Allison Malkin - ICR, IR Tarang Amin - Chairman & CEO John Bailey - President & CFO

Oliver Chen - Cowen and Company Erinn Murphy - Piper Jaffray Jon Andersen - William Blair & Company Stephanie Benjamin - SunTrust Robinson Humphrey Shannon Coyne - BMO Capital Markets Mark Astrachan - Stifel Andrea Teixeira - JPMorgan Securities

Greetings and welcome to the e.l.f Beauty First Quarter Fiscal 2017 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Ms. Allison Malkin. Thank you. You may begin.

Thank you. Good afternoon everyone. Thank you for joining us today to discuss e.l.f.'s first quarter 2017 earnings results. A copy of today's press release is available in the Investor Relations section of www.elfcosmetics.com. A recording of the call will also be available for 90 days on www.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 2017 outlook, are subject to known and unknown risks and uncertainties and therefore actual results may differ materially. Important factors that may cause actual results to differ from those expressed or implied by such forward-looking statements are detailed in today's press release and the Company's SEC filings. In addition, the Company's presentation today includes information presented on a non-GAAP basis. We refer you to today's press release for a reconciliation of the differences between the non-GAAP presentation and the most directly comparable GAAP measures. With us from Management today are Tarang Amin, Chairman and Chief Executive Officer; and John Bailey, President and Chief Financial Officer. For today's call, Tarang will begin with an overview of our results and as typical for us, John and Tarang will than alternate sharing the progress we made against our growth strategy and providing additional detail related to our financial performance and guidance. This will be followed by a Q&A session. It is now my pleasure to turn the call over to Tarang.

Thanks, Allison and good afternoon, everyone. We're pleased with our first quarter results which are highlighted by a 15% increase in revenue, 748 basis point expansion in gross margin and adjusted EPS growth of 40%. And we continue to grow much faster than the overall mass color cosmetics category. According to IRI, in the 12 weeks ended March 19 e.l.f. grew consumption 18% versus the broader category declining 1%. We did see a slowdown April scanner data and as a dynamic growth company, you'll see month-to-month variability. We remain confident in the business and our initiatives and are reaffirming our guidance of 24% to 28% sales growth for the full year. These results reflect our team's dedication to our mission to make luxurious beauty accessible for all and continued progress against our four growth strategies. Our first strategy is to build a great brand. e.l.f. is a brand that make up enthusiasts love and we know how to engage them. During Q1, we held our most successful Beauty Scape influencer activation. We brought together 45 up incoming influencers to the South by Southwest festival. We create an immersive brand experience and further build our community, reaching the combined audience of 100 million. To further strengthen our engagement with consumers we invested in social standards, a social analytics Company. This provides us the ability to leverage algorithms and machine learning to garner insights from data across key social properties. With exclusivity within beauty believe this strategic relationship will help us identify up incoming influencers react faster to innovation trends and further strengthen the effectiveness of our social engagement efforts. We also continue to build our loyalty program Beauty Squad which now has over 300,000 members. Even with this expanded base, we see average order value is 35% higher than for non-members. I'll turn it over to John to discuss progress on innovation and brand penetration.

Thanks, Tarang. Our second strategy is to lead innovation. We believe our depth and breadth of high quality innovation at an extraordinary value sets us apart from other brands. In Q1, we had 21 product launches including 9 first to mass products that formerly could only be found in prestige outlets at much higher prices. Among these launches. We introduced an expansion of our skin care portfolio with our first beauty device the e.l.f. Massaging Eye Wand. Our Eye Wand retails for $25 with comparable prestige products selling for over $130. We're encouraged by initial sales and reviews on elfcosmetics.com. We also continued our product collaborations launching a new lip palette with Iris Beilin and influencer with over 1.3 million followers. This collaboration is another great example of our speed to market as we went from idea the selling online in 13 weeks. Our third strategy is to expand brand penetration. In national retailers, we're pleased with the progress of resetting shelves at target for our 50% expansion in shelf space and continue to see strong growth at Walmart. Also building on our early success at ulta.com. Ulta shared publicly that they will be testing e.l.f in a small subset of their stores later this year. We're pleased with the growth of our relationship with this leading retailer. Our direct business which includes both elfcosmetics.com and e.l.f. stores continues to be a growth driver and generates awareness, engagement, insights and validation for new products. On elfcosmetics.com we continue to improve content and creative and add personalization and shopping tools to enhance the overall experience. As an example, we launched a foundation finder that help consumers find the best products for them and grew our online foundation sales by over 30%. In our stores, we saw a strong response to our beauty technique demos, with our associates helping consumers achieve on-trend looks with curated product bundles. These demos are another way to engage with our guests and highlight our latest products. We're excited about the focused expansion of our international business and are pleased to announce the Q2 introduction of e.l.f into superdrug, one of the leading cosmetic retailers in the UK. We have already seen an up swell on social media in that market and look forward to the launch. I'll now turn it back to Tarang to discuss our operational progress.

Thanks, John. Our fourth strategy is to drive world-class operations. We continue to make investments in the team and infrastructure to scale the business. We set up a third-party distribution center in the UK to service our entry into superdrug, our UK e-commerce business as well as potential future expansion in Europe. Our penetration into the supply chains of our customers along with our investment in inventory has enabled us to maintain over 98% fill rates for our key customers and having stock levels above 97%. In summary, we had a good start to the year. I'll now turn it back to John to discuss our financial progress and outlook for 2017.

Thanks, Tarang. For the first quarter, net sales increased 15% to $60.6 million which is notable given the significant amount of pipeline shipments for shelf resets in the first quarter last year. Gross margin expanded from 56% to 63%, primarily driven by our innovation in Sweeten the Mix program, the benefit of FX and the freight benefit of approximately 200 basis points that we do not expect continue. On an adjusted basis, SG&A as a percentage of sales was 49% compared to 40% in the first quarter of 2016, reflecting public company expenses and continued strategic investments in people, infrastructure and brand building, including the expansion of our direct business. Adjusted EBITDA with $11.7 million, compared to a $11.6 million in the first quarter of 2016. Adjusted net income with $4.4 million or $0.09 per share based on a fully diluted share count of $49.5 million. This compares to $3.1 million or $0.06 per share in Q1 2016. From a balance sheet perspective, we ended the quarter with an inventory balance of $76.9 million, reflecting an increase in our fastest moving items. In terms of our full-year outlook, we're reaffirming the guidance that we provided last quarter. As a reminder for 2017, we expect net sales of $285 million to $295 million, representing year-over-year growth of 24% to 28%. Adjusted EBITDA of $61 million to $64 million, adjusted net income of $21 million to $23 million and adjusted pro forma diluted EPS of $0.40 to $0.43 and 53.1 million diluted shares. In closing, we're pleased with our start to the fiscal year 2017 and believe we're well positioned to deliver on our objectives. I'd now like to ask the operator to open the call for questions.

[Operator Instructions]. Our first question comes from Oliver Chen of Cowen and Company. Please proceed with your question.

Regarding the inventory, the build was pretty substantial, just what are some guidelines for going forward and how do you feel confident in that relative to the sales growth? Also on the gross margin side, in the context is Sweeten the Mix, could you update us on what is underlying with average unit retail like this year versus last or how that's inter playing like-for-like versus new product introductions?

Oliver, it's John. With respect to the inventory balance, as we talked on the call last quarter, one of the things that we did in the fall this past year was proactively decided to take up our inventory in our fastest moving items. And a little bit of context there, we had just come off the movement of our warehouse from the East Coast in New Jersey to the West Coast in Ontario, California. And wanted to make sure that we were able to adequately service demand and stay in fill rate with retailers. We've been quite pleased with where those fill rates have been. But as we mentioned, we probably did overshoot a little bit in terms of that inventory balance. That said, where we were sitting a little bit heavy was in our fastest moving items. So great degree of confidence and those inventory levels normalizing throughout the year without any unnatural acts. And on this Sweeten the Mix side, it continues to be a great program for us. For those who aren't familiar, Sweeten the Mix is a systematic consumer led the way that we think about driving gross margin in the business. It really does start with the consumer first and has a couple of key components, one which is consistently launching innovation which is core to the e.l.f. model at margin profiles that are accretive to that of the overall company and the other which is looking across the existing range of products and finding places where we can deliver a tangible incremental consumer benefit, but also take up gross margin at the same time. It continues to be a great source of gross margin expansion for us and we're quite pleased with the expansion that we saw in the first quarter.

Okay. Just a follow-up on last question. On your two major wholesale partners, could you give us parameters about the - going forward and how you're thinking about space versus comp growth and if there is any nuances and sell-in versus sell-out that we should think about as we look at our quarters in our models?

Yes, Oliver, this is Tarang. I'll take that. So if you take a look at our two main customers - leading customers in Target and Walmart. At Target, we had announced last quarter that we were awarded 50% more space and we've been in the process of setting those shelves that would expect to kind of complete in the second quarter of this year. And so, we do see a combination of both space gain there, as well as our continued benefit of the innovation that we put into that space. Walmart, as we've mentioned, has a more continual process in terms of how they are going to increase space. So we'll continue to see space gains at Walmart as well. But really the gains that we're seeing there right now, lot of them are based on the innovation that we put on those shelves. So you're going to see a pretty good balance really with both customers, combination of our innovation driving, better productivity, as well as continue to pick-up more space, given what we're able to do in their categories. In terms of consumer profile we bring, as well as the growth that we're able to drive.

Our next question comes from Erinn Murphy of Piper Jaffray. Please proceed with your question.

Thanks. Good afternoon. I guess, I wanted to focus similar to Oliver's question which is on the first quarter alone. So with the 15% top line growth, could you break out for us how much, what can be incremental that you saw from targeted seems just based on the way you shapes the year a lot of that incremental linear footage is really going to be more Q2 focus. Just trying to understand there's any way to kind of break out the like-for-like versus the distribution for that 15% topline.

Erinn, it's John. So, just a quick note to refresh the group that the target pipeline for that shelf space expansion, in other words, the initial sell into the customer to eventually put that on the shelf went out in the fourth quarter of 2016. So you don't see any impact to the Company from that shelf space gain and given that those shelves continue to be step through the second quarter, won't see any meaningful impact from a replenishment perspective either. We're quite pleased with the growth in Q1 of 2017. As we mentioned on the last call, part of the reason that that were 15% which is slightly lower than the full-year guidance, is that we're comping a significant pipeline quarter from Q1 of 2016. We did not have very much pipeline at all for shelf resets and that will be a continued dynamic with this Company where certain retailers will take pipeline in the fourth quarter, certain retailers will take it in the first quarter and depending what's happening with each of those individual retailers the size and scope of that pipeline can vary. That's why we try and focus folks on the full year given those quarterly dynamics that are in here into the business.

Okay. That's helpful. And then exciting to hear about the opportunities in the UK, could you just maybe talk a little bit more about kind of what that could look like with Superdrug over the next year or so. And then other opportunities now that you're there and I noticed on your Instagram story, so definitely a lot more viral there in the London market in particular. Just curious on how we should think about that opportunity. And then was there anything specific in the inventory build Q4 year-over-year versus Q1 year-over-year dedicated to accounts like Ulta or Superdrug if you go in to the UK? Just trying to understand any new distribution pieces that we wouldn't contemplate before.

Erinn, I will take the first part and I will let John talk about inventory. So we're really excited about our launch into Superdrug. As background, we've been in the UK through our e-commerce business for a few years now and have a really great following in the UK as a direct business. Superdrug as you know is one of the leading retailers of beauty products in the UK. And we're quite excited about the partnership that we're doing in terms of our launch there as you've seen some of the Instagram and other social buzz that you see out there, UK consumers are also quite excited and so as we enter into in the second quarter, we have big plans with them. And from an inventory perspective what I'd say is our overall increase in balances reflects our expectations, both across new distribution as well as delivery to some of our existing accounts. So no specific granularity that I'd call out there.

Our next question comes from Jon Andersen of William Blair. Please proceed with your question.

Good afternoon and thanks. Tarang, you mentioned in the prepared comments that there's been some variability month-to-month in the consumption data. Could you talk a little bit about what drives that or has been driving that and maybe what you've seen more recently relative to consumption data? Thanks.

Yes, sure. I say first of all just backing up our approach is one of annual guidance and we're confident in our 24% to 28% sales growth number for this year. So we start there and then kind of as you break in the quarters, as John said, there could be some variability quarter-to quarter, [indiscernible] was in the prior period and what we're selling in. What I tell you on the periods shorter than that, is you do see quite a bit of variability and bouncing around we've seen that for quite some time. So we pay less attention to that and more to the fundamental building blocks of our business which is a combination of innovation that we can bring to the marketplace, particularly first to mass innovation as well as the white space we have both in terms of distribution space as well as our own direct business and international. So you won't necessarily see similar to the very mature businesses a more direct correlation between kind of what you're seeing at latest scanner versus overall, I think the best period for that. It's probably the first quarter where we saw an 18% consumption gain versus minus one for the category, pretty confident in our total year number.

Great, that's helpful. On the business that you're adding in the UK Are there any margin implications positive or negative relative to kind of Company average.

No, I mean, I'd say we generally do a pretty good job across our customers set of having pretty consistent margins.

And then in the direct business, can you update us on just the kind of the online growth that you're experiencing, I know you're doing a lot there as you described, I mean, is the online part of the business maintaining its relative proportion of overall sales and then if there's any update on the store count e.l.f. stores I'm talking about and expansion plans for the balance of the year. Thank you.

Hey, Jon, it's John. So overall, as you're familiar with the story, we only speak to our direct business and don't comment on quarter-to quarter changes and growth rates. But what I can tell you is, we're quite excited about each side of the direct business, both in terms of overall growth, but more importantly, what they represent back to the overall company from a strategic standpoint. Our e-com business is doing very well. And our stores also as we're coming off of 2016 with the number of new openings that were geared towards the back half, we're quite pleased with how those stores have come out of the gate in the consumer reception that we've seen. In terms of openings in cadence, I think we've talked publicly that we will open anywhere between five and 15 stores per year. 2016 was obviously on the heavy year-end of that spectrum and as I mentioned, back-half weighted. What we talked about for 2017 is a lighter opening year relative to that overall range. But overall, continue to be quite enthusiastic about the direct business.

[Operator Instructions]. Our next question comes from Bill Chappell with SunTrust Robinson Humphrey.

This is actually Stephanie on for Bill. Just looking at the top line and maybe you could give a little bit more color on how the mix is changing, so skincare and new product launches are driving the majority of the growth kind of similar to prior years? And then just kind of similar to that, maybe if you give a little more color on the growth in the quarter and how much of that was attributable to the existing stores and new distribution gains which really any additional color there would be great. Thanks.

We generally don't give that level of detail in terms of - kind of within the mix of our assortment. I mean, what I can tell you is new items do fuel our overall program just given how much we're known for our innovation. And so, I'd say, we've see no difference there in terms of continue to see items resonating with consumers. And so, I'd say, we feel good about the growth profile that we're seeing in - certainly for the full year that we look forward. And on the existing versus new distribution, while we haven't given clear numbers, I'd say, it's heavily weighted in the first quarter towards existing.

Our next question comes from Shannon Coyne of BMO Capital Markets. Please proceed with your question.

I have a question on the cash flow, it looks like your free cash flow was negative this quarter and I get the inventory piece. And sorry if I missed this, but it looks like accounts payable, accrued expenses was [indiscernible] cash. And just wondering what that was and if you expect free cash flow to be positive next quarter or how we should think about that going forward?

Shannon, it's John. So we don't provide specific granularity to cash flow. What I'd tell you is, we feel great about the outlook for the year from a cash perspective. In terms of liquidity, we have over $25 million of liquidity available to us and you'll see from quarter-to quarter, whether it is inventory building or dynamics between AR and AP, those numbers move around.

Okay. And then just one more question, can you talk at all about the profitability of the [indiscernible] stores and what you're seeing there? That's all I have. Thanks.

Yes. So we don't get into breaking out for a while economics of our stores and just given the role of that source play. What I can tell you is our stores are profitable. And more than the profitability and growth that they drive really back to what they represent to the overall Company in terms of consumer engagement and awareness continue to be powerful drivers for us.

Our next question comes from Mark Astrachan of Stifel. Please proceed with your question.

I wanted to ask about gross margin and if you could give a bit more specifics in terms of drivers by item, I think which you called out in the release, I'm just try to get a sense of sustainability relative to sort of what we've seen like as we talked about FX being some benefit in past. I mean is that big part, little part and same thing with sort of the other stuff? And yes, I have a follow-up.

Sure. So really pleased with the expansion in gross margin in the first quarter of 748 basis points, primarily that was driven by the Sweeten the Mix innovation program that we have some of the same underlying drivers. There are two other variables that we called out, one which was a freight benefit that we don't expect to continue for 2017 of 200 basis points. The other as you noted was FX and that was about 200 basis point impact as well. So relative to that 100 basis point per year of expansion that we have talked about in terms of our algorithm, the kind of core innovation proposition still well ahead of that and driving most of that.

Great, thanks for that. And then just going back to the previous question or on the previous questions on sales and your confidence in achieving the guidance for the year. I guess acknowledging one-month doesn't make a trend for sure, but the most recent data showed a fairly pronounced slowdown. So I guess, what specifically give you confidence that you're going to be able to hit the numbers which you did and maybe putting in a different way, is anything changed in your assumptions about new distribution, whether it's international into Superdrug or Ulta brick and mortar that wouldn't show up in the data that gives increased confidence in that?

Yes, so I'd say we're quite confident our 24% to 28% guidance we've given, in terms of kind of what correlates what doesn't, if you look at our business, we've got a good - pretty good percentage that isn't in track channels at all. So whether it be a direct business or international business Ulta, Amazon, lot of the dot com. So there's a number of I'd call it growth levers that you won't see kind of in scanner to begin with. But beyond that I'd say even more significantly is the white space we have in front of us both in terms of distribution as well as space gain, much of which is not showing up in the scanner that you look at particularly if you looking at a one-month period. So I would say fundamental building blocks similar to kind of what we took you through last year, nothing is really changed in those building blocks in terms of our assumptions it's quite balanced between distribution, space expansion as well as kind of the continued productivity of our innovation.

Our next question comes from Andrea Teixeira of JPMorgan. Please proceed with your question.

Good afternoon. So, could you comment more on the tests that you would post making with your products and you said later this year the tests and decisions would only probably happen in 2018. And so if it's not obviously baked in your guidance and is that fair to say that? And related to that, if your take away measured by ARI finished plus 18 while you grew 15 and I know you're basing on obviously a easier comp, it implies some inventory reductions right at the trade. So your guidance seems conservative, especially as you face much easier comps and with the announcement of Superdrug in the UK that I'm assuming is not part of a guidance. So could you help us bridge these factors and I'll come back with my follow-up.

Yes Andrea, I'll take the alter with the test comment and then Tarang can take the second part. So we talked about the fact here, more accurately Ulta spoke about the fact that we would be testing in a small subset of their stores this year. We have not yet actually launched that test within Ulta. So up until now, our business with them has been on ulta.com. And as we mentioned, very pleased with the progress on ulta.com which in many ways isn't that surprising, just given the overlap that we have with them from a consumer perspective and the fact that that they're excited to test the brand with us. So, we will give more color and context as that distribution sets, but nothing that we would point to or update on relative to the physical and store tests.

And then in terms of your question regarding kind of the consumption data versus our net sales. First of all, for our net sales, as John mentioned, we're anniversarying quite a high period last year of shipments. I think, we've shipped over, I think is over 35% growth last year in the first quarter, primarily kind of driven by a lot of pipeline shipments. And this year, we don't really have a much pipeline in the first quarter, so little explains over the 15%. And then the consumption growth, I think it's been pretty consistent in terms of the level that it's above where the category is. And so, we continue to see good growth from a category standpoint and we continue to take share in the marketplace. I think, in the 12 weeks ending March 19, we had a 3.8% dollar share in the total multi outlet data set, compared to 3.2% share last year. So we continue to build share and continue drive consumption. And as we mentioned, there are number of things in our business model that are beyond kind of track channels, that gives us confidence in the year guidance.

Yes, thank you. That's helpful. So one think to follow-up on SG&A, but I just want to make sure before I go into SG&A. The Superdrug is not included right in the guidance?

We don't actually speak to what is and isn't included in the guidance, Andrea. But needless to say that as we set out the guidance for the year and including the reaffirmation that we've given today. There are assumptions that are made for both what we would do with existing customers, as well as new customers that would be brought online.

Okay. The SG&A question is regarding the - when you adjust SG&A which obviously you guided for that, I mean an increase investment in infrastructure. You've got about $29 million in SG&A for the first quarter, is that the new level we should be looking? Obviously it's baked some growth also in your guidance, but I just want to know on a recurrent basis before you go into the second half of the year which I'm assuming a much bigger ramp up of SG&A, like we should be looking at a minimum of $29 million adjusted for [indiscernible] items right?

Yes. So what I would say is, we don't provide quarterly guidance on those metrics. But as you mentioned Andrea, this is a story of continued investment, notably in brand building, but also areas like infrastructure and people. And so, as we take a look at our outlook for the year, our guidance does imply continued investment and redeployment of gross margin dollars back into some of those areas, including brand building. So don't want to speak to minimum, so what the right levels are. But I would say, just leave you with the fact that you will see continued investment from this point forward.

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call back over to Mr. Tarang Amin for closing remarks.

Thanks again for joining us. We'll be presenting at the William Blair Growth Stock Conference in June and we look forward to discussing our second quarter results in August. Thanks, everyone.

Thanks, everyone.

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