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Edited Transcript of ELF.N earnings conference call or presentation 8-May-19 8:30pm GMT

Q1 2019 e.l.f. Beauty Inc Earnings Call

OAKLAND May 15, 2019 (Thomson StreetEvents) -- Edited Transcript of e.l.f. Beauty Inc earnings conference call or presentation Wednesday, May 8, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mandy J. Fields

e.l.f. Beauty, Inc. - Senior VP & CFO

* Tarang P. Amin

e.l.f. Beauty, Inc. - Chairman, CEO & President

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Conference Call Participants

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* Andrea Faria Teixeira

JP Morgan Chase & Co, Research Division - MD

* Bonnie Lee Herzog

Wells Fargo Securities, LLC, Research Division - MD and Senior Beverage & Tobacco Analyst

* Erinn Elisabeth Murphy

Piper Jaffray Companies, Research Division - MD and Senior Research Analyst

* Linda Ann Bolton-Weiser

D.A. Davidson & Co., Research Division - Senior Research Analyst

* Mark Stiefel Astrachan

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Oliver Chen

Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst

* Rupesh Dhinoj Parikh

Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

* Stephanie Marie Schiller Wissink

Jefferies LLC, Research Division - Equity Analyst

* William Bates Chappell

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Willa Mcmanmon

Ellipsis Ir - MD of Silicon Valley

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Presentation

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Operator [1]

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Greetings, and welcome to the e.l.f. Beauty transition period ended March 31, 2019, conference call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Willa Mcmanmon, Investor Relations. Thank you. You may begin.

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Willa Mcmanmon, Ellipsis Ir - MD of Silicon Valley [2]

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Thank you, operator, and good afternoon, everyone. Thank you for joining us today to discuss e.l.f. Beauty's transition period 2019 earnings results. A copy of today's press release is available in the Investor Relations section of elfcosmetics.com. A recording of the call will also be available for 90 days on elfcosmetics.com.

As a reminder, this call contains forward-looking statements that are based on management's beliefs and assumptions, expectations, estimates and projections. These statements, including those relating to the company's fiscal 2020 outlook, are subject to known and unknown risks and uncertainties, and therefore, actual results may differ materially. Important factors that may cause actual results to differ from those expressed or implied by such forward-looking statements are detailed in today's press release and the company's SEC filings.

In addition, the company's presentation today includes information presented on a non-GAAP basis. We refer you to today's press release for a reconciliation of the differences between the non-GAAP presentation and the most directly comparable GAAP measures.

With me from management today are Tarang Amin, Chairman and Chief Executive Officer; and Mandy Fields, Senior Vice President and Chief Financial Officer. With that, I'll turn the call over to Tarang.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [3]

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Thanks, Willa, and good afternoon, everyone. Our transition period results exceeded our expectations with net sales of $66 million and adjusted EBITDA of $12 million. Excluding the impact of e.l.f. stores, net sales were up 3% versus a year ago. These results reflect the benefit of Project Unicorn and increased marketing activations behind our new first-to-mass products.

We are making progress in our strategic repositioning and have defined 5 key initiatives that together form an integrated strategy designed to reinvigorate the e.l.f. brand and raise consumer awareness. We are seeing initial progress as we begin to execute against these initiatives. We believe the investments we are making in the brand will take time to fully realize, which is reflected in our fiscal 2020 guidance. Let me provide greater context on each of these initiatives.

Two of our key initiatives go hand in hand, driving demand in the brand and a major step-up in digital. As you know, in February, our Chief Marketing Officer, Kory Marchisotto, joined us from Shiseido. Kory has hit the ground running in redefining our marketing strategy and bringing more consumers into the brand. e.l.f.'s core value proposition, making the best of beauty accessible to every eye, lip and face still resonates with consumers. What's changing is the way we are telling our story. Kory and the team are crystallizing a campaign to reinvigorate what we've coined e.l.f.'s superpowers. These are unique brand tenets that e.l.f. users love. Our premium quality, unbelievable value, universal appeal, first-to-mass capabilities, and of course, the fact that we are vegan and cruelty-free. We plan to activate these core tenets by integrating behind fewer, bolder product stories, driving a constant drumbeat of influencers and events and transforming our approach in digital and social.

To measure our progress, we're looking at metrics such as: our year-over-year search on Google, which we see as a proxy for consumer awareness and interest in the brand, was up double digits when compared to the same period in fiscal 2018. Our earned media value, or EMV, which reflects buzz by tracking organic influencer mentions, was up close to 18% compared to the prior year. And our reach on Instagram, which passed 4.5 million followers, was up about 30% year-over-year. These metrics reflect our move to double down on digital, which is already making a difference.

In our last earnings call, we shared that social media postings from influencers, particularly Jeffree Star, were creating a surge in demand for several of our first-to-mass products and driving awareness across the brand. We saw a halo effect from this social media enthusiasm and success in our own proactive influencer outreach, including our recent collaboration with Jkissa. The impact of these efforts was reflected in our overall results and particularly on elfcosmetics.com where we had one of our strongest quarters to date. We plan to expand our reach in the coming months through a new digital awareness campaign and we look forward to updating you periodically on our progress.

We've talked a lot about our third key initiative, which is improving productivity in our national retailers. The primary driver behind this is Project Unicorn, which is aimed at shrinking our packaging footprint, elevating our brand presentation and improving the consumers' ability to navigate our sets. During the transition period, we implemented the first phase of Project Unicorn, which impacted 350 SKUs or over half of our volume. Our productivity trend improved during the period due to Project Unicorn and our marketing activations. You can see our retailers are incorporating Project Unicorn when you walk the stores.

At Target, in addition to better shelf sets, we have flex towers elevating our position as #1 in brushes and primers. Ulta Beauty has increased our space in a number of their stores as has Walgreens. At Walmart, we're seeing better in-stock results on our 4-way innovation centers. Phase 2 of Project Unicorn will roll out in the fall and convert our market-leading brushes to new designs. Along with the impact of Unicorn, our new integrated marketing approach is reflected at Superdrug in the U.K., where we've seen strong comp growth behind the marketing and merchandising of our 16-hour Camo Concealer. We're also seeing traction at Boots as we begin to roll out in stores across the U.K.

Our fourth key initiative is to focus on first-to-mass by providing Prestige quality products at an extraordinary value. This initiative is less about pivoting and more about focus. We're quite proud of our ability to innovate in as fast as 13 weeks. Going forward, we plan to use our innovation capabilities to reinforce our strengths in key product categories such as brushes, primers and brows. We're also making sure that each of our products, regardless of price point, is meeting our core value proposition of Prestige quality at an extraordinary value. In the past, we've primarily marketed our new products when they went on elfcosmetics.com. We're shifting our go-to-market approach by also supporting these products' integrated marketing campaigns as they are rolled out into our national retailer partners.

Recent examples include poreless putty primer, which has over 70,000 notify me sign-ups in elfcosmetics.com; Camo Concealer, which is helping build our leadership in complexion at a $5 price point; and Hello Hydration!, which offers a Prestige quality skin care cream at just $12. We plan to support these key first-to-mass products throughout the year. To measure how we're doing on this initiative, we will track relative rankings by product segment. Proudly, despite a challenging 2018, we ended the year at market leadership in brushes, primers, setting spray and eyelash curlers as measured by Nielsen.

Our last key initiative is cost savings, where the strategic move to close our e.l.f. stores reduced our head count by around 50% and is expected to provide G&A savings on an ongoing basis that should help us fund our marketing and digital investments. Additionally, our tariff mitigation strategy, with the help of vendor concessions and improvements in our China operations, will help to offset the 10% tariff impact. If tariffs rise to 25%, we'll look to a mix of further operational savings, selective price increases and FX offsets to mitigate the higher tariff rate. Our other ongoing projects to improve operational inefficiencies include our Columbus and Ontario, California warehouse automation and U.S. liquid fill manufacturing, which we expect to generate $3 million in cost savings in fiscal 2020.

Before I turn the call over to Mandy Fields, our CFO, to cover the results and guidance, let me share a little bit about her. Mandy has a consumer-focused background with deep financial planning and analysis experience. From her start in FP&A at the Gap to her tenure as Vice President of Finance and Analytics of Albertsons $10 billion private brands portfolio, to her most recent role as CFO of BevMo! which has 163 stores and is the #1 specialty beverage retailer on the West Coast. Mandy was awarded best non-public company CFO by San Francisco Business Times last year, and we're delighted she's joined the e.l.f. team. She's been in the role for only 3 weeks and is already making a difference in the way we approach our key initiatives.

With that, I'll turn the call over to Mandy.

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Mandy J. Fields, e.l.f. Beauty, Inc. - Senior VP & CFO [4]

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Thank you, Tarang. I'm excited to be a part of the e.l.f. team. Before I dive into the numbers, I'd like to share a bit about my journey to e.l.f. As Tarang mentioned, I've been immersed in the consumer world since the start of my career, and I admire the core values of the e.l.f. brand and its focus on accessible beauty for everyone. After my first meeting with Tarang, I was impressed with the energy and honesty with which the team is approaching recent challenges and equally impressed with the incredible culture of commitment to the e.l.f. consumer. It is clear to me that e.l.f. has a truly differentiated core value proposition and is a brand poised for revitalization. I look forward to working with the e.l.f. team and all of you as we move forward.

Now I'll discuss our results for the transition period as compared to the same period in 2018. Net sales increased to $66.1 million, primarily due to Project Unicorn and our marketing activations within the period. This was partially offset by the timing of pipeline shipments and the closing of our 22 e.l.f. stores. Excluding e.l.f. stores, net sales increased 3%.

Gross margin of 61% was in line with the prior year. Excluding e.l.f. stores, gross margin would have been about 100 basis points lower than the 61% reported as our stores yielded higher margins versus volume through other channels.

On an adjusted basis, SG&A was $33.6 million or 51% of net sales compared to $31.7 million or 48% of net sales in the same period of 2018, mainly driven by increased investment behind our marketing and digital efforts. Adjusted EBITDA was up 1% at $12 million versus $11.9 million a year ago. Adjusted net income was $3.2 million or $0.06 per diluted share, down from $5.5 million or $0.11 per dilute share a year ago.

We continued our disciplined working capital management in the transition period, generating over $8.5 million of cash flow from operations, bringing our cash balance to $53.9 million as of March 31, 2019, compared to $10.5 million last year. The improvement was primarily driven by the timing of receivables and continued progress on inventory management.

We are prioritizing investment behind our key initiatives to increase consumer awareness and build brand relevancy. Given the $54 million of cash in our balance sheet, we assessed our target and excess cash levels. As a result, in our earnings release today, we announced that our board approved a share repurchase program of up to $25 million. We are pleased that we can fund our strategic initiatives with cash from operations and also be in a position to return excess cash to shareholders through this program.

Turning to the financial impact of the February 2019 e.l.f. store closures. We incurred onetime accounting charges of approximately $22.2 million, which are presented in restructuring expenses. The majority of this expense is noncash in the period, including $16.1 million in accelerated rent and $5.4 million in accelerated depreciation expense. While closing the stores was a difficult decision, we believe it was the right choice to support our focus on national retailers and digital.

Now let me discuss our 2020 guidance. Excluding stores, we expect fiscal 2020 net sales to be down 4% to 8%, or $235 million to $245 million, adjusted EBITDA between $45 million and $48 million and adjusted net income between $18 million and $21 million or $0.35 to $0.39 per share on a fully diluted basis, with a share count of 52.5 million. Recall that gross margin without stores is roughly 100 basis points lower than with stores because direct retail margins are higher than wholesale margins.

I'd like to explain our thinking behind the ranges, particularly on net sales. As Tarang mentioned, I come from an FP&A background and believe that it's prudent to take a moderated approach in forecasting, particularly given our recent trends. We are seeing improvements in the business, but an improved quarter does not make the year. e.l.f. is heavily dependent upon track channels, which account for more than half of our revenue and, as you know, can be volatile. We are also in the initial days of our strategic repositioning. While we have seen early progress, we expect these initiatives will take some time to fully realize, and our guidance reflects this.

The decline in adjusted EBITDA guidance year-over-year is primarily the result of 2 main factors: forecasted sales declines, as I just discussed; and the additional marketing and e-commerce expenditures. I should note that in the past, we've discussed marketing spend discreetly from the spend per user acquisition on elfcosmetics.com. As we double down on digital, we believe it makes sense to discuss the 2 together.

In fiscal 2019, marketing plus e-commerce expenses were 7% of net sales. We expect these to increase to approximately 10% to 12% of net sales in fiscal 2020. We expect the additional investments to cause deleverage in the short term, as in many cases, the ROI on the top-of-funnel marketing activity lacks spend. We will provide commentary on how marketing ROI is trending on future calls. Before we turn to the question-and-answer portion of the call, let me turn the call back to Tarang to summarize.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [5]

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Thank you, Mandy. Looking at fiscal 2020, I believe we're on the right path with our strategic repositioning, supported with a clear set of initiatives. One of the things that give me confidence is the quality of the team, including the addition of Kory and Mandy. I strongly believe the long term looks promising yet remain cautious in the short term. We look forward to engaging with you over the coming quarters to discuss our progress. Operator, you may now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Oliver Chen with Cowen and Company.

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Oliver Chen, Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst [2]

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Regarding strategic repositioning, what are your thoughts on the timing of the positioning, relative to how some of your most important wholesale partners think about the beauty category and the choices they make for the beauty buys and spends? Because I'm just curious about the sequencing of sell-ins versus sellouts. And with the change happening, how will that work in terms of consumer reception and demand versus sell-in and planning? Related to that, I'm also just curious about the UPTs versus average unit retails and how those are trending relative to in-stock and your strategy on managing good in-stock levels and the AUR that you want?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [3]

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Sure. Oliver, this is Tarang. Why don't I take a first stab at your questions. In terms of the strategic repositioning, it really is the 5 initiatives we talked about working in concert with each other. We feel we're well positioned when it comes to the actual assortment that we have in stores as part of our spring resets. Project Unicorn really gave us a major kind of leg-up, and we feel good about the progress we have on Project Unicorn of having the right items in the stores presented the right way. You can see that just as you walk these different stores. In particular, our focus on first-to-mass is really coming through, both the poreless putty primer as well as Camo Concealer, off to very fast starts behind the marketing that we're putting behind them. So the strategic repositioning is well under way and we see some promising signs.

In terms of the units per transaction versus average unit retail, if you look at the first quarter, our average unit retails are up anywhere between 5% to 10%. That's less than what we've traditionally done, where our averaging at retails were up often in the 20%-plus range, and that is a strategic focus of us, making sure that we're better balancing both units as well as averaging at retails and reinforcing our overall value equation. A great example of that is Camo Concealer, which compares to a $28 Prestige item. Yet we've priced it at $5, and it really is a screaming value. So we feel good in terms of our initial progress, particularly with the acceptance of our major customers on Project Unicorn and how it's doing out the gates.

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Oliver Chen, Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst [4]

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Okay. And then last question is, as you engage in the changes and also think about simplify to amplify on some of your old products and new ideas, what should roughly happen to the cosmetics versus non-cosmetics composition of your products mix over time? Or is there sort of evolution there that we should be aware of?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [5]

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Well, we always -- I mean certainly, one of our key hallmarks is our ability to innovate, both in terms of the speed as well as the breadth of innovation across eyes and face tools and skin care. You are seeing a concerted effort to focus in particular on those key first-to-mass items. And so when I take a look at our assortment on shelf, I don't see massive shifts in terms of the number of items on shelf. We always had a good rhythm of kind of what I call weeding and feeding to every year, going -- approaching our planograms and taking kind of what we believe will be some of the best items and taking other items off the shelf, so I feel good that way. What you -- probably the biggest shift that you're seeing is this much greater focus on these first-to-mass items more than we're deprioritizing a particular category. You will see us talk less about the total number of items we're launching. You'll hear us talk a lot more about the scale of the integrations we have on the ones that we deem the most important.

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Operator [6]

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Our next question comes from the line of Bill Chappell with SunTrust.

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William Bates Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [7]

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Just wanted to see if I can maybe translate some of the message for me. In terms of -- in the past, you had talked about your marketing and advertising was mid-single digits at best, and you'd never thought you would kind of go to the full double digits as a percentage of sales just because that's not really how you ran your business, and you felt like the sales would come back. Is it fair to say that -- I guess, one, you had a new Chief Marketing Officer, who said, look if we're really going to change the trajectory, we need to make a meaningful step-up. And then two, we had a new CFO in place, and welcome, Mandy, that thought of that's not how we're going to run our guidance, we need to set -- reset the bar here so that we can rebuild some investor trust. Is that the right way to look at it?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [8]

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Sure, Bill, this is Tarang. Why don't I answer the first part of your question and turn it over to Mandy, so she can directly talk about the guidance. On the first, on the marketing -- first, the definitional. We used to always just talk about the SEC definition that you see on marketing, which for us was around 3% to 4% of net sales. So if you take a look from the marketing-only kind of investment, we had, I think, in FY '19, about 3% of net sales was roughly 3.2% of net sales. As we step forward, particularly with Kory coming in, and taking a more holistic view of our consumer engagement and marketing activities, she's saying, even though the SEC doesn't require us to break out the e-commerce spending or the spending we have to get people to our site, given that our approach is very digital and viral in nature, we're better, and a more accurate measure for us as well as investors is to combine the spending that we have in marketing as well as our e-commerce. And if you combine that spending, what we're really talking about in FY '19, that combined spend was about 7% in net sales.

In the transition period, it was about 8% of net sales, and as you heard in our guidance, 10% to 12%. The 10%, to 12%, so it's not as big a step-up as you see, mainly because we're combining both those metrics together. That is one, the first part of it. The second is a tremendous amount of confidence in terms of really bringing more consumers into the franchise. And on the macro, if you take a look, the strategic move we made to close down our stores, really, the SG&A that was involved in our stores and now being redeployed to kind of our marketing and e-commerce activities together. So we feel it's the better way to go for the long term of the business, just to give you a perspective on the marketing. Why don't I turn it to Mandy to talk to you a little bit about the guidance?

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Mandy J. Fields, e.l.f. Beauty, Inc. - Senior VP & CFO [9]

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So in terms of guidance, I just want to talk a little bit about my philosophy and approach. So I'd like to take a moderated approach with forecasting. And while we're encouraged about the things that we saw in the transition period, if we just take a step back and look at where we've been historically, so if we look at the back half coming out of calendar '18, we would have been on a negative 7% trend. If I take the transition quarter, plus what we saw in the back half, gets me to a negative 4% trend. So that bookends the guidance range from a net sales standpoint. And again, we're seeing positive traction. We're encouraged by that, but I want a chance to see progress on a sustained basis before we get too far ahead of ourselves.

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William Bates Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [10]

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Okay. I think that translates with what I was thinking. Second, just maybe a little more color around Project Unicorn. I mean we're now largely through the spring resets. Is there anything you can give us to kind of quantify how that's making a difference? And will it be expanded more this year to other retailers, to other SKUs? Or is it kind of set in place right now?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [11]

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Sure, Bill. We're feeling really good about Project Unicorn. So the first phase has been implemented. So particularly, if I look at our Walmart, Target and Ulta, we have -- I think about 350 Unicorn SKUs that have been put in the Unicorn packaging. The shelves have been redrawn in a more efficient design. And what we see in terms of results at all 3 of those customers is an improvement in our productivity trend line. So we're feeling really good about it. For balance of customers, they do get the Unicorn packaging, but it will be later that they're able to draw them more efficiently. So that's a little bit about Phase 1.

Phase 2 of Unicorn, as I mentioned, is -- involves our brushes. We have market leadership in brushes in the U.S., and those SKUs start to soft convert similar to how we did Phase 1 of Unicorn, and they will be in position by, I call it, the fall of this year. There'll be a Phase 3 as we take a look at broader elements of our lineup and other SKUs that we do in Unicorn. But I'd say the main parts of Unicorn in terms of the SKUs that were converted, the better shelf presentation and our ability to really call out some of our core segments in terms of helping consumers navigate, we're encouraged by the early signs, and you'll continue to hear more about it.

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William Bates Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [12]

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Okay. And then last one for me. Just I get the kind of trend line of negative 4% going forward, similar to your historical trend. What does that imply versus the overall -- your expectation to the overall category? Are you going to be in line? Or do you think you'll grow faster or slower in the category?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [13]

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Right now, it's relatively in line. So if I look at the first quarter of the year, the color cosmetics category in the mass side was down 3%. We'll see. Obviously, our intention is to do better, but we wanted to at least, to Mandy's point, moderate our expectations.

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Operator [14]

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The next question comes from the line of Steph Wissink with Jefferies.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [15]

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I want to follow up on Bill's question and just digest or decompose this a little bit further. Tarang, if we were to hypothetically say the March quarter pattern continues, can you help us bridge what the potential leverage is in the business, given the increased digital spend? Meaning, if the business does deliver a flat or better growth rate, do we start to see some incremental margins return to the business over the course of the year?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [16]

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Steph, what I'd tell you is, certainly, if we're seeing some deleverage with the sales decline, you will have leverage as if -- instead of seeing minus 4% to 8%, if you did see a flattening or growth in the business, there is leverage to be had there.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [17]

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So your plan wouldn't be to spend back any upside, but rather to see the benefits flow through to the bottom line?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [18]

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That's right. I mean our current assumption -- I mean a part of it depends on -- and what Mandy and Kory both want to see is how do these investments pan out. And based on how they're panning out, we'll come back and update it. Obviously, if the return comes faster, I think we like that. But we also want to reserve the ability if we're seeing really good results to further accelerate our top line.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [19]

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Right. That's great. And just the last one is on the Project Unicorn strategy. I'm wondering if you can give us some quantitative measures around the performance of those stores that have been fully converted versus a control group or an average, just to help us understand the degree of productivity enhancement that, that strategy is starting to show at retail.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [20]

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Yes. So maybe the best way I can do it, because Unicorn SKUs show up in all sorts of retailers, and so the places that you can see it probably the best are Target, Walmart and Ulta. And so as we isolate post-Unicorn versus pre-Unicorn, you can see it, frankly, at least Target and Walmart are covered in the track universe. The change in trajectory you saw in our track data over the last, I'll call it, 2 to 3 months, gives you an indication of Unicorn plus our marketing activities. Important to say, both go hand in hand. It's kind of a chicken and egg thing. The marketing would not be nearly as effective unless we had the right assortment on those shelves. The assortment wouldn't do as well unless we're amplifying that. So both, if you really take a look at the fourth quarter, of last year of calendar 2018, we were minus 4% versus the plus 3% that you see in the transition period quarter. Based -- there's only 2 things you can really attribute that to, which is Project Unicorn and the marketing activations that I talked about.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [21]

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Okay. Last question, just really quickly, is on the condition of retail level inventory. Do you feel like you have enough inventory in the channel to keep the consumption momentum going.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [22]

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We feel good about our retail inventory. If anything, we're a little tight, particularly, on a couple of these first-to-mass items. We've had out-of-stock issues on poreless putty primer and Camo Concealer. So we're working to be able to get those back in better position in our first quarter of our new fiscal year. But overall, we've made great strides. We continue to partner well with our retail partners. Last year, for example, we saw some serious out-of-stocks on our 4-way innovation centers at Walmart. As I mentioned earlier, we're doing much better on our in-stocks there. Our in-stocks overall look pretty good, but it's something that given our unit movement is always something that we're focused and working on.

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Operator [23]

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Our next question comes from the line of Rupesh Parikh with Oppenheimer & Co.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [24]

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So I had a few modeling questions, I was hoping you can provide a little more granularity. So first, on the gross margin line. I was curious if there's any more specifics you can provide there, just the key puts and takes as you look at this year. And also, I was wondering if you can provide any clarity in term of how you see the phasing of the earnings growth this year.

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Mandy J. Fields, e.l.f. Beauty, Inc. - Senior VP & CFO [25]

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Okay. So I'll start with the gross margin. Really not a lot of change in gross margin. So as I've stated, without the stores, we would have been 100 basis points lower. And so you can just trend that forward in your modeling. Currently, the gross margin rate assumes the 10% tariff rate. As Tarang spoke to, there are some mitigation strategies we have if it goes to the 25% rate. But as for now, we've assumed the 10% on the go forward. In terms of phasing of earnings, as you know, we don't give quarterly guidance, but I would say that there's some seasonality in our business. Q2 and Q3 are going to be the most important quarters for us, with Q4 and Q1 having a lesser impact. So that's what I would give you on the quarters.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [26]

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Great. And then I guess a question for Tarang. Just on category growth there. It seems like -- all the beauty players I've called it a weak beauty category, it sounds like color cosmetics are still challenging. Just curious if you have any thoughts in terms of why you're continuously challenged out there, I think both on the mass side and Prestige has even slowed recently?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [27]

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Yes. I'll be honest, it's a little perplexing how long kind of the softness has been there. I mean we've taken over the category over a long period of time. We're a little surprised by how long the category has been soft. What I would tell you is the core dimensions of the category always come back to how strong or in totality, are the new products there. We feel -- we're really encouraged that we have a couple what look like to be pretty big hitters. I don't know if the category in total has that level of innovation that we have, so I feel well positioned, particularly if we can continue the momentum that we saw in the transition period. But that would be one. And then two, there's always some question for me on measurement. You see so much that's moving online that we often -- we need to see when we look at our own business, wonder if the measured categories are picking all of that up.

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Operator [28]

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Our next question comes from the line of Erinn Murphy with Piper Jaffray.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [29]

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Welcome, Mandy. I guess a couple of questions for me. First, on the e-commerce. You talk about it being a strategic initiative. Can you just remind us what percent of sales that is today? And then what are you seeing in terms of the growth of that channel currently and maybe where that could go over time?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [30]

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Sure. So Erinn, this is Tarang. We don't break out e-commerce right now, separately. In the past, we broke out our direct channel versus national retailers. And the end of the year, I think we'll again see that break. But in between quarters, we don't.

In terms of where e-commerce stands for us, it is critically important. It's obviously a digitally native brand that was our entire business for a few years. It is one of our main vehicles in which we engage our consumers, put our new innovation on first. And so when I think about the growth rates there, what I did mention in the prepared remarks is we saw one of our strongest growth quarters on e-commerce, on elfcosmetics.com that we have in quite some time. And it's a reflection of the initiatives -- strategic initiatives that I discussed earlier in terms of driving more people, more demand in the brand, more in terms of our digital strategies, but in particular, the focus, the days, we're out of stock right now in poreless putty primer. But when we have that in stock, I mentioned, I think there's 70,000 notify me requests on getting that product back in stock. I think you'll see many of these strategies were best on elfcosmetics.com, but really, our digital efforts go well beyond e-commerce.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [31]

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Sure. Okay. And then maybe just sticking on the similar theme. As you think about the marketing and e-comm spend collectively moving towards that low double digits, has there been a change of philosophy of the mix of that spend, and what channels maybe you're starting to over-index socially? You talked a lot about that on this call. But just curious on what that could look going forward in terms of the mix versus where it was historically.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [32]

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Sure. I mean I think our marketing spend, our e-commerce spend is always and primarily digital in nature. Yet, we, in the past, sometimes siloed both types of spending. So our e-commerce spending was very much direct response-related, whether it be search, affiliates, other things that bring people to our website, whereas some of our other marketing spending, whether it had been Beautyscape or some of our influencer programs, some of our social programs, the 2 didn't really go together. And I think one of the things that Kory Marchisotto is really bringing in is a more holistic view of how we're engaging our consumer, particularly, in putting forward what she coins some of our superpowers, that making sure our consumers understand that.

So you'll continue to see us, probably, if I think of marketing from a funnel from an awareness standpoint, lower funnel activities as well as upper funnel activities, you'll continue us do a lot and be able to attribute quite a bit on the lower funnel activities to bring people to our site. But increasingly, you'll see more on the upper level -- upper funnel activities. We haven't done nearly as much there, and if you took a look at it via the incremental spend, in fact, if you even look at the transition period, really stepping up on social, really stepping up in terms of our ability of driving digital awareness and a number of -- more platforms than we have in the past, we're encouraged by site. I think you have -- being able to leverage the entire full funnel activities from an awareness standpoint, would be more effective and it very much ties into the vision that Kory and the team have in terms of how we engage our consumers.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [33]

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Got it. And then just one clarification, Mandy, for you. I think you talked in the former response on kind of the shaping of the guidance, you don't typically break it out. But when you talk about 2Q and 3Q being the most important and 1 and 4Q being a little bit less relevant, are you implying that 1Q and 4Q should be below that of the average growth rate of down 4% to down 8%, and then the others above? Or just any help on the kind of sales cadence? And then just the other clarification in the guide. You guided 52.5 million share count. Should we assume that, that's no buyback then, and that's just the dilution from options?

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Mandy J. Fields, e.l.f. Beauty, Inc. - Senior VP & CFO [34]

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Yes. Okay, so first, let me answer the question on the quarterly importance. Now my reference to Q2 and Q3 are simply because it's preholiday and holiday, which are typically larger quarters for us. So no implication there that Q1 and Q4 will be outside of the range to the negative. On the share count, the 52.5 million, yes, you're right, it's just the diluted share count.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [35]

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Okay, perfect. So no buyback? That would be incremental?

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Mandy J. Fields, e.l.f. Beauty, Inc. - Senior VP & CFO [36]

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Correct.

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Operator [37]

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Our next question will come from the line of Andrea Teixeira with JPMorgan.

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Andrea Faria Teixeira, JP Morgan Chase & Co, Research Division - MD [38]

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Welcome, Mandy and Kory. I was just hoping if you can bridge the approach to your guidance, more like how if you're just trying to -- making it more conservative. When you think about the 7% to 10% to 12% of sales going to marketing, is that both above the line and below the line? And how can like you parcel that investment? Is that a broad advertisement to increase awareness of the e.l.f. brand? Or is it more R&D? Or is it more working on getting more distribution in some of the non-track channels on your doors? If you can help us elaborate that.

And on the EBITDA margin, so it's part of the first question on how you separate those components. Like if you take out marketing, so I'm just trying to see if you can -- there is some deleverage from revenues, the impact of the revenue of the doors that you're closing or existing in company-operated stores. But also, if you're seeing some deleverage there or you can now finally start to leverage your productivity, as Tarang discussed, with Project Unicorn, the productivity per store, if you can start leveraging on that and more like the known media or known marketing overhead expenses, how we should be thinking of those.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [39]

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Okay. This is Tarang, I'll take the question and have Mandy add. So on the first, in terms of the marketing, our marketing plus e-commerce spending going from 7% in FY '19 to the range that we provided 10% to 12%, the nature of that spend is highly digital awareness-related. So it's not to drive distribution, it's not to drive other activities. It's the range of activities, everything from bringing people to our site to driving greater awareness with our new campaign, primarily digitally and via social, very much what you saw in the transition period quarter. So we feel good about that spend and the nature of that spend that's authentic to e.l.f.'s history just in a much bigger stage. And then in terms of the leverage question on productivity, maybe I'll let Mandy talk about that.

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Mandy J. Fields, e.l.f. Beauty, Inc. - Senior VP & CFO [40]

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And Andrea, so as you think about the marketing, you said you can take a look at EBITDA as marketing, is there any leverage there? And so I guess the way that I think about it is, we're investing in marketing and e-commerce in 2020, and so you should put that in the 10% to 12% range as we mentioned. But the sales, right, the sale is down 4% to 8%. It obviously makes for some deleverage there. So I think there was an earlier point that if we start to see sales come back around, would that moderate a bit? And it would. So I think what you're seeing is we're kind of putting -- laying the foundation for our marketing and e-commerce platforms going forward, our initiatives going forward, and then the sales will come subsequently.

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Andrea Faria Teixeira, JP Morgan Chase & Co, Research Division - MD [41]

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Okay. But in terms of like what -- why do you -- sorry, just to follow up, what your activities have been trying to push in terms of your overhead expenses. Is that anything we should think about in terms of savings going forward, or that's going to be like a second process?

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Mandy J. Fields, e.l.f. Beauty, Inc. - Senior VP & CFO [42]

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Sure. So one, I would say, if you take a step back, we closed all of our e.l.f. stores, 22 e.l.f. stores is a big move in order to generate some cost savings that we have repurposed over into our marketing and e-commerce initiatives. So I think we have taken some steps to generate cost savings. As we think about our ability to have mitigated the 10% tariff, we've taken steps there as well. And we're not feeling that impact on the P&L.

Secondly, I would say that there's $3 million that we called out in cost savings, and so that you should see impact 2020 as well. And that's tied to our manufacturing facility, our warehouses as we discussed in our prepared remarks.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [43]

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And just building on that, Andrea, we are always looking at abilities to take a look at our cost structure. I think we've made some pretty bold moves in closing the stores. The automation initiatives, we talked about how we're mitigating tariff impact. And we will continue to look, but we wanted to make sure our people are clear and all our investors are clear, is our #1 priority is making sure we're investing in the brand to help revitalize our growth.

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Operator [44]

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Our next question comes from the line of Mark Astrachan with Stifel.

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Mark Stiefel Astrachan, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [45]

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I just wanted to follow quickly on the last question on these productivity initiatives. Maybe just broadly, could you help us with percent of sales that will be fixed versus variable costs?

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Mandy J. Fields, e.l.f. Beauty, Inc. - Senior VP & CFO [46]

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Sorry, you need to be a little bit more specific in what you're asking.

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Mark Stiefel Astrachan, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [47]

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Well, I guess just in general, so if you look at your cost of goods, how much of that is variable versus fixed? And within SG&A, I guess, we come back out to $10 million to $12 million for the year to get a sense of how much might be this G&A piece. But effectively just trying to get a sense of what can be flexed and what is fixed, to try and get a sense of what the leverage can be if sales is better or worse than what you're guiding to?

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Mandy J. Fields, e.l.f. Beauty, Inc. - Senior VP & CFO [48]

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So I would say, from -- let's just talk about the marketing piece of things. We have set aside funds to be invested behind our marketing and e-commerce initiatives. And so if you think about that as a fixed investment, as sales materialize behind that, you would start to see leverage in the business. In terms of other flexibility that we have, as Tarang mentioned, we're always looking at different opportunities to save on our cost across the P&L.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [49]

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And I'd just add there, Mark, I get you're -- where you're coming from in terms of, hey, how much -- can you help quantify how much leverage there is in this business? To your point, we haven't disclosed that before, so let me -- let us kind of huddle and think about whether that's something -- I understand the reason why that would be important, and let us come back and decide how we want to address and if we want to start disclosing exactly how much leverage is there.

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Mark Stiefel Astrachan, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [50]

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Okay, great. And then switching gears from a business standpoint. So I get that scanner data isn't the end all and be all of the business, but it certainly seems like in some categories like skin, it started to do a little bit better in recent months. I guess I'm curious how much of a focus maybe that can be especially given what you've talked about in terms of just overall makeup category trends.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [51]

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Yes, no, we're highly encouraged by, I'd call it, overall scanner trends across the board, both in makeup as well as skin care for us, if you take a look at the trajectories we were on last year to this transition period and what we're seeing. Skin care, as I've mentioned, I think for a long time, it's highly strategic for us, mainly because we can bring the same model that we've used on color cosmetics which is Prestige quality and extraordinary value, and there's a real need for that. And so what you're seeing on skin care is momentum behind many of our new items, and that focus. I mean I think Target has been our main customer for skin care for a while. We're highly encouraged that as Ulta Beauty tested skin care, they decided to take the entire full chain, given how well it's done. So skin care, all along has been one of those categories that we're highly interested in, and everything for us always goes back to the consumer. The reason we're interested in it is this overall insight of you need good skin to have good color cosmetics coverage, and both go hand-in-hand. And we believe we have an advantage of our ability to come out with meaningful innovation.

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Operator [52]

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Our next question comes from the line of Linda Bolton-Weiser with D.A. Davidson.

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Linda Ann Bolton-Weiser, D.A. Davidson & Co., Research Division - Senior Research Analyst [53]

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So in the past, you had talked about strategically in terms of your marketing that you specifically -- or went toward influencers that are less well-known, but were up and coming. Has your strategy changed at all such that some of the increased marketing spending is going toward paying more influential influencers?

And then secondly, in terms of the calendar year and the beginning of the year resets at retail, can you comment on if there has been any differences in performance among the retailers? I mean without naming names, are there some retailers where the resets are performing better than others? Or is it pretty uniform across your retailer base?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [54]

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Why don't I take this one? On our strategy with influencers, you're right that in the past, we primarily focused on micro or kind of macro influencers and avoided the mega influencers. What I would tell you is our strategy has not changed from when it comes to a sponsorship or paying standpoint. So I mentioned in the transition period quarter, we saw quite a bit of interest from a number of influencers, including one of the mega influencers, Jeffree Star. I think one of his videos is up to 10 million views.

The other one is, I think, close to 7 million views on different e.l.f. products, and he started with e.l.f. poreless primer and then moved on to doing the entire full face with e.l.f. We did not pay for either of those video postings. It really came more from our strategy of how we're reaching out. I think in the past, we almost avoided the mega influencers and many of them actually really love e.l.f. because of what it does for their brand and with their communities and followers. And so Jeffree had seen, based on some of our other outreach efforts, a lot of buzz on our poreless putty primer, tried it out, was amazed with how well it compared to one of his favorite Prestige products that was priced at $52, and then decided to go do a full face. So I think it talks more about our strategy and our breadth of outreach than it does in terms of actually paying for endorsements, which we still haven't done outside of our normal product collaborations, where we'll collaborate with someone.

And then on the retailers, I think one of the things that is encouraging for us is it's pretty uniform in terms of where we've seen the Project Unicorn sets go in. We saw that change in trajectory across the customers, that kind of -- if you can just see it right after post resets, which I think is encouraging. You always have some variation. And for competitive reasons, our customers won't let us -- won't want us to call out who's doing better or worse, but we at least are encouraged that it wasn't one place where we saw a change in trajectory. We saw it pretty uniformly across the board.

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Operator [55]

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Our next question comes from the line of Bonnie Herzog with Wells Fargo.

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Bonnie Lee Herzog, Wells Fargo Securities, LLC, Research Division - MD and Senior Beverage & Tobacco Analyst [56]

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I actually was hoping to maybe circle back and then have you guys possibly drill down just a little bit further on the expected slowdown in FY '20 in terms of your net sales. I guess if I think back, a key reason you guys changed your fiscal year was because you'd have better visibility from the retailers. So hoping to hear just a little bit more color on what you are hearing from them regarding space, especially given the category softness that you mentioned and some of the resets that you've seen that I guess makes you guys think that your sales are going to decline 4% to 8% in FY '20.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [57]

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Yes, sure. So first of all, on your first question, in terms of the change of fiscal year, we believe that was a good move because it did allow us to see kind of how these resets are performing. If we had given full-year guidance back in kind of February, I mean, if you look at the quarterly guidance we gave you in February, it was down 8% to 12%. So this is an improvement relative to that, and that improvement was aided by our ability to see how we're coming out of these shelf sets.

The second thing I would tell you is separating our guidance approach, particularly with Mandy coming on and her approach, how she wants to do guidance and really make sure that we see the proof versus what we're seeing in that first transition period. We're well positioned relative to any of our core competitors and our key customers. So if you just take what I just mentioned from the track channel data of the first quarter, track channels were down 3% and we're plus 3%, we're obviously doing better than where the rest of the category was, or has -- is right now, and a lot of that reflects promising early signs we're seeing at both Project Unicorn as well as our marketing activations. So I try to separate out initial signs. I'm glad we changed the fiscal year. We have a much better position in terms of where we are relative to where we would have been, and then I'd say guidance is more both philosophical as well as really wanting to see the proof in it and not get ahead of ourselves.

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Bonnie Lee Herzog, Wells Fargo Securities, LLC, Research Division - MD and Senior Beverage & Tobacco Analyst [58]

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Okay. But like you mentioned, Tarang, you are seeing some signs of improvements. Because I'm also trying to understand, with the stepped up spending and some of the changes you're putting into place, obviously, there's a lag. And I'm just trying to kind of understand how many quarters we -- it will take before you see further improvements and really how much of a lift you're expecting to see from some of the stepped up spending. Any color there on some of the -- what you've implemented so far.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [59]

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Sure. So what I'd tell you is, this is a pretty responsive business and we did see really good lift and response in the transition period quarter. It exceeded our expectations in terms of how it did. Now part of that was aided by, I mentioned, the Jeffree Star videos and the massive amount of activation we had against that. So that's a little bit of where I say I don't want to get too ahead of ourselves in terms of how much we attribute to that versus marketing.

Your second point is absolutely right. I mean what you see embedded in this guidance is the assumption that marketing and e-commerce and stepping that investment up in a noisy category is absolutely the right thing to do. But let's not forget that there is a lag within that. We're hoping, over the next couple of quarters, we can see, where is that response. Again, I don't want to get ahead of ourselves, we could have easily just gone forward. But we are seeing both -- both is true. We're seeing promising signs, and at the same time, want to be cautious in terms of how we approach the year.

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Bonnie Lee Herzog, Wells Fargo Securities, LLC, Research Division - MD and Senior Beverage & Tobacco Analyst [60]

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Okay, that make sense. And just a couple of other questions for me if that's okay. Just wanted to ask if you guys are expecting to gain shelf space in FY '20. Is that embedded into your guidance? Just to clarify that or not.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [61]

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So what's embedded in our guidance right now is the shelf space that we've announced before. So we talked last quarter, Ulta giving us more space, as well as where we are with Walgreens and some of our international. It doesn't assume more than that. So if there was additional space or doors that came up, that will be an addition to what we've put out.

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Bonnie Lee Herzog, Wells Fargo Securities, LLC, Research Division - MD and Senior Beverage & Tobacco Analyst [62]

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Okay, that's helpful. And then final question is I'd be curious to hear from some of the store closing that you did a few months ago, were you guys able to recapture any of the lost sales, either through online or any of the national retailers? Is there any way for you guys to quantify that at all?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [63]

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It's hard for us to quantify it other than when we close the stores, we did do some incentive offers for people to come on elfcosmetics.com. I mentioned earlier it was one of our best quarters in elfcosmetics.com and some of that was due to people coming from stores onto elfcosmetics.com. The other thing I would tell you is one of the reasons why strategically we decided to close our stores beyond the focus and making the difficult choice and really making sure that we took that SGA and put it against the brand and e-commerce spend that I talked about earlier, was our consumer is a multichannel consumer, and we felt pretty confident that they would migrate to national retailers. And so far experience, even just from a consumer reaction standpoint, given how small that footprint was, we feel pretty confident they're getting their e.l.f. in one of those other channels.

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Operator [64]

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It appears we have no further questions at this time, so I'd like to pass the floor back over to Tarang Amin for any additional concluding comments.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman, CEO & President [65]

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Great. Well, thank you, everyone. Really appreciate the time, and we look forward to seeing some of you at the William Blair and Jefferies conferences in June and look forward to speaking to all of you on our first quarter call in August. Thanks, everyone.

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Operator [66]

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Ladies and gentlemen, this does conclude today's teleconference. Again, we thank you for your participation, and you may now disconnect your lines at this time.