Olaplex Holdings, Inc. (OLPX) Earnings Call Transcript & Summary

All right. Well, good afternoon, everyone. I'm Dara Mohsenian, Morgan Stanley's Household Products and Beverage Analyst. We're very pleased to welcome Olaplex here the fireside chat today, including JuE Wong, Olaplex's CEO; and Eric Tiziani, Olaplex's CFO. I'm not poised and pleased to read the disclosure, but we'll follow the rule. So please see Morgan Stanley's research website at www.morganstanley.com for research disclosures. And if you have any questions, you can reach out to your Morgan Stanley representative. Olaplex has a great track record of top line growth over a longer period of time and really pioneering the hair bonding category. Although recently, there's been more volatility as we've seen with a number of industry participants. And maybe first, JuE, before we get into specifics, obviously, it's been a volatile period here, particularly for young public high-growth companies. Maybe just give people a little bit of an overview of your business, the key growth drivers going forward, just for those that are less familiar with the story.

Well, thanks a lot, Dara, and thanks for having us, and thank you, everyone, for coming to this fireside chat. Yes, I mean Olaplex has -- is a fast-growth company, cash-generating organization. And really, what we are is -- we are a science-led technology-driven beauty company. And what is important for us is that we will continue to look at the pillars of growth that really helps increased stakeholders' value. And what are those pillars of growth for us? First and foremost, we want to make sure we ignite our brand. So Eric, who's our CFO, always gives us permission to as long as we are investing ahead of growth, whether it's in our people, in R&D and in sales and marketing, we are going to do just that. That will help ignite the global brands. We also want to make sure that we disrupt with our innovation. That's why you hear us about investing in innovation because technology really is so advanced today that there's no excuse for us not to bring the most differentiated product to market. Then thirdly, we want to make sure we amplify our distribution channels because we are truly an omnichannel distribution meaning that we have PRO for credibility, retail for brand awareness and direct-to-consumer, especially olaplex.com to really build consumer and give us consumer insight. And then finally, charting new geographies. As you can see, while we are a young company, about 50% of our business is still in international. But what is critical to note is that we are still not in Asia in a big way. We are not in Latin America. We are not in the Middle East. So there's a lot of opportunities for us.

Great. That's great background. And then switching more to the short-term. Obviously, you had some great success early on after the IPO and substantial upside versus what you expected. Recently, we've seen downside versus your prior expectations. Just help us understand the drivers behind that. Obviously, it's a volatile environment here. But I think we're sort of looking for visibility around the business. And how much of that is related to weaker consumer demand, how much of it maybe is related more to competitive issues, in particular, how much of it is related to retailer inventory. I know they're not necessarily precise numbers, but as you think about it conceptually, maybe run through the different drivers there to help us give us a little more understanding where the business stands.

So we have shared that there were 3 key drivers. Obviously, the macroeconomic conditions, we saw a lot of these salon visits were shortened not that they were not visiting the salons or not that they were not buying. They were making their bottles last longer. Salon visits were a little bit shorter, but it also shows that while beauty is resilient, it's not immune to the macro situation. We also saw competitive intensity, especially in promotional activities. And I'm sure a lot of you here are aware that this year, in particular, we have seen a lot more promotion activities around whether it's a Prime Day like Amazon brands, whether it's Black Friday or Cyber Monday, we are seeing a lot more of that, but Olaplex has made it a point not to participate in promotions or over-participate rather. We will participate if it allows us to recruit new customers and also allow our loyal customers to buy deeper into the brand. So with more promotional activities when we cut back it does impact our top line. It also impacts our ability to recruit new customers at a faster clip. We still recruit new customers, but not as fast as we would like it to be. And then layer on top of that is also inventory rebalancing. And what do we mean by that? Supply chain at prior probably 4 or 5 months ago, were very stressed. And what ended up happening was a lot of people were building on inventory. And then when supply chain became better, they started rebalancing. That obviously impacts our top line as well. But we also know that this is not going to be an ongoing thing. There's only so many months on hand you can reduce. So we feel really good with some of the mitigating factors that we have put into place. We'll address this and Eric can really expand on it when we have given certain sort of insight as to when this rebalancing could improve. But ultimately, what is fundamental is that the brand health is still very strong. And because the brand health is strong, our focus is on sell-through and not about just looking at each problem on his own [ contact ], but really looking at it as an overall and how do we partner with our retailers to help them sell through, then it will address the inventory rebalancing. It will also put more products hands of people who want the product. And then ultimately, hopefully, with the macroeconomic environment improving, we could then see better days ahead of us.

Okay. That's helpful. And maybe just a follow-up on those points. On the inventory side, do you think you're generally through that process by year-end, might it linger on the competitive side? Is this more just discounting? Or is it some of the larger brands that have increased in terms of share have become a bigger threat? And last, just on -- in terms of category growth, just your perspective, all economic cycles are different, right? But your perspective at this point in time around macros, particularly given you're not a company that's existed through cycles historically. So it's a little harder for us to have a sense of using history as a guide here.

Yes. So I mean, first of all, the prestige hair category is the fastest-growing category. Per NPD, when they track it, you will see that the category is faster growing than skin care, hair care and fragrance. And what is great about it is that Olaplex actually exceeds that category growth. So we feel confident, again, and we believe that because we are leading, defining and shaping the category, we continue to have a lot of runway of opportunity. The other thing is on promotional intensity. You can only do that for so long. We believe that as we engage new customers and as our loyal customers are buying deeper into the brand when we launch new innovations, there are going to be a lot more receptors to it. And then in terms of inventory rebalancing, Eric has kind of intimated on our November earnings call with the assumptions that we have built into place with the supply chain methodology and all of our tracking and conversations with our key retailers and distributors -- we believe that we are looking at a Q1 of 2023 where we can actually see some relief.

Okay. That's helpful.

Just to clarify that, what we said on the November 9 call was that we expected the inventory rebalancing to normalize by the end of the first quarter in the professional and specialty retail channels. Didn't mention direct-to-consumer because I don't think that's an issue that lingers into 2023 in that channel. And yes, this is a prestige hair care a resilient but not immune category to the macro challenges out there.

Right. Okay. So we talked about some of the challenges. Let's talk about the response to the challenges, right? You've outlined a number of things on the last earnings call. Maybe give us a bit of detail, help flesh out some of the strategy tweaks you guys are putting into place. You touched on it a bit earlier, but it would be helpful to run through how you're sort of dealing with the situation at this point.

So I'll share like 3 key things that we are doing, and there are proven concepts that we have delivered before. One is our sampling program. We have always been advised and we have seen it on our olaplex.com that our conversion rate for samples is anywhere between 30% to 40%. And if you talk to any retailers, they will let you know that, that is a best-in-class conversion rate. So we are going to definitely double-click on sampling with large retailers. And what that means for us is that the ability to penetrate deeper with our key retailers. Because while we are the leading prestige hair care brand in all of the channels that we play in, where we have a lot of opportunities is still in the penetration. So if we can penetrate deeper with our existing retailers and our distributors, we win there. The other thing that we are also looking at doing is we've introduced a Pro affiliate program. And what that program does is allows us to build a lot of goodwill with a cohort of people that really defines us and that we stand by and with them. The professional lends a lot of credibility and authority to the beauty, prestige hair care category. They are the #1 source of truth. So every time we do a survey, consumers will tell us that the place that they really gravitate to for their hair care recommendations is their hair stylist. So that program allows us to build goodwill but also allows us to help the professionals to retail because now if visits are shortened, the clients may not be replenishing at salon, but they can actually get an affiliate code from us. Give it to their clients, their clients then go to olaplex.com, transact their hair care products and the hairstylist gets the commission. And then the third thing that we have seen success in is piloting people in store that are trained by us so that they can really debunk any miss, help educate the beauty consultants and also engage with consumer. That truly means that we are only 1 degree separated from our end consumers. And that's a powerful insight that we want to make sure we capture.

Right. Okay. And that's a good segue to the next question. But let me start with the short-term version, and then we'll get the long-term, but these initiatives are they expensive Eric, as we think about the next few quarters here? But really, the broader long-term question is, historically, you guys have a great traction without having to spend a lot on the advertising side, and invest sort of a ton behind the business because as JuE mentioned, partially you had these salon advocates. How do you think about the longer-term level of spend versus where you are today? I'll ask you about household penetration in a little bit, right? But that obviously ties into that front. So maybe just a little bit of short-term update with some of these tweaks is an expensive type of process. It is a quick ROI and payback and what are you seeing in terms of early signs, even though it's early and then the longer-term greater levels of investment potentially over time and how you think about that?

Of course. So I'll start with the short-term. The activities that JuE has mentioned we're already considered in the revised guidance that we gave for 2022. And in some cases, that's redirecting funds to those activities that we think are going to generate sell-through returns. And nothing has changed about the discipline that this team and organization apply to those investment decisions. We are measuring return. When we see something that works, we're ready to ship funds and add that fuel because we're focused on that growth. In the medium-term, we've always said, we've been consistent in saying that we intend to invest in marketing, in R&D and innovation and the organization capabilities even ahead of growth because we have a long-term growth ambition that we want to support, and we believe there's a tremendous return there. That hasn't changed. At the same time, we fundamentally still believe that the business model that has led to our success to this point is a business model that's sustainable. And that is a very efficient sales and marketing model. It's a lean organization. We're not pinning that down to a number for 2023 or beyond at this moment in time. But fundamentally, we believe that, that business model is going to allow us to sustain industry-leading profitability in that medium-term.

Okay. Great. And as you think about gross margins longer-term, obviously, a very attractive financial profile. JuE, can you talk a little bit about the barriers to entry for your business, the competitive threats? Clearly, there are other companies out there that look at those margins and fairly attractive. So your level of comfort around barriers to entry and how you think about that longer-term?

So I think, first and foremost, what really differentiates us is that we have a patented technology that is proven, patented and proven and it is potent. So it delivers the performance in the very first use. Most times, when you hear of new entrants into the market, they tend to say patent pending, which is really a lot about marketing. We lean in heavily on technology because the consumers today are not going to be [ suited ] by marketing, they really want to see what works for them. So first and foremost is you've got to deliver products that work. And we actually before somebody tells me you're being very self-serving to say that competition is good, but competition is really good because it raises awareness for the prestige hair care category. I want to remind everyone that we are not just a bond building category, hair care product. We may have developed and created the bond building category, which is fundamental and foundational for healthy hair, but we essentially contribute all of our hair care segments deliver what it's supposed to do with the business, which is the bond building technology. Because we do that, we are able to be best-in-class in every 1 of the segments that we compete in. So whether it's in shampoo, conditioner, clarifying shampoo, [indiscernible] we are the #1 in that segment besides being the #1 in the category. So I believe that because of competition, the category awareness has been raised for prestige hair. And to give you a definitive point of difference is that we have seen our brand awareness almost double within the 2 years that we are in versus the first 4 years that we were in as a company. So it is because of obviously work that we have done with our sales and marketing teams but it's also because the category has more players in it. And when more people hear about it, they're going to try something and then they are going to see what works for them.

Right. Okay. Maybe that's a good time to review what are the -- what are the most important drivers in terms of expanding household penetration longer-term? How do you look to drive higher penetration? Is it the distribution expansion we mentioned, greater advertising? How do you think through the building blocks of that penetration? And also as you think out longer-term, 5 to 10 years, -- how do you think about sort of the pace of that higher penetration over time over that time period?

Yes. I mean it's a very good question. What is very important is that we believe that the prestige hair care is going through what we call the skinification, the premiumization and then the ritualization. And because it's a new category for prestige hair that 3 aspects, we are seeing it really mapped out nicely the way we have seen skin care. When I talk about skinification, what I mean is that a women that spends $100 for their serum or their moisturizer it's going to ask themselves the question and has been asking themselves the question, why am I not spending more for my haircare that truly delivers the results. So we are seeing a lot of that questioning. We are seeing people voting with their wallet and showing that the prestige hair care category is the fastest-growing category as tracked by NPD, which is an independent trade data source. And then when you talk about skinification, you're going to talk about premiumization because people are willing to pay more because they know what they are paying for. And then the virtualization is where they kind of say, look, I can't just use 1 or 2 orders because I know I need to build a regimen like I do with my skin care. So you need to treat your head. Obviously, you shampoo your condition and then you [ ask ] your head and you have your styling products. With that kind of a trajectory, we believe that Olaplex can be able to be there for them at every stage of where they are going and household penetration is really also about education because the #1 place besides hair stylists that they go to for their hair care recommendation, they are also looking at verified purchase reviews and family and friends, word of mouth. That is so important, which means that our social media platforms will continue to serve up information that is relevant for the end consumers having some fun on TikTok doesn't hurt because the engagement and the conversion quality is there. And then finally, we have also learned that the first place that a lot of our consumers go to is olaplex.com to really understand better about the brand and product. So having marketing investment and having the ability to really get deeper into those platforms will allow us to really communicate and convert our customers.

Okay. And how does the Ulta launch -- how has that impacted penetration? How do you think about that? How incremental has it been to your business overall? Maybe just give us an update there.

Well, Ulta, as we all know, is really a great platform. Great for hair care brands. 20% of their business is in hair care, and they are in multiple channels from mass, message and prestige. And always that journey is to really help that customer move up from 1 -- from mass message to prestige as well. And what I think with Ulta it's a perfect ecosystem that reflects who we are. They have the salon, which is what we call a professional credentializer. They have retail, which is what we call building brand awareness, and then they have ulta.com, which allows us to gain consumer insights. And we believe that what is important is not what I tell you is what they actually say at the earnings call. 25% of their services now uses Olaplex, this is 25% more of business that they normally would not have and because our stand-alone treatment is gaining so much traction if you go and look at their menu, there's an entry that says Olaplex standalone treatment. So that awareness built that we are a professional brand and then driving that customer for a take home hair care at their retail and then replenishing online, it's very helpful to our business in educating, communicating and branding.

Right. Okay. You've established this great brand in the hair category. Any thoughts around being able to extend that brand over time and use some of that brand equity to drive even greater value. How do you think about that?

Yes. I mean, that question comes up a lot because during our IPO, we did mention specifically in our S-1 that our technology has skin care application. But it doesn't mean just because you have skin care application, people will gravitate to it. So we did an additional study with our transformation team to an independent source. And it really shows that skin care has great adoption because people do look at Olaplex as a technology-driven organization. I think there's so much runway in here that I think it is important that we keep our eyes and our focus on he can deliver for us given that we are leading this category. And if and when we do look at something like a skin care because we have the technology, it is important that it is differentiated. Because I can guarantee you women in this room do not need another moisturizer, do not need another serum that says they will make them look 10 years younger. They need something that truly works. So when we do get into a space like this, it's because we can be differentiated, and we want to, not because we need to.

Right. Okay. That makes sense. And then as you think about expanding your retailer partner footprint, how do you think about that over time? That's obviously another big growth opportunity beyond potentially new product categories. So take us through your thought process there and how that pace plays out overtime.

So first and foremost, for us, distribution is not about opening more and more doors. Distribution growth for us is penetrating deeper and deeper being not only the #1 anchor brand for hair, but also a top 5, top 10 beauty brand with that retailer. And why that is important is when you are a top brand, you are able to partner a lot better when it comes to merchandising, messaging, programming. So that to us is more important. We are already in 1,300 doors with Ulta with a salon exposure more than 500 doors with Sephora, not including Sephora in Kohl's, just penetrating that would be very, very powerful for us. I mean, best-in-class brand penetration at Sephora is 20% to 25%, while we may be the #1 hair care brand, top 5 beauty brands, we are only penetrating 11%. So there's a lot of room for us to do so. Same thing in our international markets. We are only in 200 doors into glass. You can definitely get deeper in their distribution. And we are in full fleet now in Sephora in Europe. What we need to do is to get deeper and become -- we are the #1 hair care, but now we are striving to become the top 10. So all of this will help us focus deeper because while we want to expand distribution, distribution has to be material to the growth where we can get better partnership with our retailers and our distributors.

Right. Okay. You stole my next question on international. So maybe we continue there. Asia, you have a younger heritage there. It's a brand for obvious reasons that would translate very well given the premium status. Can you talk about how you're developing the business there. It's also a region that's a little more unique without as much salon penetration. So how do you sort of think about that differently than the way you've developed the business in the U.S. and Europe overtime?

Right. So we have a repeatable playbook that we have translated into the European markets. And you are right. In China, specifically, it's a digital first market for us, and we have been in Tmall Global. And there has been a lot of great learnings for us. We have also shared at our November 9 earnings call that we have signed a massive distributor in Southeast Asia and a massive distributor in Korea. So those are markets that really already when you ask them, how do you see Olaplex? They actually tell us that they see Olaplex as a brand that treats hair care like skin. So it is very gratifying for us because they are already on the path of understanding that premiumization and the skinification and the virtualization. If you look at where we are, we are while close to 50% of our business is in international, it's a lot more focused in Europe. We are not in Latin America in a big way. We are not in the Middle East. We are just starting out in Asia. So there's just a lot of runway for us.

And these are markets, particularly China that may start small, but we're very excited about the long-term growth potential, and we're most excited about how the brand is already resonating with consumers in those markets at the early stages of that.

Maybe talk a little bit more about some of the early signs of the brand is really resonating in those markets and what you guys see?

Well, I'll start with some and Eric, please build on it. I mean, definitely, you -- when I look at China, this is our third Double 11, they call it, and we have doubled sales from last year, primarily because our brand is resonating. And what is important to note is that Tmall Global is a smaller piece of their total China business. But it's still a material piece because we gained a lot of insights. So to us, we know that our products work on Asian hair because we have always shared and it's scientifically proven that hair bonds are hair agnostic. So with all of us in this room, if I took a strain of hair, and I just look at your disulfide bonds under with the scientist. We cannot tell your gender. We cannot tell your age, and we cannot tell you ethnicity. But we know we can repair, protect and strengthen your hair bond. Once that is done is foundational. And that message is resonating across the globe. So we are excited because it's not a difficult message for people to understand because healthy hair is something that everyone wants as well as healthy skin. So taking learnings from our U.S. market, our European market and then being able to share that with the international rest of the world, it's very powerful for us.

Great. That's helpful. And you touched on Europe a few minutes ago, but maybe give us a little detail -- more detail there on expansion potential and how you think about where that business could end up as a percent of mix and the growth drivers more specific to Europe?

So what I think is important is look at where we are already and where we can actually extend. We are in full fleet with Sephora, 200 doors we do glass. We started our pharmacy distribution in France. We're going to expand on that. We have launched actually our pharmacy distribution in Italy. And before everybody thinks pharmacy, it's like drugstores here, it's not. Pharmacy is very much about a pharmacist owning that pharmacy and being able to be that neighborhood founding board to the people in that area. And when -- and Olaplex is actually perfect for a distribution like this because the pharmacists can actually talk about our brand to their clients coming in. So there's a huge opportunity in Europe. And then ultimately, we are also looking at Travel Retail. We have said on our November 9 earnings call again that we will be able to start looking at travel retail and distributing in key selected airports by the end of this year.

Okay. I would just add, we see the repeatable model that we've used, the model that we've used in markets like the U.K. working. So it's worked in Italy. It's worked in Spain. This year, for example, applying that same omnichannel model led through professional working really well for us in France. So that's a repeatable model in those markets that we're going to continue. But the regions that really under-indexed today that have even greater growth potential at Asia broadly is the top of that list.

Right. Okay. And maybe we can touch on the margin side, Eric. Obviously, pretty significant cost pressures in the industry over the last 1.5 years. In theory, that's less an issue for you guys with your high gross margins, but you've certainly seen some cost pressures also and you responded with pricing. So how do you think about the forward cost curves based on what you see today and what the outlook is on that front? And then maybe after that, we'll touch on SG&A also, but let's start there.

Yes. From a gross margin perspective, we're actually seeing the global supply chain inflation dynamic and environment stabilize as we go into 2023. I don't think that's a surprise. Global demand across many industries is weakening, and we're seeing that come through in the prices that go into our products. And so that's a tailwind that's positive. It's going to take some time for that to fully enter into our P&L. We work through existing inventory at a higher cost base before we get to realize those benefits. And that's not the only thing that's driving our gross margin. Of course, we're also taking actions and initiatives ourselves. So we've already announced that we're opening up a new European third-party manufacturer on some of our core products, that's going to significantly reduce the cost of transporting goods around the world. That's an example of a savings project that we put in place that should give us tailwinds in gross margin as well.

Okay. Great. And then on the SG&A side, we talked about marketing. Some of the other initiatives you're very efficient from a headcount perspective, right, in other areas? Are there big sort of areas of investment as you look going forward besides the marketing line? And also just give us a sense as you sort of plan to increase marketing over time. The sense around ROI and what you're seeing there as you move to higher levels?

Absolutely. So it is the priority areas that we consistently said we're going to invest in ahead of growth. One is marketing come back to that. The second is R&D, which is going to support the innovation platform for many years to come. And the third is the organization. As we're expanding into new markets, as we're expanding the portfolio, we're continuing to build up our capabilities in really across the organization and across departments with particular focus on adding to the organization in that sales and marketing revenue driving areas. So that is expected to continue. And because we're so focused on the long-term ambition of the business, even if we're in for a more volatile macro environment. We believe with our profitability and cash generation, we can continue investing through that and come through stronger on the other end of it. All that said, yes, about the marketing investments that we're making. We have always been a very vigilant, very ROI, very disciplined organization in how we invest that money and we intend to continue to do that. But like JuE said, when we see something that's working, we are going to add fuel to those activities because not only are they going to help the short-term sell-through and momentum, but they're a part of executing our strategy and building the growth that we expect in the long-term.

Okay. Maybe we can end on the innovation side. It's been a pretty strong piece of growth for you historically. I think you tend to take a longer-term eye on pipeline and having R&D lined up. How should we think about the future contribution from innovation and ability to continue to drive the top line.

Yes, I think innovation is key for us. And that is why you hear us talk about a 72-month 5-year kind of rolling plan, making sure that whatever we launch in that 72 months rolling complements and do not cannibalize our existing offering. And if you think about it, we only have 10 to 11 retail SKUs at the moment. When you stand in front of a more traditional established brand, it's anywhere between 30, 40, 50 SKUs. And we truly offer up a regimen for customers and sometimes they have to go off brand. So we really want to keep it within the ecosystem. But at the same time, be able to give them choices that are truly technologically differentiated. And ultimately, I think where we want to be more advanced, it's not -- it's not about just adding another product, but it's about allowing them to [indiscernible] say that, look, if this product really works for me, I can now talk about it to their friends and really help with the efficacy of the brand and being able to talk through it. So I think innovation will continue to be a leading focus. I'm very -- Eric and I are very in sync when it comes to where we want to invest. And that is a place where we have we have scientists on the bench chemist on the bench, but we work with research institute, we work with companies that are developing new technology. And to us, that is where our focus is because if we -- if you think about how Olaplex has become what we have become, what's really from a genesis of our founder looking at solving a problem that most people at that time said it cannot be done, and we did it.

Great. Well, that's very helpful. We appreciate you guys being here.

Thank you so much, for having us.

Thank you.

Thank you very much.