E.L.F. Beauty, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Financial statements are unaudited. E.L.F. sells cosmetics through retail customers, its stores, and e-commerce channels.
Key financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $55.9 million | $44.1 million | $116.4 million | $96.8 million |
| Gross profit / margin | $35.9 million / 64% | $25.1 million / 57% | $74.1 million / 64% | $54.4 million / 56% |
| Operating income | $3.2 million | $0.4 million | $8.4 million | $6.6 million |
| Net income (loss) | $4.0 million | $(2.7) million | $6.1 million | $1.1 million |
| Diluted EPS | $0.08 | $(117.31) | $0.12 | $(200.43) |
The exceptionally large 2016 per-share loss figures reflect preferred-stock dividends and accretion, as well as the much smaller weighted-average share count before the September 2016 IPO; they are not directly comparable with 2017 EPS.
Q2 sales rose 27%, driven by more shelf space and productivity at leading retailers, new accounts, and growth in direct channels. Six-month sales rose 20%. Gross margin gains reflected margin-accretive innovation, improved customer terms and freight costs, and favorable foreign-exchange movements. SG&A increased 32% in Q2 and 37% for the half, rising to 59% and 56% of sales, respectively, primarily due to personnel and stock compensation, IT investment, additional stores, and sales and marketing.
Interest expense declined year over year following the December 2016 refinancing. Net income also benefited from income-tax benefits of $3.4 million in Q2 and $3.3 million for the half, primarily associated with stock-option exercises ($3.7 million and $4.4 million, respectively). These benefits materially affected reported earnings.
Cash flow, balance sheet and debt
- For the six months, operating cash flow was negative $17.9 million, versus positive $7.9 million in 2016. The company attributed the 2017 outflow mainly to a $35.2 million unfavorable working-capital movement, including a $40.3 million decline in accounts payable and accrued expenses as it paid for inventory ordered at year-end 2016. A $11.5 million reduction in receivables, driven by collection timing, partly offset the outflow.
- Investing cash outflow was $5.0 million, including a $2.9 million minority investment in a social-media analytics company and $2.1 million of property and equipment purchases. Financing provided $10.9 million, primarily from a net $14.1 million revolving-credit draw, partly offset by $4.1 million of term-loan principal repayments.
- Cash fell from $15.3 million at year-end 2016 to $3.4 million at June 30, 2017. Inventory was $72.3 million, up from $69.4 million. Management cited deliberate increases in inventory of top items.
- Total debt and capital leases were $175.5 million, including a $158.8 million term loan and $14.1 million drawn on the revolver. The $35.0 million revolving facility had $20.4 million undrawn. Both facilities mature December 23, 2021; the stated interest rate was 4.5% at quarter-end and is variable. The company reported compliance with financial covenants.
- Current assets were $107.5 million and current liabilities $50.5 million. Management reported working capital excluding cash of $53.7 million and excluding cash and debt of $76.4 million. It believes operating cash flow, cash on hand, and available revolver capacity will meet needs for the next 12 months.
Outlook, commentary and notable items
The filing provides no quantified revenue or earnings guidance. Management expects seasonal sales to be higher in the third and fourth quarters, particularly due to holiday retail purchasing, while working-capital needs are generally greater in the second and third quarters. Management said liquidity should be adequate for the next 12 months, but longer-term funding could require additional debt or equity, which may not be available on favorable terms.
- Key risks include dependence on a limited number of retailers and their order patterns; competition and the need for successful product launches; inventory and seasonal liquidity management; and reliance on third parties and China for substantially all product sourcing and manufacturing.
- Other material exposures include variable-rate debt, foreign-exchange and trade-policy changes, store leases and expansion costs, product safety and regulatory compliance, and IT, e-commerce and cybersecurity disruptions. The company reported $29.9 million of future minimum operating-lease payments; a subsequent store lease added a $2.2 million minimum commitment.
- Management reported no legal matters expected to have a material adverse effect, no off-balance-sheet arrangements, and effective disclosure controls. No material change in internal controls was reported.
- A related-party sublease with Fit for Life, LLC generated $0.1 million of income in both the quarter and six-month period. A former director and shareholder is Fit for Life’s CEO.
Most important facts to verify
- Whether sales growth and the 64% gross margin continue, and whether rising SG&A can be contained as the business expands.
- Whether inventory levels and retailer payment/order timing convert into improved operating cash flow, given the first-half working-capital outflow and low cash balance.
- Debt service, covenant compliance, variable interest-rate exposure, and availability of the remaining $20.4 million revolver capacity.
- The sustainability of earnings excluding the one-time or discrete stock-option-related tax benefits.
- Concentration in major retail customers and China-based sourcing, as well as execution and costs associated with new products, stores, and IT systems.