Allison Malkin - IR Tarang Amin - Chairman and CEO John Bailey - President and CFO

Steph Wissink - Jefferies Ralph Lauren - Cowen & Company Linda Bolton Weiser - D.A. Davidson Wendy Nicholson - Citi Bill Chappell - SunTrust Erinn Murphy - Piper Jaffray Joe Lackey - Wells Fargo Securities Jon Andersen - William Blair Christina Brathwaite - JPMorgan Dara Mohsenian - Morgan Stanley Claire Chamberlin - Stifel Rupesh Parikh - Oppenheimer

Greetings and welcome to the e.l.f. Beauty Second Quarter Fiscal 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 of ICR. Please go ahead, ma'am.

Good afternoon, everyone. Thank you for joining us today to discuss e.l.f. Beauty's second quarter 2018 earnings results. A copy of today's press release is available in the Investor Relations section of elfcosmetics.com. A recording of the call will also be available for 90 days on elfcosmetics.com. As a reminder, this call contains forward-looking statements that are based on Management's beliefs and assumptions, expectations, estimates, and projections. These statements, including those relating to the company's fiscal year 2018 outlook are subject to known and unknown risks and uncertainties and therefore actual results may differ materially. Important factors that may cause actual results to differ from those expressed or implied by such forward-looking statements are detailed in today's press release and the company's SEC filings. In addition, the company's presentation today includes information presented on a non-GAAP basis. We refer you to today's press release for a reconciliation of the differences between the non-GAAP 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 discuss the business context and action. John will then discuss our financial performance and guidance. It is now my pleasure to turn the call over to Tarang.

Thanks, Allison and good afternoon, everyone. Our second quarter saw healthy sales growth, operating profit and cash flows. This was on top of 27% net sales growth in the same period last year. We secured additional distribution at Walgreens, launched end cap [ph] displays at Rite Aid, started testing skin care at Ulta Beauty and began retail expansion in Germany. Offsetting this progress, we've seen a notable deceleration on our track channel sales. I'll review what we're doing to reverse these trends. Before doing so, I'd like to provide context on where we currently stand. e.l.f. is a 15-year old grand compared to legacy players that are over 100 years old. We are still young in our brand building journey and believe we have tremendous whitespace ahead of us. As I reflect on the past four years, we've done a number of things well to build competitive advantage. We have a brand that beauty enthusiasts love with the highest value and retention ratings in our category. We have an innovation capability that can launch 100 new items a year in as few as 13 weeks in both color and skin care. We've built a strong distribution base and remain the most productive color cosmetics brand at Target and Wal-Mart on a sales per linear foot basis. Our compelling proposition for retailers continues to get rewarded with new distribution and space. We've honed an operational advantage that provides the best combination of cost, quality and speed in our industry and we've built a great team and infrastructure to further scale the business. With that backdrop, let me now review the three things we're doing to address recent softness in track channels. First, it's time to spend more behind the brand. Second, putting more focus on our key items. And third, taking measures to get optimal assortment at retail. Let me take you through each of these. First, it's time to spend more behind the brand. Over the last four years, we've grown our community to 37 million followers and have increased unaided awareness from less than 3% to 17% using our authentic and efficient program such as Beautyscape. As greater the ROI of these activities has been, the marketplace continues to get increasingly crowded and noisy. In the last 18 months, we've seen the growth of multiple mega influencer driven brands that are competing for our younger consumers' attention. We believe our brand proposition is highly compelling with high quality, extraordinary value and 100% cruelty free, yet, we've not invested enough to communicate our message. We believe now is a natural time to increase investment behind the brand. If you think of our evolution, we spent the first four years building our distribution. We now have a strong footprint that we believe will benefit from increased brand support. We will test broader awareness and engagement efforts in the back half of this year that we can expand in 2019. We intend to fund this investment in part through operating leverage in the business. For example, we're making capital investments in our distribution facilities that we expect to drive labor savings. One of these projects is opening a second distribution center in Ohio to serve our e-commerce business. We expect this facility to reduce our operating costs, enable two day standard delivery to 90% of the country. Another project involves bringing similar automation in our West Coast warehouse. We expect these projects to be completed in 2019. Second is putting greater focus on key items. We have real strength in innovation output and speed. We launch over 100 items per year in as fast as 13 weeks. While we are proud of this innovation capability, we have an opportunity to bring greater focus to some of our best items. We have primarily marketed products when we first put them in our direct channels, but have not done nearly as good a job when we expand distribution to our national retailers. Our plan is to bring greater focus to some of our best products and support them with more holistic storytelling. As an example, in June, we put focus behind having America's number one primers. In August, we'll put an integrated effort behind beauty shield magnetic mask. Our $24 magnetic mask is the great example of our high quality extraordinary value proposition as the only other thing like it in the market is a $75 prestige product. You'll also see us further amplify our leadership position with America's number one brushes. Third is taking steps to get optimal assortment at retail. Each year, we launch new items in our direct channels. We take sales and consumer review data and make assortment recommendations to our national retail partners for their annual shelf resets. We have a strong track record over the past 10 years of driving productivity through this model. This year, we did not have the appropriate mix between new and existing products. Our new products are performing to our expectations, while we saw a greater drop off in our carry forward items. Given how much our consumers value innovation, it is important to get more of our new items on shelf. A key enabler to improve our assortment is Project Unicorn. This is a major product, package and shelf initiative that elevates brand presentation and improves navigation. By eliminating and changing outer packaging on select SKUs, this initiative will enable us to fit more new products within existing space. Project Unicorn will also allow us to highlight our premium componentry and colors, showcase our leadership position in categories like by brushes and primers and tell better product stories. Many of our national retail partners are enthusiastic about the improved space efficiency and presentation Project Unicorn will bring when it hits shelves in the spring of 2019. In summary, we're highly focused on addressing current business trends within track channels. These changes will take some time to fully implement, so we believe it's prudent to revise our 2018 outlook. John will discuss this in more detail later in the call. Importantly, the current challenges have not dampened our enthusiasm for the long term potential of the e.l.f. brand. Speaking both personally and as the second largest shareholder in the company, I have tremendous confidence in our ability to leverage the platform that we've assembled to drive value. To that end and as announced today, my plan is to purchase an additional $0.5 million of e.l.f. shares. My ownership stake is over 12% of the company and I have purchased 92% of my shares. Our entire team is highly aligned to delivering long-term shareholder value. My confidence is further bolstered by the wins we continue to get in a competitive marketplace. Even with recent trends, we remain the most productive brand on a sales per linear foot basis at our two largest customers, Wal-Mart and Target. Our Ulta Beauty expansion has exceeded our expectation and we recently started testing skin care in a subset of their stores. We offer compelling retailer proposition and continue to gain distribution and shelf space. As previously announced, we are expanding into additional Walgreens stores. We're also pleased to announce that we'll be broadening distribution to Rite Aid. An issue with an end cap display program this year and in line distribution to follow in 2019. The brand continues to resonate internationally with expansion into additional super drug stores slated later this year and the launch into Feelunique, the largest beauty e-tailer in the UK. We are beginning our initial distribution in Germany with the subset of Mueller stores. [indiscernible], a major European retailer launched e.l.f. online in Germany and will test in a subset of their retail doors, an approach similar to that of Ulta Beauty in the US. While many of these developments do not significantly impact 2018 revenue, they show the power of our brand and continue to gain space and distribution. I will now turn it over to John to discuss our financial results and 2018 outlook.

Thanks, Tarang. For the second quarter, net sales increased 6% to 59 million, primarily driven by sales growth at select national retailers. Gross margin was 62%, in line with expectations. The variance to prior year was driven primarily by unfavorable movements in foreign exchange rates, partially offset by margin accretive innovation. On an adjusted basis, SG&A as a percentage of sales was 49% compared to 52% of net sales in the same period in fiscal 2017, largely driven by timing. Adjusted EBITDA increased 29% to 13 million from 10 million in the second quarter of 2017. Adjusted net income decreased to 6.5 million or $0.13 per diluted share compared to adjusted net income of 7.3 million or $0.15 per diluted share in the same quarter of 2017. We continue to optimize our inventory levels and are happy with the progress made throughout the quarter. Turning to our outlook, accounting for current trends within select national retailer partners, we are revising our expectations for 2018. We now project net sales growth in the low single digits, adjusted EBITDA of 58 million to 62 million, adjusted net income of 28 million to 31 million and adjusted diluted EPS of $0.56 to $0.61 on 50.4 million fully diluted outstanding shares. Our guidance contemplates Nielsen data to show average declines of approximately 10% through year-end. While we have not historically provided quarterly guidance, we believe it's prudent to provide added context on our expectations for the next couple of quarters. At a high level, we expect company sales in the second half of 2018 to be flat to slightly down with declines in Q3 partially offset by gains in Q4. While our international and direct businesses are expected to be positive contributors, the significant variances are driven by national retailers, which is where I will focus my commentary. As you'll recall, the third quarter of last year demonstrated strong sales growth of 28%. We are now lapping several items from that quarter, including the early shipment of a portion of our Target holiday program, pipeline for Wal-Mart and CVS space expansion and higher sales to discounters. These items are expected to create a drag on growth in the mid to high-teens in addition to our assumption for track channel trends. These impacts are being partially offset by the growth of our specialty business, including Ulta, which we expect to contribute high single digit growth. We anticipate that the net of all of these effects will result in Q3 sales to decline in the mid to high-teens on a year-over-year basis. For the fourth quarter, we expect track channel trends to be partially offset by higher holiday sales of Target and pipeline for Rite Aid. We also anticipate growth in our specialty business, though the contribution to growth is muted, as we shipped our pipeline for full distribution to Ulta in Q4 of 2017. We anticipate that the net of these effects is sales growth in Q4 of 2018 in the mid to high single digits. Though it is far too early to discuss our 2019 outlook, we believe that while we have focused in many of the right areas to address current trends, many of these initiatives will take time. As a result, as of now, we would expect low growth in 2019. Beyond our outlook, there's been quite a bit of discussion on the topic of tariffs. While it is yet to be seen where tariffs lands, our initial plan would be to mitigate the impact through a combination of select pricing actions, negotiation with our suppliers and global sourcing efforts on a portion of our line. In addition, we believe that potential exists for advantages moves of the US dollar to RMB exchange rate that could help to offset the impact. We continue to closely monitor the evolving policy and our final plan will be dependent on how the tariffs ultimately land. In summary, e.l.f. is a beloved brand with a strong track record and a talented team that is intensely focused on meeting the needs of our beauty enthusiast consumers. The strength of our retail proposition is evidence by the continued expansion of e.l.f. into new distribution in both the US and abroad. We are highly focused on addressing current trends and delivering shareholder value. With that, I would like to now ask the operator to open the call for questions.

[Operator Instructions] We have a question from Steph Wissink, Jefferies.

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

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

The next question is from Oliver Chen, Cowen & Company.

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

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

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

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

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

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

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

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

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

And just finally, can you clarify, in terms of the 2000 stores, additional stores at Walgreens that you're gaining, are those the Rite Aid stores that are being acquired by Walgreens or are those Walgreens branded stores?

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

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

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

Next question is from Wendy Nicholson, Citi.

My first question is about the incremental marketing spending that you're talking about and I'm sorry if I didn't pick this up in your comments, but is it going to be traditional advertising, is it going to be digital media, is it going to be more promotion in store, what you're thinking about that right now?

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

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

Yeah. We believe, I mean, first of all, we've had great results behind our own Beautyscape program on influencer. So the first thing that gives us confidence is we've seen some momentum there. The second is the marketplace is crowded and we've seen a number of kind of mega influencer driven brands that have even higher reach. So in the face of, kind of, I call it, that noise or people looking for attention from our consumers, making sure, we're making enough of a voice there. And then to your previous question on kind of marketing tactics, the one place that we are not looking to put money against is promotional support. We have an extraordinary value as it is. So we're really talking about this equity building kind of marketing for both the short as well as long term.

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

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

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

And then my very last question and I appreciate you being patient with me, the Ulta skin care product, is that incremental shelf space or the product you said that is in test at Ulta, is that in incremental shelf space or is that in your standard set of beauty, what's already at Ulta?

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

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

Just trying to be straight forward and if we look at your release, you tracked data over the past 18 months, it's been decelerating and pretty much consistently for 18 months. And as we've asked and there'd been investor concern on the calls, you've both been fairly dismissive things are on track, so I'm just trying to understand, I guess first, what's change to mantra you feel like we need to put a big plan in place with the sales finally started to decline in the track channels, what changed in your head? And then two, how do we get comfortable that this decision to try to arrest [Technical Difficulty] six months too late and at this point, we should have been doing this a long time ago, and now, it's going to take that much longer to get sales going the right direction.

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

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

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

We have a question from Erinn Murphy, Piper Jaffray.

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

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

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

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

And then I just have a clarification on something you said in the Q&A, did you say the Walgreens, the 2000 doors that you talked about in June, that actually shipped back in Q4 and then the Rite Aid, it's the end caps that's what's incremental from here, I just want to make sure I understood that dynamic correctly.

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

And then the last question is just housekeeping, did you say what the number of innovations launched in the quarter was. I didn't hear it if so.

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

The next question is from Bonnie Herzog, Wells Fargo Securities.

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

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

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

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

The next question is from Jon Andersen, William Blair.

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

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

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

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

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

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

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

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

The next question is from Andrea Teixeira, JPMorgan.

It's Christina Brathwaite on for Andrea. First, I want to just circle back on a comment that Tarang made about the sales growth of older products kind of falling off faster than historically, have you made any research into what's kind of driving that deceleration there from kind of the historical trends.

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

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

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

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

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

Sorry. Did you say guide to the tax rate for the rest of the year? Should it be closer to 20% this quarter?

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

Next question is from Dara Mohsenian, Morgan Stanley.

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

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

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

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

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

The next question is from Mark Astrachan, Stifel.

This is Claire Chamberlin on for Mark Astrachan. Just wanted to ask a question about productivity in Ulta. So you've mentioned that your very high productivity in some of the large retailers, but can you talk about how you compare in Ulta versus the other mass brands in that.

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

The final question is from Steph Wissink, Jefferies.

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

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

One last question from Rupesh Parikh, Oppenheimer.

So as you look further out your deceleration at some of your larger retailers in the channel, have you seen any competitive changes that you think are going to weight on your performance. I know at least in our checks in Northern New Jersey, we've seen Walmart we will be starting to promote the next product from the stores?

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

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

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

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

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