e.l.f. Beauty, Inc.

Greetings and welcome to the Elf Beauty Incorporated third quarter fiscal 2020 earnings conference call. At this time, all participants are in a listen-only mode. A question-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note, this conference is being recorded. I will now turn the conference over to your host, Willa McMahonman. VP of Investor Relations and Corporate Communications. Ms. McMahonman, you may begin.

Good afternoon, everyone. Thank you for joining us today to discuss Elk Beauty's third quarter fiscal 2020 earnings results. As a reminder, this call contains forward-looking statements that are based on management's assumptions, expectations, estimates, and projections. These statements, including those relating to the company's fiscal 2020 outlook and long-term model, 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 gap measures. With me from management today are Tarang Amin, Chairman and Chief Executive Officer, and Mandy Fields, Senior Vice President and Chief Financial Officer. Tarang will begin the call.

Thank you, Willa, and good afternoon, everyone. We're pleased with our third quarter results with net sales of $81 million and adjusted EBITDA of $21 million. Excluding ELF stores, net sales were up 8% versus a year ago. In the 12 weeks ended December 28, 2019, our dollar share of the color cosmetics category was 5%, up 40 basis points versus a year ago, even with the short-term impact of a smaller holiday program. For calendar year 2019, of the top five mass color cosmetics brands in Nielsen, we grew the most market share. Reflecting our strong results, we are again raising guidance. We've driven these results through a relentless focus on five strategic imperatives that we've discussed with you over the past year. Let me give you a brief overview of each imperative, how our strategy works together, and why I'm encouraged about our long-term potential. Our first strategic imperative, driving demand in the brand, continues to exceed our expectations with success across platforms. Marketing and e-commerce spend for the quarter was approximately 11.5% of revenue, versus 7% a year ago. This rate was about 150 basis points below our objectives due to the timing of some of the spend, which was pushed into the fourth quarter. We are measuring the success of our investments primarily by looking at top-line growth alongside internal metrics on reach, conversion, and engagement, as well as external metrics like Google search and earned media value, all of which exceeded our expectations. Last quarter, we discussed our Elfing Amazing campaign. Based on its success, this month we are launching the second phase of our awareness campaign, which will further amplify our ELF mission of making the best of beauty accessible to every eye, lip, and face. We previously shared the early results of our Eyes with Face TikTok Challenge. The challenge has now garnered over 4.4 billion views on TikTok, with over 3 million user-created videos, a record for any brand challenged. While these numbers are impressive by any measure, it's our ability to seize on social momentum that we want to underscore. We started the campaign by creating an original 15-second eyes-lips-face song as a backdrop to user-generated videos. By the campaign's close, this evolved into a full-length eyes-lips-face music video in conjunction with Billboard's 2019 Label of the Year, Republic Records. Throughout this TikTok journey, we learned the importance of being nimble and open to new approaches to connect with our consumers. It also showed us that strong partners are an imperative in this new digital landscape. Among many awards and accolades, Adweek called Islip's face the most influential campaign on TikTok, and we were also featured by Forbes as one of the 14 social campaigns that rocked 2019. With a similar eye to innovation and partnership, in November, we proudly hosted ELF's fourth annual Beautyscape event, which reflects our brand values of empowerment and paying it forward. This year's Beautyscape built on prior year's events with an amped up vision, including two and a half times the entrance compared to 2018. Finalists joined us in the Bahamas to connect with beauty industry leaders, including keynote speaker, entrepreneur, and celebrity hairstylist, Jen Atkin. Attendees who are handpicked for their vision and love of beauty attended master classes and lectures to take their careers to the next level. Ultimately, they competed in teams to present their best original color cosmetics capsules. The winning team received a cash prize and together will introduce their elf collection this summer, exclusively through our national retailer partner, Target, who also attended Beautyscape. As we continue to explore new ways to tell our story, we are humbled at the recognition our branding efforts are receiving. We recently won three Creative Media Awards, including Best in Show. We've also been nominated for three Webby Awards and two Reggie Awards in January alone. Our efforts continue to result in more social followers as well, with our Instagram followers reaching over 5 million, up 27% versus a year ago. Our second strategic imperative, a major step up in digital, goes hand in hand with driving demand in the brand. Our digital efforts center on seamlessly tying together our channels to offer a consistent health experience. As part of this effort, our tech stack integration is becoming increasingly more sophisticated. Elf was front and center at Salesforce's Dreamforce Conference as the only beauty company utilizing the entire Salesforce cloud platform across commerce, marketing, and customer service. To highlight a few of these digital initiatives, in the third quarter, we launched Elfie, our customer service engine to serve our e-commerce consumers 24-7. We made progress enhancing personalization to make the consumer journey more engaging for our 1.6 million Beauty Squad members who account for over 65% of our e-commerce sales. Our personalization efforts offer us a single view of the consumer, allowing us to incorporate past purchases, views, and likes to customize what's being served to them online. In conjunction with this, we saw solid results in the early phase of receipt scanning, connecting us to even more data to enhance the Beauty Squad experience. To make purchasing ELF easier, we've implemented Afterplay and Google 360 so ELF consumers can pay in the way that best suits them. Perhaps the most exciting is the launch of our new mobile app on Apple and Google, which will further enable receipt scanning and personalization. Our third imperative of providing first-to-mass, prestige-quality products continues to drive competitive advantage. We've mentioned the success of our holy hydration skin cream, 16-hour camo concealer, and poreless putty primer, all of which were introduced around this time last year. We're building on these proven Holy Grail products with extensions including Holy Hydration Fragrance Free, Hydrating Camo Concealer, and Luminous and Matte Putty Primers. These extensions were created in response to ELF consumer requests. Additionally, we're introducing new Holy Grail products like our Liquid Glitter Eyeshadow, which is $5 compared to its $24 prestige equivalent. These products are bringing new consumers into the brand, with 65% of Liquid Glitter Eyeshadow purchases on elfcosmetics.com coming from new customers. Beyond liquid glitter eyeshadow, we're encouraged that five of our top 10 SKUs on elfcosmetics.com are recently introduced items. Our ability to deliver a stream of new products that deliver the best of beauty at extraordinary value continues to fuel our strategic imperatives. One of our key areas of focus is expanding our skincare offerings. We are seeing success with core products like Holy Hydration Cream and Hydrating Booster Drops. We also continue to push into new areas, such as our cannabis sativa line, which has maintained a steady pace in our top five sellers on elfcosmetics.com since its introduction in November. Our overall skincare business continues to show strong growth, up 35% in track channels in Q3. Unicorn, the project that guides our fourth strategic imperative of improving national retailer productivity, is entering its third phase centered on better visual merchandising at shelf. Going into spring resets, we're implementing over 100 different planograms across our retailers, each featuring new visual merchandising. In terms of shelf space, we've confirmed some additional space in grocery and at Boots in the UK. We expect further space decisions from other retail partners later in the year. Unicorn is also driving better merchandising results, as we continue to see strong productivity across our national retail partners. Perhaps the best example of this is our Target Flex Towers, which provides us both incremental space and a vehicle to showcase our new products. The next wave of these Target Flex Towers shipped in the third quarter, which partially offset the impact of a smaller 2019 holiday program. Performance at other national retailers was strong, with one highlight being skincare momentum across the full chain at Ulta Beauty. Our overall international business was down in Q3 as we reduced reliance on international distributors. We made the shift in the UK several years ago, and it's paying off today. In the third quarter, growth within our key UK retail partners, Boots and Superdrug, was particularly strong. We expect that momentum to continue as we look to more than double our presence at Boots over the next 12 months and expand space incrementally at Superdrug. In the third quarter, we held our first ever large-scale consumer event in the UK at Glamour Beauty Festival with nearly 5,000 attendees. The enthusiasm we saw there was reflected in UK beauty awards from Cosmo, Glamour, and Gloss, and a five-fold increase in our earned media value in the UK. We were also honored to receive a supplier award from Superdrug for Best New Cosmetics Launch in 2019 for our Poreless Putty Primer. In other markets, our most significant activity for the quarter was bringing our China e-commerce business in-house from a distributor, which will allow us to better control pricing, marketing, and the pace of new product launches. This was an important move to begin penetrating the China market in a more meaningful way. In terms of China, we're closely monitoring developments regarding the coronavirus. We would note that our ELF offices, labs, and key suppliers are at least 500 miles from Wuhan. We have a deep and geographically diverse supply chain within China. It is too soon to know the impact to our operations other than a later startup post-Chinese New Year. We have an amazing ELF team in Shanghai and strong network of suppliers who we just saw during our annual supplier summit, and we're working closely with them. Our thoughts are with our colleagues and those impacted by recent events. Turning to our fifth strategic imperative of generating cost savings to help fuel brand investments, I'll reiterate that our most important cost savings initiative was closing our 22 ELF branded stores last February. We redeployed the $13.7 million in annual spend on stores to our strategic imperatives, particularly driving demand in the brand. We're also seeing benefits from the automation of our warehouse facilities. Our new liquid-fill manufacturing facility in Southern California should start operations in the next six weeks. Mandy will discuss what we're seeing in terms of price increases and tariff dynamics, but in summary, they remain favorable and a driver of our gross margin progress. Make no mistake. Our execution of these five strategic imperatives has led to growth in a down category. We will provide FY21 guidance during our Q4 call. Meanwhile, I'd like to step back and touch on our longer-term model for the company. Over almost 16-year history, we grew in every year except calendar 2018. This year, it was critical for us to reestablish growth. Having done so, I'd like to share what we're seeing in the model over the next three years. With the momentum we're building in the brand, we believe we can continue to grow share. We also believe we have an opportunity to grow shelf space significantly at our current national retailers and in new markets internationally. Space gains are episodic, and even when we get that space, it often takes time to optimize shelf productivity. That's why our focus has been on executing our strategic imperatives. With growth, innovation, and a brand that consumers love, we believe we'll earn more space over time. Over the next three years, without major additional space or strategic extensions, we expect compounded annual top-line growth in the low to mid-single digits. As we layer in potential space gains and strategic extensions, we believe this is a business that should grow in the mid to high single digits. In both cases, we see leverage that comes with sales growth. We expect adjusted EBITDA growth to outpace net sales growth. We believe that this model of balanced growth in both the top and bottom line makes for an attractive long-term business. One of the things that gives me confidence in our model is our success in growing gross margin from 42% just a few years ago to over 63%. There was concern earlier this year on the impact of tariffs, which we have so far successfully navigated with a slight expansion in gross margin. We've taken much of this historical margin expansion and reinvested it in the business, first in the form of team and infrastructure and more recently in brand support. We believe that the team and capabilities that we have built can be leveraged for additional growth opportunities. Our strong cash position of almost $75 million at the end of Q3 gives us the opportunity to pursue strategic extensions that can further leverage our capabilities and differentiate our brand portfolio. We believe good uses of cash include small tuck-in acquisitions in adjacent categories or spaces, as well as creating our own brands. We believe such strategic extensions, in combination with our strategic imperatives, provide further confidence in the short-term as well as longer-term growth potential. With that, I'll turn the call over to Mandy.

Thank you for covering the Q3 highlights, Terang. It was another strong quarter and another quarter that we're able to raise guidance. Let me now discuss the third quarter financials, updated guidance, and our longer-term model. Excluding ELF stores, net sales of $81 million were up 8% from a year ago. Our inline performance remained strong throughout December, despite the smaller holiday program, which impacted tract channel data. You may have already seen the bounce back in yesterday's Nielsen read, which was partially aided by unicorn merchandising, particularly at Target. Growth margin of 65% was up 500 basis points compared to prior year, primarily driven by the price increases we implemented in the second quarter, along with other factors we've discussed, including margin accretive innovation, cost savings, and favorable FX rates. Year-to-date, FX has contributed a one-time benefit of roughly 200 basis points to our gross margin. I should also note on tariffs that although the Phase 1 deal was signed, 70% of our product remains tariffed at the 25% level. A very small portion, mainly lashes, also remains under the 7.5% tariff. On an adjusted basis, SG&A as a percentage of sales was 44%, up from 37% last year, primarily driven by increased investment in our marketing and digital initiatives and bonus accrual, partially offset by the closure of our 22 ELF stores. In the third quarter, marketing and e-commerce spend was 11.5% of net sales, compared to 7% in the year-ago quarter. During the third quarter, some marketing and e-commerce spend shifted to Q4, Therefore, we expect marketing spend as a percentage of net revenue to be higher next quarter. Given top-line results, we still expect to see marketing and e-commerce spend at 12% to 14% for fiscal 2020. Q3 adjusted EBITDA of $21 million was driven by the sustained performance and gross margin rate for the quarter. Gross margin and the shift in marketing spend to Q4 drove our adjusted EBITDA margin to 27% for the quarter. We expect adjusted EBITDA margin will normalize as those marketing expenses are incurred in Q4 and as we continue to see the impact of tariffs materialize. Adjusted net income was $12.2 million or $0.24 per diluted share compared to $14.6 million or $0.30 per diluted share a year ago. Last year, we had a $0.05 benefit to EPS driven by discrete tax benefits related to stock compensation that we did not have this year. For the nine months ending December 2019, we generated $37.8 million in cash flow from operations, enabling us to fund our capital investments and debt service, bringing our cash balance to $74.7 million compared to a cash balance of $51.2 million a year ago. The improvement was primarily driven by stronger operating results. In the third quarter, we repurchased approximately $1 million of stock, bringing our total through December 31st to $3.5 million. Our investment priorities remain focused on our five strategic imperatives. As Terang discussed, we continue to explore strategic extensions that could enable us to leverage the investments we've made in our platform and fuel long-term growth. Now turning to our fiscal 2020 guidance. We expect to end the fiscal year with net sales up 7% to 8% versus fiscal 2019, excluding the impact of ELF stores. We expect adjusted EBITDA between $58 and $60 million. adjusted net income between $28 and $30 million, and adjusted EPS of 55 to 59 cents per share on a fully diluted basis with a share count of 52.5 million. Our tax rate is expected to be 28% for the year. As we look to the fourth quarter, we are optimistic about our position in the market and the progress we're making against our strategic imperatives. However, we want to remind you that comps become a bit tougher as we start to cycle positive sales growth related to the poorless putty primer and 16-hour camel concealer launches in Q4 last year. These launches drove strong organic influencer activity and a halo effect on sales across our product line. Additionally, we expect gross margin to moderate as we continue to see the impact of tariffs materialize. From an adjusted EBITDA margin perspective, we are expecting 21 to 22 percent margins for the year, up from the 19 to 20 percent range provided last quarter, as we've continued to see stronger-than-expected gross margin, As I stated earlier, Q3 adjusted EBITDA margin of 27% was driven higher by the shift of marketing into Q4. Therefore, you should expect a lower adjusted EBITDA margin in Q4 as these expenses materialize, putting the full year in the 21% to 22% range. Before I turn the call over for questions, let me discuss a high-level view on our long-range model. As Terang said, over the next three years, we expect to continue delivering sales and profit growth driven by our five strategic imperatives. Assuming we don't add significant shelf space or strategic extensions, our sales growth CAGR is expected to be in the low to mid single digits. If we're successful in gaining significant shelf space or integrating strategic extensions over time, we anticipate those could add additional points of growth to the algorithm. In both cases, we anticipate adjusted EBITDA leverage will be achieved through a mix of top-line growth and annual cost savings in COGS and or SG&A. Accordingly, if we execute across all vectors, our model could reflect a mid to high single-digit sales CAGR. We will provide more detail each year when we give annual guidance, but wanted to give you perspective on our longer-term performance. We believe we are well-positioned to drive sustained growth and look forward to updating you on our overall progress in the coming months. With that, operator, you may open the call to questions.

At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is from Rupesh Parikh, Oppenheimer and Company. Please proceed with your question.

Good afternoon, and thanks for taking my question, and grats on a nice quarter. So I guess to start out, it sounds like on the call there's been more commentary towards these strategic extensions. So as you look at capital allocation, I just want to get a sense of how you're thinking about M&A versus share buybacks. And as you look at M&A, Is there a preference at all between, you know, I guess on the makeup side versus skin care? So just any thoughts there?

Hi, Rupesh. It's Mandy. I'll go ahead and take that question. So as we look at strategic extensions, we really look at a couple things. So we are looking for, you know, either small tuck-in brands, or we've talked about even potentially creating brands on our own. But really we're looking for a strong growth profile on the top and bottom line. Also looking for something that builds on our capabilities, either in an adjacent category or at a different price point. And also something that can leverage the capabilities that we've built over the past 16 years. So operationally and through our distribution network would also be something that we look at. But overall, we're looking for something that's accretive or has a clear path to accretion over time. I think we've been highly disciplined as we've looked at these over time. I know Terang has mentioned that At one point in time, we looked at Nix, but we weren't going to outbid L'Oreal for that asset. And so our heads are really around those smaller tuck-ins at this point.

Okay, great. And then maybe just one follow-up question. Just on a gross margin line, obviously a strong performance in Q3, and it sounds like the tariffs will start to have more of an impact in Q4. So if you look at your gross margin performance for FY19, is Is a 63% level, I guess, the right way to think about, like, I guess, a sustainable gross margin level going forward?

Well, I'll speak on fiscal 20 and what we expect for that. So as Terang mentioned, you know, we've grown our margin to right over 63%. Year-to-date, it's at a 64%. So I would expect the year to end somewhere in that range, in the 63% to 64% range. We did see the acceleration of tariffs into Q3, about 100 basis points. But with those levers that we discussed, we're able to continue to offset.

And FX was a 200 basis point one-time impact. So Rupesh, as you think of 65 to 63 is probably the right number in terms of what we should have done.

Okay, great. Thank you very much.

Thank you.

Our next question is from Andrea Teixeira, JP Morgan. Please proceed with your question.

Hi, good afternoon. Thank you for taking my question, and congrats on the quarter. So I understand your suppliers are loyal, and I guess, Ryan, you disclosed that, I mean, the distance to Wuhan, but I wanted to understand if you believe the factories are still closed, or if they're still operating, and I'm more concerned about the supply chain, if the raw materials are causing any disruption. And if you're embedding the risk of stockouts, probably not in the fourth quarter, so your fiscal 20 is likely safe, but into fiscal 21 and update us on how long this product would come in. And again, just to clarify that point, And on the SG&A side, and I know it's something just to the second point, is the percentage is still quite elevated as a percentage of sales. So I wonder when we should think of that leveraging more as you grow the top line. Thank you.

Hi, Andrea. I'll take the first one and give Mandy the second question. So in terms of China, for FY21, I'd tell you it's too early to tell. Our thoughts are obviously with our colleagues and our suppliers who we're working very closely with. I think the best thing is we're extremely vigilant on our health and hygiene protocols. I'm very proud that none of our employees or their immediate families have been infected. As we've checked with all of our suppliers, they've reported none of their employees have had any issues either. Part of that is the distance from Wuhan, but I think part of it is also the protocols we've put in place. In terms of our overall approach with our supply chain in China, it is one of the main advantages we have. I would say from a supply disruption or continuity standpoint, first of all, every one of our items is dual source. We're not single source on anything. So if there was an issue, we have the ability to move volume around. Say the second thing is going into Chinese New Year every year, we go in with elevated inventory levels, really, because some of these facilities will be shut for a month. We have our resets that happen here in the springtime. So yeah, we're sitting about six months worth of inventory right now, and that does not include what our customers are sitting on. So right now, certainly for the short term, I think we're feeling pretty good, but obviously this is an evolving situation and we'll continue to monitor it. We have a very good track record in terms of our ability to be able to supply our customers and work very closely with them.

That's helpful. And then, Andrea, on the SG&A point, so SG&A this quarter was really driven by two things that we called out. The incremental marketing expense, so this quarter we're at 11.5% versus last year at this time we were at 7%. And then also bonus accrual included in this quarter versus not having that. As you recall, last year we did not pay any executive bonuses, and so now lapping that with that bonus accrual. In our longer-term algorithm, we do have some combination of SG&A and or COG savings baked into that, and so over time, over the next three years as we talked, you should expect some savings there.

Right, and if I, Angie, thank you so much. One of the things that you also discussed is like very mind with the phasing of the Peerless Pure Primer and the Camo Concealer. Is that a consideration, obviously, now in the fourth quarter? And then I know you've been relaunching it, also variations of it. So I was just wondering, it's just a massive comp because it has done so well. And if you can tell us what would be the impact embedded in your guide of that, of lapping that.

Yeah, so the guidance right now at the 7% to 8% really reflects kind of what we've seen as a trend on a two-year stack basis. So if you look at the low and the high end of the guidance range, it puts you about a 5% on a two-year stack for Q4 on the low end and about an 8% on the higher end. So really in line with the trends that we're seeing, just calling out that poreless putty primer, we do have to cycle that, but we're encouraged by the trends that we're seeing so far.

And our new product program is off to a really good start. As I mentioned, I think five of our top ten items right now on elfcosmetics.com are items we just introduced in the last month or two. So while we have a big comp to overcome with poreless putty primer and camo concealer, our Holy Grail products, Grail products like our new hydration camo concealer, our liquid glitter eyeshadows, a number of other new products, we're encouraged by the fast start on those.

Perfect. I'll pass it on. Thank you.

Our next question is from Erin Murphy, Piper Sandler. Please proceed with your question.

Great. Thank you, and my congratulations. I guess I have a couple of questions. Maybe Terang, first for you, a little bit bigger picture question. As we think about just the beauty industry right now, I mean, it's obviously, particularly in math, been tough for several years now. I mean, as you go forward into 2020, 2021, how do you feel like Target, Walmart, some of your big accounts are just thinking about allocating space for the category? I mean, it's clear that you guys are gaining share, but just overall, I'm just curious on what's being allocated to beauty and how that may shift versus prior seasons or prior years.

Hi, Erin. What I'll tell you is beauty is still an incredibly attractive sector for any of our retailers. Obviously, Ulta Beauty, that's been the case, but same with Target and Walmart. They've allocated more space for beauty overall. Within beauty, you can have shifts between some of the subcategories. So we've talked over the last few years, mass color cosmetics having poorer trends than skincare, for example. But the overall footprint, at least for all the customers we deal with, where beauty is a major strategic priority, we don't foresee kind of shrinking of that footprint. In terms of allocation decisions within that footprint, it comes to growth rate, productivity, what's the level of innovation you have, and what your consumer profile is. And all four of those we score extremely well. So long-term, I'm highly confident of our ability to continue to pick up more space. The reason why we provided a long-term model in two different dimensions is space is episodic. And so we wanted to be able to give a perspective of without major space gain or strategic extensions, what level of growth do we see? And then when you layer that on, what that looks like. So I'm both encouraged long-term in terms of our ability to get space. And then short-term, I'd say, you know, often for a retailer, they have a number of other decisions besides the fundamental performance of a brand. I think one headwind there is a number of them have been focused on exclusive brands and testing new brands as they go through. A lot of those will kind of come and go. I think we're well-positioned regardless of that for legacy players.

Okay, that's helpful. And then maybe just a follow-up to hang on that for a thought. Into next year, kind of the long-term range plan at the lower end of that low to mid-single, do you assume the category stays relatively similar to where we're at today, or is there any bank improvement in the category?

We made the long-term model inclusive of the current category trend. So we assumed a down category in there, and that's why we believe it's pretty good growth without space, without strategic extensions in a down category to be able to deliver that level of growth.

Okay, that's helpful. And then just my second question is really for Mandy. As we think about marketing, I think you guys have it at like 12% to 14% of sales this year, and you go into next year. I mean, is that the general right level to think about, or was this kind of a shot in the arm to kind of rejigger the brand momentum and that starts to come down? Just curious on how you're thinking about that within the framework of the three-year plan. Thank you.

Yes. So, as we think about the 12 to 14 percent, I think we've said that's the area that we feel comfortable with. Right now, we haven't really given guidance beyond that, but to say that 12 to 14 is where we see it, at least for fiscal 20.

Okay. Great. Thank you, guys, and all the best. Thank you, Erin.

Our next question is from Linda Waltenweiser, DA Davidson. Please proceed with your question.

Hi. Could you elaborate a little bit more on your decision to use fewer international distributors and what your plan would be then for other international markets? Do you plan to go in direct markets? And can you just talk about the regions or countries that you are thinking about penetrating further? Thanks.

Hi, Linda. So our strategy, which began probably more than a year ago, was to really go direct with our key international accounts where we could, similar to our strategy in the U.S., where we have direct headquarter coverage at Target, Walmart, Ulta Beauty, and our drug channel and other key customers. As any other company, we go through a flow where you start with a lot of international distributors. You figure out which ones you want to be able to keep. But as we made that shift, for example, in the UK a few years ago, we just saw much better results of being able to go directly to Superdrug and directly to Boots. In terms of other international markets, we're testing the brand we have been for a while in Germany and other countries within Western Europe. Our big focus within Asia is really from an e-commerce standpoint with China and making the move of actually taking over that business directly from a distributor was an important move for us. And you'll continue to see us kind of sequentially go country after country, never will be a big bang, but more how we go and really make sure we're executing each country the right way.

Thank you. And then can I just follow up on the coronavirus issue? Is it your understanding that plants will reopen after the extended holiday period? or do you have any further information on that? And then I think you said your facilities are 500 miles away. Would that be in the Guangdong region, or there's like another manufacturing region slightly more north? Can you just give us a little more specificity on where your facilities are, or maybe they're in different locations? Thanks.

Sure, Linda. So our supply network is both deep and very broadly distributed. So we're in different parts of the country, particularly around the Shanghai area, but we have suppliers in various other regions. What I tell you in terms of production plans, we are scheduled next week to be in production and have shipments. We had shipments ready to go that we did right before Chinese New Year's. And we're staying very close. It's a quick dynamic and very evolving kind of situation. So very proud of our team and just how well everyone's working together, including support from the U.S. So I hope that answers the question. We haven't disclosed where all of our facilities are other than not near Wuhan, and we have talked in the past being closer to Shanghai and in other regions.

Thank you. That's very helpful.

Our next question is from Steph, Wissink, Jeffries. Please proceed with your question.

Thank you. Trang, the first question is for you. Just to remind us, where are you with your shelf space at your three biggest accounts, Target, Walmart, Ulta? Can you give us just a quick diagnostic update on how much space at each retailer you have currently?

Sure. So our most developed customer is Target, where we've been in business the longest. On average, I think we have about an 11-foot footprint at Target. Then after that would probably be Walmart. In terms of Walmart's footprint is on average, I think, about five feet. And Ulta right now would be in some combination of six-foot sets and four-foot sets, on average, about five feet as well. So in most retailers, we find that we have less than kind of half the footprint that we have at Target, which gives us that confidence longer term in terms of the footprint of the brand. I should also mention in the drug channel, we're predominantly, I think, in around a three foot set. So we still have room to grow pretty much in every channel that we're at, including at Target. I talked about kind of the benefit of Unicorn and our new merchandising vehicles with these flex towers have been terrific for us in terms of really highlighting our new products and our key holy grail innovations. And those flex towers form an additional space there as well. So still quite a bit of room to grow.

Okay, that's great. And then my question is for you on skin care. I know you talked about strategic extensions, but what about strategic adjacencies? skin, body, sun care. Just remind us how big the skin care business is today as a percentage of sales, and do you see that still as a growth opportunity?

Skin care, yes. So, Steph, this is Mandy. Skin care we still see as a big opportunity for us. As we mentioned, skin care was up for us 35% in the quarter. And when we think about strategic extensions, definitely think about adjacencies, as I mentioned, and skin care would be one of those that we would definitely consider.

And part of it is, you know, we've been in color cosmetics for almost 16 years. Skincare is still only two to three years in. Given the momentum we see, given kind of the strength of the pipeline, we see a lot of growth there, although it is still quite small in our overall range.

Thank you.

Our next question is from Oliver Chen, Cohen & Company. Please proceed with your question.

Thanks. Congratulations. Regarding Project Unicorn, that was a big focus. You've had a lot of great success. So what inning are you in with Unicorn, and how does that interplay with the opportunity for space opportunities? Related to that is pricing and elasticity. What are your thoughts on what you've been seeing in the marketplace with the unit response relative to price increases? It sounds all very encouraging. Thank you.

Thanks, Oliver. I'll take the first question on Unicorn and I'll ask Mandy to take the one on pricing. Unicorn has been a great success for us in terms of really elevating our position in each of our national retailers on shelf and with merchandising. We're currently entering the third phase of Unicorn, which is really focused on better visual merchandising, particularly bringing consumers to our key Holy Grail innovations, being able to navigate the shelves better for that. Shelves are currently being set. We'll have a better read of those really over the next four to six weeks. It's one of the reasons why last year we changed our fiscal year to be able to get that read. And then in terms of where Unicorn goes from here, I think you're going to continue to hear us talk about Unicorn at different phases. We believe there's much more we can do from a visual merchandising standpoint. And as that visual merchandising, as well as the other improvements we've made, help us increase productivity. we believe that makes for a very good case for space.

Yes, and Oliver, on the pricing side, we continue to be pleased with what we see there. I think last quarter we talked about having a 200 basis point impact from pricing, and we feel it's continuing to hold. So what we saw in Q2 continues to hold true and, you know, continues to give us some benefit from having that elevated pricing.

Okay, and TikTok.

Sorry. Yeah.

Go ahead, Oliver.

The other question, and we love your thoughts on units and that dynamic, but you've done a remarkable job with TikTok. Congratulations. How do you see that platform evolving as we digest the evolution of these platforms? How much marketing as a percentage of sales will be allocated to emerging platforms like TikTok versus some of the other expenditures?

Yep. So let me just finish up on the elasticity piece on the unit side. So we do continue to see units down on the items that we priced, but better than what we initially modeled. So that also gives us some comfort.

Yeah. And then on TikTok, I mean, it's been an incredible campaign. I'd say it's part of our overall brand recharge. And I think one of the great things about our brand recharge is getting back to our roots in terms of constantly kind of experimenting and really finding ways of engaging with our core consumer. And so TikTok in particular, really going their strength that TikTok has amongst Gen Z. We're definitely seeing, I mean, our campaign with 4.4 billion views, over 3 million user-generated videos. We see much more we can do, not only on TikTok, but other emerging platforms as well. And in fact, it's not only what we do, but what our community does. In the last couple weeks, one of the things I'm really encouraged by is there are two viral videos that were posted. We had nothing to do with them. One was for our bite-sized shadows, one of our new items. As soon as that video went on, we saw almost a 5x increase of sales of bite-sized shadows on elfcosmetics.com over the last couple weeks. Similarly, we saw another viral video go up on our lip exfoliators. This is a product we've had for quite some time, one of our core products out there. And again, I think we saw at one major retailer almost a 6x increase in terms of our lip exfoliator sales. So not only are these platforms great ways to engage our consumers, particularly Gen Zs and millennials, but we see the translation of what they can do to us from a business standpoint. And you're going to continue to see us experiment and kind of blaze new grounds.

And lastly, the aspect of creating brands, the ELF brand seems pretty versatile. So what are your inclinations in terms of opportunities as you think about either pricing or line extensions or why would creating another brand be an opportunity?

We certainly believe the biggest potential we have is continue to grow ELF. We have tremendous potential in ELF and a great belief in that. As you say, not only do we continue to get more consumers in the franchise, broaden our footprint, continue to bring out amazing new innovations, that's almost 100% of our focus is against ELF. Having said that, most of us also come with multi-brand experience, where we've seen the benefit of being able to take the investments we've made in team and our capabilities and leverage that across other brands. whether it be in a higher price point, given the quality of our products that could be applied to a different price point, or a different adjacency or space, we can see the benefit potentially of putting a new brand through as part of one of the examples of a strategic extension.

Thank you. Best regards.

Thanks. Our next question is from John Anderson William Blair. Please proceed with your question.

Good afternoon, everybody. Good afternoon. Question, maybe for Trang. On space, shelf space in 2020, I think it was mentioned that there were some wins that you've already booked, I believe in grocery and perhaps in boots in the UK. Number one, did I hear that accurately? And number two, are there some other concrete shelf space opportunities with maybe the big three national retail accounts where decisions could be made during 2020 as well.

Sure, John. So you heard that right. We did pick up and confirm additional space in grocery as well as boots where we're going to be doubling our footprint over the next 12 months. We have opportunities everywhere. There isn't one place we're at where I don't believe we have opportunities. And so I think our biggest opportunity remains more space at Walmart. We're severely under spaced there. They're our largest customer and we still have a long way to go there. But same with Ulta. We're relatively recent in our experience with Ulta. They've already this past year started taking space up from four foot to six foot sets. And then finally even Target I mentioned earlier and Drug as well. Those decisions we would expect to come later in 2020, and so when we're ready for our 2021 guidance, fiscal year 21 guidance, I think we'll be in a better position to talk about what are we seeing and where they'll be.

If those decisions are made in 2020, what's kind of the way to think about timing for shelf implementations?

Yeah, the timing for shelf implementation really is two ways to think about it. One is the spring sets which are done, and we've talked about kind of the level of space we have right now, which is really just grocery and boots. For additional space, it varies by retailer, but if there was going to be space, it'd be in the fall of this year as we went through. And again, a lot of it depends on each retailer's strategies in terms of when they make their final space decisions.

Very helpful. I had a question on pricing, just to circle back around on that for a minute. Is all of the pricing that you plan to implement, is that now in market, on shelf? And the volume response that you've seen, it sounds like better than expected, but still a volume response. How long does it typically take, in your experience, for consumers to... you know, kind of absorb that increase and you get back the ability to kind of, you know, inflect volumes, you know, positively.

Yeah, so just to break your question down, yes, pricing is implemented across all retailers and elsecosmetics.com. And as we spoke about, that started in Q2. So fully reflected in track channel data, you can see the response and the elevated AURs in all of that data. In terms of when you expect units to come back around, I mean, I think that you, you know, as I said, units are better than we modeled but still negative. But you probably need some time to cycle through that price increase before you see the unit inflection again.

Have other mass color cosmetics brands had to make similar price increases or are you in a different situation given the nature of your supply chain?

Yeah, so we lead the value segment. Pretty much every value player followed our lead and took pricing. The nature of which they took pricing was often different. Many of them peanut buttered kind of a certain approach, a certain percentage across all of their SKUs. We tended to target SKUs where we felt we had a much better value proposition or where we felt a competitor might have to take pricing. And I think that's one of the reasons why we're seeing better execution than what we modeled. But the good news is a number of our competitors have taken pricing.

Great. Just one quick one. On the liquid fill facility in California, it sounds like you're close to starting production there. How much capacity and how quickly – Will you be able to bring on that capacity? What are you looking for, I guess, out of this facility in terms of meeting overall demand? Thanks.

Yeah, so we have not disclosed what level of capacity we have, other than that facility has quite a bit of capacity. I would say in any of our startups, there's a certain curve by which you start up. So over the next six weeks, we would fully expect to start up that facility. It would be some time before it – accounted for a big portion of our volume, so we continue to see it be pretty small. China will remain probably the main source of our volume, but it has potential. We scoped it out well before tariffs, really from a standpoint of if we're going to automate certain unit operations, it'd be best to do that closer to our distribution center. And so that's where we have a lot further to go. So you'll hear us talk about that facility for quite some time. And then the other thing I would mention is we're seeing really good results with our lean initiatives in China, lean techniques that we've been applying there with our various suppliers. A number of us just came back from our annual supplier summit and heard some great cases of the continued efficiency gains and savings that we can generate there.

Thanks a lot, and congratulations.

Thanks, John.

Our next question is from Bill Chappell, SunTrust Robinson Humphrey. Please proceed with your question.

Thanks. Good afternoon.

Good afternoon.

Hi, Bill. Hey, Terang, you know, in your longer-term guidance, the comment was, I guess, low to mid single-digit growth, but when you get shelf space gains, potential for mid to high. And I only ask about that because, as we all know, Remember two years ago when you got meaningful shelf space at both Target and Walmart, sales started to actually decelerate as it seemed that the company kind of wasn't quite ready for that much more space, and it took longer to kind of get used to and grow into that. So looking forward, should we expect a continued kind of a lag as you add these spinners at Target or get shelf space at Boots or other places? Or do you feel like you've kind of re-cracked the code and can grow into that space a lot faster?

Thanks, Bill. What I would say is, one, we're further along as a company in terms of our ability to kind of optimize the space, even in bigger footprints, as we see now with Target and Walmart. But you are correct that even when we get space, it does take a while before we start to improve the productivity of that space. And so our long-term model contemplates really both scenarios without the absence of major space or strategic extensions, low to mid single digits in a down category. And then with major space as well as strategic extensions, and I think it's really the combination of the two that gives us confidence in that mid to high single digits from a growth standpoint. And it's a CAGR over three years. You know, you can see some lumpiness in that CAGR, but overall we feel much more comfortable in terms of that range given those circumstances.

Got it. And then just another term that I used to hear a lot more than I don't remember hearing on this call was sweet in the mix. So is that still, you know, are there still opportunities there on a gross margin or with the tariffs and pricing and everything, you know, going on right now, it's kind of put on the back burner?

No, Sweet in the Mix is always going to be part of this company. It's how we got from 42% gross margins to over 63% gross margins. And as a reminder for those who don't know what Sweet in the Mix is, it's a combination of margin accretive innovation, cost savings, and our ability to really drive our margins up. I would say the balance on Sweet in the Mix We believe there's still many opportunities. I mentioned a couple of them both in terms of our liquid fill facility in Southern California as well as the lean manufacturing improvements we're making in China. We believe there's an opportunity to improve gross margin further. However, we also want to be careful to John's earlier question on unit velocities and unit volumes that we don't get too greedy from a gross margin standpoint where we lose the extraordinary value that consumers know and believe in us for. So we very well could take some of the progression that we would make on a cost basis, either to take more to the bottom line or to continue to reinforce our high quality and extraordinary value. So we're, as Mandy said earlier, We're satisfied with kind of where our margins are right now. We don't have a concerted effort to say we want to get to some really high gross margin level for the sake of it. I think we took our 65% this quarter and did the one time for FX. It kind of gets you to a margin level we're pretty comfortable with.

Got it. Thanks so much. Thanks, Bill.

Our next question is from Wendy Nicholson, Citi. Please proceed with your question.

Hi. Most of my questions have been answered, but I just had one with regard to sort of online sales. And I know elfcosmetics.com has been a strong channel for you in the past. Can you remind us how much that website represents as a percentage of your sales? And specifically on Amazon, it was interesting because Cody called out Amazon as a particular area of strength. in their current quarter, and I'm wondering if that's something across beauty in general and what trends you're seeing on Amazon. Thanks.

So on the piece of the pie, how much is it, Wendy? We haven't really disclosed that. We will consider that when we talk about our K. I think the last thing we disclosed was the combination of elfcosmetics.com and our stores. So more to come on that when we issue our K. And then on Amazon, I'll let Terang talk about that.

Yeah, so I'd say our overall digital business has been an area of strength for us throughout the year, and that's across customers, both elfcosmetics.com as well as the retailer.coms. So most recently, we've seen some good trends at Amazon, but we've also seen very strong trends at ulta.com, target.com, and walmart.com. For us, we believe all of them are benefiting from the double down on digital initiatives that I talked about earlier and what we're able to do there. Now, for the third quarter, I would say we had really strong growth at the retailer.coms. Elfcosmetics.com was not as strong in the third quarter as it has been so far this year, mainly because we did not repeat a 60% off promotion we did a year ago. We feel much more confident in terms of our ability to grow our elfcosmetics.com and other retailer.com businesses through the efforts I talked about in terms of data and personalization, and we feel really great about where those and what those efforts are yielding us.

But that's still the elfcosmetics.com is still a priority kind of over the long term. It's not like you've changed your strategy big picture to walk away from direct-to-consumer.

No. I mean, we're a digitally native brand. I mean, the only thing we had was elfcosmetics.com when we started, so it's always going to be our top focus. And, in fact, our second strategic imperative of Double Down on Digital is all the initiatives I talked about, BenefitElfCosmetics.com, as to kind of our whole focus on our Beauty Squad program and everything we can do there. So, no, it's absolutely the engine that drives everything else. It's a major part of our consumer engagement as well.

Fantastic. Thank you so much.

Our next question is from Mark Ashershon-Stevel. Please proceed with your question.

Thanks, and afternoon, everyone. I guess I wanted to start with the long-term model and thinking about the gross re-extension, thinking about boots, since we say they're worth a quarter or so to go to next year, would you consider those major shelf space gains? I mean, are we looking towards high-end next year? I guess you don't have to get into guidance, but I guess I'm curious kind of how you would think about those two things as major, minor, and then more holistically on it. You're talking about fiscal year growth. You talked about shelf resets largely coming in the fall. So I guess from a dynamic standpoint, how do we think about that? Is it more of a calendar and kind of when the fall resets happen to the next year in terms of growth as opposed to flowing through on each fiscal year? So maybe some commentary there could be helpful.

Yep. Hi, Mark. It's Mandy. On the long-term model, you're right, we're not giving specific guidance on fiscal 21 at this time. That will come in May. But I think the differentiator between major space gains and minor, when we say major, we're really talking about the top three retailers that we would consider from a major space. We're talking major incremental space. So that's how I would differentiate those. And then in terms of shelf resets and the timing and when to think about that from a growth standpoint, Again, Terrain talked about fall as being the reset. And then there could also be spring of calendar 21 as well. And so those really, it just depends on when we get that space, when the reset happens, and then how quickly we can optimize that space is when you start to see the growth associated with those.

And part of that is some of the retailers themselves are evolving in terms of how they are handling space. And historically, if you recall, walmart did not have a set time for their space decisions they kind of took it as they did modules of stores and when they touched the store we picked up more space target historically was more in the spring and then alta you saw some combination the big one in the spring and then depending on what they end up doing with the department and so that's why it's no longer we used to really anchor people on the spring resets we're just seeing more kind of dynamic in terms of how they're handling space and how they're handling segments of their stores on the overall space. But on the long-term model, just a little bit more perspective there, part of the reason why we wanted to provide the long-term model is our investors have been asking us for it, of putting the context of our growth, our strong growth, the year that we didn't grow and now we're growing again, how should we think about it? So we tried to frame it in a way that you could see without space or major space or strategic extensions what it would be and then with that what it would be. In terms of Grocery and boots, I would not consider them major space extensions.

That's helpful. Thank you. And just lastly, the 12% to 14% as a percent of sales for marketing spend, how do we think about kind of puts and takes as to whether that's the right level or not? Or I guess how do you think about it as whether it's the right level or not? Like why would it go higher? Why would it stay the same? Why would it potentially go lower?

Yeah, so for the 12 to 14%, we've talked about net sales growth really being that major metric that we're looking at in terms of the effectiveness of our marketing. And so with the 12 to 14%, we've continued to see that level of success, and so that's where we've put it for now. We've gotten the question before, how do we know that's the right level? It's just the level that we feel comfortable with given where we're at today.

And some of the other internal metrics we look at, both in terms of reach conversion as well as engagement. and then externally on Google Search and earned media value. We're always looking at the effectiveness and what the ROI of that spend is. We're comfortable, particularly given the delta between that 12% to 14% to where we were. So right now, we're very comfortable with that level. And again, when we give guidance for FY21, we can update you. Thank you.

We have reached the end of the question and answer session and I will now turn the call back over to Tarang Amin for closing remarks.

Thank you everyone for joining us. We look forward to speaking with you in May when we'll discuss our full fiscal 2020 results as well as our fiscal 21 outlook. Thanks and have a great day.

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