarter, we incurred discrete charges of $6.4 million related to discontinued, excess, and obsolete inventory. Normalizing for these charges, depreciation, amortization, and stock-based compensation adjusted gross profit was $60.9 million for a 62.5% adjusted gross margin. The adjusted gross margin was impacted by higher manufacturing labor costs and overhead, which we expect will subside as we continue to move portions of our manufacturing to China and sell through higher-priced inventory purchased in 2022. Selling and marketing expense was $30.7 million, or down approximately 23% year-over-year, primarily due to strategically pulling back marketing spend given the issues regarding Sandeo. The decline was further driven by lower compensation and sales commission expense, partially offset by a reversal of cash incentive accruals in the prior year. Going forward, while remaining disciplined, We plan to prioritize marketing initiatives to strengthen provider confidence and drive further awareness of our brand. Our data suggests Hydrafacial's consumer brand has never been stronger and our provider penetration is still low. R&D expense was $1.8 million for the quarter, relatively flat with historical trends. G&A expense was $37 million or plus 55% year over year, primarily driven by higher compensation, severance, share-based compensation, and software expenses. The reversal of cash incentive accruals in the prior year was also a driver. Altogether, this resulted in a net loss of $73.8 million. Normalizing for discrete charges, our adjusted EBITDA was $9.1 million, primarily due to gross margin pressures. This compares to a net loss of 0.1 million and adjusted EBITDA of 16.3 million when excluding any adjustments for discretionary cash incentives. Moving to the balance sheet, we ended the quarter with approximately $559 million of cash on hand. The cash balance reflects the repurchase of 0.8 million shares and an average price of $5.83 per share during the quarter. As of quarter end, we had approximately 95 million remaining in our existing share repurchase authorization. As of September 30th, we had approximately 132.6 million shares outstanding. We feel comfortable with our current liquidity position, and together with our board, we'll continue to evaluate capital allocation, including liability management. Our inventory stood at approximately 74.9 million at the end of September, a decrease compared to $109.7 million at December 31st last year, primarily as a result of the impairment charges taken during the third quarter. As of the end of the third quarter, we had approximately 1,300 trade-up elites in our inventory marked at fair market value. As we sell through these systems, there will be minimal gross profit given the trade-up accounting treatment and rules. We are estimating approximately 10% of this inventory will sell through in Q4 of 2023. Given the third quarter results, we are revising our previously stated fiscal 2023 guidance. We now expect fiscal 2023 net sales in the range of $385 to $400 million and adjusted EBITDA margin of 5% to 6%, respectively. This represents approximately 7% net sales growth at the midpoint on a year-over-year basis. Our updated 2023 outlook reflects the work that remains to be done to re-accelerate Sandeo adoption in the U.S. While we are optimistic in our ability to execute against this goal, this will take time. As a result, we are suspending our long-term 2025 financial outlook. Lastly, I want to update you on our strategic transformation program we announced in September. This initiative is expected to have a significant impact on our financial profile, and we remain on track to deliver over $20 million in annualized cost savings, primarily through G&A efficiencies, during Q1 2024. We expect to incur approximately $9 to $11 million of cost to achieve for these Phase I annual savings. The costs to achieve are primarily related to severance and consulting expenses. In parallel, we have begun work on phase two of the project, which is focused on optimizing our manufacturing and supply chain footprint and continued optimization of our organizational structure. We expect phase two will deliver over $15 million in annualized cost savings during Q2 2024. We expect to provide more detail in the new year around the savings and any related costs to achieve. In closing, While we are disappointed in our results and recognize that there is work ahead, we are committed and confident in our ability to reaccelerate Zendaya adoption in the U.S. and to further our execution across our international businesses. Importantly, our long-term strategy and our business fundamentals remain intact. We look forward to speaking with all of you and sharing our progress as we continue to execute against our strategy. While we will not be hosting Q&A on this call, if you have any questions, please reach out to our investor relations team at ir at beautyhealth.com. Thank you.

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