E.L.F. Beauty, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; filed November 6, 2018. Unaudited results. The company sells cosmetics and skin-care products through retailers, e-commerce, and e.l.f. stores.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $63.9m | $71.9m | $188.9m | $188.3m |
| Gross profit / margin | $39.0m / 61% | $42.9m / 60% | $115.8m / 61% | $117.0m / 62% |
| SG&A | $32.7m | $33.1m | $102.7m | $98.8m |
| Operating income / margin | $6.3m / 10% | $9.8m / 14% | $13.1m / 7% | $18.2m / 10% |
| Net income | $3.9m | $5.9m | $5.9m | $12.0m |
| Diluted EPS | $0.08 | $0.12 | $0.12 | $0.24 |
Cash flow: For the first nine months, operating cash flow was $35.0m, versus a $6.2m use in 2017; capital expenditures were $6.5m, and cash increased $23.6m to $33.6m. Operating cash flow benefited from lower receivables and inventory, partly offset by a $15.5m reduction in accounts payable and accrued expenses.
Debt and liquidity: September 30 cash was $33.6m. Gross debt, including capital leases, was $150.7m ($150.4m net of issuance costs); the term loan rate was approximately 4.4%. The company had $49.5m available under its $50m revolving facility and reported covenant compliance. Working capital excluding cash was $55.9m. Management said cash, operating cash flow, and available revolver capacity should cover needs for the next 12 months.
Changes versus comparable periods
- Q3 sales fell 11%, mainly due to lower discount-channel sales and prior-year pipeline shipments. Gross profit fell 9% as lower volume more than offset improved customer mix and margin-accretive innovation.
- Q3 gross margin improved one percentage point, but SG&A as a share of sales rose to 51% from 46%, contributing to lower operating income and net income.
- Nine-month sales were nearly flat, with national-retailer growth offset by discount-channel declines. Gross margin fell one point, primarily on unfavorable foreign exchange; SG&A increased 4% on sales and marketing, store-related costs, and depreciation and amortization.
- Nine-month net income declined by about half. The prior-year period included $4.9m of excess tax benefits from equity awards, compared with $0.7m in 2018; interest expense was lower in 2018 following the 2017 refinancing.
Outlook, risks, and unusual items
- The filing gives no specific revenue, earnings, or margin guidance. Management cited typical higher sales in the third and fourth quarters due to holiday retailer purchasing and noted seasonal working-capital needs.
- Tariffs on some China-sourced products could raise costs and reduce margins. Potential mitigations include supplier price negotiations and selective price increases; management cautioned that success is not assured. Substantially all products are sourced or manufactured in China.
- Key risks include reliance on a limited number of retail customers and their order patterns; competition and product-launch execution; supply-chain and China exposure; variable-rate debt; and technology, cybersecurity, regulatory, product-safety, and consumer-preference risks.
- Management reported no legal matters expected to have a material adverse effect and no material changes in contractual obligations or market-risk exposures. No off-balance-sheet arrangements were reported.
- ASC 606 was adopted in 2018 using the modified retrospective method, reducing opening retained earnings by $0.1m net of tax; comparative periods were not restated. The company said 2018 sales would have been $0.2m higher for Q3 and $0.8m higher for nine months under the prior standard.
- The company expected adoption of the new lease standard in 2019 to materially increase reported long-term assets and liabilities for operating leases. Future minimum operating lease payments were $28.7m.
Investor verification points
- Determine whether the Q3 sales decline in discount channels and prior-year shipment comparisons persisted in subsequent periods.
- Track tariff effects, foreign exchange, pricing actions, and resulting gross-margin trends.
- Assess whether improved operating cash flow is sustainable, given its working-capital drivers and seasonal cash requirements.
- Monitor debt repayment, variable interest costs, revolver availability, and compliance with credit-agreement covenants.
- Review retailer concentration, store investments, and the timing and returns of e-commerce and technology spending.