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

Bonnie Herzog - Wells Fargo Securities Stephanie Wissink - Jefferies Andrea Teixeira - JPMorgan Bill Chappell - SunTrust Jon Andersen - William Blair Dara Mohsenian - Morgan Stanley Oliver Chen - Cowen & Company Erinn Murphy - Piper Jaffray Linda Bolton-Weiser - D.A. Davidson Mark Astrachan - Stifel

Greetings and welcome to the e.l.f. Beauty Inc. First Quarter 2018 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, Allison Malkin with ICR. Please proceed.

Good afternoon, everyone. Thank you for joining us today to discuss e.l.f. Beauty's first 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 presentation and the most directly comparable GAAP measures. Certain brand equity measures cited in this presentation are based on third-party settings. 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 then alternate, sharing the progress we made against our growth strategy and providing additional details 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 to report first quarter 2018 results with net sales increasing 9% and adjusted diluted earnings per share of $0.11. We took market share and tracked channels from 4.4% in Q1 of 2017 to 4.6% in the first quarter of 2018. We're also pleased with our progress in non-track channels including both our direct business, as well as Ulta Beauty. Most importantly, our results demonstrate the successful execution of our growth strategy. Our first strategy is to build a great brand. e.l.f. is a brand that young, diverse, beauty enthusiast love. Perhaps one of the best measures of our brand's strength is how we've been able to grow our value ratings. Across each of the eyes, lips and face category, e.l.f. has the highest valuating amongst any brand. We've been able to achieve this while introducing higher priced points, increasing average unit retails over the past four years from $1.98 to $3.47. I've been in the consumer sector for over 25 years and have had the privilege of winning a number of iconic brands. I've never seen a brand increase averaging at retail prices by 75% and also grow valuatings to the highest in the category. This speaks to our pricing power and the strength of our brand. In the first quarter of 2018, brand highlights include our New Orleans Beautyscape event that reached over $140 million. Our Beauty Squad loyalty program that grew to over 900,000 members and several of our most successful beauty influencer collaborations. Our Heart Defense highlighters sold out in stores in less than two weeks and [indiscernible] lash kit is a top five [indiscernible] Ulta Beauty. We also received a Glamour Best of Beauty Award for magnetic mask and a Cosmopolitan Award for our silicon sponge duo. We are pleased with both the efficiency and effectiveness of our engagement efforts in building the brand that consumers love. I'll now 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 in breadth of high quality innovation and an extraordinary value sets us apart from other brands. Additionally, our innovation approach has been the primary driver of the expansion of gross margins which have increased over 1,400 basis points in the past four years. In the first quarter, we launched 31 new items including 12 products that were first-to-mass. A major area of focus continues to be skin care with the launch of oil control and pore refining products. We continue to innovate across price points launching five items at $2 or less, including our top-selling Line & Define Eye Tape, a first-to-mass launch of $2. We also improved our speed-to-market which continues to be amongst the fastest of all the beauty brands. The average speed from the initial idea to selling online in Q1 was 20 weeks with the fastest launch being 13 weeks. We believe our ability to respond quickly to trends and consumer feedback through our direct channels provides us with the significant advantage. Our third strategy is to expand brand penetration. As we discussed during our last call, our current focus is to optimize our space at existing retailers into execute the expansion into Ulta Beauty. We are making good progress on both fronts. We also continue to build out our priority international markets including growth at Walmart Canada and at Superdrug in the UK. We have a compelling retailer proposition, bringing some of the best consumers, innovation and productivity in the category. Let me take a step back and remind everyone about our approach. Our productivity model entails optimizing revenue through a combination of both average unit retails or AUR and units. Across these two variables, we have prioritized AUR growth, which we have primarily driven through the expansion of our product to surmount to higher price points. Even with $1.49 increase in AUR over the last four years, our products remain an extraordinary value. Our AUR is currently less than half of the top three mass cosmetics brands. As such, we believe we still have a long runway to continue driving revenue through average unit retails and are comfortable with the trade off in units that one would expect. This is especially so as we continue to lead productivity in the category with unit [indiscernible] productivity that is nearly three times that of the top three brands. One of the great enablers of our productivity model is our direct channels. Our innovation is first introduced on Elfcosmetics.com and in our own e.l.f. stores. We continue to see good progress in Q1, completing the re-platform of Elfcosmetics.com and improving our mobile capabilities. We also opened an exciting new store in Austin Texas with experiential elements to drive both awareness and engagement. I'll now turn it back to Tarang to discuss our operational progress.

Thanks, John. Our force strategy is to drive world-class operations which starts with world-class people. In the first quarter, we appointed Richelle Parham to our Board of Directors. Richelle brings rich business and digital experience to our board, including as a former CMO of eBay. With Richelle's appointment, the majority of our Board is now composed of women. Out of roughly 4,800 public companies listed on the NYSE and Nasdaq, we are proud to be one of only 17 that have women as the majority of their board members. Along with an employee base of young, diverse beauty enthusiast, this shows our commitment to lead inclusivity in our industry. We also continue to build competitive advantage in our operations, which in turn enables the rest of our business model. Our supply chain delivers the best combination of cost, quality, and speed and beauty. In Q1, we brought on our first U.S. manufacturing partner, bringing us additional capabilities and speed and innovation prototyping. I'll now turn it back to John to discuss our financial progress.

Thanks, Tarang. We are pleased with our first quarter results. Net sales increased 9% to $66 million, reflecting growth across both our national retailer and direct businesses. Gross margin was 61%, in-line with expectations. The variance to prior year was driven by foreign exchange headwinds, customer mix and freight, partially offset by margin accretive innovation. On an adjusted basis, SG&A as a percentage of sales was 48%. adjusted EBITDA was $11.9 million, compared to $11.7 million in 2017. Adjusted net income was unchanged from Q1 2017 of $5.5 million or $0.11 per diluted share. We continue to optimize our inventory levels and are happy with the progress made throughout the quarter. Turning to our outlook for 2018, we are pleased with the starts of the year and given it is early, we are reaffirming our 2018 guidance. I will now turn it back to Tarang to provide some final thoughts.

Thanks, John. In summary, we're off to a good start to our fiscal year and are especially pleased with our progress making luxurious beauty accessible for all. The combination of our consumer engagement, innovation output and speed, multi-channel approach and operations advantage positions us well. There remains a great deal of whitespace for us to pursue both in the U.S. and internationally. I'd now like to ask the operator to open the call for questions.

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Bonnie Herzog with Wells Fargo Securities. Please proceed with your question.

Thank you. Hi, everyone. I just wanted to ask you guys a little bit about the category growth and if you've seen any changes versus what you guys saw three months ago and love to get your outlook for the category for the rest of the year. And then how would you characterize the current competitive environment? There just seem to be so many brand re-launches in mass so far this year and have you really seen any change in pricing or promotions? Thanks.

Sure. Hi, Bonnie. This is Tarang. As faced with the category of the last four to six weeks, we've seen a little bit of a pick up, but we tend to not focus on shorter periods. I'd say as we look at the quarter, cosmetics are doing a little bit better, but I think it's still too early to tell fundamental outlook in terms of if the category bounced back or not. In terms of competitive environment, I don't really see that much of a difference in the competitive environment. There's always a lot of competitive launches, entries, re-launches within the space. I would say we're very well-positioned amongst all of them. I think in the last quarter, we've seen a pretty good job from L'Oréal and Maybelline behind some great innovation that they have against consumer. We continue to pick up share. And then I'd say on the price promotion side, again, at least in our data, we don't see necessarily a big uptake in it, but again, we're very well-positioned just given our extraordinary value and our ability. I don't think I've seen anything different than we've seen in the past and our ability to compete against that.

Okay. Then if I may just ask one more, I know you reaffirmed guidance, but I'm curious in the context of that. Do you guys still expect your gross margins to be flat year-over-year and then how should we think about freight costs for the remainder of the year as well as possibly any impact from Chinese labor cost and exchange rates? Thank you.

Hey, Bonnie. It's John. What I'd tell you, obviously we don't provide specific gross margin guidance, but consistent with some of the commentary we gave on the last call, we would expect 2018 margins from a gross margin standpoint to be generally consistent with the levels in fiscal 2017. So no significant change there. Couple of components that you mentioned between FX and freight, I would tell you, FX was built into the plan as discussed and certainly you saw some impact of the USD to RMB exchange rate in the first quarter of 2018. And freight was really a beneficiary to the first couple of quarters last year and we called out some significant one-time freight benefits that wouldn't be repeated which are also anniversarying in the first quarter and the second quarter as well. No major departure from what we've talked about in the first quarter margins were consistent with what we would have expected.

Okay, thank you.

Our next question comes from the line of Stephanie Wissink with Jefferies. Please proceed with your question.

Thanks. Good afternoon, everyone. We have two questions. The first is under Ulta roll out. Curious if you're getting any preliminary feedback from Ulta or across your retail base in terms of progress with that account; and then secondly, if you could help a little bit about the disclosure and the fine print in your release on M&A diligence, I'm just curious how you're thinking about over the next few years of expanding the breadth of your portfolio either by category or by brand? Thank you.

Hey, Steph. This is Tarang. I'll take the first question and turn it over to John for the second. Regarding our Ulta roll out, that's a key strategic priority of ours this year. The roll out has gone really well. We're off to a very strong start, we like how Elsa sat in many of the stores and our initial numbers look good to us. So we're pretty encouraged by that.

Hey, Steph, it's John. On the M&A diligence point, in generally our position on perspective acquisitions, I would say, fairly unchanged for some of the things that we talked about on the last call. We continue to see a significant opportunity to not only continue to drive growth in the core e.l.f. brand, but also to leverage the capabilities and investments that we've made in the broader platform to extend to other value creation levers including the acquisitions of other brands. So we will continue to be active in the market. For us it's really about finding the right strategic assets that would be a solid complement for us, but consistent with what we've talked about.

Thank you.

Our next question comes from the line of Andrea Teixeira with JPMorgan. Please proceed with your question. Andrea, your line is now live.

Sorry for that. I was muted. Good afternoon there. I just wanted to go back to the commentary about the gross margin. John, you said to Bonnie's question, slack margins. Right? It's the guidance. But you obviously started the year with a bigger impact and this has moved out as we progressed because obviously you have some -- the impacts were being felt beginning of last year, kind of second half of last year. Do you think you're being able to pass on most of the price increases through the trade? Or would you say you're half of the way or how do you see that happening? And in terms of elasticity, you said you're less worried about volume at this point, but obviously, that's something that a brand that can have aspirations to enter a bigger market share. Can you comment on how that has been impacting your new client or loyalty, if you will, in terms of innovating on the price levels that you're used to or your price levels that you have the core consumer at? If you can comment on those two aspects, I would appreciate. Thank you.

Sure. I think there are a couple of things there. One, just on pricing actions and sort of where we hit from an AUR standpoint, and I just want to be clear that as it pertains to gross margin, we have not taken any price increases, certainly in 2018. And the majority of the AUR increase that you've seen historically for this business has been innovation-led as we've expanded to higher price points. To your core question of how does price points have evolved over time and how our proposition in the market continues to resonate, I will go back to some of the commentary that Tarang mentioned in our opening comments just around what happened with our value rating and how we continued to extend the franchise through that point. Certainly as you mentioned, as you continue to take prices off, there can be a trade-off in terms of units, but we're very focused on the optimization of overall revenue, as well at the same time making sure that we still have the strong value proposition given the improvement in our value rating over that time period in addition to all the feedback we continue to get through direct channels and with our consumers, we feel quite good about how we're positioned there. From the gross margin standpoint, just speak to that for a minute. We obviously are a company that does not provide quarterly guidance and try not to provide gross margin guidance either. But what I will tell you is what we're really focused on in any aspect of the business is the year and as we talk about 2018 fiscal versus 2017 fiscal, we have mentioned that those margins would be relatively similar. Of course as you go throughout the year, just given the dynamic nature of our business, you will see variability and we did have a couple of things in the first quarter of last year which we called out -- one being freight which was pretty significant that we're in the process of anniversarying, but I would focus you back on the overall year in terms of how we see gross margin evolving.

This is helpful. And then the positioning that you announced on the fourth quarter, how far are you in that process?

Sorry, Andrea, we didn't follow that. What repositioning?

I remember that you called on Walmart and Target your core clients. You're trying to reposition your mix and I think you alluded to that mix effect that you just discussed. Right? It's not a pricing activity. It's just that you're selecting what are the SKUs that make most sense for you to keep. Correct me if I'm wrong, but I got the perception that you are reanalyzing your portfolio. My question is that -- the evolution of that process, how far are you in that? If you say 50% of that or you're still in the beginning?

Sure. We call that our optimization of the space gains we got last year. We picked up quite a bit of space at Target and Walmart. The way our model works is we'll land that space and then we'll optimize it in this Spring resets that these retailers do. So the first one to set was Walmart for us in Q1 and we feel very good about how that optimization is going at Walmart in terms of our productivity on those shelves. The Target this year set a little later than they did last year, so we did see some higher levels of [indiscernible] stocks earlier in the quarter as product ran out before the new sets were shelved. And in the addition, we had a very big merchandizing program last year, really focused in our innovation, really highlighting our innovation. We had merchandizing this year, too, but focused more on some of our product collaborations and innovations. Not quite as bit. So I'd say over the next few months we'll see how the productivity pans out at Target, but overall, I think we're feeling pretty good. Certainly, Walmart is pretty much really set and Target, we're in process of further optimization.

Okay, that's helpful. Thank you.

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

Thanks. Good afternoon.

Hey, Bill.

Good afternoon.

Can you talk a little bit more about what's going on with optimization? And I know how you loved to talk about the Nielsen, so why don't we talk about the Nielsen's? When I say that, the paradox is this time last year, you were getting 50% more shelf space in Target and then eventually 20% more shelf space at Walmart. And then Nielsen's kept decelerating. Now you're not getting any big new wins this year as planned and the Nielsen's are accelerating. I'm just trying to understand, when you talk about optimization, is it maximizing out the stocks? Is it reworking what the products set looks like so that the sell-through is that much better? And where are we in that stage? Do you feel like you've cracked the code for both those retailers so this Nielsen numbers should continue or if not, accelerate?

We've only had a little bit of a disconnect between depending on the time period you will get Nielsen versus what we see and particularly given, it doesn't cover all of our business. But in terms of the optimization, in terms of how we approach it, John discussed that a key part of our model is we put all our innovation on to our direct channels first, both elfcosmetics.com as well as our own retail stores. We're able to get data off of that in terms of the performance of those products and then really it's a big reset. You see the Spring resets and there's an uptake in the Fall where we're able to get some of those new products on more broadly to some of our big retail partners. Little bit of the weight work is we'll get the space. The space in times will be I would call it whatever assortment is available then for the retailer to take. We'll then have an entire year of launches of our new product launches and one of the big hallmarks for us both the output and speed of our innovation. We launched 120 and that ends last year. We can take that data and then decide what we want to give them in terms of being able to replace. So we can replace as much as 25% to 30% of the SKUs that are on the Walmart or Target. Shelf set with new items that we can put on and that's what we mean by optimization. We're always looking that assortment in saying, working with the retailers, figure out what the right assortment is for them. And that's why sometimes you'll see and the year we have full year data as 2016, we didn't pick up any more space at Target. We saw a very strong growth year. It was a result of that optimization, so I think it's continual process that we end up going through and also includes signage, communication, how products flow on to the shelf and we're able to monitor how those SKUs are doing. A little bit more detail than we wanted, but it's a continual process for us.

That helps. And then also the comment on the domestic manufacturer. Just trying to understand what that brings? You already have very quick time-to-market of products. You've always hallmarked through the company, has been the China sourcing model. Will we expect to see more of that and what does that bring to the top line or to the bottom line?

As we've said, we have the best combination of cost, quality and speed in our industry and it's the supply chain advantage we've honed over the last 14 years. So this really is about augmenting that advantage with a U.S. supplier that can help improve our speed and innovation prototyping. So it's just really strengthening our current model, majority of those continue to be in China which we've honed in and we just think it further strengthens the advantage that we have particularly on innovation.

Does that mean time-to-market could go down even lower?

That's always our goal. I think we've stressed our numbers over time that I think in the last call, we talked about our four-year progress where we used to be over 30 weeks for us to launch a new product on average. Last year as I mentioned, we launched 128 items and the average was 22 weeks from idea to settling in our direct channels. We talked this first quarter the average and the items we launched in the first quarter was about 20 weeks and the fastest being 13. We always strive to improve our speed and when we look at speed, we're looking at as an average across all of our launches, not just the select few. I think we have real advantage when it comes to innovation, both the output as well as the speed and we will continue to improve that advantage.

Got it. Thanks so much for the color.

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

Oh, I got mister. Thanks and hello, everybody. Couple of questions. Could you unpack to the extent that you're willing to the 9% growth in the quarter? How much generally-speaking was the velocity or same-shelf growth in what the contribution from new locations was, and then you think about the guidance for the full-year 68%, the composition of that as well from a velocity versus distribution expansion standpoint?

Hey, Jon. It's John. The big picture, I would say on the 68%, just going back to some of the commentary made on the last call merely was predicated on that existing distribution that we had and the continued optimization efforts that Tarang just talked through as well as the expansion of our full chain roll out at Ulta Beauty, which is just in the process of completing. So that's how we think about the broader year. As it pertains to the quarter, I would tell you that things aren't that different. As we think about some of the drivers underpinning the 9%, well, we don't break that out of the granular level. Certainly some of the space that we got last year and the anniversary impact, as well as some benefit from Ulta Beauty despite the fact that those stores were setting throughout the quarter were beneficiaries to that headline growth rate.

Okay. Is the Ulta roll out complete and was that wholly contained within the first quarter?

No. We have said that it was going to be at first half of '18, so it is largely complete right now. But it did go past the first quarter.

Okay. And then a quick follow-up. You talked about a lot of white space remains for the brand in the U.S. and internationally and that's clearly the case. Can you talk a little bit about how the international portion of the business is performing and any opportunities to expand either with existing retailers or future retailers? And then from just an overall timing perspective domestically, how should we think about other big chain opportunities and the timing around those? Thank you.

Sure. On the international business, we feel great about the progress on the international. It's just a reminder. Our international footprint, the main components of it really are with Walmart in Canada and Mexico and then our entry last year in Superdrug in the UK. We continue to see really good progress with Walmart internationally and feel really great about our Superdrug business. What we find is that the brand really does resonate in these international markets. The combination of high quality extraordinary value and our engagement model resonates in each of these markets. So we feel quite bullish about international going forth.

And Jon, to your point on new distribution, what I'd tell you is back to the comment around whitespace. We mentioned earlier certainly a number of places where we think the e.l.f. brand can go that it isn't currently carried. We're constantly in conversations with perspective partners. For us it's really about where the beauty enthusiasts wants to see e.l.f. and making sure that that particular retailer partner is committed to executing the category well and that it's on the right terms. Certainly continue to have a number of folks who would be potential candidates over time.

Great. Thank you.

Our next question comes from the line of Dara Mohsenian with Morgan Stanley. Please proceed with your question.

Hi. Good afternoon, guys.

Good afternoon.

If we look at the Nielsen data, it looks like your volume trends are declining on a mid-single digit basis year-over-year, year-to-date. And I'd assume that the volume is down also on a reported basis of your larger retailer customers, just backing out Ulta DDC [ph] International and some of the solid price mix. So, A, can you just give us more clarity on what's driving those volume declines at your larger retailers, especially in light of the increased shelf space; and B, how does that impact the ability to garner sort of new distribution wins over time?

Sure, Dara. So, I don't know if we're looking at the same data because if we take a look at the last 12 weeks in Neilsen ending in Mach, we were up 4% in that tracked business and as we've explained before, our business is broader than tracked. In terms of key customers, I think we described both in terms of Walmart which is already reset. We feel pretty good about the trends that we're seeing there. I explained on Target and the merchandizing in other stocks the difference versus a year ago so we'll have to wait a couple more months there. But I'd say overall footprint, we're satisfied with where we're at right now and continue to see real potential as we go forward.

Okay. I guess I'm looking at it on a year-to-date basis as opposed to just the last couple of periods. But even if I just look at reported trends with the strength you mentioned in DDC International, the Ulta launch price mix, it would seem like volumes have been down in the last couple of quarters year-over-year. Correct me, but I'm just trying to get a sense of what those levels are.

I got it. Sorry. Got it. We're talking two different things. I was talking dollars and I think you're talking units. I get it. As we talked earlier in the call, we've had a conscious strategy over the last four years of really driving averaging at retails as the primary driver of revenue growth and what's different about our business and many other is we described our unit productivity versus the top three brands in the categories as nearly three times that of the top three brands. We felt those are real opportunity, in fact one of our biggest challenges were staying in stock in a number of our retailers. So we have been optimizing AUR primarily through margin accretive innovation and have been willing to take lower volumes for that. We have such a big golf between us in the next best brand in terms of unit productivity. That has been very conscious. We try to talk to that in the comments. It's not that different than what we've seen in the past as we've optimized AUR and we're comfortable with that mix particularly as we've talked about our revenue guidance.

Okay. That makes sense. The pricing has been impressive and obviously still a nice contributor in the last couple of quarters. But I guess what I'm wondering is it does seem like there has been a clear slow down versus that great longer term four-year history that you mentioned. What sort of a difference -- because it doesn't feel like price mix has accelerated. You've obviously had the strong growth there for a number of years, but it feels like volume has decelerated in the last couple of quarters. I'm just trying to understand the sequential change in year-over-year growth.

I think some of the themes we talked last year were we did hit some headwinds in terms of the overall category and we're not immune from overall category headwinds. We factor that in as we provide the guidance for this year. You think people will worry about where the category was? We said don't assume any change in category trajectory and we can continue to see that as we go forward. To this combination, there's always going to be healthy tension for us of driving AUR and extraordinary value at the same time and we feel really good about our progress there. Again, I haven't seen a brand drive AUR to the extent that we have and still achieve the highest value ratings in the category. So we believe there's real power to continue to do that as we go forward. I think we also talked about the difference between the year-over-year in terms of the number of new doors and space we picked up we said this year. We're really focused on optimizing our existing space as well as the Ulta Beauty roll out. So, probably haven't built into that 68 leap. I think as we looked at last year, people got confused about what was an in. So we said, 'Hey, 68 is based on these things'. That would explain the real difference.

Okay. Thanks, guys.

Thank you.

Our next question comes from the line of Oliver Chen with Cowen & Company. Please proceed with your question.

Hi. Thank you. Regarding social standards and your use of data analytics, what are your thoughts in your head in terms of how you're harnessing that in your existing accounts? Second question was just regarding Target. Target conducts a lot of the re-imagining stores and also re-imagining a lot of the beauty areas of the stores. How does that position you? It looks like the displays are really quite good and a lot of these new stores would love your thoughts there. Thank you.

Hey, Oliver. It's John. Why don't I take the social standards piece and then let Tarang comment on some of the things that we're seeing at Target. But directly to your question, I'd say we're thrilled with some of the capabilities that that partnership and investment has brought us. As we think about different ways to harness and leverage data to make better decisions throughout really a number of different areas of our business ranging from product innovation, quick responsiveness to trends or even identification of really great authentic partners that could be good members of our beauty scape program and good advocates of e.l.f. over time, it has been incredibly powerful in terms of some of the things that that has done for us. I think it's part of a broader theme of how we leveraged data here in the business. Obviously starting with the core direct channels and some of the approach that we built over the last 14 years and how we validate that innovation, but it's been a strong complement to some of those activities.

And then on Target, as you know, Oliver, they are our longest-standing retail partner and we love working with Target and one of the reasons we love working with them is they take beauty extremely seriously and they're always looking to see how they continue to extend their leadership there. Whether it be their beauty blow out stores where you have the elevated fixturing and communication or some of the things they do both in terms of merchandizing as well as assortment, there's a lot of opportunities for us to partner with them. On the beauty blow out stores, we're looking at different kind of configurations that continue to elevate e.l.f.'s presence and space within Target there. In terms of merchandizing, I think one of the best examples was what we did with Target over the holiday period where we really were a critical part of their holiday success and beauty in gifting. And then in assortment, Target was the lead customer for our Beauty Shield line as we expanded it from our direct channels into national retailers. That's doing extremely well including the product that we described getting the Glamour Best of Beauty Award, our magnetic mass is really one of our top items within Target. Really that collaboration and partnership continues to be like a real hallmark in terms of our business model.

Okay. And lastly on the color cosmetics versus skin care and also the degree of units every year. What should we understand with your product mix evolution as you continue to think about attractive diversification and executing on micro-trends? How will the mixes evolve and if there are any margin consideration that we should know about in our long term modeling?

Yes, Oliver. All I'd say is generally speaking, you're quite aware of our evolving skin care portfolio, which we continue to be very excited about. We only launched skin care a couple of years ago, so we still see tremendous potential to expand that over time. The preponderance of the business is still in color and I think you'll continue to see that for some time just given the nature of the history that we have there and how emergent that skin care business is. But fair to say that we will see skin care increasing in terms of the penetration of our portfolio.

Thank you. Best regards.

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

Great. Thanks. Good afternoon. I guess my first question is just a clarification on how you're thinking about the cadence of sales guidance. Clearly you're above the range, 68% in the first quarter, but your lapping [indiscernible] comparisons in Q2 and Q3, both in the mid to upper 20s. Curious if we should expect flattish in the next couple of quarters and then a re-acceleration in the fourth quarter or any timing or things we should be aware of and if Ulta still rolled out Q2 as well? Any help on that would be great.

Hey, Erinn. It's John. Obviously difficult question to answer and that we don't provide quarterly guidance, but I think you touched on a few important points. In the e.l.f. business, obviously a lot of changes that you can see from quarter-to-quarter if you look at our history since IPO, I think it has demonstrated in the results that we've announced depending on what could be happening in the prior year or new pieces of distribution or new programs that come in the current period. As we think about the second and third quarter last year, obviously, those were very strong in terms of headline growth. So all I would say is that if you think about the anniversary impact, certainly would take that into account relative to the cadence throughout the year.

Okay. But you're not providing specific Q2-ish thoughts? Just to get the consensus aligned at this point?

No. We just don't do the policies since IPO. We haven't issued quarterly guidance. And I think again, it's not to hold back on disclosure. It really is just a reflection of how many timing elements there are in the business and the danger of doing that. But certainly try and help you guys understand some of the things that were happening in the prior year.

Got it. And then just a couple other one for me then. Just on cut-through mix, I know that was still a headwind for growth margin. Any clarification around how big that was at the overall 200 basis point erosion and then where are we at right now? What's your assumption for overall off-price for this year? I know it's a little bit higher than last year, but does it normalize as we exit Q1? Any help there?

Yes. Just to take the second part of that, I would tell you, we don't have higher plans for off-price this year relative to last year. We've long said that off-prices are core part of our business as we take items off the wall and discontinue items and it's been roughly less than 5% of the overall business. I don't see any difference this year. With respect to the margin variance in Q1, what I'd tell you as the biggest movers were actually FX and freight. Obviously FX pertaining to the broader USD to RMB exchange rate and just what happened there over the course of the last 12 months; the second being the freight benefit that we saw and called out in the first quarter of 2017 and the anniversary impact. We did see some impact from off-pricing Q1, but I'd tell you, that was largely more due to timing than anything else. If you recall in 2017, most of those volumes were back halfway to I think over 80% of that off-price business came in the second half of last year versus this year where we see it being relatively more balanced. It was modestly higher in the first quarter, but less of a driver than those other two items I mentioned.

That's helpful. Thank you. And then just last from an M&A perspective. I get that the right brand presented itself. How much debt would you, the Board be, I guess comfortable taking on a balance sheet, maybe give it to us in that perspective or in net debt to EBITDA, just so we can kind of understand the scope of what you guys could be potentially looking at?

Yes. I'm not sure that we commit to an actual leverage level, Erinn, other than we are comfortable using our balance sheet for the right acquisition. I think the actual details on that really do depend on the nuances of the asset itself and cash flow dynamics of that asset, as well as just making sure that we balance the flexibility that we all continue to want to have in terms of investing back in the platform. But it is something that we would be comfortable using for the right acquisition. And also what I'd say is this is a business that is operated at much higher levels of leverage. So certainly not to signal anything, but just more to evidence that we have operated at levels higher than the ones than we currently see.

Thank you.

Our next question comes from the line of Linda Bolton-Weiser with D.A. Davidson. Please proceed with your question. Linda Bolton-Weiser: Hi. I was just curious if you could comment on how as your business has evolved and grown and especially like adding more in skin care, how your social media channel strategy has evolved along with those changes. So has some mix of what you're putting your efforts towards in social media, has that changed over time? And also maybe you could comment on if you're spending more on traditional advertising? Because I think over time, you had intended to maybe up that spending. Is that something that's occurring? Thanks.

Sure. Hi. This is Tarang. What I'd say our strategy in social is really what best engages our consumers. Often that is our innovation. As we've innovated more in skin care, you will see more skin care in our social media conversations and what our consumers are talking about. But the overall overarching pieces, how are we engaging them in an authentic manner, I described in the first quarter, our New Orleans Beautyscape activation, one of the key parts of that activation was having a winning team help collaborate and design some new products with us. Those types of collaborations really drives a great deal of engagement as well as build success of us being able to bring those product collaborations not only into our own direct channels, but also with our national retail partners. And then on the second part, yes, just with respect to advertising spend, our model continues to be highly efficient and I think we've said for quite some time now that we do want to continue deploying investments back against the brand for the long term opportunity that we see and we continue to do that. But if you take a look at how it tends to be with methods that still have that efficiency and most importantly are authentic and resonate with our core beauty enthusiast. So we will continue to put additional spending behind the brand. We are a test-and-learn company, so it depends what you mean by traditional as to different vehicles that we might pursue over time. But we're not afraid to test anything, but we continue to be very efficient relative to the legacy brands that's been upwards of 20% to 30% of their sales on traditional advertising. Linda Bolton-Weiser: Thank you.

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

Thanks and good afternoon, everyone. I wanted to ask a little bit of a follow-up on the last question. Could you talk about whether there's any change in the trade programs with retailers regarding brand funding? Particularly as retailers out there seem to be focusing on introducing more mass brands? In other words, how does e.l.f. differentiate itself in an increasingly competitive market to do the retailers or have the retailers ask for more specific funding within stores to drive incremental shelf space?

One of the great things about our business is we don't have the level of trade spend and trade discounting that you will often find in many legacy brands that have much, much higher pricing and only the deal back to customers. The customers are aware of our formula of high quality and extraordinary everyday value. That really makes it much more efficient for us to go to market and then we also don't have to do the same types of tactics that other brands may have to do given that we do offer an extraordinary value every single day. Often when you will see e.l.f. merchandized, it will be merchandized at full retail prices. In terms of shelf space and other mass brands, as we mentioned, we have an incredibly compelling retailer proposition that is not dependent on writing them a check. The three things we have that every retailer is interested in is we have one of the best consumers in the entire category -- these young, diverse, beauty enthusiasts that they're trying to attract to their category if they're serious about beauty. The second thing that we have that every retailer wants is our innovation and our innovation pipe-lining capability. If you think about our innovation and the number of items we launch and then more importantly qualify via our direct channels, says that you don't have to take the risk with e.l.f. makes a huge difference. And the third is our insights and data which often are translated in terms of our unit productivities, but insights that they're getting through our direct channel both in the form of the sales data we have over 14 years, as well as the over 130,000 reviews and engagement we get from our stores as well as online end up allowing us to have a pretty compelling proposition that is not dependent on us stepping up with a big, big check. And then in terms of differentiation, the best way we know how to differentiate: one, for retailers is to collaborate with them in ways that they're most interested in. There's always a healthy tension there because we want retailers to carry our best sellers or the majority of what they carry our best-sellers, but we're perfectly happy collaborating. I'd give a couple of examples. I gave one earlier in terms of our Beauty Shield and really collaborating with Target early on our Beauty Shield skin care line as such that they get first dibs at that for the first six months. Similarly, we collaborated with Walmart on our active line. They were very interested in this segment. We're able to collaborate with them, they were able to put a lot of support and differentiate there. So ways of differentiating that are not depending on price discounting has been our focus. We have a great weapon both in terms of our consumer profile as well as our innovation capability.

Okay. Maybe just asking a different way. Has there been a change in the mark up of the products of retail? Meaning from what you're selling the product to the retailer for? I guess I wonder that, too, in the context of the AUR focus where selling prices are going up. And I'd say that in part in the context of uniquely where your product is positioned price-wise, it's less expensive than most other products within the category on shelves. So the retailer presumably makes less dollar profit per turn or sale than they would some other items, so you have to sell more and to Dara's point earlier, volumes have been a little bit weaker. So how do you make that up from a retailer or if you're a retailer?

We make it a couple of different ways. We turn so much faster than just about any other brand. As I talked about our unit productivity throughput being nearly three times the top three brands. [Indiscernible] retailers have on us are incredibly attractive, mainly because of that unit productivity. So we're willing to trade off volume in higher averaging of retails between those two things to be able to continue to drive productivity numbers that we have been able to. It's different than the go-to market of many of the legacy brands out there that are already very high-priced where we have this luxury of being able to really drive AUR and given the lead that we have within that. Our margins within retails, that's their choice in terms of where they price brands. I think the overall margin structure is pretty comparable. I think between most of them set at their category level. So given the movement that we have and the efficiency we have in terms of penetrating their supply chains, I think our overall profitability model for retail is also quite strong.

Okay. Thank you.

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

Great. This is Tarang. Thanks again for joining us. We look forward to seeing you at the William Blair and Jefferies' conferences in June and discussing our Q2 results in August. Thanks, everyone.

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