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Edited Transcript of ELF.N earnings conference call or presentation 8-Aug-18 8:30pm GMT

Q2 2018 e.l.f. Beauty Inc Earnings Call

OAKLAND Oct 5, 2018 (Thomson StreetEvents) -- Edited Transcript of e.l.f. Beauty Inc earnings conference call or presentation Wednesday, August 8, 2018 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Allison C. Malkin

ICR, LLC - Senior MD

* John P. Bailey

e.l.f. Beauty, Inc. - President & CFO

* Tarang P. Amin

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

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Conference Call Participants

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* Christina Marie Brathwaite

JP Morgan Chase & Co, Research Division - Analyst

* Claire Elicia Chamberlin

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

* Dara Warren Mohsenian

Morgan Stanley, Research Division - MD

* Erinn Elisabeth Murphy

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

* Jon Robert Andersen

William Blair & Company L.L.C., Research Division - Partner

* Joseph Bernard Lachky

Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst

* Linda Ann Bolton-Weiser

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

* Ross A. Collins

Cowen and Company, LLC, Research Division - Associate

* Rupesh Dhinoj Parikh

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

* Stephanie Marie Schiller Wissink

Jefferies LLC, Research Division - Equity Analyst

* Wendy Caroline Nicholson

Citigroup Inc, Research Division - MD and Head of Global Consumer Staples Research

* William Bates Chappell

SunTrust Robinson Humphrey, Inc., Research Division - MD

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Presentation

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Operator [1]

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Greetings, and welcome to the e.l.f. Beauty Second Quarter Fiscal 2018 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Allison Malkin of ICR. Please go ahead, ma'am.

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Allison C. Malkin, ICR, LLC - Senior MD [2]

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Good afternoon, everyone. Thank you for joining us today to discuss e.l.f. Beauty's second quarter 2018 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 year 2018 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 presentations and the most directly comparable GAAP measures. Certain brand equity measures cited in this presentation are based on third-party studies. With us from management today are Tarang Amin, Chairman and CEO; and John Bailey, President and CFO. For today's call, Tarang will discuss the business context and action. John will then discuss our financial performance and guidance.

It is now my pleasure to turn the call over to Tarang.

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

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Thanks, Allison, and good afternoon, everyone. Our second quarter saw healthy sales growth, operating profit and cash flows. This was on top of 27% net sales growth in the same period last year. We secured additional distribution at Walgreens, launched endcap displays at Rite Aid, started testing skincare at Ulta Beauty and began retail expansion in Germany. Offsetting this progress, we've seen a notable deceleration on our track channel sales. I will review what we're doing to reverse these trends. Before doing so, I'd like to provide context on where we currently stand.

e.l.f. is a 15-year-old brand compared to legacy players that are over 100 years old. We are still young in our brand-building journey and believe we have tremendous whitespace ahead of us. As I reflect on the past 4 years, we've done a number of things well to build competitive advantage. We have a brand that beauty enthusiasts love with the highest value and retention ratings in our category. We have an innovation capability that can launch 100 new items a year in as few as 13 weeks in both color and skincare. We've built a strong distribution base and remain the most productive color cosmetics brand at Target and Walmart on a sales per linear foot basis. Our compelling proposition for retailers continues to get rewarded with new distribution and space. We honed an operational advantage that provides the best combination of cost, quality and speed in our industry, and we've built a great team and infrastructure to further scale the business.

With that backdrop, let me now review the 3 things we're doing to address recent softness in track channels. First, it's time to spend more behind the brand; second, putting more focus on our key items; and third, taking measures to get optimal assortment at retail. Let me take you through each of these. First, it's time to spend more behind the brand. Over the last 4 years, we've grown our community to 37 million followers and have increased unaided awareness from less than 3% to 17% using our authentic and efficient program, such as Beautyscape. As greater the ROI of these activities has been, the marketplace continues to get increasingly crowded and noisy. In the last 18 months, we've seen the growth of multiple mega-influencer-driven brands that are competing for our younger consumer's attention.

We believe our brand proposition is highly compelling with high quality, extraordinary value and 100% cruelty-free, yet we've not invested enough to communicate our message. We believe now is the natural time to increase investment behind the brand. If you think of our evolution, we've spent the first 4 years building our distribution. We now have a strong footprint that we believe will benefit from increased brand support. We will test broader awareness and engagement efforts in the back half of this year that we can expand in 2019. We intend to fund this investment in part through operating leverage in the business. For example, we're making capital investments in our distribution facilities that we expect to drive labor savings. One of these projects is opening a second distribution center in Ohio to serve our e-commerce business. We expect this facility to reduce our operating costs and enable 2-day standard delivery to 90% of the country. Another project involves bringing similar automation in our West Coast warehouse. We expect these projects to be completed in 2019.

Second is putting greater focus on key items. We have real strength in innovation, output and speed. We launched over 100 items per year in as fast as 13 weeks. While we're proud of this innovation capability, we have an opportunity to bring greater focus to some of our best items. We have primarily marketed products when we first put them in our direct channels but have not done nearly as good a job when we expanded distribution to our international retailers. Our plan is to bring greater focus to some of our best products and support them with more of a holistic storytelling. As an example, in June, we put focus behind having America's #1 primers. In August, we will put an integrated effort behind Beauty Shield Magnetic Mask. Our $24 Magnetic Mask is a great example of our high quality extraordinary value proposition, and the only other thing like it in the market is a $75 prestige product. You will also see us further amplify our leadership position with America's #1 brushes.

Third is taking steps to get optimal assortment at retail. Each year, we launch new items in our direct channels. We take sales and consumer review data and make assortment recommendation through our national retail partners for their annual shelf resets. We have a strong track record over the past 10 years of driving productivity through this model. This year, we did not have the appropriate mix between new and existing products. Our new products are performing to our expectations, but we saw a greater drop-off in our carryforward items. Given how much our consumers value innovation, it is important to get more of our new items on shelves.

A key enabler to improve our assortment is Project Unicorn. This is a major product, package and shelf initiative that elevates brand presentation and improves navigation. By eliminating and changing outer packaging on select SKUs, this initiative will enable us to fit more new products within existing space. Project Unicorn will also allow us to highlight our premium componentry and colors, showcase our leadership position in category by brushes and primers and tell better product stories. Many of our national retail partners are enthusiastic about the improved space efficiency and presentation Project Unicorn will bring when it hit shelves in the spring of 2019. In summary, we're highly focused on addressing current business trends within track channels. These changes will take some time to fully implement, so we believe it's prudent to revise our 2018 outlook. John will discuss this in more detail later in the call.

Importantly, the current challenges have not dampened our enthusiasm for the long-term potential of the e.l.f. brand. Speaking both personally and as the second largest shareholder in the company, I have tremendous confidence in our ability to leverage the platform that we've assembled to provide value. To that end and as announced today, my plan is to purchase an additional $0.5 million of e.l.f. shares. My ownership stake is over 12% of the company, and I have purchased 92% of my shares. Our entire team is highly aligned to delivering long-term shareholder value.

My confidence is further bolstered by the wins we continue to get in the competitive marketplace. Even with recent trends, we remain the most productive brand on a sales per linear foot basis at our 2 largest customers, Walmart and Target. Our beauty expansion has exceeded our expectations, and we recently started testing skincare in a subset of their stores. We offer a compelling retailer proposition and continue to gain distribution and shelf space. As previously announced, we are expanding into additional Walgreens stores. We are also pleased to announce that we'll be broadening distribution to Rite Aid, initially with an endcap display program this year and in-line distribution to follow in 2019.

The brand continues to resonate internationally with expansion into additional Superdrug stores slated this year and the launch into Feelunique, the largest beauty e-tailer in the U.K. We are beginning our initial distribution in Germany with a subset of Müller stores. Douglas, a major European retailer, launched e.l.f. online in Germany and will test in a subset of their retail doors, an approach similar to that of Ulta Beauty in the U.S. While many of these developments do not significantly impact 2018 revenue, they show the power of our brand and continue to gain space and distribution.

I'll now turn it over to John to discuss our financial results and 2018 outlook.

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [4]

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Thanks, Tarang. For the second quarter, net sales increased 6% to $59 million, primarily driven by sales growth in select national retailers. Gross margin was 62%, in line with expectations. The variance to prior year was driven primarily by unfavorable movements in foreign exchange rates, partially offset by margin accretive innovation.

On an adjusted basis, SG&A as a percentage of sales was 49% compared to 52% of net sales in the same period in fiscal 2017, largely driven by timing. Adjusted EBITDA increased 29% to $13 million from $10 million in the second quarter of 2017. Adjusted net income decreased to $6.5 million or $0.13 per diluted share compared to adjusted net income of $7.3 million or $0.15 per diluted share in the same quarter of 2017. We continue to optimize our inventory levels and are happy with the progress made throughout the quarter.

Turning to our outlook. Accounting for current trends within select national retailer partners, we are revising our expectations for 2018. We now project net sales growth in the low single digits, adjusted EBITDA of $58 million to $62 million, adjusted net income of $28 million to $31 million and adjusted diluted EPS of $0.56 to $0.61 on 50.4 million fully diluted outstanding shares. Our guidance contemplates Nielsen data to show average declines of approximately 10% through year-end.

While we have not historically provided quarterly guidance, we believe it's prudent to provide added context on our expectations for the next couple of quarters. At a high level, we expect company sales in the second half of 2018 to be flat to slightly down, with declines in Q3 partially offset by gains in Q4. While our international and direct businesses are expected to be positive contributors, the significant variances are driven by national retailers, which is where I will focus my commentary.

As you will recall, the third quarter of last year demonstrated strong sales growth of 28%. We are now lapping several items from that quarter, including the early shipment of a portion of our Target holiday program, pipeline for Walmart and CVS space expansion and higher sales to discounters. These items are expected to create a drag on growth in the mid- to high teens in addition to our assumption for track channel trends. These impacts are being partially offset by the growth of our Specialty business, including Ulta, which we expect to contribute high single-digit growth. We anticipate that the net of all of these effects will result in Q3 sales to decline in the mid- to high teens on a year-over-year basis.

For the fourth quarter, we expect track channel trends to be partially offset by higher holiday sales at Target and pipeline for Rite Aid. We also anticipate growth in our Specialty business, though the contribution to growth is muted as we shift our pipeline for full distribution to Ulta in Q4 of 2017. We anticipate that the net of these effects is sales growth in Q4 of 2018 in the mid- to high single digits. Though it is far too early to discuss our 2019 outlook, we believe that while we are focused in many of the right areas to address current trends, many of these initiatives will take time. As a result, as of now, we would expect low growth in 2019.

Beyond our outlook, there has been quite a bit of discussion on the topic of tariffs. While it is yet to be seen where tariffs land, our initial plan would be to mitigate the impact through a combination of select pricing actions, negotiation with our suppliers and global sourcing efforts on a portion of our line. In addition, we believe that potential exists for advantageous moves in the U.S. dollar to RMB exchange rate that could help to offset the impact. We continue to closely monitor the evolving policy and our final plan will dependent -- will be dependent on how the tariffs ultimately land.

In summary, e.l.f. is a beloved brand with a strong track record and a talented team that is intently focused on meeting the needs of our beauty enthusiast consumers. The strength of our retail proposition is evident by the continued expansion of e.l.f. into new distribution in both the U.S. and abroad. We are highly focused on addressing current trends and delivering shareholder value.

With that, I would like to now ask the operator to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a question from Steph Wissink, Jefferies.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [2]

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John, I just wanted to follow up on the inventory comments. I think you mentioned you're pleased with the progress there. It looks like inventories, they are down, about in line with your third quarter comment on guidance. So can you give us some insight into the complexion of the inventory that you currently hold? Is that also consistent with the key item strategy in some of the brand investment you're going to make in the back half?

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [3]

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Yes, Steph. So yes, we have been quite pleased with our inventory levels, obviously, a topic of discussion a year or so ago and have really brought those in line as expected. We're happy with the composition of inventory relative to what we see coming, including the launch of Project Unicorn, which Tarang can speak to more broadly, but does involve a different packaging system. So we're happy with where those sit.

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Operator [4]

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Next question is from Oliver Chen, Cowen and Company.

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Ross A. Collins, Cowen and Company, LLC, Research Division - Associate [5]

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This is Ross on for Oliver. In terms of just the Project Unicorn initiative, just taking a step back, how are you guys thinking about kind of optimizing the mix between new and existing products?

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [6]

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Sure. So I'd say real focus within Project Unicorn. One of the reasons I'm really excited about it is it really has 4-key benefits. First is to take some of the products out of their kind of black packaging to allow us to better showcase our premium componentry and color. Our primers are a big example where we -- getting these out of the box improves their kind of premium communication. The second is a much more flexible product and shelving approach, where Unicorn allows products to fit on shelves or hang in pegs. But probably the most important as it relates to new products is greater shelf efficiency. We're able to fit more products into existing space. So if you think about it, our retailers will be able to take more of our new products into even their existing space, and so it helps that mix in terms of new versus kind of carryforward items, and at the same time, allows for a better communication on shelf and a better navigation as well, including some of the core areas of product strength that we have. So in total, we believe Unicorn will be an important step forward in terms of really getting that optimal assortment on shelf.

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Ross A. Collins, Cowen and Company, LLC, Research Division - Associate [7]

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Got it. Okay. That's helpful. And then secondly, with regard to the savings, the operating leverage savings. Just curious if it goes beyond just the labor optimization or if you could just provide more detail there, also with regard to timing, that would be helpful.

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [8]

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Sure, happy to. So if you look over the last few years, we've been reinvesting a lot of our operating leverage savings back into the business, and we talked quite a bit about the areas of those investments have been going into historically people and infrastructure, and then to an increasing level, brand over the course of the last few quarters. We see a great opportunity to continue putting additional dollars against the brand, and as Tarang mentioned, really want to ramp those efforts up into 2019. In addition to the natural operating leverage that we do have inherent in our business, we're also pursuing a couple of initiatives to free that up even further. And Tarang mentioned a couple of them, which really relate to capital investment in a couple of our warehousing and logistics facilities. The first actually requires no capital outlay on our own. It's a facility in Ohio for our e-com business, which not only will free up some savings but will also allow us to get to 2-day delivery as consumer expectations have continued to get greater with the rise of players like Amazon. And then the other is in our West Coast facility, where we will be putting capital on the floor that will generate significant labor savings. The latter of that, those 2 projects is the more significant in terms of the actual dollars that are freed up and are likely to be complete by the middle of 2019.

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Operator [9]

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Next question is from Linda Bolton-Weiser, D.A. Davidson

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Linda Ann Bolton-Weiser, D.A. Davidson & Co., Research Division - Senior Research Analyst [10]

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So in terms of your projection or expectation of Nielsen decline of 10% for the remainder of the year, how much of that is category decline versus share losses, I guess, by you?

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [11]

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Linda, it's John. So in terms of the assumption for the balance of the year, we have said it's an average of negative 10% for the remainder. And I think the most recent periods have come inside of that. Certainly, I think there will be a category impact. We've talked quite a bit about what we've seen in mass color and some of the drivers. And as a key player on mass color, not immune to things that are happening in the category. As far as how share is expected to play out, that's largely dependent on factors that are beyond our control. So it's a bit difficult to forecast that at the moment, but those are how we're thinking about the assumption for the balance of the year, which would be a combination of the 2.

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Linda Ann Bolton-Weiser, D.A. Davidson & Co., Research Division - Senior Research Analyst [12]

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And then just long term, when you talk about investing more behind the brand, just in a very long term kind of big picture way, do you think that your advertising ratio has to double from where it is now from the 3% level? Or triple to 9%? Or what are kind of your long-term thinking about where that ratio needs to go?

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [13]

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Yes. So we haven't pegged where the long-term ratio needs to be. Our approach is very much kind of an ROI-driven approach. So a lot of what I talked about is -- if you look at our approach, it's first and foremost, we have some high ROI activities that we will double down, first and foremost. And the second thing we do is we test quantitatively few of our other tactics and see where we're getting the greatest returns. So we do not believe -- we kind of contrast our 3% to sometimes legacy players that are over 20-some percent. We don't believe we'll ever get to that level, but we do believe more than 3% makes sense, and I think they'll be guided by what we're seeing in terms of return.

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Linda Ann Bolton-Weiser, D.A. Davidson & Co., Research Division - Senior Research Analyst [14]

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And just finally, can you just clarify. In terms of the 2,000 stores, additional stores at Walgreens that you're gaining, are those the Rite Aid stores that are being acquired by Walgreens? Or are those Walgreen-branded stores?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman & CEO [15]

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So with the -- what we've previously announced is we're picking up additional doors at Walgreens. So we've been in Walgreens, and we actually shipped pipeline for Walgreens in Q4 of last year, and those are Walgreen banner stores. In addition, we are broadening distribution to Rite Aid stores, and we're doing that first through and endcap program, a display program for this year, followed by inline distribution in 2019. So you'll get both Walgreens as well as Rite Aid.

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Linda Ann Bolton-Weiser, D.A. Davidson & Co., Research Division - Senior Research Analyst [16]

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And how does that go along with the acquisition of Rite Aid by Albertsons?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman & CEO [17]

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So you will -- in that, you will have some -- certainly, you'll have some Rite Aid stores that Walgreens has acquired that will go to Walgreens, and you'll have others that are kind of stand-alone. Both, we see as kind of viable going forward.

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Operator [18]

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The next question is from Wendy Nicholson, Citi.

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Wendy Caroline Nicholson, Citigroup Inc, Research Division - MD and Head of Global Consumer Staples Research [19]

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My question -- my first question is about the incremental marketing spending that you're talking about. And I'm sorry if I didn't pick this up in your comments. But is it going to be traditional advertising? Is it going to be digital media? Is it going to be more promotion in store? What's you're thinking about that right now?

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

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Sure. So Wendy this is Tarang. The first component is -- some of the tactics that we already like and have good ROI against. So if I think about Beautyscape influencer program, we've had great results in terms of reaching their communities and the amount of reach that we get through that program, putting more behind Beautyscape and other influencer efforts that we believe we can continue to build an authentic community. Second is we have a number of digital efforts that we're also seeing pretty good returns on that we would put more investment behind. And then third, I'd say, is testing other approaches. So we have, for example, I mentioned our overall message on extraordinary value and high quality as well as 100% cruelty-free, having some messaging that we put into kind of video -- digital video and kind of broader -- and testing kind of broader awareness, building tactics that way as well as sampling. So there's a number of -- and we've always been a test-and-learn brand that we will test and see where we get the greatest return and kind of allocate dollars against those activities.

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Wendy Caroline Nicholson, Citigroup Inc, Research Division - MD and Head of Global Consumer Staples Research [21]

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And do you feel like -- in the first part of that, the spending more behind the beauty influencers, et cetera, do you feel like there is a waning of support on their part such that you feel pressure to spend more? Is it just that you think there's an opportunity to sort of accelerate the momentum of their enthusiasm, if you will?

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

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Yes. No, we believed -- I mean, first of all, we've had great results behind our own Beautyscape program on influencers. So the first thing that gives us confidence is we've seen some momentum there. The second is the marketplace is crowded, and we've seen a number kind of mega-influencer-driven brands that have even higher reach. So in the face of kind of, I call it, that noise or people looking for attention from our consumers, making sure we're making enough of a voice there. And then to your previous question on kind of marketing tactics, the one place that we are not looking to put money against is promotional support. We have an extraordinary value as it is, so what we're really talking about is equity building kind of marketing for both the short as well as long term.

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [23]

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And I think -- Wendy, it's John. The only other thing that I would add -- just kind of back to other things we're seeing in the category. For a long time, we really prided ourselves on our authentic and community-driven tactics and the fact that we didn't pay influencers at all. And I think that was a good kind of guide for us as a brand. Yet at the same time, we do think there's an opportunity to spend a little money and do it in a way that really does come forward as authentic and the way that our e.l.f. consumer would want to see us show up. In that increasingly noisy world, not being afraid to participate in the right way is something that we should be thinking a lot about.

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Wendy Caroline Nicholson, Citigroup Inc, Research Division - MD and Head of Global Consumer Staples Research [24]

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Got it. And then just one question on your pricing strategy, the $24, I think you said it was a mask, but is a lot cheaper than the $75 alternative. But are you finding any confusion or any feedback in the market as you launched some more premium-priced products and you kind of get off that specific $3 peg?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman & CEO [25]

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Yes. Well, the key for us is to innovate across all price points, including opening price point. I mean, I think one of the items I feel most enthusiastic about is our $2 brow pencil. It's the #1 brow pencil in America. It's a phenomenal item. And so I think the key for us is it's not any particular price point but making sure we offer an extraordinary value in anything that we introduce, and that includes in the opening price point. You'll continue to see that be an important focus of ours and making sure that we have those items that consumers want even at those low price points.

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Wendy Caroline Nicholson, Citigroup Inc, Research Division - MD and Head of Global Consumer Staples Research [26]

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Got it. And then my very last question, and I appreciate you being patient with me. The Ulta skincare product, is that incremental shelf space? Or the product you said that is in test at some Ultas, is that an incremental shelf space? Or is that in your standard set of beauty that's already at Ulta?

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

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So the Ulta test is in an incremental space. It's in their skincare space, and we're testing on a subset of their doors. Broadly and other places, we typically prefer having skincare within our overall e.l.f. set. We like that approach better, but they were so excited about our skincare, in particular our innovation pipeline, that we said let's get this a try, and we'll continue from there.

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Operator [28]

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We have a question from Mr. Bill Chappell, SunTrust.

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William Bates Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [29]

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Just trying to be straightforward. And if we look at your -- at least your track standard data over the past 18 months, it's been decelerating and pretty much consistently for 18 months. And as we've asked, and there have been investor concern on the calls, you've both been fairly, dismissive, things were on track. So I'm just trying to understand, I guess, first, what's changed too much where you felt like we need to put a big plan in place? Was it sales finally started to decline in tracked channels? What changed in your head? And then two, how do we get comfortable that this decision to try to arrest that whole change isn't 6 months too late? I mean, it's, boy, we should've been doing this a long time ago, and now it's going to take that much longer to get sales going the right direction.

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

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Sure, Bill. This is Tarang. So I would say the biggest change is we saw that deceleration that you've seen even more dramatically over the last, I would call it, 8 to 10 weeks. And so as we took a look at our plan, it did actually surprise us relative to what our initial expectations were even when we kind of talked about 6% to 8%. We had kind of an algorithm between kind of where we expected tracked sales to be versus non-tracked, and so that was a surprise. I'd say in terms of the actual actions that we're taking, a number of these we believe are the right things not only for the short but long term. I think, I mean, we've talked for a while now wanting to invest more in the brand, and I think it's part of our natural evolution as we spend a lot of time kind of building a sufficient enough distribution base. We think that being able to spread that marketing across that distribution base will be even more effective. Same with the key items, Bill, because I think that was probably one of the learnings from this year, is we've seen some others do a pretty good job getting after key items. We launch so many things that sometimes some of our key items get lost in everything that we launch in doing a better, more concerted effort, particularly when things get to national retailers. And then finally, the optimization process. That's continual. Every single year, we'll go through that, and we'll learn things in terms of what the right mix is between new products and our existing products as we go through. So I don't -- I would say in many of our actions, it isn't like we're picking completely new topics. It's more of putting greater intensity behind them, mainly based on what we're seeing some of the tracked data.

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William Bates Chappell, SunTrust Robinson Humphrey, Inc., Research Division - MD [31]

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Okay. And then just switching to looking at the tracked data. Is there a risk as we move into 2019 that some of the share gains or shelf space gains you've had over the past couple days -- couple years get scaled back just because you're running negative comps in the stores? Or do you feel comfortable that, that's there to stay?

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

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Yes. So what I'd tell you on those, if I just take a look at like where we picked up some of the most space, Target and Walmart. We have a history of 25 years working with both of them. And the key currency with both of them is the combination of what consumer are you bringing to my stores, what's your innovation pipeline and how productive are you. Even with recent trends, we remain the most productive brand that Target and Walmart carry on a linear -- on a sales per linear foot basis. So our overall strength relative to category is really quite strong. The other thing I would tell you is when I look at from a competitive standpoint, there are some competitors that had years of sustained kind of issues before action was taken. We certainly do not intend to be in that position. We take very seriously both our relationship with these customers as well as our role in helping them grow in their category. And so I feel really good about kind of the plans we have going forward with both Walmart and Target, particularly resting as we've shared kind of Project Unicorn and what that can bring in terms of getting more of our new products on the shelves, other things that we can do with them kind of as we continue to partner. So I feel good both in terms of where we stand and our overall productivity but, more importantly, in terms of what our future plans are with them.

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Operator [33]

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We have a question from Erinn Murphy, Piper Jaffray.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [34]

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I guess just first, trying to understand a little bit about how you see the pathway from here. I think you talked a little bit about 2019 being slight growth, so definitely going back from the 10% to 15% sales CAGR you talked about at ICR. But within that growth, are you assuming kind of ongoing pricing that you've had over the last several years? And then how does that mix between U.S. and international? It's curious just given that you're talking more on international today.

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [35]

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Erinn, it's John. So on 2019, obviously, not in a position to give guidance on the year. I think there's a lot of 2018 left, but we did acknowledge that we have that 10% to 15% out there. And likely, a question on everybody's mind is how would this play out in the next year. I think there's a lot that remains yet to be seen before we would be in a position to be able to talk with any level of specificity on 2019 other than if kind of current trends continued on the path that we're talking about and acknowledging that the investments and initiatives we have in place will take time, that we would expect '19 to be a low growth year. Beyond that, hard to get more specific other than some of the things that Tarang mentioned in terms of some of the seeds that are being planted in both international geographies like the U.K. and Germany as well as some of the continued distribution opportunities that we see here in the U.S.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [36]

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So maybe if you could talk a little bit more about the international. It sounds like you're expanding within the U.K. and then Germany. Would love to just hear kind of how you're building the team. Are you kind of resourcing it out of there? And how are you able to scale that so it can be a bigger, longer-term opportunity for the brand?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman & CEO [37]

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Sure, Erin. This is Tarang. I would say our international strategy mirrors a lot of what we've done in the U.S. in terms of a discipline sequential rollout. We identified -- I think last year we talked about few priority countries that we wanted to first kind of enter. We started our journey with Canada and Mexico, obviously being next to the U.S. and having a great partner in Walmart to be able to expand into those geographies. As we looked into the U.K., our initial focus beyond our e-commerce business was with Superdrug, a division of A.S. Watson's, and they, again, were a great partner to kind of efficiently enter that market, such that not only would we see kind of, I would call it, consumer messaging that market, but so would they. 'So it ended up being a very good way of kind of launching to that market. You're seeing us do similar things in -- as we look at Germany and other big markets, is find the right retail partners that we can put our model in place with the that actually are wanting e.l.f. already given our kind of extraordinary quality and value and that have a role in that market. And so it's a pretty efficient model relative to other international expansion models I've been part of, mainly because it really relies on many of the same things we've done in the U.S. It's just pretty efficient partnering with the key retailers that matter for color cosmetics in that particular market. So we're pleased with the rollout. What you did not hear us say is we're broadening the brand into 40 or 50 countries at a time. We really want to make sure that we feed each market the right way, partner with the right retailer and kind of nurture and then expand from there, quite similar to what we did in the U.S. if you think about us starting with Target and going from there.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [38]

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Okay. And then I just have a clarification on something you said in the Q&A. Did you say that Walgreens, the 2,000 doors you talked about in June, that actually shipped back in Q4? And then the Rite Aid, it's the endcap that's what's incremental from here? I just want to make sure I understood that dynamic correctly.

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

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That's right. So we shipped pipelines from Walgreens in Q4. This year will be replenishment on Walgreens and then Rite Aid was -- the displays were incremental.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [40]

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Okay. And then the last question is just a housekeeping. Did you say what the number of innovations launched the quarter was? I didn't hear it. If so...

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman & CEO [41]

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We did not say what they were, but they're about constant to where we were last year. I think they're around 30 launches this year, including in this quarter, in Q2, including I think about 8 first-to-mass launches. So the pace of innovation continues for us. I think the main emphasis of focus for us is -- and we'll always have a number of launches. We'll always be known for our speed and putting it in our direct channels and getting the data that way. I believe the biggest change you see is just much greater concerted effort once we expand distribution. Often, what we do is we have all these launches. For example, last year, we had 128 new product launches in our direct channels. Yet when we went on shelf at kind of a Target, Walmart, there wasn't very much marketing or emphasis we put. We believe that was missed opportunity. We believe by being able to put, for example, what we're going to do in August against our Magnetic Mask. It's just a phenomenal product. It's already kind of a top seller. And being able to put more behind that, we believe, will give us better returns. So I think the overall innovation engine is the same as it's always been. It's more of how do we better leverage the best items coming out of that, particularly when we expand distribution.

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Operator [42]

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Next question is from Bonnie Herzog, Wells Fargo Securities.

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Joseph Bernard Lachky, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [43]

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It's actually Joe Lachky on for Bonnie. So I guess, I just wanted to clarify. I didn't really catch what's going to be causing the deceleration in the second half in the Nielsen to down 10%. I mean, that's pretty dramatic from, I guess, flat in Q2 and down high single in the last month. So I, again, wanted to try and get an idea what's driving that because I think comparisons do get easier in the second half.

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [44]

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Joe, it's John. So you're correct that, obviously, an average of negative 10% sustained for the balance of the year would be inclined an added deceleration from what we have seen over the course of the last couple of months. I think from our standpoint, obviously acknowledging where we have seen that trend line go and wanting to make sure that with a revision to guidance, we do put something out that contemplates potential continuation of that deceleration felt prudent. So certainly, to the extent that we see things leveled off where they are, obviously, there could be some upside to the numbers that we're talking about here today. But otherwise, thought that it was prudent to take that approach.

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Joseph Bernard Lachky, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [45]

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Okay. And my other question, I guess, you kind of touched on this in your prepared remarks, but I feel like there has been a number of new entrants at the value end of mass cosmetics, including from retailer-owned brands. So how are you working to ensure you maintain an attractive value proposition and differentiate your products versus these newer brands?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman & CEO [46]

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Yes, sure. Joe, this is Tarang. I would say the core of our proposition is high quality extraordinary value. We've always had value brands come and go in our category. We've obviously had good brands in terms of quality. Our unique ability to put those 2 things in a way -- in a compelling way together is really what differentiates us. So we always look at any new entrant coming through and really evaluate kind of what the quality of that product is and what the absolute both price point and overall value is, and we feel quite comfortable in terms of how we stack up with them. And again, I'll go back to one of the things I talked earlier, which is making sure that we're innovating across price points, including the lower price points in our overall value creation. The last thing, we've spent quite a bit of time given just how critical this is for us. And one of the things I said in the prepared remarks that I want to make sure doesn't get unnoticed is we do a large base size kind of consumer studies every year, and we have the highest value ratings in the category, and that has not changed. If anything, we've kind of increased those value ratings last year. So at the same time that we're taking average unit retails up, our ability to have extraordinary value is a core part of our proposition, and you'll continue to see us have great appeal and focus there.

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Operator [47]

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The next question is from Jon Andersen, William Blair.

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Jon Robert Andersen, William Blair & Company L.L.C., Research Division - Partner [48]

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Most of my questions have been asked but -- and answered, but just a couple. You talked recently about broadening your sourcing model to include sourcing capabilities outside of China. Can you give us an update there with respect to that effort? And how quickly or important that is in that kind of party list right now.

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

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Sure, Jon. This is Tarang. So we talked, I think, the last quarter that we've kind of had our first U.S.-based kind of manufacturing. It's still a very small portion of our business. Most of our businesses is manufactured in China. But we do believe it's important as part of our overall global approach and, more importantly, taking our supply chain advantage. So this is a best combination of cost, quality and speed. As we take a look whether it be a tariff environment or not going forward, the combination of kind of pricing negotiations with our existing suppliers as well as taking a look at other sources of supply, including potentially having some in the U.S., is -- everything is on the table.

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Jon Robert Andersen, William Blair & Company L.L.C., Research Division - Partner [50]

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Okay. And then can you talk a little bit about where you are today? And is there reference to it in the press release? I think the ability to create shareholder value by leveraging kind of the platform and the capabilities that you've built over the years via e.l.f., are you referring to expansion of the portfolio to include multiple brands? Just trying to kind of understand where you sit relative to that, and if that's something that you continue to consider and look at.

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [51]

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Yes, Jon. It's John. The thesis has not changed there at all. Obviously, we've made a lot of investments in this platform and have capability in a number of different areas. And so as we look out in the marketplace, whether it's an opportunity to leverage those capabilities, to start new brands or to think about strategic acquisitions that could stand to benefit from those capabilities in a synergistic and value creative way, I think all options are still on the table in terms of tapping into some of those additional vectors, like shareholder value. And we continue to be quite active out there in the marketplace, taking a look at different opportunities to make that happen.

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Jon Robert Andersen, William Blair & Company L.L.C., Research Division - Partner [52]

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Okay. Last one for me. As you contemplate spending more in advertising, other demand generation investments behind the brand, what's the right way to think about this build, if you will? Is the second half of '18 kind of just more kind of a test-and-learn period? And then you may step up to a structurally higher ad spending ratio in 2019? I'm trying to get a sense for how you see that evolving.

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [53]

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Yes, so generally speaking, I think that's a right way to think about it, which is we're testing a number of different activities in the back half of the year, and would look to scale those up even further in 2019. I think the plan affords us to get behind something in a potentially greater way if we see things sooner, but just the nature of the timing of some of those tests are such that our expectation would be up to 2019 event. In terms of where we see kind of those scaling up to, I would go back to some of Tarang's commentary around ROI focus. Obviously, we wouldn't pursue that spend unless we thought there was a corresponding benefit that accompanied it. And we have a long way to go before we ever came close to our legacy competitors and don't have any intention of being there. So I think we're not in a position to give specific guidance on how many dollars or what percentage. If I was forced, I would say single digits is absolutely appropriate, and I could feel quite comfortable with that. But we're excited about the prospect to put more dollars behind this brand.

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Jon Robert Andersen, William Blair & Company L.L.C., Research Division - Partner [54]

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That's helpful. Let me squeeze one more in. I know you're limited in what you can say about 2019, but you did comment that you expect sitting here today it to be a low growth year. Is that low-growth-year comment apply to sales and earnings?

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [55]

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Again, I think you said it well, Jon, that we're not in a position to give kind of clarity on 2019, really more intended to be a reflection that if things that we currently see in terms of those trends played out forward into '19, that a low growth year should be expected relative to some of the earlier rates that were on the table. The only thing that I would mention is if a low growth year were to manifest itself, suffice to say, we would be looking for the opportunities for operating leverage in the business and places to continue reinvesting in the brand.

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Operator [56]

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The next question is from Andrea Teixeira, JPMorgan.

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Christina Marie Brathwaite, JP Morgan Chase & Co, Research Division - Analyst [57]

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It's Christina Brathwaite on for Andrea. First, I wanted to just circle back on the comment that Tarang made about the sell-through of older products kind of falling off faster than it's been historically. Have you done any research into what's kind of driving that deceleration there from kind of the historical trend?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman & CEO [58]

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So we've done a bit of analysis. The specific piece I was talking about is there is a mix every year on our shelves of bringing new products on and what we call our carryforward, and we do see a little bit of a falloff on carryforwards over time. It is a natural kind of falloff as consumers are constantly looking for a new innovation, and so there's always this healthy balance there. And I would say in this particular -- and it varies sometimes retailer by retailer. You can have at a particular retailer a competitive initiative on brushes that could impact your brush business in one place versus another or face products. And so I would say for us, it's really about the mix of how much new versus old do we have. And we know -- I think one of the great things that we have is we have so many new products that we can pick from. And if I just go back to the -- if I just look at this year as an example, I talked earlier about Magnetic Mask being a phenomenal item for us. That was not in broad distribution until just now that we are really broadening that out. We had a -- for example, in our pipeline last year, we had a $4 total face sponge, which is a terrific product and a great kind of value proposition. Again, that's only going in distribution now versus kind of where it was in the spring. Mist & Set is a great category for us. We didn't have kind of the larger size kind of available there. Our oil control primer mist, our lip plumping glosses. There are a number of items that we were not able to get on the shelf, and we think that hurt us, frankly, relative to -- versus kind of our carryforwards and what we're seeing there.

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Christina Marie Brathwaite, JP Morgan Chase & Co, Research Division - Analyst [59]

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Okay. And then to go -- move back over to the tariff commentary. How are you thinking about -- and then one of the comments that you made was that you could pass on pricing to kind of preserve your margin because of the tariff. But how are you thinking about your ability to pass on higher pricing just given the volume pressure you've seen this year, which I think is partially, or at least during the last call, was distributed to raising kind of the ticket. How much flexibility do you think you have there just versus your original brand composition of being the lowest cost provider and in this environment with private label continuing to -- taking share and be more aggressive?

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [60]

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Christina, it's John. So I don't want to get too far into it just given the uncertainty of where some of these conversations stand and then competitive sensitivity as to what we may or may not do, but I think it's important to note that pricing is one of several levers that we see available to us. As we mentioned, obviously, having our suppliers, who have long partnerships with us over the years, share in some of that burden. And also some of the things that we would expect in terms of the broader exchange rate that would certainly serve to be a mitigant here would obviously play into the calculus as well. That said, selectively on a number of different items, that we believe that there could be opportunity to take price. And if you think about the mass landscape in particular, many of the folks that we're actually sitting alongside also have sourcing in country, and so that would help inform a pricing strategy. So I would just leave it at that, but it would be a combination of things of which pricing would be one.

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Christina Marie Brathwaite, JP Morgan Chase & Co, Research Division - Analyst [61]

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All right. That's helpful. And then I guess last one for me. I'm just trying to reconcile the difference in commentary between the need to invest more behind the brand and then the contraction that you saw on SG&A dollar growth during this quarter. Was there something specific like discrete to 2Q that was pulled out in terms of SG&A? Just trying to think about how we should be growing that line item and the rest of the year.

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [62]

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No, there was nothing specific that we would call out. I think it was more timing than anything else. Certainly, as you take a look at SG&A levels in the back half of the year, you will see them tick up. And as I mentioned earlier, some of that is really about getting us flexibility to get behind brand spend in a greater way if, for whatever reason, some of the earlier tests we really wanted to get behind.

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Christina Marie Brathwaite, JP Morgan Chase & Co, Research Division - Analyst [63]

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Okay. Oh, sorry, did you say guide to the tax rate for the rest of the year? It should be closer to 20% of your products this quarter?

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [64]

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It would still be consistent with what we guided to last quarter, which is about 28%.

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Operator [65]

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Next question is from Dara Mohsenian, Morgan Stanley.

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Dara Warren Mohsenian, Morgan Stanley, Research Division - MD [66]

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So Tarang, I just want to follow up on the question on your shelf space allocation or your larger mass customers going forward. I guess, my concern would be, your revenue trends are now declining fairly significantly at those customers, and that's a pretty pronounced shift versus the strong momentum you saw historically. So I understand you're still productive, but seems like that's a risk factor. You're also expanding into other retailers in 2019 beyond those key mass retailers, and it sounds like you may look for some pricing. So I would think all those things would create some pretty difficult discussions at the larger customers and potential shelf-space risk. You didn't sound as concerned earlier. So can you just give me a little more detail around sort of what drives your confidence on that front? And also in the 2019 revenue guidance you gave, what are you assuming in shelf space at those mass retailers in 2019?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman & CEO [67]

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So I'll take the first one and John the second. So in terms of our approach with our key customers, what we like is finding partners with both Target and Walmart. So we're with them all the time, where we're talking the business, we're talking kind of the trends, what we have coming in our pipeline and kind of where we go forward. So I go back to -- our overall productivity is extremely strong. Even more important than that, our plans going forward are even stronger. So if I take a look at kind of what are our learnings this year in terms of what new items would we have on the shelves, which ones do we want on, what do we have in our pipeline, those conversations are going really well. And it is a continued kind of partnership in terms of how we help kind of grow their category. And overall track record, I'd tell you, is our 10 years at Target is like the first year where we've run into this. And so we'll have very frank and great conversations with them in terms of what we're going to do. Same with Walmart for perspective. The majority upper chain at Walmart is still -- the vast majority is still only in the 4%, compare that to close to 30-foot run on some of the legacy players. We are so far above kind of on both productivity as well as kind of underspaced in terms of what our fair share allocation would be that, that conversation hasn't even come into kind of the picture as much as kind of what are we going to do to continue to partner to help grow their category. So you never say never. I think we've had some competitors kind of get in trouble that way, but I feel very confident in terms of our plans going forward both with Target and Walmart and our position. And then on the second part of your question, which is, hey, as you expand distribution, I think we've been very careful of how we've expanded distribution. If you think of our approach kind of from Target to Walmart, we really made sure we had a strong plan at Target before we went into Walmart. And as we continue to expand in Walmart, same thing with Walmart as we've gone into Ulta. I mean, we're talking about 15-year-old brand that's only now really getting into kind of drug in a bigger way, and each have a role that we can map towards. And -- but first and foremost is making sure, and our strategy all along has been take care of kind of where we already have business, and we don't take that lightly. And I tell you there's a lot that goes after, making sure that we continue to partner well with them.

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [68]

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And Dara, yes, on the 2019 question, I'd just echo some of my earlier perspective that it's far too early to talk specifics.

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Dara Warren Mohsenian, Morgan Stanley, Research Division - MD [69]

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Okay. And then on the China tariff side, are you assuming in your guidance there is a 10% tariff on your imports into the U.S.? And do you have any backup plans in place in terms of sourcing if the regulatory delays and other things like that out of China maybe is sort of an indirect result of some of these tariffs?

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [70]

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So there's no assumption of a tariff in the back half of 2018, I think even, again, difficult to comment on some of the plans that are on the table, but in question would be the timing of when some of those things would take hold. The other thing I'd say is no benefit from some of the mitigating levers that we talked through earlier. And the second point in terms of our supply and if there's any issues there, be it on kind of looking from a global supply basis, a lot of it just comes to our inventory position and how that flows through. So we're comfortable right now, but really, we have to see kind of where the tariffs finally land.

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Operator [71]

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The next question is from Mark Astrachan, Stifel.

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Claire Elicia Chamberlin, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [72]

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This is Claire Chamberlin on for Mark Astrachan. I just wanted to ask a question about productivity in Ulta. So you've mentioned that your very high productivity in some of the larger retail. But can you talk about how you compare and also versus the other mass brands in there?

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman & CEO [73]

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Sure, Claire. This is Tarang. So we -- Ulta doesn't want us to give specific numbers, so I'm not going to give you a particular and relative. What I can tell you is we're both very pleased with kind of the productivity of e.l.f. in -- as they did their full chain rollout. And I think a great testament to that is on testing skincare in a subset of their stores. So we're quite excited by what we're seeing at Ulta, and again, it goes back to kind of, we believe, as a good consumer overlap as well.

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Operator [74]

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The final question is from Steph Wissink, Jefferies.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [75]

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We're trying to be compliant with one question, so we'll throw another one out there. I just want to follow up on your comments on tracked data. So the down 10%, if we look at the second half guidance that you gave, specifically the rollout into Rite Aid, higher holiday at Target. Just curious, wouldn't those imply that tracked data should actually get better versus worse? I think those are both tracked data retailers. So maybe talk a little bit about tracked versus untracked and how we should think about the distribution initiatives not affecting tracked data but being factored into your guidance.

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [76]

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Steph, it's John. So always a little bit difficult to draw heavy correlation from track data and sell through all the way up through company sales. And we've spoken to that in the past and a number of things that actually influence company sales that aren't reflected in the tracked piece, but there are a few things I'd say. First, obviously, that 10% number is an average for the balance of the year. I think a couple of things that I would draw to your attention to kind of keep in mind as you think about the delta between that and the company sales would really come back to some of my commentary on the third quarter. Obviously, there were quite a few things that were transpiring in the third quarter of 2017 that create pretty significant dislocation to what that headline growth rate will look like in Q3 of '18. And so I think you'd have to sort of normalize that back out to get a better sense for how you could sort of compare the company sales to track sales. The other piece I mentioned on Q4, which was the shipment of Ulta pipeline. Obviously, that doesn't get captured in tracked channels generally and in year-over-year some of the non-tracked benefit is more muted than the fourth quarter as a result.

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Operator [77]

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One last question from Rupesh Parikh, Oppenheimer & Co.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [78]

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So as you look for that -- your deceleration at some of your larger retailers in the metro channel, have you seen any competitive changes that you think have had a weight on your performance? I know at least in our checks in Northern New Jersey, we've seen Walmart at least starting to promote the NYX product in some of their stores.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman & CEO [79]

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Sure. I mean, I think every year, you're going to have -- in every retailer, you're going to have different impacts kind of at each of their stores. I think on NYX, I think in particular we've seen NYX come into Target a few years ago as we came into both Ulta and CVS. We don't have as much interaction with NYX. Now it's still early days, and we'll have to take a look. So I wouldn't point to NYX as an interaction. In fact, a lot of times, we will recommend to retailers that they anchor their departments with both e.l.f. and NYX as we both appeal to kind of core enthusiast consumers but a different consumer set. And so we think they're a good competitor and we have yet to see kind of real impact there. I would just say from a macro standpoint, probably less so on kind of some of the legacy players in the space and more on some of these other kind of brands that are kind of mega-influencer-driven that are -- gains our consumers' attention. But again, we map it out both by customer as well as by core competitor.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [80]

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Okay. And then one quick last one. John, I was hoping you can provide some guidance in terms of how you're thinking about the outlook for gross margins in the back half of the year.

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John P. Bailey, e.l.f. Beauty, Inc. - President & CFO [81]

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Sure. So I would say consistent with our expectations coming into this year, we would expect gross margins to be in line with where they were in 2017. I think the way that, that plays out, you'll probably see them come in a little below where they were last year for the third quarter, and then the balance will be made up in Q4.

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Operator [82]

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This concludes the question-and-answer session. I'd like to turn the floor back over to management for closing comments.

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Tarang P. Amin, e.l.f. Beauty, Inc. - Chairman & CEO [83]

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Okay. Well, thanks again for joining us. While we're currently facing challenges, e.l.f. is a young brand with plenty of whitespace ahead of it. We believe investing more in the brand, integrating efforts behind our key products and improving our retail assortment through Project Unicorn are important actions for both the short and long term. Additionally, our business model and brand remains strong. e.l.f. is a brand young, diverse beauty enthusiasts love. And we have a high quality beauty products at an extraordinary value. Finally, we have a great platform and team.

We look forward to seeing you at the Wells Fargo Conference in September. Thank you very much.